PropertiesofRegulationonCostBenefit AnalysisandEffectsonSocialWelfare

AaronStreick

ABSTRACT Thisessayanalyzeshowcostbenefitanalysiscanbeappliedtoregulatorypolicies, andthecharacteristicsofregulationunderthescrutinyofsuchaframework,while alsoexplainingandcategorizingregulationintomoremanageablepolicies.Also furtherexaminationwillbegiventocriticalmodelsofregulation,andhowtheyare expectedtoinfluencesocialwelfare;eventhat,undercertainassumptions,increasing regulation,ratherthanderegulation,canincreasemarketefficiency.Acorollaryto thisexaminationwillexpoundthefailuresofcostbenefitsanalysisofregulation,and ensureacertainunderstandingofthefindingsofacostbenefitreport.

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PropertiesofRegulationonCostBenefitAnalysisandEffectsonSocialWelfare CostBenefitanalysisisanimportanttoolindeterminingtheimpactof certainpoliciesandactionsbygovernmentbodies,orprivatemarketactors.Much ofthisframeworkfocusesontheprovision,orpoliciesofgovernment,andhowthis affectssocialwelfarewithinaneconomy;howeverwithinthesameframework therearedifferencesregardingtheanalysisofregulatoryprograms.GenerallyCost Benefitanalysisfocusesonjustificationforinfluencingtheeconomy;thislargelyis unchangedforregulation,butexpoundingonregulationassistsinexplainingtheuse ofregulation. Inarudimentaryform,regulationpredominantlyrestrictschoices,as opposedtoothermethodsmorefocusedoninfluencingeconomicagents.This exposeunderlinestheneed,topreliminarily,elaborateonthespecific characteristicsofregulation.SocialwelfareisanimportantaspecttoCostBenefit analysis;oftenthisdiffersfrommarkettomarket,andbetweendifferenteconomic influences.Differentmodels,showingtheinfluenceofregulation,areusefulin determininghowsocialwelfareislikelytochangeasthelevelofregulationis varied.Finally,oftentherearefailuresinevaluatingregulationunderCostBenefit framework;circumstancesunderwhichregulationisbestweightedundera differentmethodmaybetterexplainthebenefitsofaparticularregulation. ThroughoutthisdocumenttheCostBenefitframeworkwillbeexamined,as itpertainstoregulatoryprograms.Onacasemycasebasis,howregulationaffects socialwelfare,willbeshown.Aswellsomeofthelessintuitiveimplicationsof regulation,onsocialwelfare,willbeexpoundedandexamined.

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Governmenthasmanyavenuesforinfluencingeconomicagents,butthese arenotallclassifiedasregulation.InparticularregulationistheuseofGovernment power,throughtheuseoflaw,tocoerceorrestrictthedecisionsofeconomicagents. Amorespecific,andexactdefinitionbeing: astateimposedlimitationonthediscretionthatmaybeexercisedby individualsororganizations,whichissupportedbythethreatofsanction. Source:AlanStone,RegulationandItsAlternatives(WashingtonD.C.:Congressional QuarterlyPress,1982),p.10. Theimportantaspect,thatmustbehighlighted,istheuseofsanction,or betterknownasjudicialpower.Withoutthischaracteristicagovernmentpolicy couldnotbeclassifiedasaregulation.Thelegalandoversightaspecttoregulation leadstosignificantlyhighlevelsofadministrationcosts.Indevelopednations, wherethereisstrongregulatorypresence,regulationcoststendtofallbetween7% 19%ofGDP(Guasch&Hahn,1997).WithintheUnitedStatesthereareclearcosts forregulatorybodies,showninthetablebelow: Table1)AnnualCostsofFederalRegulationintheUnitedStates (InBillionsof1991dollars) Regulation: EnvironmentalRegulation: OtherSocialRegulation: EconomicRegulation Efficiency: Regulation: ProcessRegulation: SubtotalofCosts: 1977 42 29 120 1977 122 313 1988 87 30 73 1988 153 343 1991 115 36 73 1991 189 413 2000 178 61 73 2000 221 533

