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Rate of return regulation

Rate of return regulation. Why we regulate?. Public Interest Theory Monopoly power & abuses Improved regulator procedures, greater accountability of regulatory authority, more consumer interest Example, IL Tollway Authority Capture Theory Starts with consumer interest

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Rate of return regulation

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  1. Rate of return regulation

  2. Why we regulate? • Public Interest Theory • Monopoly power & abuses • Improved regulator procedures, greater accountability of regulatory authority, more consumer interest • Example, IL TollwayAuthority • Capture Theory • Starts with consumer interest • Ends with firm’s interest • Close ties between regulatory firm and regulating agency • Example, Illinois Power Authority

  3. Economic Theory of Regulation • Stigler (1971), Peltzman (1976) • Groups demand gov’t favors that result in wealth transfers • Gov’t supplies transfers in form of regulation • Gov’t supplies to those most influential: votes, fund, future political favors • Successful groups • Greater expected net benefit • Concentrated benefits (smaller vs. larger groups)

  4. Economic Theory of Regulation • Stigler (1971), Peltzman (1976) • Win-win • Consumers want lower prices • Firms want restricted entry • Regulatory authority is simply contract enforcer

  5. Ways to regulate? • Entry • Example, PURPA • Price & Cost Allocation • PLP • Ramsey Pricing • FDC Pricing • Quality/Reliability matters • Assumes TR>TC • Rate-of-Return Regulation

  6. Rate-of-Return Regulation • Costs are reviewed • Unnecessary costs are eliminated • ROR on certain costs determined to be fair • Price is determined • Profit Maximization Problem Subject to Rate-Return Constraint

  7. Problems with ROR Regulation • Allowable Costs • Firm wants to exaggerate costs • Depreciation Expenses • Falls into rate-base and tax bill • Accelerated depreciation vs. straight line depreciation • Incentives for Cost reduction • Failure to seek out least cost solutions • Rate-base Determination • Used and useful, known and measureable, just and reasonable

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