Rate Of Return Regulation

You probably know, as a knee-jerk fact, that monopolies are dangerous. But you probably don’t think much about why. (And it's not because all those hotels on Park Place will bankrupt you if you roll an 11).

The main danger posed by monopolies comes from the fact that customers don’t have any choice. By definition, a monopoly is the only provider of a particular good or service. Therefore, they can charge whatever they want. It makes gouging a distinct possibility.

You live out in the way, way boonies. There's only one gas station for hundreds of miles. That gas station can charge pretty much whatever it wants for gas. No competition. It has a local monopoly. $5...$6 a gallon...whatever it can get away charging before you decide you'd rather just ride a bike, or buy a mule.

But monopolies usually don't get a chance to take full advantage of this pricing power. Regulators step in to put a cap on the amount they can charge. These are known as rate of return regulations.

The rules involve the government setting prices for the thing provided by a monopoly. The regulations allow the company to earn a set rate of return, but don't permit them to take advantage of consumers.

Think about the electric company or the water works (two classic monopolies). The amounts they can charge are heavily regulated by the government.