Transcript 755_l18_reg_prin

Regulation
1. General
2. Second Best
3. Industry Capture
Traditional View
• Departures from marginal cost.
It’s all about
• Key idea is that MC = MB
QUANTITY!
• Mathematically:
Benefits = W(Q) = Willingness to pay for
Q.
Costs = C(Q) = Cost of producing Q.
• Maximize U = (Benefits - Costs):
U = W(Q) - C(Q)
dU/dQ = W - C = 0
Mgl WTP = Mgl Cost
Departures
• If the price of a good
equals someone's
willingness to pay, then
if we price at marginal P
cost, then we should
move to an optimum.
• All of us are aware of
the standard monopoly
model that shows
departure from
optimum.
• We have the WRONG
quantity
MR
Demand
MC
Q
Although you have
excess profit, the welfare
loss has to do with the
wrong QUANTITY
Departures
• This is a fairly standard
diagram. The efficient
choice of production is at
point C.
Because the firm has
monopoly power, it
produces output Q1 and
sells for price P1.
At this point, the
willingness to pay is P1 >
MC.
If we could get the
producer to increase
production, well-being
would be improved.
A
P1
P
Demand
MR
C
Q1
Q
MC
Departures
Here, regulator could come in,
and force monopolist to price
at P2 rather than P1.
Makes for a horizontal MR
curve up to where it
intercepts the demand curve.
Monopolist will produce at D,
rather than at A, and will
reduce welfare loss triangle
from gold to pink.
Key feature here is sense of
knowing what marginal cost
is. There are some fairly
tricky information problems
here as well.
A
P1
P
P2
Demand
MR
D
Gold
pink
Q1
Q
MC
Second Best
• One argument against
regulation has to do with socalled "second best
considerations."  if you
have more than one
P
imperfection, moving toward
MC, MAY not improve welfare.
Here's an example.
• Consider a monopolist who is
also a polluter. The pollution
imposes social costs on
society, although the
monopolist does not act on
them.
• We get a diagram that shows
the problems
Demand
MSC
MR
MC
Q
Second Best
• Suppose monopolist faces
constant marginal production
PMON
cost, but the more he
P
produces, incremental
amount of pollution
increases.
• The monopolist does not
face these costs, but society
does. We can calculate the
amount of output, and the
implied amount of pollution
that the monopolist comes
up with.
•Now, suppose the regulator comes in and,
again, imposes marginal cost pricing.
Demand
MSC
MR
MC
QMON QOPT
QMKT
Q
Second Best
• This increases both the
amount of output and the
amount of pollution.
Demand
PMON
MSC
MR
P
?
• The general sense of the
theory of the second best,
then, is that when there
are many imperfections,
addressing one of them
does not necessarily
improve well-being.
QMON QOPT
MC
QMKT
Q
Industry Capture
• Are the regulators beneficent?
• What if the industry “captures” the
regulatory process?
• There are lots of trade associations;
for example, American Medical
Association, American Hospital
Association.
Peltzman on Regulation - Capture
Starting premise: Regulatory process constitutes a
transfer of wealth. Treats the process as if taxing
power rests on direct voting.
Regulator seeks “votes”, in particular a majority, M.
(1) M = nf - (N - n) h
n = # of potential voters in beneficiary
group
Seek to
get
majority
f = probability that beneficiary will
grant support
n/N.
N = total number of potential voters
h = probability that (non-n) opposes
(1) M = nf - (N - n) h
Peltzman on
Seek to get
majority
Regulation
(2)
n/N.
(2) f = f (g)
g = per capita net benefit
(3) g = [T - K - C(n)]/n
T = total transferred to beneficiary group
K = $ spent by beneficiaries to mitigate
opposition
C(n) = cost of organizing direct support of
beneficiaries and efforts to mitigate opposition
T = transfer
K = $ to mitigate opp.
z = K/(N – n)
Peltzman on
Seek to get
majority
Regulation
(3)
n/N.
Assume that K and T are chosen. What is optimal tax
rate t?
T is raised by taxing the “others.”
(4) T = t B(t) (N - n)  t = T/[B(t) (N - n)]
B = wealth
Opposition is generated by tax rate, and mitigated by
education expenditures per capita z, so:
(5) h = h (t, z)
(6) z = K/(N - n)
T = transfer
(7) fg > 0; fgg < 0
K = $ to mitigate opp.
(8) hz < 0; hzz >0
z = K/(N – n)
(9) ht > 0; htt < 0.
(1) M = nf - (N - n) h
Peltzman on
Seek to get
majority
Regulation
(4)
n/N.
So, office holders must pick:
n = size of group they will benefit
K = amount they will ask group to spend for
mitigating opposition.
T = amount transferred to beneficiaries.
Substitute all of these into (1):

T
K 
 T  K  C ( n) 
M  nf 
 ( N  n) h 
,


n
B
(
t
)(
N

n
)
(
N

n
)




Peltzman on Regulation (5)
M
c' g
dt
dz
 f  nf ' (  )  h  ( N  n)ht
 ( N  n)hz
n
n n
dn
dn
Note: from (4)
t B(t) = T/(N-n); z = K/(N-n)
(tBt + B) dt = T/(N-n)2 dn
dt/dn = tB/[(tBt + B)(N-n)], from substitution.
Similarly, for dz/dn
M/n = -(g + c)f + -f ht [tB/(B+tBt)]- hz z + h = 0 (10)
M/T = f - ht [1/(B+tBt)] = 0
(11)
f´ = mgl benefit
M/K = -f
(12)
ht, hz = mgl cost
- hz
=0
Peltzman on
Seek to get
majority
Regulation
(6)
n/N.
Making all of the substitutions:
f g ( g  a)
n
C
C
 1
, where a  , m 
N
f  h  f g (m  a )
n
n
It works. What does it mean?
First, assume there are no organization costs, such
that a = m = 0.
 f g 
f


fgg
n
 g f 
 1
 1
N
f h
f h
Peltzman on
Seek to get
majority
Regulation
(7)
n/N.
Making all of the substitutions:
f g ( g  a)
n
C
 1
, where a 
N
f  h  f g (m  a)
n
With diseconomies of scale, m > a
Denominator falls, you’re subtracting a larger
number and (n/N) 
So, there is an optimal fraction, and it is less than 1.
As n/N , there is a bigger majority, BUT less to tax,
and more opposition if you raise the tax.
Peltzman on Regulation (7)
M/T = f - ht [1/(B+tBt)] = 0
(11)
Let’s rearrange:
f (B+tBt)
[Mgl 
in prob.
of
support]
[Mgl
prod.
raising
revenues
from
losers]
= ht (11)
=
[Mgl
opp.
from 
taxes]
T = transfer
K = $ to mitigate
opp.
z = K/(N – n)
Peltzman on Regulation (7)
MR from taxation
(B+tBt) = Rt
MC from opposition
(B+tBt)
ht /f
= ht /f
$ or R
If you tax to maximize
revenue (tmax), you compromise
your majority by mobilizing
opposition.
tmax
T = transfer
K = $ to mitigate opp.
z = K/(N – n)
ta
tax rate t