Rate-of-return regulation

Rate-of-return regulation is a system for setting the prices charged by government-regulated monopolies. The main premise is that monopolies must charge the same price that would ideally prevail in a perfectly-competitive market, equal to the efficient costs of production, plus a market-determined rate of return on capital. Rate-of-return regulation is a system for setting the prices charged by government-regulated monopolies. The main premise is that monopolies must charge the same price that would ideally prevail in a perfectly-competitive market, equal to the efficient costs of production, plus a market-determined rate of return on capital. Rate-of-return regulation has been criticized because it encourages cost-padding and because if the rate is set too high, it encourages regulated firms to adopt capital-labor ratios that are too low. That is known as the Averch–Johnson effect, or simply 'gold-plating.' The nature of rate-of-return regulation makes there be no incentive for regulated monopolies to minimize their capital purchases since prices are set equal to their costs of production.