Voting on Prices: The Political Economy of Regulation

Gerald R. Faulhaber

Abstract

Economists have long recognized that regulation is an imperfect solution to
market failure. Do the inefficiencies of regulation outweigh the inefficiencies
of market failure? In this paper, we develop a stylized model of a 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
(i) median voter pricing can yield substantially lower aggregate surplus than
monopoly pricing; and (ii) empirical evidence of the recent evolution of US
telecommunications prices confirms the model.

JEL Classification Codes: D72, L51

Keywords: Regulation, Political Economy, Median Voter, Telecommunications,
Pricing.


Professor Gerald R. Faulhaber
Dept. of Public Policy & Management
Wharton School, Univ. of Pennsylvania
Philadelphia, PA 19104
Tel: 215-898-7860
Fax: 215-898-9463
http://rider.wharton.upenn.edu/~faulhabe