What is 'Rate Of Return Regulation'

Rate of return regulation is a form of price setting regulation where governments determine the fair price which is allowed to be charged by a monopoly. It is meant to protect customers from being charged higher prices due to the monopoly's power, while still allowing the monopoly to cover its costs and earn a fair return for its owners.

BREAKING DOWN 'Rate Of Return Regulation'

Rate of return regulation was used most often in the United States to price goods and services offered by utility companies, like gas, television cable, water, telephone service and electricity. A history of anti-trust sentiment and anti-trust regulation led to the implementation of rate of return regulation in the U.S., which was upheld by the 1877 Supreme Court case Munn v. Illinois and further developed through a series of cases beginning with Smyth v. Ames in 1898.

Rate of return regulation allowed customers to feel that they were getting a fair price for essential services, while allowing investors to feel that they were getting a fair return on their investments in these industries. Rate of return regulation remained common in the U.S. through much of the 20th century, gradually being replaced by other, more efficient methods, such as price-gap regulation and revenue-cap regulation.

Advantages and Disadvantages of Rate of Return Regulation

Customers benefit from prices that are reasonable, given the monopolists operating costs. It offers long-term rate sustainability, as it provides some resistance for rates against the popularity of a company amongst investors and against changes that might take place within that company. It provides stability in monopolized industries, while preventing monopolies from making large profits with price-gouging. Investors, while they will not make huge dividends, will benefit from substantial and consistent returns. Customers do not feel as if they are being overcharged for essential services, and the monopoly in question benefits from a stable public image as a result.

Rate of return regulation is often criticized because it provides little incentive to reduce costs and increase efficiency. A monopolist who is regulated in this manner does not earn more if costs are reduced. Thus, customers may still be charged higher prices than they would be under free competition. Rate of return regulation can contribute to the Averch-Johnson effect, whereby firms thus regulated accumulate capital and allow it to depreciate in order to subvert the system and obtain governmental permission to raise rates.

RELATED TERMS
  1. Natural Monopoly

    A natural monopoly is the domination of an industry or sector ...
  2. Legal Monopoly

    A legal monopoly is a company that is operating as a monopoly ...
  3. Price-Cap Regulation

    A price-cap regulation is a form of economic regulation that ...
  4. Regulation F

    Regulation F is a regulation that sets limits on the amount of ...
  5. Price Maker

    A price maker is an entity with a monopoly that has the power ...
  6. Average Cost Pricing Rule

    The average cost pricing rule is imposed on certain businesses ...
Related Articles
  1. Insights

    How and Why Companies Become Monopolies

    Without competition, monopolies can raise prices and lower quality, leaving consumers little choice. But monopolies can benefit consumers as well.
  2. Insights

    A History Of U.S. Monopolies

    These monoliths helped develop the economy and infrastructure at the expense of competition.
  3. Small Business

    How Monopoly Antitrust Laws Affect Consumers

    Monopolies often receive a negative reception, but sometimes they can benefit consumers.
  4. Small Business

    Antitrust Defined

    Check out the history and reasons behind antitrust laws, as well as the arguments over them.
  5. Insights

    Understanding a Free Market Economy

    Why would we want a free market economy?
  6. Insights

    How States May Regulate Wall Street Under Trump

    Donald Trump’s stunning election upset brings with it many questions about the future of the financial regulatory industry.
  7. Insights

    A Short History of the US Federal Trade Commission

    Since the early 1900s, the Federal Trade Commission has preventing anticompetitive, deceptive, and unfair business practices.
  8. Investing

    3 Groups of Companies that are almost a Monopoly

    A look at companies that have a monopolistic place in the marketplace, and whether or not it's a good idea to invest in them.
  9. Investing

    Dow, DuPont Deal Hinges on Appeal to EU Regulators

    EU antitrust regulators have expressed concerns about the tie-up, which would create the world’s biggest chemical company.
RELATED FAQS
  1. What are Common Examples of Monopolistic Markets?

    Providers of water, natural gas, telecommunications, and electricity have all been historically monopolistic markets. A monopoly ... Read Answer >>
  2. What are the characteristics of a monopolistic market?

    Learn about monopolistic markets and the main characteristics that distinguish from other markets and whether or not they ... Read Answer >>
  3. How strongly does government regulation impact the utilities sector?

    Read about the impact of government regulation on the utilities sector, particularly as is pertains to the water and electricity ... Read Answer >>
  4. How does a monopoly contribute to market failure?

    Read a simple overview of the theory of market monopoly, where it originated and some contemporary challenges to the classical ... Read Answer >>
  5. What are the most famous monopolies?

    Learn about famous monopolies from Carnegie Steel to Comcast that challenge free-market competition and encourage government ... Read Answer >>
  6. How does government regulation impact the internet sector?

    Learn about the debate on how government regulation could affect the Internet sector and where Americans stand on Internet ... Read Answer >>
Hot Definitions
  1. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  2. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  3. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  4. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  5. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  6. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
Trading Center