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The Behavior of a Firm Subject to Stochastic Regulatory Review

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  • Alvin K. Klevorick

Abstract

In recent years, the behavior of regulated public utilities has received increasing attention from economic theorists. The principal structure used in analyzing this behavior has been the Averch-Johnson model of the regulated firm. The current paper presents an alternative view of the regulated firm, one which attempts to narrow some (though by no means all) of the gaps between the now standard model and the actual regulatory process. In particular, the new model proposed here considers the firm's operations in a dynamic context -- with the firm looking to the future in making today's decisions -- and it incorporates the interplay between the regulatory agency and the firm. The model captures the price-setting role of the regulators, and it encompasses the phenomenon of regulatory lag. The uncertainty associated with the occurrence of rate reviews is modeled by positing that reviews occur stochastically through time. And, although the treatment of the issue is rather simplistic, the model does incorporate technical change generated by the regulated firm's program of research and development. The regulated firm's optimal policy is characterized, and the implications this optimal policy has for two traditional issues in regulatory economics -- the input efficiency of regulated firms and the effect of regulatory lag on research and development -- are examined.

Suggested Citation

  • Alvin K. Klevorick, 1973. "The Behavior of a Firm Subject to Stochastic Regulatory Review," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 57-88, Spring.
    • Handle: RePEc:rje:bellje:v:4:y:1973:i:spring:p:57-88
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    Citations

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    Cited by:

    1. Chisari, Omar O. & Kessides, Ioannis N., 2007. "The pricing dynamics of utilities with underdeveloped networks," Policy Research Working Paper Series 4198, The World Bank.
    2. repec:lan:wpaper:1128 is not listed on IDEAS
    3. Ismail Saglam, 2023. "Incentives of a monopolist for innovation under regulatory threat," Economics of Governance, Springer, vol. 24(1), pages 41-66, March.
    4. repec:lan:wpaper:1193 is not listed on IDEAS
    5. Glazer, Amihai, 2001. "Regulatory tune-ups," Information Economics and Policy, Elsevier, vol. 13(4), pages 427-438, December.
    6. Paul L. Joskow, 2014. "Incentive Regulation in Theory and Practice: Electricity Distribution and Transmission Networks," NBER Chapters, in: Economic Regulation and Its Reform: What Have We Learned?, pages 291-344, National Bureau of Economic Research, Inc.
    7. Caroline Elliott & Melinda Acutt, 2007. "Antitrust Policy: The Impact of Revenue Penalties on Price," Experimental Economics, Springer;Economic Science Association, vol. 7(1), pages 1-8, March.
    8. Rajeev Goel, 2007. "Research spending under regulatory uncertainty," The Journal of Technology Transfer, Springer, vol. 32(6), pages 593-604, December.
    9. Mirucki, Jean, 1980. "Vérification des conditions d'efficacité dans la production chez Bell Canada [Checking the conditions of efficient production in Bell Canada]," MPRA Paper 30147, University Library of Munich, Germany, revised Jun 1980.
    10. Mirucki, Jean, 1980. "Comportement de l'entreprise réglementée: étude de l'hypothèse Averch-Johnson [Behavior of the Regulated Firm: A Study of the Averch-Johnson Hypothesis]," MPRA Paper 27669, University Library of Munich, Germany, revised 1982.
    11. C F Elliott & M Z Acutt, 2001. "Threat-based regulation and endogenously determined punishments," Working Papers 539877, Lancaster University Management School, Economics Department.
    12. William P. Rogerson, 1989. "Optimal Depreciation Schedules for Regulated Utilities," Discussion Papers 852, Northwestern University, Center for Mathematical Studies in Economics and Management Science.

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