No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Fourteen: Decision-making in Democracy: Public Choice 343 Regulation in the broadest sense is outside pressure that constrains an actor from behaviors they might otherwise engage in. So what is private regulation? You and I self-regulate all the time—we certainly don’t respond to every fleshly desire. We also are regulated by voluntary choices we make. For example, I might like to sleep in until 10 a.m. every day, but my employer regulates my behavior by promising to pay me a salary if I show up to work daily by 8 a.m. The local ice cream store may want to be stingy with the size of the cone, but competition regulates their stinginess. The point is that some type of regulation is needed—we live in a fallen world where sinful people behave badly. The question is, which institutional arrangement regulates best? Self regulation is undoubtedly best since no external resources are needed to lead to socially optimal behavior. This is a good reason for public officials to embrace the importance of religion and morality. After self regulation, private regulation from market participants and competition is a 2nd best solution, since desired behavior will be obtained voluntarily. Finally, a consideration of government regulation may be made, understanding the limits identified in this chapter. RENT SEEKING Economist Gordon Tullock came up with an original insight on the cost of monopolies in the 1960s. It was widely known that monopolies had a deadweight loss due to a reduction of output. To repeat what we covered earlier in chapter 8, a monopolist will produce where marginal revenue equals marginal cost—resulting in a deadweight loss (as illustrated by the blue triangle in Figure 14.6 ) from the reduction in output from the competitive level, Q*, to the monopoly level, Q M . The reward of monopoly pricing would be equal to the area of the red rectangle minus the producer’s share of the blue deadweight loss triangle (area L). Economist Arnold Harberger calculated the area of the deadweight loss due to lost gains from trade to provide the first welfare costs of monopoly. While Harberger thought the welfare costs of monopoly were quite low, Tullock thought differently. He reasoned that if there were potentially a large reward available you would expect profit-minded entrepreneurs to pursue it. Tullock showed that hopeful monopolists would spend up to the expected value of the monopolist’s profit to obtain the profit. Since barriers to entry was the primary enabler of monopoly, significant resources would be expended to erect these barriers—usually by lobbying government officials to provide either exclusive monopoly rights or by regulation via legislation. The resource costs of competing potential monopolists lobbying government Figure 14.6, Price Searcher (Monopoly) equilibrium. A price searcher in pursuit of monopoly profits will produce an output of Q M and charge P M . The additional quantities above Q M but less than Q* are valued by consumers greater than the opportunity cost of the resources used to produce them, so the price searcher output is not allocatively efficient. P ($) Q (#) Q* P * Q M P M Consumer Surplus Deadweight Loss Producer Surplus Monopolist Profit D L S=MC MR