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...are politically likely on some occasions, but not on others. The answer to the question as to when corrective action will be taken depends in part on the reason for the inconsistency, and in part on other aspects of the situation. In what follows we sketch some ideas to distinguish the politically likely from the practically impossible.
We begin with some basic categorization of reasons for inconsistency with the benchmark model of choice. A key issue is whether the behavior on the part of consumers or firms arises from information imperfections, real transactions cost, or from deviations of preferences from those postulated in the benchmark case. Our conclusions can be summarized on these three cases as follows:
(1) If the cause of the deviation from benchmark behavior is information imperfections, the solution for the government either is (a) to provide the information or (b) to mandate or incentivize the action that would have occurred if the agent(s) had been properly informed. Whether doing so will be politically feasible or cost-effective depends on whether citizens are aware that they are imperfectly informed and how expensive it is to communicate this information to them.
(2) If the cause is transactions costs, steps to reduce them in efficient ways should be taken. One should not necessarily assume that information technology or other similar strategies will lower transactions costs enough to cover insurers' own costs, or that the government (as opposed to buyers or sellers of insurance) should pay those costs. However, markets do sometimes take steps to lower costs, even if the steps are small and slow. Probably the best example is automobile insurance, where the less costly "direct writing" method eventually displaced the more expensive (if more attentive) independent agent approach.
(3) If the cause is a preference structure different...
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More articles from Foundations and Trends in Microeconomics
Market-based approaches to environmental regulation., October 01, 2005
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3 Issues in the design of market instruments., October 01, 2005
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