Economics Commons^™

An Empirical Test Of Regulatory Effects, H. Craig Petersen

Economics and Finance Faculty Publications

Averch and Johnson have provided analytical support for the assertion that rate of return regulation causes inefficient 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 …