01 RATIONALES FOR CONSUMER LAW & POLICY
Introduction
1. General principles
Usually consumer law requires one party to be acting in a business capacity & the other to be
acting in a private capacity
Consumer: Generally a natural / legal person who is acting for purposes which are
outside his trade, business, craft / profession (Unfair Commercial Practices Directive)
For mixed contracts, the Consumer Rights Directive allows a person to be a consumer
so long as the trade purpose is ‘not predominant’
Consumer law aims to protect consumers from the risk of suffering ‘consumer detriment’
Consumer detriment: ‘A commercial practice / behaviour of a business / trader resulting
in harm (loss of welfare) caused to individuals’ (Consumer Protection Partnership)
Consumers are typically less powerful, less knowledgabel and/or less wealthy than traders
2. Principal sources of consumer problems (Ziegel)
Disparity of bargaining power between trader & consumer
Disparity of information between trader & consumer ‘Information asymmetry’
Disparity of resources between trader & consumer
‘The Chicago School’: Classical / Neo-classical / Free market economic theory
3. Assumption 1: Markets work best with minimal regulation
If markets were to work perfectly, there would be little / no need for state intervention
FMEs would argue that some laws (e.g. contract / property law) are necessary to set out
the rules but the laws should not impose provisions which restrict consumer choice (e.g.
mandatory standards / prior approval by licensing)
High enforcement costs Create an exclusionary effect
Regulations are prone to backfire / tend to be counterproductive
‘Paradoxes of the regulatory state’ (Sunstein)
Overregulation produces underregulation
A stringent standard will provide the regulators with a powerful incentive for
inaction as their effect can appear disproportionate
Stringent regulation of new risks can increase aggregate risk levels
The standards for new products is likely to make them more expensive than they
would’ve been had the standards not been introduced Increases the price gap
between old & new products Discourage consumers from purchasing new
ones
To require the best available technology is to retard technological development
If we insist firms to use the best technology available, industries have little
incentive to come up with better ways of doing things Discourages innovation
Redistributive regulation harms those at the bottom of the socioeconomic ladder
Disclosure requirements may make people less informed
People may be poor at processing information, not helped by regulators being
under incentives to generate information overload
If we apply standards at too high a level we may reduce the amount of
information as traders refuse to advertise for fear of their information being
deemed misleading
Independent agencies & not independent
May be independent from the Gov but will be subject to other significant
pressures
BUT: It comes down to the designs of the instruments Balanced regulation
4. Assumption 2: Consumers are ‘sovereign’ & ‘rational maximisers of their own utility’
Sovereign: In control of the market
BUT:
Rather than respond to the demands of consumers, suppliers create those
demands in the first place (JK Galbraith)
, Traders have the power to manipulate market demands via effective marketing
strategies
Rational: Act consistently in accordance with their preferences
A rational individual is assumed to act based on cost-benefit analyses & self-interest
An ‘average consumer’ is ‘reasonably well-informed & reasonably observant &
circumspect’ (ECJ test Unfair Commercial Practices Directive)
BUT:
Possible consumer images as a reference point for the law (Wilhelmsson)
o Fully informed consumer
o Information seeker (closest to the ‘average consumer’)
o Passive glancer
o Snatcher
o Irrational consumer
o Consumer without choices
‘Average consumer’: Not entirely objective The law does not assume that all
consumers are the same
Behavioural economics: Consumer biases / tendencies (Ramsay) Helps in
analysing the effectiveness of current EU consumer law & how it can be
improved
o Hyperbolic discounting: The tendency to prefer small benefits now rather
than larger benefits later
o Over-optimism: The tendency to over-estimate one’s competence
o Framing effects: How information is framed / presented matters
enormously to how it is perceived by the individual
o Availability: Individuals estimate the probability of a risk by the ease with
which the particular risk comes to mind May result in consumers being
unduly pessimistic (particularly prominent information e.g. airline
accidents)
o Anchoring: Individuals tend to focus on convenient / easily accessible
information in decision-making
o Information overload
o Fairness: Individuals care about how others are treated in the market &
