When a regulatory agency uses rate of return regulation,the
A) agency is able to eliminate the deadweight loss.
B) firm's managers have an incentive to inflate the firm's costs.
C) regulated firm's profit must be maximized for the market to be efficient.
D) regulated firm must receive a government subsidy.
E) the agency is using a form of marginal cost pricing.

Question

Quizplus · Accepted Answer

In rate of return regulation, the regulatory agency sets a target rate of return for the regulated firm. The firm then sets its prices to earn a return on investment that meets or exceeds the target rate. This creates an incentive for the firm's managers to inflate the firm's costs, as higher costs lead to higher prices and thus more profit. This can lead to inefficient outcomes, such as deadweight loss, as consumers may end up paying more than they would in a more competitive market.

When a Regulatory Agency Uses Rate of Return Regulation,the