REGULATION OF PRODUCT-SAFETY CHARACTERISTICS UNDER IMPERFECT OBSERVABILITY

In this paper, we consider the problem of setting minimum safety stand ards for observable safety characteristics and the proper amount of ef fort in the production of safety for a product which has some unobserv able safety attributes. We formulate a second-best optimum for a regul ator, examine the interplay between safety effort and a minimum safety standard, and study how the internalization of excess costs or benefi ts by a self interested regulator affects the minimum safety standard and the safety effort level. Finally, we present two examples using a utility function which is widely used in the law and economics literat ure.