June 4, 2020 

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PERFECT COMPETITION, REVENUE DIVISION: The marginal approach to analyzing a perfectly competitive firm's short-run profit maximizing production decision can be used to identify the division of total revenue among variable cost, fixed cost, and economic profit. The U-shaped cost curves used in this analysis provide all of the information needed on the cost side of the firm's decision. The demand curve facing the firm (which is also the firm's average revenue and marginal revenue curves) provides all of the information needed on the revenue side.

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The notion that a government agency established to regulate an industry for the benefit of society acts instead for the benefit of the industry. In effect, the government agency is "captured" by the industry it is regulating. The capture theory of regulation indicates that government regulator acts as the decision-making "head" of a now monopolized industry. This is achieved by a "rotating door" between the government agency and the industry, with members of the regulating agency being former and future employees of the industry. Rather than promoting efficiency, the regulating agency creates an inefficient allocation of resources.
The capture theory of regulation provides insight into the close connection that tends to arise between a government regulatory agency and the industry it is charged with regulating. Federal, state, and local governments commonly create agencies designed to oversee and regulate specific industries.

Problems arise when a regulating agency acts in the best interests of regulated industry to the detriment of the general public. Consider an official (albeit hypothetical) agency of the Shady Valley city government charged with regulating the Shady Valley sundial manufacturing industry. It was established to ensure that Shady Valley sundial manufacturers produce a safe, high-quality product and that the three firms in the industry don't monopolize the market.

This regulatory agency is likely to be captured by the industry if the five members running the agency also happen to be former executives of the regulated firms and hope to be reemployed by the firms after a brief stint in the agency. Their careers are not tied to the paltry pay they receive as government regulators, but as executives in the sundial industry.

With this in mind, when an issue comes before the agency, such as whether or not sundial manufacturers should be required to use a more expensive material that doesn't tend to explode when the temperature reaches 90 degrees, they are likely to rule in favor of a less expensive (possibly exploding), but more profitable material. The sundial firms are better off and the regulators future incomes are likely to be higher when they rejoin their former employers.

Government, The Regulator

The government sector is the economy's rule maker. Governments create and enforce the rules. That is, the public sector regulates the private sector. This regulation can be as simply and as common as traffic laws or as complex and intricate as industrial regulation.

A few of the more notable industries subject to public sector regulation are communications, energy, transportation, and banking. For example, the Federal Communications Commission (FCC) regulates the television and radio broadcasting industry and the Federal Reserve System (the Fed) regulates the banking industry.

Regulations imposed by these agencies include price controls, quantity controls, production techniques, and even operating practices. The FCC, for example, regulates who can use the electromagnetic spectrum to broadcast programs. The Fed regulates who can provide banking services.

The stated objective of such regulation is "usually" to protect and promote the public interest. Many of the regulated industries have a significant degree of market control and/or provide an "essential" good or service. Regulation is then undertaken to prevent the industry from creating problems for society by charging high prices or limiting production.

Agency Capture

While government regulatory agencies are "suppose" to protect the public from the actions of the industry, at some times they act only in the best interests of the industry. This can happen when the industry "captures" the regulatory agency. How might an industry capture its regulatory agency?

A regulatory agency usually requires a great deal of specialized knowledge about the industry being regulated. Regulation of the banking industry requires knowledge of how the banking industry works. Regulation of the broadcast industry requires knowledge of the broadcast industry.

Unfortunately those who have the most knowledge about the industry tend to be the ones working in the industry, ranging from technical support staff and scientists to managers and executives. A person might spend 20 years working in the industry, 5 years with the regulatory agency, then return to the industry for the next 10 years.

The question with this temporary, revolving door service is who are the regulators actually serving? Are they looking out for the best interests of the public? Or are they looking out for the best interests of the former and future employers. If the agency is effectively controlled by "regulators" who remain, in essence, industry employers in every sense of the word except receiving a current paycheck, the industry has captured the regulatory agency.


Presuming that the regulatory agency was established for the purpose of correcting inefficiency, when the industry captures the agency, the inefficiency is not corrected. In fact, industry control of the agency can even worsen inefficiency.

In particular, government agencies are often created to regulate oligopoly industries comprise of a small number of firms, each with a moderate degree market control. If the industry captures the agency, this industry can be effectively transformed into a monopoly. The regulatory agency then exerts a great deal more market control acting as the effective "head" of the industry.


Recommended Citation:

CAPTURE THEORY OF REGULATION, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2020. [Accessed: June 4, 2020].

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