10.1 Monopoly Regulation

Question 1

Monopoly Regulation Diagram

Answer 1

Question 2

What are 4 reasons that a competition authority may choose to intervene?

Answer 2

A competition authority may choose to intervene when there is antitrust behavior and cartel agreements, when markets are highly concentrated with dominance from one or a few firms, when there is merger activity that could result in outcomes against the public interest, and to ensure that state aid control in the form of subsidies to domestic firms in a given industry does not restrict competition or provide an unfair advantage over another industry.

Question 3

When do competition authorities have rationale to intervene in an industry?

Answer 3

Competition authorities have rationale to intervene in an industry when the public interest is being harmed due to monopoly or oligopoly market abuses.

Question 4

What is antitrust behavior?

Answer 4

Antitrust behavior refers to firms in highly concentrated oligopolistic markets agreeing to fix prices or quantities acting clearly against the public interest.

Question 5

How can regulators intervene to liberalize the market?

Answer 5

Regulators can intervene to liberalize the market using policies such as privatisation, deregulation, and trade liberalisation when markets are highly concentrated with dominance from one or a few firms leading to outcomes against the public interest.

Question 6

What can regulators do when there is merger activity that could result in outcomes against the public interest?

Answer 6

When there is merger activity that could result in outcomes against the public interest, regulators can step in and investigate, potentially breaking up the merger if that merger leads to market share in excess of 25% and market domination.

Question 7

What is state aid control?

Answer 7

State aid control refers to ensuring that subsidies to domestic firms in a given industry do not restrict competition in an economic area like the EU or provide one industry an unfair advantage over another.

Question 8

What do regulators investigate if subsidies are only going to a state-owned provider of services?

Answer 8

If subsidies are only going to a state-owned provider of services, regulators can investigate to ensure no artificial advantage is at play.

Question 9

What is excess pricing?

Answer 9

Excess pricing is where monopolies exploit consumers by charging prices in excess of marginal cost, reducing consumer surplus and burdening those on low incomes in particular.

Question 10

What is the aim of ensuring the quantity and quality of provision is high?

Answer 10

The aim of ensuring the quantity and quality of provision is high is to prevent monopolies from producing at an output below socially desirable levels, which restricts consumer choice. Without a competitive drive, the quality of the good or service produced might not meet the demands of the consumer. Regulation can enforce minimum standards for the monopolist.

Question 11

How can regulators promote competition in concentrated markets?

Answer 11

Regulators can promote competition in concentrated markets by liberalising markets, which could take the form of privatisation, deregulation, or trade liberalisation, all of which encourage more competition and contestability in the market, breaking up market dominance.

Question 12

What are natural monopolies?

Answer 12

Natural monopolies are industries with very high fixed costs and huge economies of scale. It makes sense for one firm to exploit full economies of scale and supply the entire market. Competition would be wasteful both in economies of scale lost but also in terms of resources used as the incumbent will price out new entry.

Question 13

Why is it dangerous to allow one firm to dominate a natural monopoly market freely?

Answer 13

Allowing one firm to dominate an industry freely is dangerous because the monopoly pricing and provision can be against the interest of consumers, hence there is rationale for regulation to promote socially desirable outcomes in a natural monopoly market.

Question 14

What is the aim of promoting technological advancement?

Answer 14

The aim of promoting technological advancement is to prevent monopolies from making large supernormal profits but not re-investing them back into the company. Regulators can intervene and force the re-investment of profits if it is in society’s best interest.

Question 15

What is the intention of price regulation?

Answer 15

The intention of price regulation is to cap prices of monopolists at allocatively efficient levels in the market, acting as a price ceiling. This can increase social welfare in the market and recover the deadweight losses of both consumer and producer surplus that existed due to monopoly abuses.

Question 16

What is RPI price regulation?

Answer 16

RPI price regulation caps price increases by the RPI inflation rate. Allowing firms to increase prices by the rate of RPI inflation will allow firms to cover their costs and still make a profit if they find efficiency savings (cost savings).

Question 17

What is RPI-x price regulation?

Answer 17

RPI-x price regulation is more severe than RPI regulation, where x represents a given percentage. If PI is 4% and x is 2%, this means that firms can only increase prices by 2% forcing efficiency savings to be found. If regulators feel that monopolies are charging excessively high prices, they can punish firms by setting a high value of x to protect consumers.

Question 18

What is RPI +/-k price regulation?

Answer 18

RPI +/-k price regulation allows firms to increase prices by enough to fund capital investments whilst still protecting the consumer from excessive prices, where k represents a given percentage. If RPI is 4% and k is +1%, it means firms can raise prices by no more than 5% to make enough profit to fund capital investment. If regulators feel as though enough profit can be made if prices rise by less than RPI, k can be negative.

