Question

According to the regulatory capture view, which of the following is true?

a.	Regulation of a competitive industry increases output.	b.	Regulation of the airline industry imposes minimum fares.
c.	Regulation of a natural monopoly by setting price is equal to marginal cost.	d.	Regulation of agriculture reduces barriers to entry.

Answer 1

Answer is (c) Regulation of a natural monopoly by setting price is equal to marginal cost.

Regulatory capture is a form of government failure where those bodies regulating industries become sympathetic to the businesses they are supposed to be regulating. Regulatory capture can mean monopolies can continue to charge high prices

The opposite of regulatory capture is ‘public interest theory’ – the idea that government regulation can influence monopolies to behave in the public interest.

How does regulatory capture occur?

1. Regulators become friendly with the firms they are dealing with. Spending time with people makes you more sympathetic to their viewpoint. If the regulator is in close contact and communication, then they can end up being sympathetic to their point of view and end up giving generous terms of regulation.

2. Asymmetric information. The regulator may rely on information coming from the firm – e.g. information about prices, costs, levels of investment. With biased information, the regulator may be generous to firms – e.g. allowing price increases to fund ‘necessary investment.’

3. Inefficiencies of public sector. It is argued that those working for a regulator do not have the same incentives to work hard and act like surrogate competition. Public regulators cannot keep any reduced profit. Owners of business by contrast have a greater vested interest in promoting higher profits. This means it can be an unbalanced competition.

4. Possibility of corruption. Firms giving ‘bribes’ to regulators.

5. Under-resourced. In the UK OFGEM (regulator of whole gas and electricity industry) has 878 staff. This compares to 28,579 staff in British Gas, 10,000 National Grid and 15,000 at EDF Energy (Regulators bound by limitations)

6. Firms can push for regulation of their industry. According to Adam A. Posner the “The railroads supported the enactment of the first Interstate Commerce Act, which was designed to prevent railroads from practicing price discrimination, because discrimination was undermining the railroads’ cartel.”