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
Date Written: November 2010
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
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