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EconomicRegulation 228 130 130 130 Transfers: TotalCosts: 540 473 542 662 (Guasch&Hahn,1997) Thisisnottosaythat,inallways,thecostofregulationishigherthanthatof otherpolicies.Undersomecircumstances,governmentwillhave3choicestomake: regulation,noaction,andpublicprovision.Inthecaseofcomparisontopublic enterprise,thepublicdepartmentwillberesponsibleformanagementoftheentity; thisfallsunderadministrationcosts,andvaryalotbetweenthatoftheprivate industry.Thetablebelowshowsseveralstudiesdone,onthehigheradministration costsduetopublicenterprise: Table2)ComparisonofPrivateandPublicPerformance: Area,Author,andYearofStudy: Findings: Utilities: Electricity: WallaceandJunk(1970) Publicfirmshave4075%higheroperating costsand40%higherinvestmentcostperkwh. Meyer(1975) Publicfirmshaveloweroperatingcostsbut highertransportanddistributioncosts. Spann(1977) Privatefirmsareasefficient,andprobablymore efficient,withrespecttooperatingcosts. Junker(1975) Nodifferencebetweenpublicandprivatecosts. Neuberg(1977) Publiccost23%lessthanprivate. PescatriceandTrapani(1980) Publiccostslessthanprivate. Primeaux(1977,1978) Competitionreducescostsofpublicprovision. DeAlessi(1974) Privatesectorsupplylowercostthanpublic. DiLorenzoandRobinson(1982) Publicfirmsareslightlylessproductive. AtkinsonandHalvorsen(1986) Publicandprivatefirmsareequallycost inefficient. Area,Author,andYearofStudy: Findings: Water: MannandMikesell(1976) Publicfirmshave20%highercosts. Morgan(1977) Publicfirmshave15%highercosts.

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CrainandZardkoohi(1978) Publicfirmsare40%lessproductive. HealthandInsuranceHospitals: Clarkson(1972) Innonprofitmakinghospitalsredtapeis moreprevalent. WilsonandJadlow(1980) Proprietaryhospitalsdeviatelessthanpublic hospitalsfromperfectefficiencyindex. InsuranceClaims: Frech(1979) Mutualinsurancefirmsare4580%morecostly thanproprietaryfirms. RefuseCollection: Pier,Venon,andWicks(1974) Municipalsuppliersaremoreefficient. Kitchen(1976) Municipalsuppliersaremorecostlythanprivate ones. PommerehneandFrey(1976) Operatingcostsaresignificantlylowerfor privatethanformunicipalfirms. StevensandSavas(1977) Municipalfirmsare1030%morecostlythan privatefirms. CollinsandDownes(1977) Nonsignificantcostdifferences. Spann(1977) Publicfirmsare45%morecostly Savas(1974,1977) Privatelesscostlythanpublic. EdwardsandStevens(1978) Publicservicelesscostlythanprivate. BennettandJohnson(1979) Privatelesscostlythanpublicprovision. Transport: Railroads: Oelert(1976) Publicfirmshaveonaverage160%highercosts comparedwiththecontractpriceofprivate firms. Cavas,Christensen,andSwanson Nosignificantdifferencesinproductivity:CN (1980) (CanadianNational)waslessefficientduringthe highlyregulatedperiodbefore1965;its productivityhassinceincreasedmorerapidly thanthatofCP(CanadianPacific). Airlines: Davies(1977) Privateairlineisclearlymoreefficientthanthe publicone. Services: Banks: Nichols(1967) Mutualfirmshave1330%higheroperating costs. Davies(1982) Inprivatebanksproductivityandprofitability arehigherthaninpublicbanks. Area,Author,andYearofStudy: Findings: Cleaning: Bundesrechnungshof(1972) Thecleaningofofficesis4266%more

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expensiveifundertakenbythepublic corporationitselfifitiscontractedout. FischerMendershausen(1975) Cleaningcostscouldbereducedby30%if80% ofthespacewerecontractedout. WeatherForecasting: BennettandJohnson(1980) Governmentserviceis50%morecostly. Source:LouisDeAlessi,ManagerialTenureunderPrivateandGovernmentOwnership intheElectricPowerIndustry.JournalofPoliticalEconomy,May/June1974. Source:(Viscusi,Vernon,&HarringtonJr.,EconomicsofRegulationandAntitrust, 3rdEd.,2000). Theabovetableshowsmultiplestudies,whichsupportthegeneral

hypothesis,thatprivatefirms,inanunregulatedmarket,aremoreefficientthan publicenterprise.Aregulatoryframeworkthatkeepsthisprivatefirmefficiency, whilestillmeetingregulatorygoals,willthusdecreaseadministrationcosts comparedtoapublicenterprisealternative.Overalleventhoughthereareexpected increasestothecostsofadministration,dueprimarilytolitigationandoversight, gainsfromallowingprivatemanagerialefficiencywilllikelycurtailsomeofthecost totheregulation. CategoriesofRegulation: Tomorecarefullyunderstandregulatoryframeworkitisprudenttoexamine

themunderthecategorythatbestdescribesthatspecificregulation.Discernmentof regulationshowsthreemaincategories: EconomicRegulation, Socialregulation,and

