Input Choices and Rate-of Return Regulation: An Overview of the Discussion
AbstractThis article reviews the substance of the literature stemming from the Averch-Johnson model of the firm under rate-of-return regulation. It examines a number of propositions, among them the following: (1) The profit-maximizing firm under rate-of-return regulation will tend to use a capital-labor ratio greater than that which minimizes cost for its output level; (2) The profit-maximizing firm under regulatory constraint will use a capital-labor ratio and produce an output greater than it would in the absence of regulation; (3) The closer the "fair rate of return" is to the true cost of capital, the greater the quantity of capital the firm will want to use; and (4) The sales (total revenue)-maximizing firm under regulatory constraint will use a labor-capital ratio greater than it would when unconstrained. The second of these propositions, which has been widely taken to have been proved by Averch and Johnson, is shown to be false. The paradoxical assertion in the third proposition is explained and its regulatory implications discussed. Two models involving regulatory lag are described along with their implications for policy. Finally, some evaluative comments are offered on the entire issue of what has come to be known as the "A-J effect" and its importance in regulatory economics.
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Bibliographic InfoArticle provided by The RAND Corporation in its journal Bell Journal of Economics.
Volume (Year): 1 (1970)
Issue (Month): 2 (Autumn)
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- C. A. Knox Lovell, 1976. "Output of the Constrained Revenue Maximizing Firm," Eastern Economic Journal, Eastern Economic Association, vol. 3(1), pages 52-58, January.
- R. Poudineh & T. Jamasb, 2013. "Determinants of Investment under Incentive Regulation: The Case of Norwegian Electricity Distribution Networks," Cambridge Working Papers in Economics 1324, Faculty of Economics, University of Cambridge.
- J.A. den Hertog, 2010. "Review of economic theories of regulation," Working Papers 10-18, Utrecht School of Economics.
- Ingo Vogelsang, 2010. "Incentive Regulation, Investments and Technological Change," CESifo Working Paper Series 2964, CESifo Group Munich.
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