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Microeconomics Question from Walter E. Williams:Edit

Discuss the following statement: "In a competitive market the least cost production techniques are revealed through entry and exit, while in public utility regulation they are revealed by commission rate hearing. It is easier to fool the commission than the market. Therefore, whenever possible competition should be permitted."

AnswerEdit

In a competitive market, if profits are being made, new firms will enter, increasing supply, driving down the prices, and encouraging innovation. All firms that remain must have a production function that allows them to produce at a cost low enough so that in the long run they are not taking losses. Firms with higher costs of production will not be able to sell at the going price without taking a loss and will therefore exit the market. This exit channels resources previously used by these firms into the hands of low-cost, efficient producers. The commission board essentially regulates the profit level and thereby reduces the incentive to search for the least cost method of production. They generally do not have least-cost production as their only goal. There is no way for a commission to ‘reveal’ least-cost production techniques, since they can only guess what the market would reveal. (Nothing prevents firms from using guesswork, but they prefer the market as it is more accurate.) Additionally, a commission shifts the focus from market competition to competition for favors from the commission. So competition should be permitted.

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