1 REGULATION (B) When/Where Government Regulation of Business is Justified (produce benefits in excess of costs) in a Market Economy

2 There is only one valid state purpose for economic regulation: THE EFFICIENT USE OF SOCIETY’S SCARCE RESOURCES

3 Regulation can promote a more efficient use of society's scarce resources in at least four instances : restraint of trade  It promotes effective competition — restraint of trade. natural monopoly  It permits the public to enjoy economies of scale or scope obtainable only under monopoly of supply — natural monopoly. externalities.  It compensates for divergences between private and social costs — externalities. information asymmetries and information or transaction costs.  It reduces the number of mistakes made by parties to private market transactions by standardizing product or service attributes or working conditions — information asymmetries and information or transaction costs.

4 Regulatory Optimum

5 When does regulation have a comparative advantage vis a vis its alternatives? In the natural monopoly case, the externalities case, and the information asymmetries case, the benefits sought by regulation may also be secured by alternative institutional arrangements or measures.

6 natural monopoly In the natural monopoly case, regulation will seldom be the most efficient means of realizing single plant or industry economies. Some form of franchise and bidding arrangement, a system of multi-part tariffs, or public provision will usually dominate administrative regulation. regulators If potential service suppliers understand the demand characteristics of their markets and the production and cost behavior in their industry better than the regulators and they can be prevented from colluding, then competitive bidding for the right to serve the market ought to work better than regulation. If the regulators are better informed than are managers in the regulated industry, then private ownership has no significant function or responsibility to discharge and the market ought to be served by a public entity.

7 abating external 'bads' or promoting external 'goods.' In the externalities case, regulation will usually be inferior to the manipulation of market incentives and penalties as means of abating external 'bads' or promoting external 'goods.' Incentives may take the form of charges (e.g. pollution taxes), subsidies, or marketable property rights. Wherever producers can determine better how to reduce externalities than regulators, market incentives will outperform regulation.

8 In the information asymmetries, market incentives together with either public provision of information or — in the case of information asymmetries — reassignment of liability, public certification, or enforced disclosure will often produce more efficient outcomes than will a regulatory program that restricts the range of goods and services made available, enforces maintenance standards, or establishes maximum levels of exposure to health and safety hazards. Where participants in private market transactions err only because information is absent, public provision of information will be more efficient than regulation. This follows from the observation that public provision of information can meet economic objectives without removing alternatives from the market that some consumers or workers would prefer.

9 Enforced Disclosure?

10 Where does regulation have a comparative advantage, where will it dominate alternative institutional arrangements?  Difficult, probabilistic judgments involving the risk of serious, irreversible errors. –In this case, regulation may be less costly and/or more effective than information provision simply because the cost of information processing and thereby the sum of the costs of avoiding errors and the consequences of error may be minimized by delegating the task to to an expert. –Most likely to produce satisfactory outcomes where individual preferences are known to be fairly homogeneous or where standardization is valuable for its own sake..  Where the regulators have a better understanding of the consequences of workplace or product hazards than have managers at the work site or manufacturers.

11 uncertainty is is unavoidable mistakes that might result are serious To the extent that uncertainty is is unavoidable at a reasonable cost or where computational costs are simply very high and the mistakes that might result are serious enough to warrant any state action at all, regulation can and very likely will be the most appropriate means of coping with the situation. ignorance is an important and valid justification Since another word for uncertainty is ignorance, what I am saying is that ignorance is an important and valid justification for regulation. where the regulator's behavior is most, not least, likely to be 'arbitrary and capricious, not well-supported by the evidence.' That is, regulation's comparative advantage as an instrument of state action is greatest where it is directed at the indeterminant, where the regulator's behavior is most, not least, likely to be 'arbitrary and capricious, not well-supported by the evidence.'

12 The paradox of regulatory policy  The canons of procedural due process tie the regulator’s hands whenever the optimal policy is uncertain  R egulation can be employed as an instrument of state action only where other measures would be more appropriate ignorance justifies regulation, BUT there is often NO justification for ignorance