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Market Failure & Role of Regulation 1
Market Failure & Role of Regulation 1
Regulation
RRS I – What is a Regulation
Market
Regulation
Failure
Regulation Equitable
Distribution
Types of Market
Perfectly Competitive Market
Goods/services offered are all same
Numerous buyers and sellers and no single buyer or seller can
influence the market price - price takers
Oligopoly
Few sellers
Each participant is aware of the actions of the others
Monopolistic
Goods/services are slightly differentiated
Numerous sellers – each seller has some ability to influence the price
Monopoly
No substitute available for the goods/services offered
Only one seller and this seller sets the price – price maker
Competitive Market
Free Market
Forces Efficiency
John Stuart Mill, Henry Sidgwick mark a turning point in the literature of
market failure
Imperfect Asymmetry
Adverse Selection – Ignorant party lacks information while negotiating a
transaction (Akerlof – Lemon’s Problem);
Moral Hazards – ignorant party lacks information about performance of
the of the agreed upon transaction (Peltzman argument on insured driver
taking more risks);
Externalities
Negative Externalities
Over production of goods where the social costs >
private cost
Over consumption of demerit goods where social benefit
< private benefit
Positive Externalities
Under consumption/provision of merit goods where the
social benefit > private benefit
Information failure may lead to under-consumption
(individuals not fully aware of the benefits to themselves
of consuming a merit good)
Market
Regulation
Failure
Many goods have a public element but they are not pure
public goods – congested motorway
Power
Monopoly – A price maker compared to price
taker of a firm in competitive market
Telecommunications, electricity,
water, railways etc. are some
natural monopolies
(Mankiw, 2007)
Market
Regulation
Failure
Finally the market for poor quality of cars only exist – Good products and
good customers are under represented while bad products and bad
customers are over represented
(Pindyck and Rubinfeld (2001)
Market
Regulation
Failure
The higher the current rate of unemployment, and the higher the wage
paid over the market wage, the more effective will be the threat of
dismissal
(Pindyck and Rubinfeld (2001)
Market
Regulation
Failure
Legislation: laws and administrative rules are Enforcement is difficult and expensive
passed to prohibit or regulate behaviour that
imposes an EC, e.g. pollution permits
Education, campaigns and advertisements solve Benefits must outweigh the costs of implementation.
the problem of imperfect information by A lot of time may be needed for effects to be felt
allowing the external costs to be made known to
the consumer, discouraging demand
Market
Regulation
Failure
Legislation include regulation seatbelt usage, Enforcement requires constant checking which may
compulsory education etc. translate to high costs.
Market
Regulation
Failure
Imperfect Imposition of a lump-sum tax on a monopolist (shifts AC upwards), and supernormal profits are taken as
markets tax. Governments may also regulate MC/AC pricing for monopolies.
Natural Monopolies In the case of Natural Monopoly the essence of regulation is the explicit replacement
of competition with governmental orders with principal institutional device for
assuring good performance.
There are four principal components of this regulation that in combination distinguish
the public utility from other sectors of the economy: control of entry, price fixing,
prescription of quality and conditions of service, and an imposition of an obligation to
serve all applicants under reasonable conditions.
(The principles of economic regulation, A.E.Kahn)
Market
Regulation
Failure
Utilities Natural Monopoly, CERC, SERCs Licensing, Tariff Electricity Act 2003
Externalities, Public fixation, QoS
Good, standards, Dispute
Resolution
Oil & Gas Natural Monopoly, Petroleum and Natural Licensing, Tariff Petroleum and Natural
Externalities Gas Regulatory Board fixation, QoS Gas Regulatory Board
standards, Dispute Act 2006
Resolution Petroleum Act 1934
Petroleum and Minerals
Pipelines Act, 1962
Consultation paper on Approach to Regulation Issues and Options, Planning Commission India
Regulation - Summary
The possibility of market failure underpin the economic
rationale for state regulation of market economies.
(Parker, 2000)
References
Books
1. Mankiw, N. Gregory. (2007). Principles of Economics. 3rd Indian Edition,
4. Michael, A. & Hahnel, R,. A quiet revolution in welfare economics. Online book.
Journals
1. Dollery, B. and Worthington, A. (1996). The Evaluation of Public Policy.
Normative Economic Theories of Government Failure. Journal of Interdisciplinary
Economics 7(1):pp. 27-39.
2. Medema, G. Steven. (2004). Mill, Sidgwick, and the evolution of the theory of
market failure. History of Political Economy
7. Dollery, B., & Wallis, J. (2001). The theory of market failure and
policy making in contemporary Local Government. Working Paper
in Economics