6.3 Regulation and Market Failure Flashcards
What are regulations in economics?
Regulations are rules or laws enacted by the government which economic agents must operate within.
What is the purpose of regulations in solving market failure?
Regulations are a non-market based approach to solving market failure by starting with a rule intended to either decrease or increase consumption/production to resolve market failures without the use of the price mechanism. Therfore regulation can overcome the problems of more market basaed approaches such. as taxation and subsidy where inelastic demand can be a major reason for such policies being ineffective in fully solving market failures
What is the relationship between government control and consumer/producer behavior, and how can the government ensure compliance with regulations to achieve socially optimum levels of quantity and welfare in the market?
There is a strong incentive for consumers/producers to follow rules set by the government as long as the control side of the policy is strong. This involves strict punishments for those found to be breaking the rule (fines, negative publicity etc) and crucially, strong enforcement of the policy via policing for example. In this way the behaviour of economic agents will be altered whereby quantity in the market either decreases or increases according to the intention of the regulation. Quantity in the market will now reflect the socially optimum level where allocative efficiency is achieved and welfare maximised.
What is the disadvantage of regulation in terms of cost?
Cons/Evaluation
Regulation is very costly to enact. Administration of drawing up the regulations and getting them through the political process is costly as is the strict enforcement that is needed. There is a substantial opportunity cost involved therefore if surplus tax revenue does not exist. One can also question whether this is the most effective use of tax payers money, particularly if a less costly and more effective alternative policy could have been used instead. Once more if the government cannot afford to properly police the regulation, individuals would know that ignoring it is unlikely to be caught thus regulation will not work at all. If the cost of the regulation outweighs the gains in welfare, there will be government failure and a worsening of the misallocation of resources.
What is the difficulty in setting the regulation at the right level?
Cons/Evaluation
It is difficult to set the regulation at the right level. This is because measuring the value of the externalities is difficult in reality and because knowing the exact impact of certain regulations altering the behaviour of economic agents is imperfect. As a result, regulations might be set too lax where behaviour is not altered enough to bring quantity in the market to the social optimum. Another way of looking at this is that enforcement is weak where rational individuals (consumers or producers) ignore the regulation taking a perceived low risk action thus continuing to over or under consume/produce.
What is the risk of setting regulations too lax?
Regulations might be set too lax where behavior is not altered enough to bring quantity in the market to the social optimum. Enforcement is weak where rational individuals (consumers or producers) ignore the regulation taking a perceived low risk action thus continuing to over or under consume/produce.
What is the impact of regulation on different firms?
Regulation may be highly unfair in its impact on different firms. Pollution caps are a good example of this whereby all firms are forced to meet pollution standards regardless of the cost involved of doing so. Some firms will find it easier than others disproportionately affecting firms who find such change unbearably costly. This might lead to such firms shutting down or moving production abroad where regulation is not so severe causing unemployment, once more a government failure.
