Definition
Rate-of-return regulation is a mechanism for determining the prices charged by monopolies that are subject to government control. Essentially, monopolies will be required to charge the same price that would ideally prevail in a completely competitive market, which is equal to the efficient costs of production plus a rate of return on capital decided by the market.
What is ‘Rate of Return Regulation’
Rate-of-return regulation is a mechanism for determining the prices charged by monopolies that are subject to government control. Essentially, monopolies will be required to charge the same price that would ideally prevail in a completely competitive market, which is equal to the efficient costs of production plus a rate of return on capital decided by the market.
Explaining ‘Rate of Return Regulation’
Customers profit from prices that are acceptable when compared to the monopolist’s operational expenses and overhead. Rate of return regulation is often criticized since it offers no incentive for businesses to cut costs and improve productivity. If expenses are decreased, a monopolist who is subjected to this kind of regulation does not gain any more money. As a result, buyers may still be subjected to higher costs than they would be subjected to in a free market.
Rate of Return Regulation FAQ
How does rate return regulation work?
Rate-of-return regulation provides protection against the hazards associated with bad technological advancement in exchange for a reduced rate of return to investors. As a result of price control, businesses are provided with significant incentives to reduce costs, which may result in large profits, placing pressure on the regulatory compact.
What is the difference between price cap regulations and rate of return regulation?
Rate-of-return regulation has been criticized for giving wrong incentives to regulated enterprises as well as for being prohibitively expensive to implement and maintain. When it comes to price-cap regulation, it falls short of addressing the essential regulatory question of whether an industry is a natural monopoly in its whole or in part.
What is the rate of return on utilities?
Various public utility commissioners permit different rates of return on their rate bases, but an annual return on the rate base of 8 percent to 10 percent is a decent representation of the average.
Further Reading
- Rate-of-return regulation and utility capital structure decision – www.jstor.org [PDF]
- Price-cap versus rate-of-return regulation – link.springer.com [PDF]
- An expository note on depreciation and profitability under rate-of-return regulation – link.springer.com [PDF]
- Financial aspects of rate-of-return regulation – www.jstor.org [PDF]
- Property rights versus public spirit: Ownership and efficiency of US electric utilities prior to rate-of-return regulation – www.jstor.org [PDF]
- Flotation Cost Allowance in Rate of Return Regulation: A Note – www.jstor.org [PDF]
- Rate-of-return regulation and two-part tariffs – academic.oup.com [PDF]
