Person 1: “Business needs to be regulated. If business firms were not regulated, then prices would be higher, quality would be lower, employees would be treated poorly, and who knows what else.”
Person 2: “But I’ve heard that regulations can end up doing more harm than good.”
Hear what and how the economist thinks:
Where to begin? When it comes to regulation, there seems to be so much to discuss. Person 1 says that if business firms were not regulated, certain things would follow, such as higher prices, lower-quality goods, and so on. This isn’t necessarily true.
Economists often point out that competition between firms is often what keeps prices low, quality high, and so on. In short, firms often compete on price, quality, terms of service, location, and more. Think of firms producing computers for sale. Does one computer company care about the prices other computer companies are selling their computers for? Does it care what quality of computer is being offered by other computer companies?
If it doesn’t take into account where potential customers can buy their computers, then the company may find itself without any sales.
Regulation isn’t guaranteed to give consumers the lowest price or highest quality goods. Suppose profit regulation is enacted, in which the government requires that the price be set equal to the average total cost so that economic profits are zero.
But now the regulated firm can let its average costs rise, knowing that it will then be allowed by the government to raise its price.
In other words, with profit regulation, sometimes called average cost pricing, we might see higher prices over time.
Finally, it also seems that person 1 believes that the regulations that government imposes on business firms are regulations that business firms would rather do without. In other words, business firms do not want the regulations that government foists upon them. But this isn’t always true. To illustrate, suppose there are ten airline companies operating in the country. These ten airline companies may actually want government to impose certain regulations on the airline industry. For example, they may want a regulation that says that each of the airlines cannot compete on price.
In other words, a trip between New York and Los Angeles is set at \($500\) and no firm can charge a lower price than \($500.\) Or perhaps these airline companies want a regulation that restricts the number of airline companies that can travel the same route between cities.
Or maybe the ten airline companies want a regulation that prevents new airline companies from entering the industry. Regulating price, routes, and entry into the existing airline industry serves the ten airline companies by preventing them from competing with each other in terms of price or routes, and by preventing new firms from entering the industry and competing with them.
Person 2 thinks like an economist by saying that regulations can end up doing more harm than good. This is not necessarily the case, of course. But the statement does show an understanding that there are both costs and benefits to regulation.
Questions:
1. “It is in the best interest of the consumer for government to regulate business.” This is a somewhat broad statement. What do you think is missing from, or left unidentified, in this statement?
2. A person believes that government almost always benefits consumers instead of producers when it regulates business. Would an advocate of the capture theory of regulation agree? Why or why not?