Rationale For Regulation:

Basically there are two theories for government regulation, viz., market failure and public interest. Market failure occurs when there are externalities in the production process. In the presence of externalities the exclusion principle may not hold entirely. Moreover, the market mechanism cannot capture externalities and the production is not at socially optimum level.  As private sector does not find it profitable to carry out production of commodities with positive externalities, there is a need for government intervention. In fact, in the case of pure public goods there is a strong case for government production.

There are certain situations where excludability features apply and there is market for the commodity under consideration. According to the public interest theory, it is in the interest of general public that the government should intervene in the market. We look into situations that warrant government regulation on grounds of public interest. Before that we briefly state the fundamental theorems of welfare economics without proof.