Factor price changes, technical efficiency, and revenue requirements regulation

A regulatory framework is considered in which output price adjustments can be initiated only by a change in the price of a non-capital input (e.g. fuel) at some time in the future which is uncertain. At that time there is a processing period and then an adjustment of the output price so that the revenues of the firm meet an allowed rate of return s. The regulated firm choosing a putty-clay technology is shown to overcapitalize for large values of s and to undercapitalize for sufficiently small values of s. A decrease in the length of the processing period is found to accentuate the extent of either the undercapitalization or overcapitalization resulting from the specified rate of return.status: publishe