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The Impact of Regulation on Input Substitution and Operating Cost

Listed author(s):
  • Gerald Granderson
  • C. A. Knox Lovell

We investigate the impact of rate-of-return regulation on the substitutability between pairs of inputs, where substitutability is measured using Morishima elasticities of substitution (MES), and on operating cost. Theory does not provide a qualitative characterization of the impact of regulation on input substitutability, although it does provide a basis for speculation. We test our speculation using a 1977–87 panel of 20 U.S. interstate natural gas pipelines that were subject to rate-of-return regulation during the period. We find that regulation increased the MES of each rate base input for the non-rate base input and reduced the MES between the two rate base inputs and of the nonrate base input for each rate base input. We also find that the regulatory distortion of input substitutability led to an increase in operating cost of 16%, on average, across all companies and through all years in the sample.

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Article provided by Southern Economic Association in its journal Southern Economic Journal.

Volume (Year): 65 (1998)
Issue (Month): 1 (July)
Pages: 83-97

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Handle: RePEc:sej:ancoec:v:65:1:y:1998:p:83-97
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