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    Another method of regulation, which is very similar to average cost pricing, is intended to make sure the firm earns a fair rate of return on invested capital. This method is known as "rate-base pricing" or "fair rate of return pricing." The greater the value of the capital stock of the regulated firm, the greater revenue it needs to earn a "fair rate of return." Under this method of regulation, as investment increases, prices increase.

    One significant problem with this method is that it can cause a regulated firm to over-invest in capital goods. This tendency to over-invest is known as the Averch-Johnson effect. The guarantee of a rate increase due to new investment, regardless of market conditions, provides a significant incentive to over-invest and can lead to serious technical inefficiency as well as productive and allocative inefficiency.

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