Managers of a natural monopoly regulated using rate of return regulation have an incentive to
A) exaggerate the firm's costs.
B) underestimate the firm's costs.
C) minimise the monopoly's deadweight loss.
D) exaggerate the firm's profit.
E) make zero economic profit.

Question

Quizplus · Accepted Answer

Managers of a natural monopoly regulated using rate of return regulation have an incentive to exaggerate the firm's costs because the regulator allows the firm to earn a fair rate of return on its investment, which is based on the firm's costs plus a markup. By exaggerating the firm's costs, the firm can earn a higher rate of return, which ultimately benefits the managers and shareholders.

Managers of a Natural Monopoly Regulated Using Rate of Return