A Dynamic Model of the Regulated Firm with a Price Adjustment Mechanism

E.G. Davis

Bell Journal of Economics, 1973, vol. 4, issue 1, 270-282

Abstract: Instead of the Averch-Johnson assumptions of instantaneous regulation of the rate of return, but no regulation over the setting of individual rates, this note assumes that the regulator applies the new rates to the test year's output to predict the revenue requirements under the allowed rate of return. A mathematical model of the firm is then worked out. When the A-J view of the regulated firm is dynamized in a rather straightforward fashion, the A-J point no longer has any special significance: it is not the stationary points of the dynamic version of the model. While it is true that the stationary-point does exhibit overcapitalization in the A-J sense, the regulatory agency can use the extent to which it adjusts prices as a further control variable to influence the stationary point.

Date: 1973
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