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ProcessRegulation(Guasch&Hahn,1997). Inmostcasesaregulationwillnotfallperfectlyintoonedefinition;however distinguishingtheirqualities,andprimarilygoals,influencestheinterpretationof theresultsregardingaCostBenefitanalysis. EconomicRegulationistheinfluenceoffirmbehaviorsusingeconomic

controls.InrealityGovernmentcanregulateanypartofafirmsbehavior;however themostcommonformsare:ControlofPrice,ControlofQuantity,ControlofEntry andExit(Viscusi,EconomicFoundationsoftheCurrentRegulatoryReformEfforts, 1996).Pricecontrolcanexistforvariousreasons,suchas:monopoly,predatory pricing,fairnesstoconsumers,etc;thisentailsthatregulatorybodiescanset maximumprices,minimumprices,arangeforprices,orinsomecasesevena detailedpriceframework.ControlofQuantitysetslimits,thesamewayasprice, howeveritrestrictsthequantitybroughttomarketbyfirms;whichmayormaynot meetmarketdemand.BycontrollingEntryandExit,thegovernmentcanregulate thenumberoffirmsinaparticularindustry;thiscanbedonebyeitheracost structuretoEntryandExit,orbysimplyrejectingandacceptingclaimsbyprivate firmstoenteraparticularindustry(Viscusi,Vernon,&HarringtonJr.,Economicsof RegulationandAntitrust,3rdEd.,2000). SocialRegulationusuallyincludespublichealthandsafety,and

environmentalregulation;inrealitysocialregulationaffectsasignificantlywider rangeofindustriesthandoeseconomicregulation.Regulatorybodiesusetwo primarymethodsforsocialregulation:PerformanceStandards,orSpecification Standards(Guasch&Hahn,1997).

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PerformanceStandardsgivefirms,orindustries,atargettoreach,but allowfirmstochoosehowtheymeetaregulation.Thisallowsmarket agentstochooseamethodthatismostcosteffectiveforthatfirm. Performancestandardsaremoreflexibleforfirms,whichentails lowerMC/ACrelativetospecificationstandards.Howeverfroman oversightperspectivethismethodismoreexpensivetoimplement, duetodifficultyinmonitoringfirms;thisresultsinhigher administrationcoststhanSpecification(Viscusi,Economic FoundationsoftheCurrentRegulatoryReformEfforts,1996).

SpecificationStandardsnotonlygivefirmsagoaltoreachbutalso specifieshowtheyaretomeetrequiredstandards.Insomecases regulatorsrequirefirmsusespecifictechnologytomeetstandards (Viscusi,EconomicFoundationsoftheCurrentRegulatoryReform Efforts,1996).Thisregulatorymethodischeaperintermsof oversightcosts;howeverthiscomesatacostofhigheroperatingcost tofirms.Itisintuitivethatthiscanhavelargeeffectsinsecondary markets,wheredemandisinflatedbygovernmentrequirementsfor procurementofaspecifictechnology.IntermsofCostBenefit,this secondarymarketeffectmaybelargerthanwhatiscapturedby equilibriumdemandcurvesorworsestilliftherearefailuresinthe secondarymarket(Boardman,Greenberg,Vining,&Weimer,2006).

ProcessRegulations,moresimply,requirespecificmanagerialproceduresof

publicandprivateenterprise(Guasch&Hahn,1997).Usuallythiscomesintheform

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ofspecifictypesofpaperwork,orstandardsforadministration.Thistypeof regulationmostlyaffectstheadministrationcostsoffirms,whichwouldinfluence theircostscurves.However,processregulationscanimplicitlyhavebenefits;inthe caseofinformationasymmetryinthemarket,andtheprocessstandardsreduces thisasymmetry.AccordingtoCostBenefitframeworkthiswouldleadtoan improvementinsocialwelfare,whichmayabatetheregulatoryadministrationcosts (Boardman,Greenberg,Vining,&Weimer,2006).Otherwisemostofthisdocument willfocusontheeffectsofeconomic,andsocialregulation. Withintheframeworkofeconomicregulation,asdiscussedabove,thereare

threemaintools:pricecontrol,quantitycontrol,aswellentryandexitcontrols.For anygovernmentinterventioninthemarket,prudencegenerallydictatesthatthere mustbeproperjustification;whichinthecaseofeconomicregulationfallsunder thegoalofefficiency.Economicefficiency,fromthecontextofregulation,isto ensurethatmarketdemandismetatthelowestcosttosociety(Guasch&Hahn, 1997);thisshiftsourfocuslesstowardstheequilibriumpoint,whichincompetitive marketsissetatsupplyequaldemand(whichfocusesonmarginalcost),andinstead focusesonminimizingaveragecostforalloutput(Boardman,Greenberg,Vining,& Weimer,2006).ForthepurposesofCostBenefit,whichhasafocalpointofsocial welfare,somespecificeconomicmodelsrequireexpositiontoshowhowthegoalof economicefficiencyaffectssocialwelfare. Oftenreferredtoasthenaturalmonopolyproblem,fromthestandpointof

regulators,monopoliesprovideadilemma.Firstitisworthnotingthatanatural monopolyexistsduetolongrunaveragecostdeclining,foralloutput;whichmeans

