The Peltzman model 1

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The Peltzman model 1
Also known as the Economic Theory of Regulation
(ET), here is Professor Peltzman's attempt to
extend and improve upon Stiglers "capture
theory" of regulation.
1Sam Peltzman. "Toward a More General Theory of
Regulation," Journal of Law and Economics, August
1976211-240.
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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.

3
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 utility-maximizing
politicians and regulators in response to the
demand for regulation by interest groups.
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Key assumption
Those who control regulatory policy do so to
maximize political support. Political support
comes in the form of votes or campaign
contributions.
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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
and
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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.
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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 Rs and ?s that yield equal
  political support.

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Iso-political support functions
Hear audio explanation (wav)
M3
M2
M1
?
?
Profits of regulated firms
Note M3 is preferred to M2, which is preferred
to M1
?
Utility Rates per KWH
0
R2
R1
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Optimal regulatory policy
Hear audio explanation (wav)
M3
M2
M1
?
Profit function
Profits of regulated firms
?
Utility Rates per KWH
0
R
RC
RM
10
Extreme outcomes
Regulators captured by consumers
Stigler solutionRegulators captured by
regulated industry
MC
?
MF
Profits of regulated firms
Profit function
?
Utility Rates per KWH
0
RC
RM
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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)
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