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.
Related or Semi-related Video
Finance: How Do You Calculate Rates of R...35 Views
finance - a la shmoop how do you calculate rates of return? well invest a dollar get
more than a dollar back right? well yeah you hope so anyway in in finance land [dollar bill on table]
and Wall Street and any other professional gig. well rates of return
from financial investments are generally stated as annual returns, so calculating
a rate of return revolves around the one year at a time thing. there are a ton of
curveballs that get thrown into these calculations. here's a big one,
dividends. well guess what clueless financial journalists with little to no [dividends defined]
real schooling in finance quote stock market returns all the time. let's say
that shares in random example industries traded at the same price at the
beginning of the 1970s as they did at the end of the decade. prices for random
example industries were totally flat from 1970 to 1980. that's what one of
those journalists might say. and they don't even get fired for making such a [man reports news]
narrow statement .no nothing happened at all. and wrong. had they taken this course
they'd have realized that monster-sized dividends were paid out during that time
period. five six seven eight percent a year, each year. yet the journalists
ignored them when they stated that the stock market was in fact flat for a
decade and maybe shares of that company were also flat for a decade. but it
implied that they got no return from their investment which is absolutely [icons of stock market and a stock deflate]
wrong. did readers get their money back for that bad journalistic work? yeah we
doubt it - well what about zero coupon bonds? that is their bonds that pay no
dividends or interest along the way and they sell at a discount to par. what does
that mean? that is $1,000 par value bond pays you a grand in seven years. well how
do you calculate the annualized rates of return there? well today that bond sells
for six hundred forty two dollars. like you buy it today for six hundred forty
two you get a thousand bucks in seven years. well what's the rate of return on [zero coupon bond rates of return listed]
that bond? hmm. well vanilla bonds like these we're a whole lot easier to
calculate. because like you got the interest rate right there on the thingy.
yeah so the question is really what interest rate will accrue and then
compound for this bond such that in exactly seven years you get a thousand
bucks? well if it compounded at ten percent a year the compounding would
look like this. you see the table right there and whoa we've already passed the
grand way ahead of seven years. so the compound rate must be less than ten
percent right well what if it compounded at five percent a year well then the [compound rate listed]
rates of return would look like this and basically we're just multiplying 1.0
five times a 6.2 and we take that compound totally multiply 1.05 again and
so on and so on. much closer .well here's the formula you'll want to remember.
where f is the face value PV is the present value and n is the number of
periods. well in our example the face values a thousand bucks, the present
value is 642 dollars and the number of periods is the number of years or seven
years. all right well then we just you know put our handy-dandy calculator to [mathematical formula shown]
work and get a yield of well right around here. so here's the key idea rates
of return are an annual thing when quoted among finance professionals. among
fun dance professionals well and maybe a different story. [three stooges pictured]
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