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Typically, competition aligns the interests of producers with those of consumers. Consumers want higher quality and less costly products, and producers have an incentive to provide them because, if they do not, their rivals will. However, this alignment can break down in a variety of circumstances. For example, if consumers lack information about quality or price, they can end up purchasing products they would not have otherwise wanted. If there are enough uninformed consumers, producers may have the incentive to set prices that are too high or quality that is too low.
Consumer protection laws and regulations are designed to realign the incentives of producers with the goals of consumers by preventing certain kinds of firm behavior, like deceptive advertising, and by mandating others, like information disclosures. However, these regulations also raise costs, so assessing whether consumers are better off under these regulations requires careful benefitcost analysis.
For example, in 2005 the European Commission required that airlines compensate passengers in the event of canceled flights, regardless of the cause. So when airlines sell tickets, they must bundle what amounts to trip insurance with the tickets. Consumers are better off if the price of airline tickets goes up by less than the value that consumers place on the trip insurance. But if some consumers value trip insurance while others do not, then unbundling tickets from insurance may be a better solution, as it allows those consumers who do not value the flight insurance to purchase tickets without it. Finally, there is the consideration of safety. If airlines were forced to pay more for canceled flights, one would expect to see more flights in bad weather, with a corresponding decrease in safety. Balancing all of these considerations is necessary to determine whether the regulation helps or hurts consumers.
Consumer protection agencies want to enforce regulations and laws where there is the biggest net benefit, and this has led them to focus most of their enforcement resources on prosecuting deception. If sellers misrepresent their products or services, mislead consumers about the terms of the bargain, or unilaterally try to change those terms postpurchase, then transactions can occur that reduce welfare. Such behavior is most likely where products are infrequently purchased, where claimed characteristics of the product are not verifiable by consumers or rival sellers at low cost, where seller reputations are unimportant for profitable sales, or where buyers are particularly vulnerable or gullible. Governments focus much of their consumer protection efforts on such markets. In this role, government can act as an efficient agent for the mass of consumers who might have suffered injury, but do not pursue individual legal remedies because of the cost. Governments attempt to obtain remedies that will correct the wrong, and also efficiently deter future violations by the offending firm (called specific deterrence) and others (called general deterrence).
Beyond simply deterring deception, consumer protection actions can sometimes improve market outcomes through the provision of information (e.g., health warnings by governments or by firms), by development of standard metrics that make consumer shopping and market competition more efficient (e.g., uniform interest rate calculations), or by regulating the conditions for sale of valuable, but potentially unsafe, products or services (e.g., minimum quality standards for drugs, or vehicle tires). Also, in instances of extreme consumer susceptibility, governments sometimes intervene to regulate the terms of implicit or explicit contracts (e.g., “at need” funeral purchases, unmonitored marketing to children, or mandatory waiting periods for finalizing mortgages).
Early-twenty-first-century changes in consumer protection laws and enforcement have been caused by the migration of advertising away from magazines and newspapers to broadcast radio and TV, cable, direct mail, telephones, and the Internet. Because the newer media span the globe and because retail marketing by distant sellers has become more common, consumer protection has become an international and multilingual endeavor, with cross-border partnerships being formed by regulators from different nations. Law revisions are designed to more efficiently deter deception, but some are aimed at ensuring consumer privacy. One of the most effective efforts is the 2003 Do Not Call rule that allowed U.S. consumers to choose to avoid a large portion of marketing calls. By 2005 more than 100 million Americans chose to have their phone number included on the list, allowing them to avoid unwanted telemarketing calls.
In the United States, consumer protection laws began in the early 1900s, by protecting competitors—not consumers—from damage resulting from rivals’ deceptive claims. Over time, the law became more centered on harm to consumers, but the fear of monopoly power was often the only effect economists considered. Systematic thought about the economics of consumer issues began with George Stigler’s 1961 paper inviting academics to think about how information and advertising might play a positive role in shaping market outcomes. At the same time, economist, social reformer, and U.S. Senator Paul H. Douglas (D-IL) drafted one of the first major consumer information rules—the Truth in Lending Act—that was enacted by Congress in 1968. A decade later, a small group of economists began working on consumer issues at the U.S. Federal Trade Commission.
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