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THE ECONOMICS OF REGULATION

THE ECONOMICS OF REGULATION. Normative: Public Interest Theory vs Positive: Interest Group Theory. Public Interest Theory . Regulation Mitigates Market Failures Natural Monopoly Externalities Imperfect Information May strive for “Second Best” Reduces DWL relative to no regulation

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THE ECONOMICS OF REGULATION

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  1. THE ECONOMICS OF REGULATION Normative: Public Interest Theory vs Positive: Interest Group Theory

  2. Public Interest Theory • Regulation Mitigates Market Failures • Natural Monopoly • Externalities • Imperfect Information • May strive for “Second Best” • Reduces DWL relative to no regulation • May not reach maximum Social Welfare • Not really a theory • Observes that SW can be improved and assumes it will happen (Normative) • Cannot explain regulation of “competitive” industries (taxi cabs, trucking) or deregulation

  3. Capture Theory • Regulators are “captured” by the regulated industries • Decisions benefit regulated firms • More observation than theory • Cannot Explain • Regulations that reduce profits or lack industry support (environment, safety) • Regulation followed by deregulation

  4. Interest Group Theories • Stigler-Peltzman • Regulation is a response to demands by maximizing agents that redistributes wealth • Politicians maximize political support • Firms and consumer/voters maximize wealth • Regulatory decisions maximize political support by equalizing the marginal support received from each affected group • Example: trade-off between profits and low prices

  5. Interest Group Theories • Becker Model • Competition among interest groups • Regulation raises wealth of more influential group • Groups apply “pressure” strategically • To influence politicians toward their desired outcomes • In response to “pressure” applied by opposing groups

  6. Interest Group Theories • Outcomes • Small groups with strong preferences dominate large groups with weak preferences • Even pro-producer regulators set policies (prices) below the unregulated monopoly level • Relatively competitive or relatively monopolistic industries most likely regulated • Market failure makes regulation more likely • Winners gain more than losers lose as DWL reduced • Compensation Principle

  7. Interest Group Theories • Critique • Politicians may follow ideologies rather than interest groups (“shirking”) • Regulators not perfectly controlled by legislature • Ignores judges & courts – What motivates them? • Explains “everything” – can’t be tested • Empirical Studies • Deregulation of Railroads & Telecom vs. Airlines and Motor Carriers • Utility reg. involves complex trade-offs: multiple competing consumer groups as well as the regulated firm • Theory becomes very complex with > 2 groups

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