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Regulation in Happyville*

Authors


  • *

     We thank the Editor and the two anonymous referees as well as David Bardey, Timothy Besley, Yann Bramoullé, Patrick Gonzales, Kevin Haninger, Bruno Jullien, Jack Marshall and Bernard Salanié for comments. We also thank audiences at the Universities of Toulouse, Iowa State, Santa Barbara, Wageningen, Nottingham, Lille, Grenoble, Montréal-Uqam and Harvard. This research has benefited from the financial support of the Chair ‘Marché des risques et création de valeurs’, Fonation du risque/SCOR.

Abstract

How does risk perception affect risk regulation? Happyville is a society in which citizens wrongly believe that the drinking water supply is contaminated. We discuss conditions under which a benevolent Director of Environment Protection would invest in a water cleanup technology. This holds if the Director is populist, namely if he maximises social welfare based on citizens’ pessimistic beliefs. More surprisingly, investment in the water cleanup technology may occur if the Director is paternalistic, in the sense that he maximises social welfare based on his own beliefs. The reason is that he must take into account citizens’ responses to regulation.

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