are willing to punish firms that act unfairly
o Emotions: Basis for decision-making (e.g. status & ‘bandwagon’ effects)
5. Elements / Characteristics of the ‘perfect market’
Numerous buyers & sellers
Free entry to & exit from the market
Product homogeneity
‘Perfect information’
No ‘externalities’
Can be regulated via legislation
Can be regulated via private law (contract, tort, property law)
Consumers will modify their behaviour even if there were minimal legislation due
to the redress available via private law
6. Benefits of the free market
Efficiency: Competition
Firms will be under incentives to improve quality, offer better terms & lower prices to
attract & retain customers Goods products will drive out poor products
Ideology: Respectful of individual autonomy
Regulation typically limits consumers’ choices, replacing them (in effect) with choices
made by the state
7. Private law
Contract: Great emphasis on the ‘freedom of contract’
, Agreements entered into ‘freely & voluntarily’ (Jessel)
BUT: People seldom contract on equal footing; usually traders have the advantage
(Ziegel)
Arguments against intervening on bases that contracts are substantively unfair (Collins)
Apparent unfairness is illusory
o While an outcome may appear unfair at 1 st glance, there may be a
legitimate reason for the result
Intervention makes it harder to construct markets
o Parties need to know that their agreements will be respected so that they
can plan appropriately
Danger of regulatory backfiring
Better to tackle market failure
Tort: Protects consumers’ economic interests & safety
Not premised on the agreement of the parties (cf contract law)
Transaction costs: The expenses of enforcing consumer rights are usually much higher than the
actual loss suffered by consumers
Consumers may require a ‘superspite’ attitude to pursue their rights (Leff)
Produces uneven benefit distributive effects (for the disadvantaged consumers)
Market failure
8. General principles
In reality, markets often fall short of the ideal ‘perfect market’
Where the allocation of goods & services is not efficient
The ‘principal factor justifying consumer policy market interventions’ (OECD) Market-
correcting
9. Factors which result in market failure
Lack of competition
Natural monopolies: Uneconomic to have numerous suppliers
Situational monopolies (e.g. airplanes’ prices)
Oligopolies: Dominance of a (select few) supplier(s)
Barriers to entry
Economic barriers
Legal barriers (e.g. prior approval by licensing)
Product differences
Information gaps / asymmetry / deficits
Unevenness of information between parties (typically between traders & consumers, to
the benefit of traders)
Information consumers generally want (London Economics for the OFT)
Price of the product, complements & substitutes
Quality of the product (relative to substitutes)
Terms of trade
Why won’t the market supply information?
Credence goods: Goods of which the characteristics cannot be identified even
after they have been consumed
o cf Search goods (goods of which the characteristics can be identified
before purchase) & experience goods (goods of which the characteristics
can only be identified after they have been consumed)
Incentives for traders, rivals & 3rd parties
Bounded rationality (Herbert Simon) Information overload Focal point
competition
Complementary products
o ‘Shrouded attributes’: Additional costs deliberately hidden from
consumers
Introduction
1. General principles
Usually consumer law requires one party to be acting in a business capacity & the other to be
acting in a private capacity
Consumer: Generally a natural / legal person who is acting for purposes which are
outside his trade, business, craft / profession (Unfair Commercial Practices Directive)
For mixed contracts, the Consumer Rights Directive allows a person to be a consumer
so long as the trade purpose is ‘not predominant’
Consumer law aims to protect consumers from the risk of suffering ‘consumer detriment’
Consumer detriment: ‘A commercial practice / behaviour of a business / trader resulting
in harm (loss of welfare) caused to individuals’ (Consumer Protection Partnership)
Consumers are typically less powerful, less knowledgabel and/or less wealthy than traders
2. Principal sources of consumer problems (Ziegel)
Disparity of bargaining power between trader & consumer
Disparity of information between trader & consumer ‘Information asymmetry’
Disparity of resources between trader & consumer
‘The Chicago School’: Classical / Neo-classical / Free market economic theory
3. Assumption 1: Markets work best with minimal regulation
If markets were to work perfectly, there would be little / no need for state intervention
FMEs would argue that some laws (e.g. contract / property law) are necessary to set out
the rules but the laws should not impose provisions which restrict consumer choice (e.g.
