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THE AVERCH-JOHNSON THESIS AND THE FAIR RATE OF RETURN: AN EXERCISE IN MULTIOBJECTIVE PROGRAMMING
Abstract
The work of Averch and Johnson represents a significant landmark in the theory of regulation. They provided analytical support for the proposition that a monopoly firm subject to rate-of-return regulation may employ an inefficient combination of resources. In this dissertation, a mathematical programming model, namely multiobjective programming, is introduced. It is suggested that reformulation of the original A-J model in terms of this alternative model would improve the decision-making environment of the regulatory agencies. A simplified version of a multiobjective model is then developed to examine the empirical implications of the A-J proposition. A three input, Hicks-neutral-technical-change, translog production function is adopted for empirical analysis of the production process in the electric generating industry. We assume that the A-J thesis is operative and specify a log-linear cost function in terms of input quantities. By replacing the market cost of capital for the fair-rate-of-return parameter, the fair-rate-of-return constraint is removed from our multiobjective programming model. A series of cost functions, reflecting the cost structure of electric generating units under various market costs of capital, are estimated. These cost functions are minimized subject to some arbitrary levels of production. The results show that there was no factor substitution in the generation of electricity between 1959 and 1963. By virtue of this observation, we conclude that the A-J proposition could not have been operative for the period under consideration. It is also found that there are some economies of scale in the generation of electricity. The global minimum point of the average cost curve, over the period 1959-1963, is found to be in the neighborhood of 1400 to 1500 million kilowatt hours per year.
Subject Area
Business costs
Recommended Citation
EFTEKHARI, HOSSEIN, "THE AVERCH-JOHNSON THESIS AND THE FAIR RATE OF RETURN: AN EXERCISE IN MULTIOBJECTIVE PROGRAMMING" (1985). ETD collection for University of Nebraska-Lincoln. AAI8521453.
https://digitalcommons.unl.edu/dissertations/AAI8521453