3.6 Government intervention

Intervention to control mergers

The CMA (competition & markets authority) is the UK gov regulator: ensure monopoly power is avoided.

-main forms of consumer exploitation is high prices, low output, poor quality + less choice.

One way to control monopoly power is to prevent it from forming in the first place.

2 roles of CMA in controlling mergers

Monitor merger activity with the aim in preventing a single firm gaining more than 25% market share (legal monopoly)

• CMA has the authority to stop it from happening, or can allow it to go ahead but insist the new firm sells certain assets which would limit its market share.

• e.g. In April 2019, CMA blocked the merger between Sainsbury’s + Asda as they believed it would lead to higher price, reduced quality + poor shopping experience.

Intervention to control monopolies

Price regulation

Profit regulation

Quality standards

Performance targets

Price regulation

Monopolies are profit maximising (MC=MR), resulting in higher prices+limited output+lower CS.

• CMA uses max prices to lower prices + increase output. (usually on natural monopolies)

  • set max price at point of allocative efficiency where P = MC

  • firms will make less supernormal profit

e.g. ofgem, a gas + electricity company, set an energy price cap

Benefits + evaluation of max prices

+rise in consumer surplus + reduction in producer surplus

+deadweight loss is eliminated- economic+social welfare is maximised

-excess demand

-reduces incentive to invest in innovation due to lower profits

Price regulation in UK

RPI-X formula: RPI=retail price inflation and X=expected efficiency improvements; price is set below inflation rate which limits how how prices can rise + forces firms to be more efficient to continue to make profit.

RPI-X+K: K=level of investment; allows firms to make profit but forces them to invest back into firm to gain more profit- efficiency gain passed onto consumers. used in water industry + has allowed for investment of £130bn

-difficult to know where to set value of X due to rapid improvements in technology + disputes over it

-firms may lie about what the efficiency gains might be (asymmetric info). e.g. water industry forced to cut prices by 10% in 2000.

Profit regulation

CMA can limit the supernormal profit a monopoly can earn by setting the price to allow firms to cover their operating costs + then earn a rate of return on capital employed.

-aim is to encourage investment + prevent firms from setting high prices for more profit.

e.g. Southern California Edison(SCE) for water services has a specific rate of return on investment in infrastructure e.g. power plants, transmission lines, etc.

Cons of profit regulation

-firms try to inflate perceived costs to make more profit than allowed- imperfect info

-costs are difficult for CMA to calculate

-little incentive to minimise costs + be more efficient as it will not improve their situation.

Quality standards

Pros + cons

• One way to maximise profits is to reduce quality of raw materials, reducing the quality of the end good/ service.

  • regulators can insist that certain quality standards are met.

+protects consumers by ensuring safety, reliability + high performance

+reduces monopolistic exploitation

-can be difficult to know the potential quality of a product/ what standards to impose

-monopolies may lobby/ suggest self-regulation

Performance targets

Pros + cons

Raise quality of service+improve customer satisfaction.

-targets over price, quality, consumer choice, CoP

e.g. UK rail sector- train companies given targets over % of trains that arrive on time

+encourages efficiency + improved service

+provides measurable benchmarks to ensure firms meet economic + social objectives

-monopolists attempt to find ways to meet targets without actually improving quality e.g. changing train timetables so train journeys become officially longer

-asymmetric info as performance data isn provided by firms

Intervention to promote competition + contestability

Promotion of small businesses (to enhance competition)

Deregulation

Competitive tendering

Privatisation

Promotion of small businesses + its pros

Gov. give training + grants to new entrepreneurs + encourage small businesses through tax incentives or subsidies.

+increases competition as there will be more firms within the market + offer a chance for more firms to join.

+increases innovation + efficiency- new firms likely to provide new products, incumbent firms unable to be X-inefficient.

Deregulation

Removing government controls+regulations from markets e.g. price controls, in order to increase competition, contestability as it is easier to enter market, as well as efficiency + innovation.

e.g. UK postal services market deregulated in 2006: Royal Mail lost monopoly to open to competition from other delivery companies: Evri, DPD, etc.

