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Stigler-Peltzman model
Petr Gapko
Course structure
BLOCK 1 – REGULATION AS AN
IMPLICATION OF MARKET
IMPERFECTIONS
BLOCK 2 – APPLIED REGULATORY
POLICY (CZ, EU & USA)
BLOCK 3 – REGULATION AS AN
IMPLICATION OF THE POLITICAL
PRESSURE OF INTEREST GROUPS
BLOCK 4 – PRACTICAL APPLICATION
(MICROSOFT CASE)
Course structure
BLOCK 3 – REGULATION AS AN
IMPLICATION OF THE POLITICAL
PRESSURE OF INTEREST GROUPS
Stigler model,
Becker model
Recap of regulation theories
source: http://www.clt.astate.edu/crbrown/reg3.htm
The issue: What factors can explain
why certain markets/industries are
subject to economic regulation and
others are not? Moreover, economic
regulation produces winners and losers-what determines who wins and who
loses? Here we present the essential
features of three alternative theories of
regulation, including
The public interest theory
The capture theory
The economic theory
Normative Theory as a
Positive Theory
According to the NTPT, regulation
is the manifestation of
political pressure brought to bear
by the public, which demands that
a market failure be corrected.
NTPT - Examples
Monopoly power enjoyed by railroad
companies gave rise to discriminatory
freight charges--to the detriment of
farmers and industries located in
remote areas. Interstate Commerce
Commission (ICC) was created to
correct for this market failure.
Incompletely specified property rights
create the possibility of externalities or
spillovers (such as air pollution). Hence
the Clean Air Act and regulation of firms
by the Environmental Protection Agency
(EPA).
Criticism of NTPT
Viscusi, Vernon, and Harrington state that
NTPT puts forth the hypothesis that
regulation occurs when it should occur
because the potential for a net social
welfare gain generates a public demand
for regulation". They note, however,
that "[m]any industries have been
regulated that are neither natural
monopolies nor plagued by
externalities; for example, price and
entry regulation in trucking, taxicab,
and securities industries"
The capture theory
Government has "legal" coercive power
and thus has monopoly control of the
"supply" of regulation.
Government regulation can protect
incumbent firms from rivalrous price
wars and prevent entry into lucrative
markets.
Since the regulated firm oftentimes has
a more comfortable and profitable
existence than the non-regulated firm,
private companies "compete" for a
scarce supply of regulation.
The capture theory
Though a regulatory agency may have
been created with the (vague) intention
of correcting market failures, as time
goes by the agency is subject to
"capture" by the firms they regulate.
That is, the regulatory agency
invariably tends to issue regulations
that work to the advantage of regulated
firms.
The capture theory
Regulated firms expend considerable
resources to lobby the regulators. It is
not uncommon for an official of a
regulatory agency to wind up in a highpaying job with a firm that previously
fell under their regulatory purview. The
regulators may not want to antagonize
the firms they regulate because they
want to "keep their options open."
Capture theory predicts that regulated
firms will earn higher rates on return
(on average) than non-regulated firms.
Criticism of the Capture
theory
Does not supply a theoretical
explanation of the process by which the
regulators get captured.
Does not square with the widespread
practice of cross-subsidization in
regulated industries.
Cannot be reconciled with the long list
of regulations adopted by regulatory
agencies but opposed by regulated
firms.
Economic Theory of Regulation



Regulation: a way how interest groups
reach public benefit
Assumptions when do interest groups do
well
The public wealth is not what’s going on
Economic Theory of Regulation
Original papers:
Stigler, G. J.: The Theory of Economic
Regulation, in: Stigler, G. J.: Chicago Studies
in Political Economy, pp. 209-233, The
University of Chicago Press, Chicago and
London 1988
Peltzman, S.: Toward a More General Theory
of Regulation, in: Stigler, G. J.: Chicago
Studies in Political Economy, pp. 234-266,
The University of Chicago Press, Chicago and
London 1988
The Stigler - Peltzman model
Presentation based on: http://www.clt.astate.edu/crbrown/peltzman.ppt
Also known as the Economic
Theory of Regulation (ET),
here is Professor Peltzman's
attempt to extend and
improve upon Stigler’s
"capture theory" of
regulation.
Suppositions of the ET
 Various groups (e.g., consumers and
regulated firms) compete against each other in
the political arena to increase their income and
wealth, or to achieve other objectives (such as
environmental cleanliness). That is, groups vie
to shape regulatory initiatives in a way that will
serve their own (sometimes narrowly-defined)
interests.
Agents are rational in choosing actions that
are utility-maximizing.
The basic hypothesis of the ET
Regulation is one means by which
state power can be exercised to
the benefit of specific groups.
Regulation is supplied by utilitymaximizing politicians and
regulators in response to the
demand for regulation by interest
groups.
Key assumption
Those who control
regulatory policy do so
to maximize political
support. Political
support comes in the
form of votes or
campaign contributions.
Optimal regulatory policy
Let the political support function (M) be described by:
M = M(R, )
Where R is rates established for the regulated service (e.g.,
electricity) by the regulatory authority (e.g., the New York
Public Service Commission) and  is the allowed level of
profit earned by the regulated firm (e.g., New York
Edison).
Notice that M is inversely related to R, ceteris paribus, and
directly related to , ceteris paribus. That is:
M / R  0
and M /   0
In other words, regulators or
politicians prefer to set low rates,
other things being equal, since this
strategy will garner political support
from the customers of regulated
firms. On the other hand, allowing
the regulated firm to earn high profits
(which would mean higher rates, by
the way) puts the regulated in good
stead with business and social elites
that own/control regulated firms.
Conflicting agendas
• Thus we have two interest groups with conflicting
agendas. Consumers want low rates; whereas
regulated firms want high profits.
•The politicians/regulators face a trade-off. If they
allow higher profits, they gain political support
from firms they regulate but lose support from
consumers. The reverse is also true. This tradeoff is
illustrated by the iso-political support function.
•The iso-political support function illustrates all
combinations of R’s and ’s that yield equal
political support.
M3
M2
M1
2

1
0

Note: M3 is
preferred to
M2, which is
preferred to
M1

R1
R2
Utility Rates
per KWH
M3
M2
M1

 max

1
0
RC
R*
RM
Profit
function
Utility Rates
per KWH
MC
Regulators
“captured” by
consumers
Stigler solution—
Regulators
“captured” by
regulated industry

 max
MF
Profit
function

0
RC
RM
Utility Rates
per KWH
We never see these extreme cases in
practice. Rates established always fall
between RC and RM. In states with
powerful consumer advocacy groups
(e.g., Wisconsin, Massachusetts), rates
generally are closer to RC than in states
with weak consumer advocacy (e.g.,
Mississippi)
Highly probable that the regulator won’t
choose monopolistic or competitive price
Compromise: significant decrease of opposition
with a small price movement
P* -> P mon. :
Izokvanty pol. podpory
M(∏,p)
∏
opposition of consumers
P* -> P konk. :
∏(p)
opposition of the monopoly
P konkur. P*
P monopol Cena p
Explain whether and how the regulation
will be


Heavily competitive environment &
monopolistic price:
pressure of consumers to change the
regulation
Heavily monopolistic environment &
competitive price:
pressure of the monopoly to change the
regulation
It’s not about a public wealth!
Economic criterions used
Next lecture:
G. Becker: A Theory of
Competition Among Pressure
Groups for Political Influence