Transcript Rate of return regulation - Illinois State University

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
 Ends with firm’s interest
 Close ties between regulatory firm and regulating
agency
 Example, Illinois Power Authority
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)
Economic Theory of Regulation

Stigler (1971), Peltzman (1976)
 Win-win
 Consumers
want lower prices
 Firms want restricted entry
 Regulatory
authority is simply contract enforcer
Ways to regulate?

Entry
 Example,

PURPA
Price & Cost Allocation
 PLP
 Ramsey
Pricing
 FDC Pricing
 Quality/Reliability matters
 Assumes TR>TC

Rate-of-Return Regulation
Rate-of-Return Regulation

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

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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
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