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An Empirical Test of Regulatory Effects

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  • H. Craig Petersen
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    Abstract

    Averch and Johnson have provided analytical support for the assertion that rate of return regulation causes insufficient production because of the overuse of capital. Empirical evidence in support or refutation of their thesis is just beginning to appear. This paper provides additional evidence. The regulated firm's objective is stated in terms of cost minimization subject to a regulatory constraint. The effect of changes in the allowed rate of return on capital are evaluated. It is shown that as the allowed return approaches the cost of capital, costs increase and the percentage of total costs paid to capital also increases. These are testable implications of the revised A-J model. Data on costs, input prices, and output are collected for electric power production. Three measures of regulatory policy with regard to the allowed return are formulated. Econometric analysis suggests that lower allowed rates of return are significantly associated with higher costs and larger proportions of cost going to capital. These findings are consistent with the revised A-J model and with those of other recent investigators.

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    Bibliographic Info

    Article provided by The RAND Corporation in its journal Bell Journal of Economics.

    Volume (Year): 6 (1975)
    Issue (Month): 1 (Spring)
    Pages: 111-126

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    Handle: RePEc:rje:bellje:v:6:y:1975:i:spring:p:111-126

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    Cited by:
    1. Lynk, E. L., 1995. "Testing efficiency in intermediate regulated industries," Economics Letters, Elsevier, vol. 49(3), pages 323-328, September.
    2. Mary H. Acker, 1985. "Assessing the Impact of Regulation of Trucking Firms," Eastern Economic Journal, Eastern Economic Association, vol. 11(2), pages 135-143, Apr-Jun.
    3. 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.
    4. Alberto Alesina & Silvia Ardagna & Giuseppe Nicoletti & Fabio Schiantarelli, 2003. "Regulation and Investment," NBER Working Papers 9560, National Bureau of Economic Research, Inc.
    5. Gerald Granderson, 2000. "Regulation, Open-Access Transportation, and Productive Efficiency," Review of Industrial Organization, Springer, vol. 16(3), pages 251-266, May.
    6. 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.
    7. Baffoe-Bonnie, John, 2004. "Learning-by-doing and input demand of a rate-of-return regulated firm," Economic Modelling, Elsevier, vol. 21(6), pages 1015-1037, December.
    8. Ramos-Real, Francisco Javier, 2005. "Cost functions and the electric utility industry. A contribution to the debate on deregulation," Energy Policy, Elsevier, vol. 33(1), pages 69-87, January.
    9. Halkos, George & Tzeremes, Nickolaos, 2011. "A conditional full frontier approach for investigating the Averch-Johnson effect," MPRA Paper 35491, University Library of Munich, Germany.
    10. Gerald Granderson & Finn Forsund, 2014. "Rate of return regulation and the Le Chatelier principle," Journal of Productivity Analysis, Springer, vol. 41(2), pages 263-275, April.
    11. Ohler, Adrienne M., 2014. "Behavior of the firm under rate-of-return regulation with two capital inputs," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(1), pages 61-69.
    12. Earl A. Thompson, 1977. "An Economic Basis for the "National Defense Argument" for Protecting Certain Industries," UCLA Economics Working Papers 084, UCLA Department of Economics.

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