Pros + cons of deregulation

+leads to new & innovative products + services, as companies are free to take risks e.g. deregulation of postal services market led to growth of e-commerce + online retail which also increased competition- improved allocative efficiency

+improved consumer choice- new companies can enter market+existing firms can expand offerings, increasing contestability (improves economic welfare)

-inequality- large companies may dominate market + small businesses may struggle to compete

-reduced safety + quality- companies may prioritise profits over safety+quality to increase market share

Competitive tendering (contracting out)

Private sector firms bid against each other for contracts to provide public sector services/ projects.

e.g. laundry service in hospitals, school meal services

Pros + cons of competitive tendering

+promote competition: encourages competition among suppliers, leading to better prices + improved competition.

+greater efficiency: by opening up gov contracts to private companies, it encourages greater efficiency + innovation in service delivery.

-quality of services: private companies may prioritise profits over quality, leading to decline in standards

-limited choice: discourages bidders + limit no. of offerings if process deemed too competitive

Privatisation

• The transfer of ownership of a state-owned enterprise to the private sector.

  • can be done through an initial public offering (IPO) involving selling shares to the stock market.

-firms may be hesitant to enter industry if gov. owned + has access to all of the gov’s resources: privatisation encourages entrants as they can compete more effectively with private firms.

e.g. Royal mail was fully privatised in 2016, initially through IPO where private investors purchased shares.

Pros + cons of privatisation

+access to capital: provides businesses with access to private capital, allowing for investment in infrastructure+technology upgrades.

+economic efficiency: incentive to innovate, reduce waste + improve service quality to remain competitive- leads to improvement in productive + dynamic efficiency.

-profit motive: may lead to higher prices for consumers + a focus on profit at the extent of service quality.

-job losses: new owner may seek to cut costs by downsizing the workforce. e.g. there’s been redundancies at Royal mail since privatisation.

Intervention to protect suppliers + employees

Protecting suppliers:

Restricting monopsony power

Nationalisation

Protecting employees:

Workers rights

National minimum wage

Protecting suppliers

Anti-monopsonist laws: make certain practices illegal+can introduce a regulator who force monopsonists to buy fairly.

-can subsidise firms suffering from abusive monopsony power + set minimum prices which buyers have to pay suppliers.

Nationalisation: when gov. takes control + ownership of firms that were in the private sector.

-break market power of abusive firm resulting in better treatment of suppliers

Pros + cons of nationalisation

+allocative efficiency: services + industries are operated in the public interest rather than for private profit e.g. utilities, healthcare

+job security: private companies often prioritise profit over job security, leading to wage cuts+layoffs.

-lack of innovation: not driven by profit + competition, so often less dynamically efficient + innovative.

-bureaucracy: increased bureaucracy+red tape as public firms are subject to more regulations + procedures, slowing decision making + its inefficient.

Protecting employees

Profit maximising firms often try to cut costs by reducing wage expenditure as it results in higher profits.

• national minimum wage legislation

• workers rights- legislation on health, safety, working hours + employment conditions e.g. maternity pay

  -permitting trade unions to operate (organisations that aim to protect+advance the interests of its members in the workplace).

Impact of gov intervention

Prices: ↓ prices for consumers

Profit: ↓ abnormal profit (supernormal) of firms which lower CS + turn it into PS

Efficiency: ↑ productive, allocative + dynamic efficiencies

Quality: improve quality of products where it’s an issue

Choice: ↑ consumer choice both of supplier and of product

2 limits to gov intervention

Regulatory capture

Asymmetric info

Regulatory capture

When a regulator begins to favour the company they’re regulating.

-firms have more info than regulators, or can threaten to take regulator’s decisions to court which puts jobs at the regulatory body at harm

-some firms pay their regulators, so firms have power over the regulator

e.g. regulators with BP- gave them permits to drill for oil in Gulf of Mexico without checking if it was safe, leading to oil spills

Asymmetric info

• Firms can minimise amount of unfavourable info given to regulator

• Governments may not have enough info when setting price caps, leading to poor decisions + waste of resources