Describe the main problem with rate of return regulation and name ...

[geodog55]

Describe the main problem with rate of return regulation and name an alternative regulatory scheme that has been devised to deal with that problem.
 
  What will be an ideal response?

Question 2

Using Figure 9.1, explain what a firm would do in the short run if the market price of its product dropped below P1.
 
  What will be an ideal response?

[shoemake]

Answer to Question 1

The main problem with rate of return regulation is that a firm might be inclined to inflate its costs, because its price is set at a level that permits the firm to recoup all its costs. Therefore, the firm might incur unnecessary costs that serve the interests of its managers, such as lavish offices, company cars, travel, entertainment, etc. The alternative regulation scheme is price cap regulation. With price cap regulation, the regulating agency sets the maximum price the company can charge. The company is allowed to charge any price below the cap and can keep all (or some) of any economic profit it can make.

Answer to Question 2

The firm would shut down since it would be suffering an operating loss. For the firm to remain in business in the short run the price must be equal to or greater than the average variable cost.

[geodog55]

Gracias!

[nyrave]

Thanks for the timely response, appreciate it