REGULATING EXTERNALITIES THROUGH TESTING

Testing for compliance with regulation of a negative externality is analyzed in a strategic framework. The outcome is described where the number tested and the penalties for observed noncompliance are each controlled by different agencies, or by different levels within the regulatory agency, and where the number tested cannot be precommitted. Comparative statics results are provided, and the equilibrium is compared with the welfare optimum for different objectives of those doing the testing. It is shown that the actual enforcement decision can sometimes be optimally delegated, even if those doing the enforcement have objectives different from minimizing expected social cost. © 1990.