Knowledge that Transforms

This paper concerns the regulation of hazardous economic activities. Economists have generally viewed ex ante regulations (safety standards, Pigouvian fees) that regulate an activity before an accident occurs as substitutes for ex post policies (exposure to tort liability) for correcting externalities. This paper shows that where there is uncertainty, there are inefficiencies associated with the exclusive use of negligence liability and that ex ante regulation can correct the inefficiencies. In such a case it is efficient to set the safety standard below the level of precaution that would be called for if the standard were used alone.

Best-price provisions guarantee buyers that the prices they pay are the lowest available. If the seller subsequently cuts price, then each previous buyer is entitled to a refund. A durable-good monopolist who offers certain forms of these provisions can construct a consistent plan yielding the same profits as rental agreements and contracts with explicit quantity commitments. The provisions require special circumstances to be practical, but they are simple and effective and appear in a variety of economic settings. Three applications are discussed: international commodity agreements, markets for electric turbogenerators, and markets for financial claims.