ABSTRACT
Economists have long recognized that regulation is an imperfect solution to the problem of market failure. The term regulatory failure is often used to denote the inefficiencies inherent in government intervention in the marketplace. Policymakers are thus confronted with a practical problem of comparative institutions: Do the inefficiencies of regulation outweigh the inefficiencies of the asserted market failure (say, of monopoly)? In this chapter, we develop a simple stylized model of a (potential) monopolist offering two services, one more widely demanded than the other. We compare aggregate surplus from unregulated monopoly with aggregate surplus from a median voter model of price setting in a (perfectly) regulated monopoly. We find that:
Median voter pricing can not only yield lower surplus than monopoly pricing, it can actually yield negative surplus for one of the services.
Whether or not median voter pricing is surplus-inferior to monopoly pricing depends upon the elasticities of demand in the two service markets.
The more widely demanded both services become, the less is the inefficiency from median voter pricing.
