Monopoly is a classic example of market failure. To protect the customers from abuse of market power, thegovernment has several policy instruments at their disposal. Historically, the rate of return regulation has been themost widely used regulatory instrument, and despite its shortcomings, it remains in use today. In this regime, theregulated company can recover the incurred costs while the customers are protected from overpaying for themonopoly services. Like any regulation regime, however, the rate of return regulation has its shortcomings.
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