Regulating Markets

Regulating Markets

Jean Tirole, professor of economics at MIT, has won the 2014 Economics Nobel Prize, the Royal Academy of Sciences announced on Monday. Tirole’s research interests are microeconomics, game theory and industrial organization, and he was awarded the most prestigious prize in economic science for his works on “market power and regulation, and his taming powerful firm.”

Although it is widely believed that markets are the best way to coordinate activities in an economy, it is well-documented that markets do not always provide the best outcome for societies. Under certain circumstances, like existence of market power and externality, markets fail to deliver socially optimal outcomes; therefore, often there is a long debate on how to improve economic performance for the benefit of all the strata of society. Market power, a firm’s ability to influence the price of goods or services in absence of high number of competitors, is a common feature of many industries. Banking sector, automobile industry, communication industry are just some textbook examples of industries that are not competitive enough to avoid unpleasant results.       

The powerful firms in these industries may keep their prices high or even survive despite the low level of productivity, and impose high costs on the economy.
Where market power is inevitable, economists suggest regulating the market or industry somehow, the desirable outcomes emerge. However, there is no unique regulatory framework which can promise handling the task optimally. For example, if the government imposes price ceiling in non-competitive industries, the policy may reduce the price for all firms. But since all firms are not homogeneous, big firms can benefit from excessive profit while smaller firms may face difficulties and quit, which by extension would distort competition.
Tirole has been working on a general framework for designing policies and regulations regarding the market power and applied them to a wide range of industries. His research helps governments to efficiently regulate the market and ensures that powerful firms would improve productivity without undermining healthy competition.

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