mandatory standards / prior approval by licensing)
High enforcement costs Create an exclusionary effect
Regulations are prone to backfire / tend to be counterproductive
‘Paradoxes of the regulatory state’ (Sunstein)
Overregulation produces underregulation
A stringent standard will provide the regulators with a powerful incentive for
inaction as their effect can appear disproportionate
Stringent regulation of new risks can increase aggregate risk levels
The standards for new products is likely to make them more expensive than they
would’ve been had the standards not been introduced Increases the price gap
between old & new products Discourage consumers from purchasing new
ones
To require the best available technology is to retard technological development
If we insist firms to use the best technology available, industries have little
incentive to come up with better ways of doing things Discourages innovation
Redistributive regulation harms those at the bottom of the socioeconomic ladder
Disclosure requirements may make people less informed
People may be poor at processing information, not helped by regulators being
under incentives to generate information overload
If we apply standards at too high a level we may reduce the amount of
information as traders refuse to advertise for fear of their information being
deemed misleading
Independent agencies & not independent
May be independent from the Gov but will be subject to other significant
pressures
BUT: It comes down to the designs of the instruments Balanced regulation
4. Assumption 2: Consumers are ‘sovereign’ & ‘rational maximisers of their own utility’
Sovereign: In control of the market
BUT:
Rather than respond to the demands of consumers, suppliers create those
demands in the first place (JK Galbraith)
, Traders have the power to manipulate market demands via effective marketing
strategies
Rational: Act consistently in accordance with their preferences
A rational individual is assumed to act based on cost-benefit analyses & self-interest
An ‘average consumer’ is ‘reasonably well-informed & reasonably observant &
circumspect’ (ECJ test Unfair Commercial Practices Directive)
BUT:
Possible consumer images as a reference point for the law (Wilhelmsson)
o Fully informed consumer
o Information seeker (closest to the ‘average consumer’)
o Passive glancer
o Snatcher
o Irrational consumer
o Consumer without choices
‘Average consumer’: Not entirely objective The law does not assume that all
consumers are the same
Behavioural economics: Consumer biases / tendencies (Ramsay) Helps in
analysing the effectiveness of current EU consumer law & how it can be
improved
o Hyperbolic discounting: The tendency to prefer small benefits now rather
than larger benefits later
o Over-optimism: The tendency to over-estimate one’s competence
o Framing effects: How information is framed / presented matters
enormously to how it is perceived by the individual
o Availability: Individuals estimate the probability of a risk by the ease with
which the particular risk comes to mind May result in consumers being
unduly pessimistic (particularly prominent information e.g. airline
accidents)
o Anchoring: Individuals tend to focus on convenient / easily accessible
information in decision-making
o Information overload
o Fairness: Individuals care about how others are treated in the market &
are willing to punish firms that act unfairly
o Emotions: Basis for decision-making (e.g. status & ‘bandwagon’ effects)
5. Elements / Characteristics of the ‘perfect market’
Numerous buyers & sellers
Free entry to & exit from the market
Product homogeneity
‘Perfect information’
No ‘externalities’
Can be regulated via legislation
Can be regulated via private law (contract, tort, property law)
Consumers will modify their behaviour even if there were minimal legislation due
to the redress available via private law
6. Benefits of the free market
Efficiency: Competition
Firms will be under incentives to improve quality, offer better terms & lower prices to
attract & retain customers Goods products will drive out poor products
Ideology: Respectful of individual autonomy
Regulation typically limits consumers’ choices, replacing them (in effect) with choices
made by the state
7. Private law
Contract: Great emphasis on the ‘freedom of contract’
, Agreements entered into ‘freely & voluntarily’ (Jessel)
BUT: People seldom contract on equal footing; usually traders have the advantage
(Ziegel)
Arguments against intervening on bases that contracts are substantively unfair (Collins)
Apparent unfairness is illusory
o While an outcome may appear unfair at 1 st glance, there may be a
legitimate reason for the result
Intervention makes it harder to construct markets
o Parties need to know that their agreements will be respected so that they
can plan appropriately
Danger of regulatory backfiring
Better to tackle market failure
Tort: Protects consumers’ economic interests & safety
Not premised on the agreement of the parties (cf contract law)
Transaction costs: The expenses of enforcing consumer rights are usually much higher than the
actual loss suffered by consumers
Consumers may require a ‘superspite’ attitude to pursue their rights (Leff)
Produces uneven benefit distributive effects (for the disadvantaged consumers)
Market failure
8. General principles
In reality, markets often fall short of the ideal ‘perfect market’
Where the allocation of goods & services is not efficient
The ‘principal factor justifying consumer policy market interventions’ (OECD) Market-
correcting
9. Factors which result in market failure
Lack of competition
Natural monopolies: Uneconomic to have numerous suppliers
Situational monopolies (e.g. airplanes’ prices)
Oligopolies: Dominance of a (select few) supplier(s)
Barriers to entry
Economic barriers
Legal barriers (e.g. prior approval by licensing)
Product differences
Information gaps / asymmetry / deficits
Unevenness of information between parties (typically between traders & consumers, to
the benefit of traders)
Information consumers generally want (London Economics for the OFT)
Price of the product, complements & substitutes
Quality of the product (relative to substitutes)
Terms of trade
Why won’t the market supply information?
Credence goods: Goods of which the characteristics cannot be identified even
after they have been consumed
o cf Search goods (goods of which the characteristics can be identified
before purchase) & experience goods (goods of which the characteristics
can only be identified after they have been consumed)
Incentives for traders, rivals & 3rd parties
Bounded rationality (Herbert Simon) Information overload Focal point
competition
Complementary products
o ‘Shrouded attributes’: Additional costs deliberately hidden from
consumers
