Behavior of the Firm Under Regulatory Constraint

A recent article in this Review by Averch and Johnson [3] on the fair rate of return regulation in public utilities industries (or more generally regulated industries) attracted the attention of many economists. In essence, Averch-johnson argues that the introduction of an constraint of a fair rate of return type would induce the firm to invest more than the original profit maximizing value of capital, and this would create an inefficient allocation of inputs. In addition to frequent citations in verbal arguments, it has invited some thieoretical extensions by economists such as WVestfield [8] and Klevorick [5]. All of the writers seem to accept the basic theoretical foundations set by Averch and Johnson. For…