Governmental Economic Regulation and its Effects

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Economic regulation is defined as any law, statute, or governmental action that alters the function of markets in some way. It can be an attempt to alter supply (restricting or encouraging production, restricting or encouraging imports, etc.) or demand (price controls, taxation of specific goods such as luxury or excise taxes). It can also take the form of social regulation in that it is viewed that the existing market does not provide the optimum amount of a social good, or that a negative externality is not sufficiently compensated for.

Economic regulation has two basic effects. One is that it moves price points away from equilibrium. By doing so, some amount of economic surplus is lost, either for buyers or sellers. This is not intrinsically negative in that such regulation may expand a market in the long run. In the short run, price controls hurt producers and benefit consumers; in the short run, price subsidies benefit both producers and consumers (but at the cost of government expenditures). In the long run, the market will re-establish equilibrium, taking the element of regulation in market prices into account. The second effect of economic regulation is to artificially expand or contract a market or markets. Additionally, market regulation may increase the demand for substitute goods, which is quite often the purpose of such regulation, as in cigarette taxes, which are meant to make substitute goods more attractive and thus reduce the demand for tobacco products.

In both monopolistic and oligopolistic market structures, the two entities affected by regulation include firms and consumers. In a monopolistic market, the regulation that is imposed upon firms typically consists of price ceilings. For many goods, such as energy or other utilities, concentrating supply in the hands of a single firm is considered to be in the best interest of the public. When the factors of production preclude entry or extensive competition would disrupt the supply of an essential good, monopolistic market conditions can create stability. Yet, in exchange for permitting either publicly or privately run monopolies, firms must abide by limitations on the amount of money that can charge customers. This also affects customers by protecting them from the higher prices that could be imposed by firms.

Similarly, in an oligopolistic market structure, firms might be tempted to collaborate with other firms by fixing prices in order to keep out new entrants and create predictable market conditions. Regulation impacts firms by banning price-fixing and collusion. Prohibitions on collusion make it more difficult for firms in an oligarchic model to avoid competition with competitors or to act to block new market entrants from entering the market through price-fixing. Consumers are impacted when oligopolistic firms engage in non-price competition to compete for higher revenue. While oligopolists are reluctant to compete in terms of price, they provide non-tangible incentives that consumers can benefit from.

Social regulation is an attempt to alter the existing market for goods because either a) the market is not producing the socially optimal amount of the good or b) the market is failing. An example of the former would be a town where property owners plant or do not plant trees on their properties. Trees enhance the value of a property, but they also enhance the value of the town: this is a positive externality. However, rational actors will consider only the value to themselves of planting a tree; thus, the socially optimal amount of the good (the sum of the benefit to the property owner and the positive externality) will not be reached in a free market. Therefore, if the town government subsidizes the planting of trees, the socially optimal quantity of the good will be produced. An example of market failure is that for private health insurance, wherein because of the “death spiral” effect whereby more and more customers are excluded, the market fails (buyers want to buy, and sellers want to sell, but no transactions take place).

The primary entities that are affected by social regulation include private and public firms and the labor force. Private firms include privately owned businesses while public firms include government and non-profit organizations. The labor force refers to the eligible workers who are currently employed or unemployed. Private and public firms are impacted by social regulation because regulations impact every component of the operation. Laws that impose conditions on hiring practices, workplace safety regulations, and environmental protection measures are among the social regulations that businesses must comply with.

The main consequence of social regulation is that it increases operational costs for businesses, which can result in an increased price for consumers. Further, social regulations can negatively impact the labor force by making hiring more expensive and reducing the demand for labor. However, improved working conditions and increased wages are among the benefits that social regulation holds for the labor force. Because the benefits of social regulation have the potential to outweigh the detriments they cause in terms of profit, the overall impact of social regulation upon entities is primarily neutral.

Another occasion necessitating government regulation is a natural monopoly. A natural monopoly exists when either absolutely or as a practical consideration, no one else can enter the market. Natural monopolies most commonly exist in industries that are capital-intensive and where economies of scale give an existing firm a huge advantage over any other firm that may wish to enter the market. A common example is municipal utilities; also, cable television and internet distribution systems. The monopoly exists because the utilities have been granted exclusive rights-of-way; also, most utilities’ monopoly status is codified via a “franchise” or some other kind of exclusive operating charter. Per Berg and Tschirhart (1989), regulatory mechanisms’ functions change over time: “After a survey and analysis of natural monopoly regulation in practice, the links between technological change and regulation are identified” (Berg & Tschirhart, 4). The reason for allowing the creation and continuance of a natural monopoly is to encourage investment of capital; by guaranteeing a “captive” market, regulating entities ensure that an adequate return on capital investments will be produced for the investing entities. The flip side of this is that such firms cannot be allowed to operate unfettered; most if not all natural monopolies are heavily regulated in terms of price and to whom they can offer products and services.

Another major component of government regulation of markets is antitrust law. These laws are also aimed at monopolies, but with the intention of destroying or preventing rather than regulating them. The Sherman Act of 1890 forbids any action the primary purpose of which is restraint of trade. Some actions are per se violations, while others are not (thus, an action which restrains trade is not necessarily a violation). The Clayton Act of 1914 deals with mergers and interlocking directorates, wherein “competing” firms may actually be ruled by the same hand. The Robinson-Patman Act of 1936 forbids price discrimination. Finally, the FTC Act empowers the Federal Trade Commission to enforce the above legislation.

The three primary federal industrial regulatory commissions are the Federal Energy Regulatory Commission (FERC), which regulates energy production and pricing; the Federal Trade Commission (FTC), which regulates interstate and foreign trade, in addition to enforcing antitrust laws as described above; and the Federal Communications Commission (FCC), which oversees all aspects of interstate communication such as radio, television, shortwave radio, and so forth. It reserves and allocates bandwidth and issues broadcast licenses. All of these agencies regulate their areas by issuing licenses, enforcing violations of regulations, and creating and regulating markets.

The five primary federal social regulatory commissions are the Consumer Product Safety Commission (CPSC), which is responsible for enforcing consumer safety in manufactured products; the Food and Drug Administration, which oversees consumer safety in the production of foodstuffs and drugs; the Occupational Safety and Health Administration (OSHA), which regulates safety and health in the workplace; the Environmental Protection Agency, which is responsible for the protection of the environment in all U.S. territory, including regulation of polluters and the protection of water supplies, wildlife habitat, etc.; and the National Highway and Transportation Safety Administration (NHTSA), which oversees the nation’s transportation networks, infrastructure, and safety regulations. All of the above agencies have sub-agencies that deal with particular aspects of their purview (for instance, the Federal Aviation Administration (FAA) is an offshoot of the NHTSA), each operating with varying degrees of autonomy.

Reference

Berg, S. V., & Tschirhart, J. (1989). Natural monopoly regulation. Cambridge, UK: Cambridge University Press.