Question 19

Evaluation 1: What is a benefit of price regulation?

Answer 19

Price regulation of any sort encourages firms to find efficiency savings, to cut costs as much as possible in the hope to charge prices at the regulated price but still making a profit as costs have been cut by more than the price increase.

Question 20

Evaluation 2: What is a potential problem with regulatory bodies setting the level of x and k?

Answer 20

Regulatory bodies may set the level of x and k wrongly because they lack perfect information regarding costs and revenues for a given firm despite their investigations. As a consequence, x might be set too high or k too low where firms do not make enough profit to survive in the industry deciding instead to shut down or move production elsewhere. If x is set too small or k too high, prices may still be charged in excess of marginal cost, burdening consumers and reducing consumer surplus. As regulation is costly in maintaining the existence of regulatory bodies and in both administration and enforcement of regulation, these unintended consequences could result in government failure, where the costs of intervention outweigh the benefits.

Question 21

Evaluation 3: What is a cost-related drawback of regulation?

Answer 21

Regulation is very costly in maintaining the existence of regulatory bodies and in both administration and enforcement of regulation. There is an opportunity cost argument where this money could have been used more effectively to fund other policies or other areas of the economy. This is a strong argument if regulation creates unintended consequences or is not strict enough to promote socially optimum outcomes.

Question 22

Evaluation 4: What is a potential problem with firms successfully adapting to regulation?

Answer 22

Firms may be punished for successfully adapting to the regulation. For example, if firms found efficiency savings of more than x allowing supernormal profits to be made even with RPI-x regulation, regulators may respond by increasing x, burdening firms unfairly.

Question 23

Evaluation 5: What is regulatory capture?

Answer 23

Regulatory capture could occur when managers and CEOs that continue to work in the industry influence the regulator in a way that benefits them as opposed to the interests of society. The end outcome is a lower value of x or a higher value of k resulting in a slight improvement in resource allocation, but not enough to fully solve the inefficiency of monopoly and promote competition due to regulation set that is purposefully weak. Given the very high costs of regulatory bodies, this is substantial government failure.

Question 24

2) What is Quality Control or Performance Targets in monopoly regulation?

Answer 24

Quality Control or Performance Targets can be used to regulate monopolies, such as fining monopoly train providers for having more than a certain number of delays a day, forcing gas and electricity providers not to cancel winter supply if a pensioner fails to pay a bill, or imposing time targets for ambulance services to get to patients who need emergency care. Such targets force a monopolist to meet the needs and wants of society providing services at minimum requirements and increasing the quantity of services provided.

Question 25

Evaluation 1: What are the potential negative consequences of strict performance targets?

Answer 25

Strict performance targets can have unintended consequences, such as shortcuts being taken or mistakes made in diagnosis due to GPs rushing meetings with patients to hit their performance targets.

Question 26

Evaluation 2: How can strict performance targets lead to firms finding ways around regulation?

Answer 26

Strict performance targets can lead to firms "gaming" the system and finding ways around the regulation. For example, train companies might lengthen journey times beyond what is necessary to compensate for potential delays, in order to avoid fines for excessive delays. History suggests that heightened regulation will promote such behavior by firms, going against the intentions of the policy.

Question 27

3) What is Profit Control or 'Rate of Return' Regulation in monopoly regulation?

Answer 27

Profit Control or 'Rate of Return' Regulation is where regulatory authorities impose a maximum level of profit that a firm is allowed to make, equalizing that to what a competitive firm would make given the same costs and revenues. The equation used is for operating costs to be covered adding on a rate of return for all capital machinery employed. This will force firms to reduce prices to make profits within the permitted level as excessive profits will either be taxed away or regulators will enforce harsher price cuts on the monopolist.

Question 28

Evaluation 1: What are the potential issues with regulators having perfect knowledge of costs and revenues?

Answer 28

Such profit regulation requires regulators to have perfect knowledge of costs and revenues of the monopolist. However, there is asymmetric information and a strong incentive for the monopolist to over-report costs to increase permitted profit.

Question 29

Evaluation 2: How can profit regulation promote the wrong incentives for a firm?

Answer 29

Profit regulation promotes the wrong incentives for a firm who will not control their costs, knowing that costs will always be covered by the profit control equation. This encourages wastefulness in production and inefficiency, an unintended consequence of the regulation.

Question 30

Evaluation 3: How can profit regulation incentivize firms to make inefficient production decisions?

Answer 30

Profit regulation will incentivize firms to over-employ capital even if it is not necessary and not a worthwhile investment for the firm. This is because more capital employed will increase the permitted level of profit that can be made. This is wasteful and an inefficient production decision, an unintended consequence of the regulation.

Question 31

What are windfall taxes on monopoly profits?

