Saturday, March 4, 2017

220 Why governments regulate the market.

Steiner & Steiner (2014, p 319) state that there are two circumstances why regulation of the private sector is warranted. The first that is indicated by them is when certain "flaws" result in what they call "undesirable consequences; and the second is when there are "sufficient social or political reasons" for this to happen.

They admit that free markets yields the most optimal results, but maintain that some regulation is necessary.

The first reason according to them is when a natural monopoly exists. A natural monopoly exists when "a firm can supply the entire market for a good or a service more cheaply than a combination of a number of smaller firms". They then use the example of public utilities that are able to restrict output and raise price.

In this case did the market fail? The answer is no! If a utility raises its prices in order to maximise prices it does not matter that its costs are lower than possible competitors - it is the price that consumers are paying that will determine whether it is profitable for an alternative producer to enter if no regulation exists to prevent such action. So the threat of competition will keep prices low if no entry barriers exist. A regulator is not required. A free market is.

The second reason according to them is "destructive competition". Through cutting of prices large dominating form can eliminate their competition. Though this may theoretically be possible - what will happen is that the products will have to be sold under the cost of production (of the cost of competitors) to be effective. This will be a benefit to consumers. If the large firm raises prices after eliminating their competition, competitors will simply enter the market again if there are no regulatory constraints. Laws are not necessary to eliminate predatory prices or price fixing if entry into the market is completely free.

The last reason for governments to intervene are the existence of externalities. An externality is where apart of the cost of production is borne not by the business itself, but by another party. The damage caused by pollution is the best example of this.

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