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)agency is using a form of marginal cost pricing.

Question

Quizplus · Accepted Answer

When a regulatory agency uses rate of return regulation, the firm's managers have an incentive to inflate the firm's costs. This is because the rate of return is based on the firm's costs, so if the firm can show higher costs, they will be able to earn a higher rate of return. This creates a potential for inefficiency and higher prices for consumers.

When a Regulatory Agency Uses Rate of Return Regulation, the