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onef firmcanpro ovidemarke etoutputatalowercos stthancana acompetitiv vemarket, withmultiplefir rms(Viscusi,Vernon,& &Harrington nJr.,Econom micsofRegu ulationand Antit trust,3rdEd d.,2000).Sincetheregulatorsgoal listoreach haleastcos st productionpoin nt,themono opolyispref ferredtoac competitive emarket;bu utthisdoes requirejudiciou usoversighttoensuret themarketd doesnotset ttleatamon nopolyprice e (Visc cusi,Vernon n,&Harring gtonJr.,Econ nomicsofR RegulationandAntitrus st,3rdEd., 2000 0).Inthisca asetheprim marytoolbyregulatorsispricecon ntrol,whichwillbeset asam maximump priceforthe emonopoly,ensuringth hatthereisamoresoci ially bene eficialprice.Thegraphb belowshow wsacaseoftheidealpo olicysolutio on: 1) N NaturalMon nopolyunde erPriceCon ntrol si,Vernon,& &HarringtonJr.,EconomicsofReg gulationand dAntitrust, (Viscus 3rdEd.,2000)

Inthismodelwesee eafewoptio onsforregu ulators,andtheirassociatedcosts

tosociety.Undernormalco ompetitivec circumstanc cesthemark ketprice(Pc)issetat

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themarginalcostcurve;howeverinthecaseofanaturalmonopoly,ifregulators choosethispricethemonopolywillberunningunderalossequaltothegreen shadedarea.ThisoccursduetotheMCcurvebeingbelowtheACcurveatall quantities,inthenaturalmonopolymodel.Sincesettingthispriceisnotsustainable forthefirmitisnotaviableoptionforregulators;regulatorsdohavetheoptionto subsidizethemonopolytoensureitdoesnotoperateataloss.Allowingthe monopolytoreceiveprice(Pr)fromsubsidization,butonlychargingprice(Pc)to consumersensuresthatconsumersurplusisnotdiminished,butdoestransferthe greenlossareatogovernment.Afinaloption,forregulators,istosettheprice(Po), whichequalsthefirmsACcurve;thisensuresthefirmdoesnotoperateataloss,but doesdiminishsocialwelfarethroughareductioninConsumersurplus.One importantfactortocaptureis,ifregulatorsdonothing,themonopolyislikelyto chargeamonopolyprice,whichwillcauseamuchhigherlosstoconsumersurplus thanifregulationisinplace(Viscusi,Vernon,&HarringtonJr.,Economicsof RegulationandAntitrust,3rdEd.,2000). Inthecaseofcompetitivemarketsweknow,fromgeneraleconomictheory,

thatanydeviationfromthecompetitiveequilibriumwillcauseadecreaseinsocial welfare.Stillpricecontrolsmaybeinplaceforvariouspolicyreasons,eithersocial, orevenpolitical,whichweexpecttocauseadeadweightlosstosociety.Inmost casesweexpectthatlessregulationwillbebeneficialtosocialwelfare;howeverthis isnotalwaysefficient.Inthemodelbelowweseethatincreasedregulationina market,intheformofentrycontrol,canimprovesocialwelfareandeconomic efficiency:

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2) Effe ectsofEntry yControlan ndPriceCon ntrolonCom mpetitiveM Markets (Viscus si,Vernon,& &HarringtonJr.,EconomicsofReg gulationand dAntitrust, 3rdEd.,2000)

Thismod deltheregul latedpricei issetat(Pr),whichlea adstoadead dweight

oftheshade edtrianglet totherightofQ.Evenincompetiti ivemarkets softenthere e losso arem minimumef fficientscale es;whichleadstooptim malfirmsize es,asaport tionof mark ketoutput,a astominim mizetheaver ragecostofthefirm.In nthemodelabovegiven n there eare20firm ms,evenlyd dividingmar rketshare,t theoutputp perfirmisQ Q/20.Atthis level ofoutputth hefirmhasnotminimi izeditsAC,a andtherefo oretheactua alcostto socie ety,fromthe estandpoin ntofefficien ncyistheentireshaded darea.Ifthereislower entry ycontrolwe eexpectanincreaseinthenumber roffirms,le eadingtoan nevenlower mark ketsharean ndamovem mentleftont thefirmsAC Ccurve.The eeffectofm morefirms

