Market Failure Due to Imperfect Information 467rates can hold prices upas well as down. Critics argue that regulators are often
“captured’’ by the firms they are supposed to regulate and that government inter-
vention has spread into many areas that are a far cry from natural monopolies:
trucking, airlines, and banking, for example. Regulations that limit market entry
and fix prices frequently do more harm than good in markets where competition
otherwise would be viable.
Beginning in the late 1970s, policy makers have increasingly adopted regula-
tory reforms calling for deregulation. Deregulation focused on a wide variety of
industries, including airlines, banking, brokerage firms, cable television, natural
gas, railroads, trucking, and telecommunications. Did the predicted benefits of
deregulation come to pass? On balance, the answer is yes. For instance, in the rail-
road and trucking industries, firms have engaged in vigorous price competition
and have become more efficient once free of restrictive regulations. Competition
also has been vigorous in the areas of banking and brokerage services.
Perhaps most successful has been the case of airline deregulation.
Deregulation has produced entry by no-frills airlines, greater competition along
high-traffic routes, lower average fares, greater variety and frequency of service,
and increased airline efficiency (stemming from hub-and-spoke operations and
reduced labor costs) with some reduction in service quality. Overall, consumers
have benefited significantly from the 25 years of airline deregulation.
Nevertheless, deregulation is not without problems. In 2007 and 2008, the
subprime mortgage crisis, partially the result of deregulation, roiled financial
markets. The result has been thousands of painful foreclosures, a tightened
credit market, lower economic growth, and increased unemployment. Thus
government policy makers are revisiting the regulation–deregulation debate.
Recently, Congress has enacted broad legislation to more tightly regulate finan-
cial markets and institutions.MARKET FAILURE DUE TO IMPERFECT
INFORMATION
In our previous discussion of market efficiency, we took for granted that the con-
sumer is the best judge of the value he or she will enjoy from the purchase of a
good or service; that is, the buyer fully understands the benefits and costs asso-
ciated with any transaction undertaken. This is a good working presumption for
many, if not most, transactions. However, some economic transactions involve
significant uncertainties as to product quality, reliability, or safety. In these cases,
consumers may not have sufficient information to make efficient choices.
There are numerous cases of market inefficiencies due to imperfect infor-
mation, ranging from the routine to the dramatic. As a simple example, con-
sider two lines of household batteries marketed by competing firms. The first
firm’s battery is a best seller; it is cheaper to produce and thus carries a lower
price (10 percent lower) than the competition. According to objective tests,c11RegulationPublicGoodsandBenefitCostAnalysis.qxd 9/29/11 1:34 PM Page 467