Increasing Returns to Scale and Optimal Investment Policy of the Regulated Firm

Seiichi Katayama and Fumio Abe
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Seiichi Katayama: Kobe University
Fumio Abe: Kagawa Unversity

Kobe Economic & Business Review, 1989, vol. 34, 85-100

Abstract: This paper investigates the optimal investment behavior of the regulated profit-maximizing monopoly that exhibits increasing returns to scale. The Averch-Johnson effect of overcapitalization is reconsidered in a dynamic adjustment cost model with non-concave revenue function. We show that there may be three cases of undercapitalization, overcapitalization and neutrality. In particular, we make clear the role of the assumption of increasing returns to scale or the non-concave revenue function and show that the crucial point in the Averch-Johnson argument is not the economies of scale but the level of the regulated rate of return.

Date: 1989
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