Prof. Bryan Caplan

Econ 103

Spring, 2000


Week 9: Quality Regulation


I.                     Quality Competition

A.                 Question: Why don't we all consume the highest possible quality? 

B.                 Answer: Higher quality must be more expensive.  "You get what you pay for." 

C.                Supply and demand of quality: When quality increases...

1.                  Demand increases (people are willing to pay more for higher quality)

2.                  Supply decreases (it is more expensive to produce higher quality products, so suppliers are willing to sell fewer units at each price).

D.                While this does create an incentive for suppliers to secretly cut prices, this is mostly solved with reputation and warrantees.

II.                   Regulation and Quality

A.                 Does it benefit consumers to ban low quality levels?  (Note: Safety is presumably one aspect of quality).  How could it?  This just forces people who want low quality to either buy nothing or pay for more quality that they don't want.

B.                 Applications:

1.                  Airbags.

2.                  FDA.

3.                  Urban renewal.

C.                Recall: How do price controls affect product quality?  The quality of surplus products tends to improve; the quality of products in shortage tends to decline.  Ex:

1.                  Shrinking candy bars during Nixon's price controls.

2.                  Deterioration of NYC housing stock.

3.                  Meals on regulated airlines.

III.                  Black Markets, Prohibition, and Quality

A.                 Sometimes certain varieties or qualities of products are banned or "prohibited."  Ex: Narcotics, alcohol, prostitution, gambling, irreligious books.  This constriction of variety reduces consumer welfare.

B.                 What are the deadweight costs of a 100% successful ban?

C.                Once prohibited, products are often still sold illegally on the "black market."

D.                Supply and demand of prohibition: How do legal penalties on sellers affect the market?  Legal penalties on buyers?

E.                 One obvious impact of prohibition is to raise the price.  (Why?)  A less obvious impact is to reduce product quality.

F.                 Product quality tends to decline because the usual market assurances of quality (reputation, warrantees) don't work well in an illegal market. 

G.                Reputation makes you an easier target for the police, and warrantees are hard to enforce in an illegal market.  Therefore you get a lot of rotgut liquor, adulterated narcotics, venereal disease... 

H.                 This is due to prohibition, not the products themselves.