Governmental Regulation & Deregulation of the Economy

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  • 0:02 Why Regulate?
  • 2:11 Impact of Regulation
  • 4:20 Financial Regulation
  • 6:05 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Government regulations affect all aspects of the economy. However, some sectors are subject to specific regulations due to their importance. This lesson explores the purposes and methods of economic regulation and deregulation.

Why Regulate?

Imagine that you live in a small village before industrialization. Like most everyone else in the village, you're a farmer with a small herd of cows and a small flock of sheep. And like everyone else, you let your animals graze on the grassy area in the middle of the village - an area you all refer to as the town common.

One day you are out working in the field, and your plow hits something hard. You dig down to investigate and find out that you have uncovered buried treasure! Suddenly, in addition to living in a much bigger house, you can now afford a much larger flock of chickens and a much larger herd of cattle. At the same time, you are still using the town common. The town common isn't big enough for your new animals and all of the animals owned by your fellow farmers, so it becomes a stinky mess. The other farmers want to punish you for doing this, but why? You are simply doing what you've always done.

The above example is not just a sad story, it's also an economic theory known as the tragedy of the commons. The theory asserts that individuals who act in their own self-interest might deplete a common resource important to a whole group of people. The tragedy of commons theory is sometimes used by economists to show what happens without regulation. Regulation is action by a government or another authority to help make sure that the economy is as fair as possible. Not equal, but fair. That is a really big distinction and one that plays out in economic history.

Regulation can take many different shapes. Social regulation focuses on how the commons would be treated, with regards to things such as pollution or caring for the footpaths. In our modern society, things like pollution, health care, and the food supply are shaped by social regulation. Economic regulation, on the other hand, determines who gets to use the market and how it can be used. In this lesson, we will focus primarily on economic regulation.

Impact of Regulation

As I said before, economic regulators determine which firms get to enter a marketplace. Now, this isn't such a bad thing for your business. Only companies that have met the requirements are able to participate in a market, which, in turn, means that you've all had to pay the same price to be there. As a result, you have less competition, since in many cases, a government may just decide to grant you a monopoly in order to limit their own costs in regulating an industry. This is sometimes done for utilities. Think about it; you don't shop around for water or electric companies the same way you shop around for a cell phone provider, now do you?

Monopolies themselves are subject to regulation - remember that bit about the government setting the price to enter the market? The government reserves the right to limit prices in order to keep a legal monopoly from engaging in unfair business practices. An example of an unfair business practice might include raising a price so high that it stifles economic growth. On the other hand, in cases where a government decides against regulation to force a monopoly to behave, it will instead pass anti-trust legislation to limit the opportunities for the monopoly to emerge, which eliminates the need for regulatory costs.

Of course, all this regulation comes at a price. If you look at a list of economic regulators, you'll notice that many of them are concerned with utilities and financial markets. These markets are areas that are vital to other companies as well. If you own a toy company, a criminal scandal at a clothing factory doesn't really affect you. However, your toy company couldn't function without utilities, nor could it hope to raise funds on the financial markets without reliable and trustworthy financial firms. In the past, such as during the Great Depression, the food industry was subject to increased economic regulation due to the fact that there was the real danger that people would be unable to feed themselves due to the Dust Bowl, which threatened food stocks.

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