Abstract
In this paper we show that the Averch-Johnson effect of overcapitalization by a regulated monopoly does not obtain when the firm operates in the decreasing cost range of output. We develop a dynamic adjustment-cost model of the firm and apply a recent result by Brock and Dechert for non-concave Hamiltonians to solve for the optimal investment policy for the firm. With a phase diagram analysis we are able to make sharp comparisons between the regulated and unregulated cases. In particular we show that investment by a regulated firm is lower than that of an unregulated firm, even when the rate of return constraint is not binding.
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