Theme 6 II F: Firms and Decisions

State command and market-orientated policies

Command measures	Market-oriented Measures
Regulation Deregulation Regulate pricing Nationalisation (Public ownership)	Subsidies Corporate taxation

Describe MonoC, Oligo, Mono on whether need GI

MonoC	AE: Extent of welfare loss not severe  Normal profits in LR -> equity  Overall: Benefits > costs -> no GI
Oligo and mono	AE: High market power -> large extent of welfare loss  Supernormal profits in LR -> inequity  Overall:  Monopoly: yes GI  Oligopoly: yes GI in more concentrated (heading towards a monopoly - collusion)

Define market dominance

• Market dominance (Def.): Extent to which the total output in a market is produced by one firm 

Describe aim of CCCS

• Aim of CCCS: Ensures firms battle on a level playing field and compete through greater efficiency, lower pricing, and improved products so that consumers benefit from lower pricing, new products, and greater choices

State regulations government can impose

1. Disallowing mergers / acquisitions that lead to a significant concentration of market power by a single firm 

2. Making price-fixing (where firms agree to sell their product at a specific price) and predatory pricing illegal

3. Breaking up monopolies 

Explain Making price-fixing (how it works)

• Firms must pay fines if they get caught -> disincentivises firms from engaging in anti-competitive agreements -> less supernormal profits

• Less market power + more competition -> improve AE 

• Governments use loss aversion to nudge firms against anti-competitive behavior -> firms want to avoid loss from fines

Explain Making price-fixing (limitations)

1. Difficult to prove that firms collude or engage in anti-competitive actions (Especially tacit collusion) 

2. Small fine may not be sufficient to disincentivise firms from engaging in anti-competitive behaviour -> loss aversion on firm limited -> reduce effectiveness of fine as deterrent

Explain Making price-fixing (example)

In 2018, after Grab acquired Uber’s Southeast Asia operations, Grab was fined about $6.4 million while Uber was fined $6.58 million by CCCS as the merger was deemed to have significantly reduced competition in the ride-hailing market in Singapore (As it removed Grabs closest rival)

Explain breaking up monopolies (how it works)

• Governments can file lawsuits against large firms that abuse their market power to break them up into smaller firms

• Firms are forced to divest, selling off a portion of their assets to increase competition -> improve AE

Explain breaking up monopolies (limitations)

1. Rival firms may abuse anti-trust laws to retaliate against successful firms who captured a large part of the market because they were able to provide consumers with a better product

2. Prevent firms from reaping the benefits of mergers (EOS -> lower costs and prices)

Explain breaking up monopolies (examples)

In 2022, the US Federal Trade Commission filed an antitrust lawsuit against Facebook (now Meta) -> targeting the takeover of Instagram and WhatsApp, to break up the monopoly power

Describe deregulation

• Governments can also ‘open up’ markets by reducing BOE -> increase supply, competition and innovation -> lower prices for consumers

• With a reduction in market power of dominant firms, the market moves towards a more efficient and equitable outcome

Describe electricity market in Singapore 

• Natural monopoly due to high BOE (high cost of setting up generators, purchasing specialised equipment and laying cables) 

• Since 2001, the Singapore government has progressively opened up the electricity market

• The potentially competitive functions of generation and retail have been separated from functions such as the transmission and distribution of electricity, which exist as natural monopolies

• Starting from 2018, households can choose to buy electricity from a retailer at a price plan that best suits their needs 

• At its peak, households and businesses can choose to purchase electricity from around 12 active and licensed electricity retailers, compared to just from SP Group (back then was a monopoly)

Describe entities involved in bringing electricity to consumers

1. Generation companies manage the power plants that generate electricity

2. Grid company manages the transmission and distribution network

3. Retailers and Market Support Services Licensee (MSSL) sell electricity to consumers

• In Singapore, SP Services serves as the MSSL

• It provides services such as retail settlement and meter reading, facilitates customer transfers between retailers for all consumers and supplies electricity at the regulated tariff (pre-determined fixed price) to consumers who have not appointed an electricity retailer

4. Energy Market Authority (EMA) regulates the market to ensure that Singaporeans have a secure, sustainable and affordable energy supply (NOT bring electricity to consumers)

Describe regulate pricing 

• Monopoly has significant EOS -> case for continuation of monopoly is strong as consumer get lower prices 

• BUT firms with market dominance restrict output and produce less than AE output 

• Government can regulate monopoly/oligopoly pricing 

Describe natural monopoly 

• Market can only support 1 firm 

• Characterised by falling AC and MC throughout whole range of output level for market 

• Arises from significant EOS + high set-up costs 

• Eg. Railroads 

• Deregulation is not an option since only one firm can produce the good/service profitably

• AND better for industry to remain a monopoly for lower prices (can supply a good or service to an entire market at a lower unit cost than could two or more firms)

Describe MC pricing on natural monopoly 

• Original welfare loss: area abe 

• Government uses MC pricing -> compel monopolist to charge Pmc and produce Qmc where MC = AR 

• Firm will earn subnormal profits of (Pac-Pmc) x Qmc (shaded area) 

To solve this: 

1. Government would have to subsidise the natural monopolist for the loss (shaded area) so that the monopoly earns at least normal profits 

• In order for the monopoly to be able to continue production

OR 

2. Natural monopolist is allowed to levy a fixed initial charge for access to the service such that this fixed charge = shaded area to offset the loss due to pricing the goods below the AC

• Charge = registration fees, connection fees, administrative charges

• This is ‘two-part tariff’ system

Draw MC pricing on natural monopoly graph

Draw MC pricing on normal monopoly/oligopoly graph

• MC pricing: earn supernormal profits if P₁ = MC > AC₁

• AC pricing: earn normal profits

Describe AC pricing on natural monopoly

• If the government is not willing or unable to subsidise the monopoly, then the next best alternative is to implement AC pricing

• Make the natural monopolist charge Pac and produce Qac so monopolist makes normal profits

• Improve AE (but still have a little welfare loss) without government incurring expenditure from subsidy

State limitations of MC/AC pricing

• Due to imperfect information, regulators do not know the demand and cost curves of the monopoly

• In order to maximize profits, the monopolist has incentive to provide regulators with inaccurate information so that they can produce less and charge higher prices for more profits.

Describe nationalisation and its limitation 

• Governments take over the natural monopoly and become the producer of the good -> nationalised firm will produce the allocative efficient output and charge the price, P = MC (funded by tax revenue) 

OR 

• Government to build and manage the network and allowing private profit-maximising firms to rent the network to supply the product and services directly to consumers

• Eg. The government could own and operate the cable network for cable TV and different private cable TV firms can pay the government for the use of the network while competing against each other in supplying cable TV programmes to consumers.

Limitation:

1. Government lacks incentive to minimise costs -> X-inefficiency 

2. If the government covers the losses of the natural monopoly, it may result in opportunity cost

Describe subsidy and limitation 

• Government could provide the monopolist with a per unit production subsidy that lowers MC so MC (that is inclusive of the subsidy) = MR @ AE output 

Limitation: 

• Such subsidies lower the firm’s AC -> increase supernormal profits -> more inequitable income distribution

Describe tax and limitation 

• Government could tax the monopolist’s supernormal profits -> improve income distribution (taxes redistributed to the poor in society) 

Limitation: 

• Reduces the incentive for the firm to invest in R&D -> no DE