Deregulation and Separation of Combination Utilities

By Armstrong, Thomas O.; Leppel, Karen | Atlantic Economic Journal, September 1995 | Go to article overview

Deregulation and Separation of Combination Utilities


Armstrong, Thomas O., Leppel, Karen, Atlantic Economic Journal


Ever since 1930 when the Federal Power Commission was established, utilities have faced regulatory constraints. Combination gas and electric companies have been among the utilities affected. It has been presumed that these firms are natural monopolies, providing services at lower cost than two or more firms could. However, regulation of monopolies may induce inefficiencies [Averch and Johnson, AER, December 1962, pp. 1052-63]. This note asks whether these combination utilities should be divided into separate gas and electric companies and, if so, would continued regulation be needed.

A regulated, combination gas and electric utility minimizes production costs: subject to a technological constraint and a rate-of-return constraint established by state regulatory commissions. A combination utility's potentially unregulated cost function can be constructed from the regulated cost function by relaxing the rate-of-return constraint so the constraint is non-binding. [Fare and Logan, Bell JE, Autumn 1983, pp. 405-12; Armstrong, Penn Econ Rev, Spring 1992, pp. 64-74]. The empirical specification of the regulated cost function used here employs the standard multiproduct translog functional form. This form is quadratic in the logarithms of all the variables, including all second order interactions. The data set used contains annual information for the years 1982-88 for 10 combination gas and electric utility companies [Armstrong and Leppel, J Econ Bus, August 1994, pp. 195-206.]

Armstrong and Leppel [1994] examined regulated and potentially unregulated costs of combination gas and electric utility companies. There was insufficient evidence to conclude that either the regulated or potentially unregulated utilities were natural monopolies. …

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