Answer 31

Windfall taxes on monopoly profits are taxes that could be applied to the supernormal profits earned by a monopoly firm, incentivizing the firm to lower its prices and overall profit. The revenue collected from these taxes could be used to enforce other forms of monopoly regulation, maintain the existence of regulatory bodies, or fund essential public services in the economy.

Question 32

How could taxation affect the outcomes for consumers?

Answer 32

Taxation increases marginal costs for monopolists, leading to even higher prices and lower quantities at the profit-maximizing level. This worsens outcomes for consumers and leads to an even greater misallocation of resources, which goes against the intentions of the policy.

Question 33

How could taxation promote tax avoidance behaviour?

Answer 33

Taxation on monopoly profits promotes tax evasion and tax avoidance behaviour, where firms find loopholes in the tax system to avoid paying full tax or they simply underreport the level of profit made to evade paying taxes. Monopoly pricing and large supernormal profits remain, with little benefit from the tax revenues collected.

Question 34

What is the potential disadvantage of taxing monopoly profit?

Answer 34

Taxing monopoly profits can reduce significant dynamic efficiency gains, where firms reinvest supernormal profit back into the company in the form of technology advances, innovative new products, and R&D. Consumers benefit from dynamic efficiency by receiving brand new, better quality products over time. Prices could be lower too if technology advances reduce costs for businesses. Taking away profits through taxation will therefore take away these significant benefits to the consumer.

Question 35

5) What can competition authorities do if a merger between two companies results in a market share in excess of 25% and is likely to harm the public interest?

Answer 35

If a merger between two companies results in market share in excess of 25%, competition authorities can act in two ways if the merger is likely to harm the public interest. The merger could be blocked completely or the merger can be allowed but with forced selling of stores to rivals to encourage greater competition in areas where there is danger of monopoly pricing.

Question 36

6) What are Privatisation and Deregulation?

Answer 36

Privatisation is the sale of state-owned assets to private firms, and deregulation involves reducing government regulations on firms to increase competition. These are both competition policies aimed at increasing competition and efficiency in markets. They can also have distributional effects on income and wealth. The government may choose to privatise or deregulate industries in order to increase efficiency or raise revenue.

Question 37

1) What is the flaw in the assumption that regulators will have perfect information when enacting price regulation and profit regulation?

Answer 37

The assumption that regulators will have perfect information when enacting price regulation and profit regulation is flawed because information regarding monopoly costs and revenue is imperfect with clear information asymmetry in reality. Excessively strict regulation could result in unintended consequences such as firms shutting down or moving production to another country where regulation is not as severe. Similarly, if regulation is too lax, there may not be the allocatively efficient outcomes desired, resulting in costs of the regulation outweighing the benefits and therefore government failure.

Question 38

2) What is the cost of maintaining regulatory authorities and what are the consequences if benefits via lower prices, better quality and higher quantities produced where social welfare improves in the market do not occur due to regulation being set incorrectly?

Answer 38

Regulation is costly in maintaining regulatory authorities, and in both administration and enforcement. Taxpayers must pay this cost in the hope of benefits via lower prices, better quality and higher quantities produced where social welfare improves in the market. If these benefits are minimal or do not occur due to the regulation being set incorrectly, regulatory capture, or the financial costs being excessively high, government failure will result, worsening the prior misallocation of resources and reducing social welfare even further.

Question 39

3) What is the biggest concern of monopoly regulation and why does it occur?

Answer 39

Regulatory capture is the biggest concern of monopoly regulation as regulators are often ex-industry personnel. The risk of regulators acting too softly on firms because of the influence of industry contacts significantly increases the chance of government failure and regulation not resulting in outcomes that increase social welfare.

Question 40

4) What are the advantages of monopoly and when is there an argument for lax or no regulation?

Answer 40

Monopoly can have significant advantages such as dynamic efficiency benefits, economies of scale exploitation, and cross-subsidization. If monopolies are engaging in any of these activities, there is an argument for lax or no regulation as this is clearly in the public interest, benefitting society significantly. Strict regulation that prevents these benefits from occurring would reduce social welfare and could result in government failure where the costs of the policy outweigh the benefits.

Question 41

5) Why is the type of regulation used important in a natural monopoly market, and what type of regulation is needed for a private natural monopoly?

Answer 41

If the market is a natural monopoly, it makes sense for one firm to supply the entire industry. The type of regulation used is important in such a market to ensure that welfare-promoting outcomes are attained. Liberalizing the market by opening it up to competition would promote a wasteful duplication of resources, allocative inefficiency, and lack of the huge economies of scale that a single natural monopoly would be able to exploit, resulting in productive inefficiency. Instead, a private natural monopoly needs regulation that lowers prices and generates higher quantities at the allocatively efficient level given that natural monopolies often provide essential services for the function of society.