3.3.5.1 - government intervention in product markets

the case for government intervention

governments should control monopolies because profit maximising monopolists are not productively/allocatively efficient and earn supernormal profit at the expense of customers

measures to control monopolies & mergers - price regulation

the government can impose a maximum price on monopolies, set to the marginal social cost of production. this would ensure allocative efficiency in the market.

measures to control monopolies & mergers - profit regulation (& issues with it)

the govenrment can ensure that monopolies do not earn more profit than they would in a competitive industry, by setting a maximum level of profit.

however, this has many issues associated with it:

- requires regulators to have a good understanding of the firm's costs, and the monopolist has incentive to ensure there is asymmetric information so they can earn more profit

- monopolies have little incentive to minimise costs, does not matter what they are as they are paid by the customer

- incentive to employ too much capital if they are awarded percentage rate of return on it

measures to control monopolies & mergers - quality standards

govts can set quality standards where it is an issue for monopolies that are profit maximisers and so focus on profit rather than quality

measures to control monopolies & mergers - performance targets

govts set targets for various outputs from firms, such as price, quality, customer choice etc.

monopolies resist the imposition of performance targets, particularly if they will look bad for not meeting them, and so find ways to get around them

measures to control monopolies & mergers - referral to regulatory authorities

laws allowing monopolies to be investigated by govt if it is thought to be exploiting consumers/being anticompetitive, and can be made to pay a fine

measures to control monopolies & mergers - legislation to control mergers/takeovers

preventing monopolies happening in the first place --> laws to investigate large mergers that reduce competition in market

merger policy is designed to prevent firms from exploiting customers by raising prices and reducing choice in the market due to less competition

measures to promote competition & contestability - tax incentives/grants to promote small businesses & fdi

govts can give training/grants to new entrepeneurs, or subsidise small businesses to encourage growth and create greater competition in the market

fdi firms receive fundiggn an expertise to expand and produce goods that enter the market faster, use the latest technology & practices to ensure efficiency, often joint ventures between foreign/domestic firms that increase competition and choice and decrease prices

measures to promote competition & contestability - deregulation

deregulation is the process of removing government control from markets, and can decrease monopoly power

- govt may allow private firms to compete in a market being supplied by a state monopoly

- govt may lift regulations preventing competition between private firms, eg. lifting the limit of premises in a local area a firm can use

- improved efficiency through competition by decreasing prices (productive efficiency) and output while reducing prices (allocative efficiency) as firms will be forced to reduce them in order to compete with the rest of the industry

CREAMING: firms only providing services in most profitable areas of markets, problem with deregulation

measures to promote competition & contestability - privatisation

privatisation will only increase competition if the national firm is split into competing firms or if barriers to entry are low enough to entice new firms into the market

private sector firms under increased competition should lead to lower prices and higher output

measures to promote competition & contestability - competitive tendering for public sector contracts

when the government makes a contract for the good or service they need made from the private sector (eg. army tanks, hospital bedsheets) and invites private sector firms to bid for the contract to deliver it -- firm offering lowest price wins

encourages competition as opposed to going to the same firm every time, since it could become a monopoly supplier

measures to promote competition & contestability - trade liberalisation

removal/reduction of protectionist measures against free exchange of goods/services like tariffs/quotas

allows efficient foreign firms to export to a country and keep prices low, domestic firms encouraged to be more efficient to compete, and local monopolies cannot charge higher prices anymore due to higher competition and contestability

measures to protect suppliers and employees - local sourcing of raw materials & components

can force firms to use a minimum amount of raw materials/components that are sourced locally, preventing firm from using too many imports and so protects domestic firms

measures to protect suppliers and employees - employment legislation to protect workers from exploitation

- legal protection in health and safety, maximum hours, redundancy procedures and the right to trade unions all protect workers from exploitation and firms must adhere to them or be prosecuted

- trade unions can protect members from employers in advocating for safe working conditions and wage rates, the govt must make a legal framework for trade unions to operate

- govt can encourage firms to write codes of conduct for employment practices, but this is voluntary and often unsuccessful

measures to protect suppliers and employees - barriers to entry of foreign firms

govts can force foreign firms to have a percentage of the business be owned by a local person/firm, preventing them from setting up in a country and making high profits to send back to their own country

measures to protect suppliers and employees - restrictions on monopsony power of firms

monopsonies have the power to considerably reduce the prices they pay to suppliers & exploit them, therefore:

- govts can pass anti-monopsony laws

- can hire an independent regulator to force monopsonists to change practices through a code of practice with the threat of large fines

- can encourage self-regulation so they draw up their own code of practice, but this is often unsuccessful

measures to protect suppliers and employees - nationalisation

nationalisation can solve the problems of private sector monopolies damaging consumer surplus through high prices/low output

a nationalised monopoly can operate for the benefit of consumers, prices can fall and output can increase, and costs do not have to rise if the govt can employ the right management

however, inefficiency may rise, leading to higher costs and eventually higher prices due to lack of competition

impact of government intervention

- lowers prices for consumers

- reduces supernormal profits that firms gain by converting con. surp. into prod. surp.

- increases productive/allocative/dynamic efficiency

- increases product quality

- increases customer choice of products and suppliers

limits to govt intervention - regulatory capture

govt failure, when a regulatory agency created to act in public interest is more concerned with dominating business/political groups in the regulatory industry

it advances the agenda of the people/entities it is supposed to regulate, more likely to give generous terms of regulation

limits to govt intervention - asymmetric information

regulator may rely on information from firms that may be biased, and so may be generous to firms as a result as they have less information than the firm and so cannot make a truly informed decision

voluntary codes of conduct usually result in firms writing them in a way that minimises costs, and can pressure the government if they are told to make the codes more thorough

limits to govt intervention - inadequate resources

resources can be insufficient to investigate and control monopolies or promote competition, such as understaffing

limits to govt intervention - lack of regulatory power

if regulators have limited power, monopolies can continue being anti-competitive, particularly if it is profitable for them, regulation will be ineffective