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willbelessmarketefficiency,andthereforeanincreaseinthecosttosociety.If thereisanincreaseinregulation,intheformoftighterentrycontrol,wewillseean increaseinthemarketshareofeachfirm;whichinthegraphabovemeansa movementrightontheACcurveandareductioninthecosttosociety(Viscusi, Vernon,&HarringtonJr.,EconomicsofRegulationandAntitrust,3rdEd.,2000). Comprehensiveregulationisimportanttoincreasingeconomicefficiency,

andsocialwelfare.Priceregulationononeindustrymaywellpushforprovisionby anotherclosesubstituteindustry,withinthatmarket.Thecostsofthesubstitute industrywillbehigherthantheprimaryindustry;otherwisethesubstitutewould havepreviouslybeeninthemarket.Thisleadstoaninefficientoutcome.Increasing regulationonthesubstituteindustrieswillcauseanincreaseinthedeadweight loss,butwillleadtoamoreefficientoutcome,throughgrowthofproducersurplus totheprimaryindustry.Thismodelshowsthecostinefficiencycausedby competitionfromsubstituteindustries: 3) EffectsofEntryControlandPriceControlonCompetitionfromCompeting Industries (Viscusi,Vernon,&HarringtonJr.,EconomicsofRegulationandAntitrust, 3rdEd.,2000)

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Thismod delidentifiestwomainindustries,whichcanb bothprovid deforthis

mark ket,industry y1withaco ostcurveof f(C1),andin ndustry2w withacostc curveof(C2). Supp poseimplem mentationof fapricecon ntrolonindu ustry1of(P Pr),ifthereisnoprice contr rolonindus stry2wewi illexpectth hatindustry y2willstepintothema arketwitha a price eequaltoth heircostofC C2,andama arketquant tityofQ1.Byensuringt theprice contr rolappliest tobothindu ustries(Pr),therewillb bealowerin ngofconsum mersurplus s causi ingadeadw weightlosso ofthegreen ntriangle;h howeversinceindustry y2willhave e noin ncentivetoe enterthema arketprovis sionwillbefromindus stry1.Thish hasthe effectofincreasi ingmarketefficiency,leadingtoan nincreaseinproducersurplusof theredrectangle.Inthisspecificcasei increasedre egulation,as ssumingnochange significantchang geinadmin nistrationco ost,willbeb beneficialto osocietysin ncethered recta angleismuc chlargertha antheincur rreddeadw weightloss.

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Bothofth heseexamp plessupport tthat,eveninacompet titivemarke et,

incre easingthele evelofregul lationcanm makeimprov vementstosocialwelfa are,and economicefficie ency.Entrya andExitcon ntrolsalsoh haveusefuleffectsinot thernon comp petitivemar rkets,espec ciallyinthecaseofoligo opoly. Similarto othebenefi itsinacomp petitivemar rket,withm minimumeff ficiency

scale e,thereisro oomforentr rycontrolto oimprovea anoligopoly ymarket.Bo othmodels areq quitesimilar r,excepttha atinthecas seofanoligo opolyweex xpecttoseeamuch stron ngerminimu umefficienc cyscale,and dfewerfirm msinthema arket.Them modelbelow w simu ulatesthebe enefitsineff ficiency,and dtoconsum mersurplusofentryeff fectsinan oligo opolymarke et: 4) EffectsofEntryC Controlona anOligopoly yMarket (Viscus si,Vernon,& &HarringtonJr.,EconomicsofReg gulationand dAntitrust, 3rdEd.,2000)

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Inthismodelthereisastrongminimumefficiencyscale,whichwillleadtoa

marketwithfewfirms.Inanoligopolysituationwedoexpectsomeeconomicrent, asfirmshavesomecontroloverprice,asopposedtoinanormalcompetitive market.Thisprofitgivesincentiveforfirmstotryandenterthemarket,despitethe lackofmarkettosupportanotherefficientfirm;whichleadstoaninefficient numberoffirmsgivenfreeentry(Viscusi,Vernon,&HarringtonJr.,Economicsof RegulationandAntitrust,3rdEd.,2000).Inthegraphaboveassumethatthereare somenumberoffirms,above3,leadingeachtohaveamarketshareof(q),thisleads toamarketpriceof(P1).Introductionofentrycontrol,byaregulatorybody,will decreasethenumberoffirmsto3,whichleadstoamarketshareof(Q/3)ata marketpriceof(P2).Inthiscaseweseethattheaveragecostfor(Q/3)thanfor(q), whichleadstoalowermarketprice.Intermsofcostbenefitthiswillbecapturedas anincreaseinconsumersurplus,causedbyanincreaseineconomicefficiency. Paramounttothismodelistheassumptionthatthefirmswithinthe

