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) minimize the monopoly's deadweight loss.
D) make zero economic profit.
E) exaggerate the firm's profit.

Question

Quizplus · Accepted Answer

Rate of return regulation allows a monopoly to set prices that cover its costs plus a specified rate of return on its capital. Managers have an incentive to exaggerate the firm's costs to increase the price they are allowed to charge, thereby increasing their profits.

Managers of a Natural Monopoly Regulated Using Rate of Return