A general theory is offered here to explain why some industries are usually regulated and other industries are not. According to the theory regulation exists only when three simultaneous conditions are met. One, the commodity or service is subject to substantial shifts in supply and demand. Second, supply reliability cannot be achieved through precautionary stocks or other techniques. Finally, the interruption of supplies is associated with substantial social costs.
In an environment where there are large social costs associated with a supply interruption and the usual techniques of hedging are not available, there arises a demand for regulation. Regulation, especially when rates and returns are controlled, encourages the provider to invest in extra reliability in order to reduce the probability of interruption or to mitigate the consequences of an interruption.
December 18, 1935 – January 21, 2022
