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Market Failure or Success

The New Debate

Edited by Tyler Cowen and Eric Crampton

Recent years have seen the development of new theories of market failure based on asymmetric information and network effects. According to the new paradigm, we can expect substantial failure in the markets for labor, credit, insurance, software, new technologies and even used cars, to give but a few examples. This volume brings together the key papers on the subject, including classic papers by Joseph Stiglitz, George Akerlof and Paul David. The book provides powerful theoretical and empirical rebuttals challenging the assumptions of these new models and questioning the usual policy conclusions. It goes on to demonstrate how an examination of real markets and careful experimental studies are unable to verify the new theories. New frontiers for research are also suggested.
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Chapter 9: The demand for and supply of assurance

Daniel B. Klein


1 Daniel B. Klein QUALITY AND SAFETY RESTRICTIONS Many agree that the consumption and production of bread are best left to voluntary processes. But many who favor free enterprise for such tangible goods oppose it for matters of quality and safety. The economist Jerome Rothenberg (1993) says: ÔThe marketÕs myriad decentralized actions do not themselves ensure adequate safety. Centralized controls of various sorts are needed. These have been instituted in the form of regulations, constraints, information programs, licensing and certificationÕ (172). Sometimes economists and others espouse quality and safety restrictions such as housing codes, occupational licensing, pharmaceutical approval, consumer product recalls, financial exchange regulations, and workplace safety regulations. I will offer a formulation of these matters that suggests that the broad reasons we favor free enterprise in bread carry over to quality and safety issues. TRUSTERS AND PROMISERS Many transactions involve promises of quality and safety that cannot be fully verified before the fact. One party decides whether to trust the other to deliver what is promised. A consumer decides whether to trust the grocer or pharmacist or mechanic to deliver the quality promised. A merchant decides whether to trust a prospective employee. A landlord decides whether to trust a prospective tenant. The canonical example is a creditor deciding whether to trust a borrower who promises to repay the loan. The trust relationship is clarified by Figure 9.1. Truster (the creditor) decides either to trust or not trust Promiser (the prospective borrower). If Truster decides to trust, then Promiser...

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