The dynamics of price adjustment in regulated industries

Actual rates of return to regulated firms that face systematic growth in demand, in factor prices and in technical productivity are rarely, if ever, precisely at the target rates set by regulatory agencies. If regulators make discrete price adjustments only after the firm's actual rate of return deviates from the target rate by some threshold amount, then during periods of strong wage growth, the actual returns are less than the target return on the average, and price increases are required at ever shortening intervals. If regulators make continuous price adjustments so as to minimize a quadratic penalty (disutility) function, then the firm's return may be consistently above or below the target rate.