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A Frontier Approach to Testing the Averch-Johnson Hypothesis

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  • Donald Vitaliano
  • Gregory Stella

Abstract

The mathematical programming technique Data Envelopment Analysis is used to test the famous hypothesis of Averch and Johnson that utility regulation leads to overuse of capital because the regulated firm earns a return s greater than its cost of capital r, an implicit capital subsidy resulting in allocative inefficiency. Technical and allocative inefficiency are based on cost and production frontiers from 337 electric generating plants using 1970 data, and r is based on the Capital Asset Pricing Model. Significant capital overuse and general failure to minimize costs is detected, but a second-step regression analysis finds no relationship between the overuse and the s-r subsidy. A small updated data set covering the period 1980-2004 suggests that overuse of capital is no longer a problem, a result that may be owing to recente deregulation and restructuring.

Suggested Citation

  • Donald Vitaliano & Gregory Stella, 2009. "A Frontier Approach to Testing the Averch-Johnson Hypothesis," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 16(3), pages 347-363.
  • Handle: RePEc:taf:ijecbs:v:16:y:2009:i:3:p:347-363
    DOI: 10.1080/13571510903227031
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    References listed on IDEAS

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    More about this item

    Keywords

    Electric Utilities; Economics of Regulation; Programming Models;

    JEL classification:

    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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