Will Governments Fix What Markets Cannot? The Positive Political Economy of Regulation in Markets with Overconfident Consumers

30 Pages Posted: 15 May 2010 Last revised: 6 Sep 2016

See all articles by Patrick L. Warren

Patrick L. Warren

Clemson University - John E. Walker Department of Economics

Daniel H. Wood

Federal Trade Commission

Date Written: November 2010

Abstract

In the behavioral industrial organization literature, market forces may not eliminate inefficiencies associated with biased consumers. Regulations usually exist that could, but we show that self-governing citizen-consumers will not always enact these welfare-improving policies. In a market for goods with add-ons, consumers never support regulations that would reduce consumption from inefficiently high levels. Even worse, consumer overconfidence reduces demand for regulation to correct a separate classical market failure, incomplete contracting. Consumer biases have two Effects: they produce deadweight losses, and they redistribute income away from biased consumers. The benefits of redistribution discourage regulation.

Keywords: shrouded attributes, overconfidence, market failure, government failure, behavioral economics, behavioral public policy, behavioral industrial organization

Suggested Citation

Warren, Patrick L. and Wood, Daniel H., Will Governments Fix What Markets Cannot? The Positive Political Economy of Regulation in Markets with Overconfident Consumers (November 2010). Available at SSRN: https://ssrn.com/abstract=1605146 or http://dx.doi.org/10.2139/ssrn.1605146

Patrick L. Warren (Contact Author)

Clemson University - John E. Walker Department of Economics ( email )

Clemson, SC 29634
United States

Daniel H. Wood

Federal Trade Commission ( email )

600 Pennsylvania Ave NW
Washington, DC 20580
United States

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