oligopolydonotcolludetodriveupmarketprices,andincreasetheirprofits;which comesattheexpenseofconsumersurplus.Inthecaseofcollusionregulatorshave twooptions:setapricecontrol,oruseantitrustlitigationtoensurefairpricing. Pricecontrols,aswehavealreadynoteddistortthecompetitiveprice,whichinthe caseofcollusionisnotpresent,andcausesdeadweightloss.Litigationcosts,inthe formofantitrustlawsuits,addtoadministrationcosts,andaresignificantfactorto thehighcostofregulationalreadydetailedinthecaseoftheU.S.federal government.

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Pricecontrolsdohaveothereffectsthatarelessobvious,andcancausedead

weightlosstoincreasemorethanwouldbeexpected.Inacompetitiveunregulated marketfirmshavecontroloverthequalityoftheirproduct,bydistinguishingtheir brand,andthepricetodeterminehowmuchtheywillsell.Inthecaseofamarket withpricecontrolfirmscannotdistinguishtheirproductsthroughtheuseofprice, andmustthereforeuseothermeanstogainmarketshare. Ifregulatorschooseapricecontrolastoassistingivingproducersaneeded

surplus,itisnotalwaysclearthatfirmswillrealizethissurplus(Viscusi,Vernon,& HarringtonJr.,EconomicsofRegulationandAntitrust,3rdEd.,2000).Firmsmayuse excessivenonpricecompetitiontocurtailthegainofthepricecontrol.Sofarinthe modelsshownwemaketheassumptionthatamarketwithapricecontrolonlyhas onetypeofundistinguishableoutput.Inrealitymarketshavemanytypesofthe samegoodsandservicesthatcomeatdifferentlevelsofquality;intermsoflevelof qualityweexpectthatconsumerswillalwayschoosethehigherqualitygood assumingpricesarethesame.Inthefollowingmodelwewillseetheadverseeffects ofpricecontrolonlowerqualitygoods: 5) EffectsofPriceControlonNonPriceCompetition (Viscusi,Vernon,&HarringtonJr.,EconomicsofRegulationandAntitrust, 3rdEd.,2000)

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Thismod delprovides salookattw wodistingu uishablever rsionsofthe esamegood d: oneh highquality y(h)andonelowqualit ty(l).Thequalitydiffer renceisalso oassociated d withdifferentco ostschedule es:forhighquality(Ch) ),andforlowquality(C Cl),which willb beequaltot themarketpriceunder rnormalcompetitivem marketcond ditions. Addingtothism modelaprice econtrol(P Pr)willappl lytobothth hehighqual lity,andlow w quali ityversionsofthegood d.Sincecons sumersarenowfacedw withthesam mepricefor r boththeywilldi iminishthei irdemandf forthelowq qualityvers sionto0;resultingina shiftofdemandforthehigh hqualityver rsionfromD Dh1toDh2. .Aswithan nyothercase e there eisagenera ateddeadw weightloss,b butunlikep previousmo odels,inthis scasethere e isals sodeadweig ghtlosscau usedbythel lossofthelowqualityv versionofthegood.As anin ndirectresul ltofthepric cecontrol,t thedeadwe eightlossinincreasedt totheentire e green nshadedar rea,notjustthatofthehighquality yversion(V Viscusi,Vern non,& HarringtonJr.,E Economicso ofRegulationandAntitr rust,3rdEd d.,2000). Itisappa arentlyfrom mthesemod delsthatofte enthereare eunforeseenchangesin socia alwelfaredu uetocontro olsonamar rket.Ultima atelythegoa aliseconom mic effici iency,fromthestandin ngofthereg gulator,andinallcasesefficiencyh hasbeen incre eased.When nanalyzingregulation,usingCostBenefit,the eselessintuitiveeffects s

