Behavior of the Firm Under Regulatory Constraint: A Reassessment
Ten years ago Harvey Averch and I developed a model of the firm's behavior under the constraint that the return on capital investment not exceed a given level, specified by a governmental regulatory body. Major assumptions of the model are that (a) the firm seeks to maximize profit, (b) the market cost of capital is constant, (c) the allowable or fair rate of return exceeds the cost of capital, and (d) no regulatory lag exists. Under these assumptions the model leads to conclusions that the capital-labor ratio is greater than that which would minimize cost at the level of output selected by the firm, and that the firm may have an incentive to serve competitive markets even if revenues fall below incremental cost in those markets, with the difference more than compensated by increased net revenues permitted through price increases in its monopoly services. This formulation has attracted numerous comments, critiques, and replies. However, virtually all the discussion has remained on theoretical grounds. Unfortunately, little empirical analysis has appeared to suggest the importance of these distortions in the real world. The purpose here is briefly to note major developments in the theory, to examine bits of evidence that have come to light, and to address possibilities for further empirical work.
- Export
- BibTeX
- Sources
- openalex