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Rate of return regulation and the Le Chatelier principle

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  • Gerald Granderson
  • Finn Forsund

Abstract

This paper examines whether rate-of return regulation alters the input quantities firms use to produce their selected output level when the corresponding input prices change, in a manner similar to the Le Chatelier principle. More specifically, would the change in a rate regulated firm’s input quantity due to a change in its input price be less price elastic than the unregulated firm’s change in the input quantity due to a change in its input price. We follow Färe and Logan ( 1986 ), Nelson and Wohar ( 1983 ) in estimating a rate regulated cost function and capital input share system of equations. Using a 1992–2000 panel of 34 US major investor-owned electric utilities, empirical results indicate that the regulated own-input price elasticities of demand for labor and fuel are less price elastic than their corresponding unregulated own-input price elasticities of demand (a Le Chatelier principle type effect). Having a fuel clause (1) reduces the firm’s willingness to substitute from fuel to either non-fuel (capital, labor) input when the price of fuel rises, and (2) enhances the firm’s willingness to substitute from non-fuel inputs to fuel when the price of non-fuel inputs rises. Copyright Springer Science+Business Media, LLC 2014

Suggested Citation

  • Gerald Granderson & Finn Forsund, 2014. "Rate of return regulation and the Le Chatelier principle," Journal of Productivity Analysis, Springer, vol. 41(2), pages 263-275, April.
    • Handle: RePEc:kap:jproda:v:41:y:2014:i:2:p:263-275
    DOI: 10.1007/s11123-012-0300-4
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    References listed on IDEAS

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    1. Rolf Fare & James Logan, 1983. "The Rate-of-Return Regulated Firm: Cost and Production Duality," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 405-414, Autumn.
    2. Christensen, Laurits R & Jorgenson, Dale W & Lau, Lawrence J, 1973. "Transcendental Logarithmic Production Frontiers," The Review of Economics and Statistics, MIT Press, vol. 55(1), pages 28-45, February.
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    4. Atkinson, Scott E & Halvorsen, Robert, 1980. "A Test of Relative and Absolute Price Efficiency in Regulated Utilities," The Review of Economics and Statistics, MIT Press, vol. 62(1), pages 81-88, February.
    5. Baffoe-Bonnie, John, 2004. "Learning-by-doing and input demand of a rate-of-return regulated firm," Economic Modelling, Elsevier, vol. 21(6), pages 1015-1037, December.
    6. Kaserman, David L & Mayo, John W, 1991. "The Measurement of Vertical Economies and the Efficient Structure of the Electric Utility Industry," Journal of Industrial Economics, Wiley Blackwell, vol. 39(5), pages 483-502, September.
    7. Ofori-Mensa, Charles, 1990. "Tests of perverse input demand behavior by the rate-of-return-regulated firm," Resources and Energy, Elsevier, vol. 12(1), pages 97-106, April.
    8. Kwoka, John E., 2002. "Vertical economies in electric power: evidence on integration and its alternatives," International Journal of Industrial Organization, Elsevier, vol. 20(5), pages 653-671, May.
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    Cited by:

    1. Guohua Feng & Jiti Gao & Xiaohui Zhang, 2018. "Estimation of technical change and price elasticities: a categorical time–varying coefficient approach," Journal of Productivity Analysis, Springer, vol. 50(3), pages 117-138, December.

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    More about this item

    Keywords

    Regulation; Fuel adjustment clause; Le Chatelier principle; D24; L51;
    All these keywords.

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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