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onsocialwelfaremustbeproperlycaptured,andmonetized,inordertoaccurately assesstheimpactoftheregulation. CostBenefitAnalysisisausefultoolforensuringtheoptimalresults,of governmentpolicies;howeverthereareoftentimeswheninterpretingtheresultsof costbenefitrequiresacceptanceofcertainlimitationsoftheframework.Regulation certainlyissusceptibletoincompatibilitywithrudimentarycostbenefit,and requiressomeexpoundingontheareasinwhicharegulationmaynotbesocially optimal,butmaystillbeworkpursuing. Negativeoutcomesarelikelyinregulatedmarkets,andcanbeseenquite clearlyinsomeofthemodelsassessedpreviously.Inthecaseofnaturalmonopolies, forregulatorstosetaregulatedpriceequaltoaveragecost,theregulatorsmust somehowknowtheaveragecostcurveofthemonopoly.Inrealitythisinformation isnotreadilyavailabletoregulators,andoftenisattheprovisionofthemonopoly; inthiscontextthereisverylittleincentiveforthemonopolytobetruthful,as claiminghigheraveragecostallowsforthefirmtogainprofit(Viscusi,Vernon,& HarringtonJr.,EconomicsofRegulationandAntitrust,3rdEd.,2000). Informationasymmetriesarealsopresentinthereversecaseaswell;where firmsarenotentirelysureofthecostsfromagovernmentregulation.Within governmentregulatoryframeworkthereissignificantlegalaspects,whichtaketime toimplement,andcannotbeeasilyadaptedtomeetchangingmarkets.Onwayin whichgovernmentscancurtailthisproblemisbyallowingregulatorylawstobe writteninaway,whichallowsmorediscretiononthepartoftheactualregulators (Guasch&Hahn,1997).Howeverthistransferspowerofinterpretationoverto

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lawy yers,andpol liticians,wh hichmakesitdifficultfo orfirmstoj judgetheim mpactof regul lationonth heircosts.Th hisinformat tionasymm metry,ifseve ereinnatur re,willcause firms stoactasiftheircostsarehighert f thantheyac ctuallyare,whichcausesaless thansociallyopt timaloutcom me(Guasch h&Hahn,19 997). Inthecas seoflessfle exibleregula ation,therewillbetheexistenceo ofalagtime betw weenchange esinthemarket,andch hangesinre egulationtomatchnew wmarket equil librium.Oftenopponen ntstoregula ationcitead decreaseinincentivefo orfirmsto innov vate,inawa aythatincreasesefficie ency,dueto oregulation npreventing gfirmsfrom m earni ingprofits;whicharer requiredtopaydownth hecostofre esearchand d development.In nthemodelbelowweseehowless sflexiblereg gulatoryfra amework canimprovethe eincentivet toinnovate,andallowf forfurthere economicef fficiency: 6) EffectsofReg gulatoryLagonInnova ation: (Vis scusi,Verno on,&Harrin ngtonJr.,Eco onomicsofRegulationandAntitru ust,3rdEd., 2000)

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Thismodel,forregulatoryflexibility,showshowalagtimeof1periodcan increaseincentivesforinnovation.Inthiscasebeforeinnovationtheregulatedprice isequalto(C1),whichisalsotheaveragecostofthefirm.Thefirmthenacquires newinnovation,inthenextperiod,whichlowerstheiraveragecostto(C2);ifthere isa1periodlaginregulation,theregulatedpricewillstillbeat(C1),allowingthe firmtocapturethegreenTerm1areaasprofit.Inthenexttermthefirmusesnew innovationtoloweraveragecostto(C3),howeverregulationhasnowmovedtolast periodsaveragecostof(C2)duetoregulatorylag.Thisallowsthefirmtocapture theredareaTerm2,astheirprofit.Iftheseprofitareasarelargerthanthecostof researchanddevelopmentfortheinnovation,thenthereisstillproperincentiveto innovate(Viscusi,Vernon,&HarringtonJr.,EconomicsofRegulationandAntitrust, 3rdEd.,2000).Thisshowsthathavinganinflexibleregulation,inthiscaseprice control,canresultinbotheconomicefficiency,andsocialwelfareimprovements. OftenSocialRegulationalsorequiresabasiswithverylittleknown information,orsituationsrequiringsignificantvaluejudgment,especiallyinthe caseofenvironmentregulation(Guasch&Hahn,1997).Inthecaseofenvironmental issues,wherebenefitstoregulationareoftenfarinthefuture,thereissevere dependenceontheuseofdifferentdiscountrates;oftenthesedependenciesare quitecontentious,andrequirestrongvaluejudgments,butmaystillbework pursuing(Boardman,Greenberg,Vining,&Weimer,2006). Regulationiscommonlyusedtomeetgoals,suchas:toimproveequality,or accesstorightsorserviceswithinanation;eventoupholdacertainminimum standardofliving(Guasch&Hahn,1997).Oftenthesegoalsareknowntohave

