Interactive Glossary

BROWSE:

Averch-Johnson effect (AJ effect):

Named after two economist who developed a stylized model of the rate-of-return regulated firm. They found that when firms are subject to rate-of-return regulation, if the allowed return is greater than the required return on capital, the firm will tend to over-invest in capacity. This incentive to increase the level of capital beyond what is needed for economically efficient production involves a number of assumptions about future allowed returns and the future cost of capital.

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