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Regulation with "20-20 Hindsight": Least-Cost Rules and Variable Costs

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  • Lyon, Thomas P

Abstract

Regulators sometimes review a regulated firm's input decisions in retrospect (i.e., with "20-20 hindsight") and punish bad outcomes rather than bad decisions. When such practices are applied consistently to contracts for variable factors in a regime with profit regulation, the firm increases its capital stock and relies more heavily on spot market purchases for its variable inputs; the firm's profits are reduced, but welfare effects on consumers are ambiguous. If applied as a type of "stochastic price cap" regulation, however, hindsight review can induce variable input choices that minimize expected costs. Copyright 1992 by Blackwell Publishing Ltd.

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  • Lyon, Thomas P, 1992. "Regulation with "20-20 Hindsight": Least-Cost Rules and Variable Costs," Journal of Industrial Economics, Wiley Blackwell, vol. 40(3), pages 277-289, September.
    • Handle: RePEc:bla:jindec:v:40:y:1992:i:3:p:277-89
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    Cited by:

    1. Armstrong, Mark & Sappington, David E.M., 2007. "Recent Developments in the Theory of Regulation," Handbook of Industrial Organization, in: Mark Armstrong & Robert Porter (ed.), Handbook of Industrial Organization, edition 1, volume 3, chapter 27, pages 1557-1700, Elsevier.
    2. Severin Borenstein & Meghan Busse & Ryan Kellogg, 2007. "Principal-agent Incentives, Excess Caution, and Market Inefficiency: Evidence From Utility Regulation," NBER Working Papers 13679, National Bureau of Economic Research, Inc.

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