IDEAS home Printed from
   My bibliography  Save this article

Input Choices and Rate-of Return Regulation: An Overview of the Discussion


  • William J. Baumol
  • Alvin K. Klevorick


This 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.

Suggested Citation

  • William J. Baumol & Alvin K. Klevorick, 1970. "Input Choices and Rate-of Return Regulation: An Overview of the Discussion," Bell Journal of Economics, The RAND Corporation, vol. 1(2), pages 162-190, Autumn.
  • Handle: RePEc:rje:bellje:v:1:y:1970:i:autumn:p:162-190

    Download full text from publisher

    File URL:
    File Function: full text
    Download Restriction: Access to full text is restricted to JSTOR subscribers. See for details.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    1. Westfield, Fred M, 1971. "Methodology of Evaluating Economic Regulation," American Economic Review, American Economic Association, vol. 61(2), pages 211-217, May.
    2. MacAvoy, Paul W, 1971. "The Regulation-Induced Shortage of Natural Gas," Journal of Law and Economics, University of Chicago Press, vol. 14(1), pages 167-199, April.
    Full references (including those not matched with items on IDEAS)

    More about this item


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:rje:bellje:v:1:y:1970:i:autumn:p:162-190. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.