Government intervention

Competition and markets authority

A UK government regulator tasked with ensuring that the creation of monopoly power is avoided and that consumers are not exploited in markets

• The main forms of consumer exploitation include higher prices, less choice and lower quality products

Types of intervention in Monopoly markets

• Price regulation

• Profit regulation

• Quality standards

• Performance targets

Why does the CMA intervene in markets?

To promote competition and protect the interests of consumers

Price regulation

Monopolies aim to profit maximise at MC=MR

• This results in higher prices, and restricted output

The CMA uses maximum prices to lower prices and increase output

• Where the maximum price is set, is determined by where allocative efficiency is

Firms will make less SNP than before.

Profit regulation

The CMA may choose to limit the SNP a monopoly can earn

• This is done by calculating the firms total costs then adding a percentage profit to it

• The effect of this can be limited however for several reasons/evaluations

Evaluation of profit regulation

It may be less effective because:

• Costs are difficult for the CMA to calculate

• Firms often try to inflate their perceived costs so as to make more profit than allowed

• Monopolies have no incentive to lower costs, so if costs are higher than they would be in perfect competition, consumers still end up paying higher prices

• Even with this policy in place, natural monopolies seem to post record profits year on year

Profit regulation can be done by forcing firms to lower prices to the point where ideal profit is being made

Quality standards

One way to maximise profit is to reduce the quality of raw materials, which reduces the quality of the end good/service

• If there are no substitutes, then this is a likely outcome (evident in a monopoly)

• Regulators can step in to insist that certain quality standards are met

• This reduces SNP for the firm, because they face higher costs

Evaluation of quality standards

It can be difficult for the regulator to know what the potential quality of a product is, or what standards to impose

Firms can push back on these quality standards

Performance targets

Regulators can also set performance targets, so as to raise the quality of the service and improve customer satisfaction

• This is often seen in the rail industry where targets are set based on the percentage of trains running on time

Intervention to promote competition and contestability

• Promotion of small businesses

• Deregulation

• Competitive tendering

• Privatisation

Promotion of small businesses to promote competition/contestability

Providing tax incentives or subsidies to small firms can help increase the number of new entrants into industries, thus promoting competition

Deregulation to promote competition/contestability

This is the process of removing government controls from markets in order to increase competition

Government regulations can increase industry costs or act as a barrier to entry. Removing regulations can promote competition, which will also increase contestability

Competitive tendering

This is when the government draws up a specification for a good/service it wants to provide and receives bids from private firms for the contract to provide it.

(The bidding here is the costs of providing the good/service by the private firms, governments will choose the most cost effective option)

Competitive tendering to promote competition and contestability

If the firm is the provider of the good/service, then the gov is the only provider, meaning no competition. This comes with many downsides

The government can then use competitve tendering, meaning private firms take control of providing that good/service.

By outsourcing the supply of these products, it generates more private sector actitvity and promotes competition

Privatisation as a method to promote competition and contestability

Firms are hesitant to enter an industry when the dominant firm is owned by the government and has access to all of the government resources.

• Privatisation encourages new entrants as they feel they can compete more effectively with private firms, which will have fewer resources available to them

• Private firms are easier to compete against because they have less access to funding and resources compared to the government

Nationalisation

When the government takes control and ownership of firms that were in the private sector

Intervention to protect suppliers

Monopsony power is abuse to suppliers, and can change the nature of entire industries overtime

• Governments can pass anti monopsony laws and issue fines if breaches occur

• They can encourage firms to self regulate and trade fairly

• They can appoint a regulator to monitor the practices

• They can subsidise firms suffering from abusive monopsony power

• They can set minimum prices which buyers must pay suppliers

Intervention to protect employees

• Wage bills for firms are often one of their highest cost

• With a goal of profit maximisation, firms always seek to reduce wage expenditure, as it will result in higher profit

• This means there’s a role for the government to protect workers who could be exploited by firms.

• This could be:

  • National minimum wage

  • Legislation on health and safety, working hours, and employment conditions

  • Permitting trade unions to operate in the economy

  • Encouraging firms to adopt best practice and draw up codes of conduct.

The impact/desired outcomes of government intervention

• Affordable and stable prices

• Enough profit to keep a firm in business (normal profit), but not too much to protect household income

• Efficiency

  • Minimum wastage is optimal, and this can be done by developing rigorous competition

• Quality

  • Ensuring products are fit for purpose and contribute to a better standard of living

• Choice

  • Wider choice improves the standard of living, and also improves product quality. More choice also generates more economic activity in an economy, and increases GDP.

    • More economic activity is created because consumers are more willing to spend on products more catered to them.

Limits to government intervention

• Regulatory capture

• Asymmetric information

Regulatory capture

This occurs when firms influence regulators to change their decisions/policies to align more with the interest of the firm

• Firms can spend millions lobbying regulators/politicians directly

• Some lobbying activity is corrupt.

  • There’s a fine line between influencing activity and bribing. The UK government has an agenda to improve the transparency of any lobbying activity

When markets are more complex, this becomes more significant

Outcome of regulatory capture

It can lead to unfair outcomes in the markets concerned

Asymmetric information as a limit to government intervention

• Often governments believe they’re making the best decision in order to meet their aims

• Many times, it is not the best decision due to the fact that the government or regulators either do not have the full and relevant information - or they don’t understand the market they’re trying to regulate

• This leads to government failures

• When markets are more complex, this becomes more significant