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negativesocialw welfareresu ults,butthegoals,whic charenotm monetarilye estimable, arew worththeco osts.Onesuchmodelca anshowhow wregulation nofthisnat turewill havenegativeso ocialeffects: 7) Ef ffectsofCro ossSubsidiz zationRegul lation (Viscus si,Vernon,& &HarringtonJr.,EconomicsofReg gulationand dAntitrust, 3rdEd.,2000)

Thismod delhighlight tscrosssub bsidization;whichisthe egovernme entensuring g amin nimumleve elofserviceinonesecto or,whichca ausesalosstofirms,by yproviding profi itsinanothe ermarketto osubsidizefortheloss.Inthiscase ewehavetw womarkets s, astro ongermark ketwithmor reprovision n,andawea akermarket twithlessp provisionof f servi ice.Toensu ureaminimu umaccesst toservicein ntheweaker rmarket,re egulationis impo osedwithca ausesadead dweightlos ssofthegre eentriangle; ;howeverfi irmsinthis mark ketareoper ratingatalo oss,andthis sisnotsust tainable.Inr responseth he governmentallo owsthosesa amefirmsto ochargeah higherprice einthestron nger mark ket,alsolead dingtoade eadweightlossofthegreentriangl leinthestronger mark ket.Thetota aldeadweig ghtlossforthisregulat tionistheco ombination nofboth trian ngles;howev verifaccess singtheserv vicewereco onsidereda aminimums standardof f

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living,inthecountry,thenthislosswouldseemjustifiable(Viscusi,Vernon,& HarringtonJr.,EconomicsofRegulationandAntitrust,3rdEd.,2000). CostBenefitanalysisisstillausefultoolinthesecases;dependingonthe valuejudgmentsmade,andthediscretiongiventoinstanceswherealessthan optimaloutcomeisinevitable,itgivesagoodestimateofcoststomeetingregulatory goals.Socialregulationmakescostbenefitespeciallydifficult;ofcoursereasonable estimatescanbeusedforbenefitsthatarenoteasilymonetized,butthatisnotto saytheyhavemuchrelationtotheactualvalues.Insuchcasescostbenefitbecomes moreanassessmentforthecostofaregulation,notaccuratelycapturingthe benefits,andcanbeusedtodecideifsocietywishestoincurthosecostsofmeeting regulatorygoals. Ingeneralregulationdoesvaryfromregularpolicy,andthesedifferencesdo haveeffectsontheframeworkofCostBenefit.Applyingcostbenefittoregulation requiresassessmentcommensuratetotheeffectsofregulationonsocialwelfare,as wellastheeffectsithasoneconomicefficiency.Thecasesandmodelsaboveshow themorecommoneffectsofregulation,andcanbeadaptedtoanumberofmarkets. Fundamentallytherearemagnitudedifferencesintheadministrationcostof regulation,especiallyduetolargelegalframeworks;howeverwedoseeefficiency gainsfromprivateprovisionoverthatofgovernmententerprise.Regulationwill affecttheequilibriumpriceofmarkets,andcomparedtoperfectcompetitionthis willbesuboptimal.Althoughalsoshownareanumberofmodels,inwhich increasingregulationfurther,willactuallybenefitsociety.Overallcostbenefitis applicabletoregulation,evenwithsomelessthanperfectfitareas.Ifregulatory

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AaronStreick

goals,evenifnotestimable,areworththenegativecostthendespitenegative resultsfromcostbenefitregulationmaystilloccur.Regulationisanimportanttool forgovernment;applicationofcostbenefittoregulationassistsinensuring governmentisawareofeither,theareasthatcanbenefitfromincreasedregulation, orthecostsformeetingsocietalgoals.

Bibliography
Boardman,A.E.,Greenberg,D.H.,Vining,A.R.,&Weimer,D.L.(2006).Cost BenefitAnalysisConceptsandPractice3rdEd.NewJersey:PearsonPrentice Hall. ConsultingandAuditCanada.(1995).BenefitCostAnalysisGuidefor RegulatoryPrograms.TreasuryBoardSecretariat,RegulatoryAffairs Division.Ottawa:ConsultingandAuditCanada. Guasch,L.,&Hahn,R.W.(1997).TheCostsandBenefitsofRegulation, ImplicationforDevelopingCountries.TheWorldBank. Viscusi,K.(1996).EconomicFoundationsoftheCurrentRegulatoryReform Efforts.TheJournalofEconomicPerspectives,119134. Viscusi,K.,Vernon,J.,&HarringtonJr.,J.(2000).EconomicsofRegulationand Antitrust,3rdEd.Cambridge,MA,U.S.:TheMITPress.