3.1.19 - Government Intervention Flashcards
What is government intervention?
Occurs when the government intervenes in a market through regulatory action to overcome market failure.
What is the role of the competition and markets authority regarding mergers?
Investigates mergers that result in a market share of around 25% or more to prevent uncompetitive outcomes.
This investigation helps ensure that mergers do not exploit customers through practices like high prices or low quality.
What outcomes does the competition and markets authority aim to block in mergers?
Outcomes that are not in the public’s interest, such as:
* High prices
* Low quantity
* Low-quality standard
These outcomes are potential risks associated with large market share ownership.
Under what conditions is a merger more likely to be prevented?
If the merger company would have a large market share in a large and economically powerful market.
Such markets are often scrutinized to maintain competition and protect consumers.
In which types of markets are mergers more likely to be prevented due to national interest?
Markets of particular national interest, such as:
* Financial services
* Media
These sectors are critical to the economy and public welfare.
What consideration must the UK government take into account for multinational companies during merger evaluations?
Competition regulation in other countries, such as the EU or USA.
This consideration ensures compliance with international regulations and maintains fair competition.
How is the UK’s approach to regulation described?
Considered to have a ‘light touch’ towards regulation in the area of mergers.
A lighter regulatory approach can encourage investment but may also lead to vulnerabilities.
What is a potential downside of the UK’s ‘light touch’ regulation?
It leaves UK firms open to hostile takeovers which may not be in the long-term interest of the UK economy.
Hostile takeovers can disrupt company operations and affect job security.
What was the reason the Competition Commission blocked Lloyds TSB’s takeover of Abbey National in 2001?
It was felt that it would adversely reduce competition in the current account market as they would have a 27% share.
The decision was made to protect competition in the banking sector.
What market share would Hienz have gained from its takeover of HP in 2006?
80% market share in the sauce and ketchup market.
This raised concerns about potential higher prices in the market.
What action did Hienz take in 2007 after the takeover of HP?
Closed the HP factory and moved production abroad.
This indicates the impact of mergers on local production.
What does the difference in treatment of the Lloyds TSB and Hienz cases suggest about government priorities?
It may indicate the difference in the perceived importance of these two markets to the UK economy by the government.
The government may prioritize competition in essential markets differently.
What are the three types of price caps used for regulating monopolies?
- RPI inflation cap
- RPI-X cap
- [additional type not specified]
Each type of cap varies in strictness depending on the required regulation.
What does the RPI price cap allow firms to do?
Increase their prices by the level of RPI inflation.
This helps firms cover inflationary increases in their costs.
In the RPI-X pricing cap, what does ‘X’ represent?
A certain percentage lower than the retail price index.
This encourages firms to increase their efficiency.
True or False: The RPI price cap allows for real price increases.
False.
In real terms, prices have stayed the same despite nominal increases.
Fill in the blank: The first price cap is based on the _______.
inflation measurement retail price index.
This cap is designed to reflect inflationary pressures.
What is the purpose of implementing the RPI-X price cap?
To restrict price increases by a lower percentage than that of the retail price index.
This method aims to promote operational efficiency among firms.
What is the condition for a firm to make a substantial profit under price regulation?
The firm must cut their costs by more than the value of X.
What is the relationship between price increases and the rate of RPI in price regulation?
Prices can only be increased by a percentage below the rate of RPI.
What does K represent in the context of price caps?
K is a percentage that allows the firm to make a large enough profit for capital investment.
In what industry is this type of price regulation most commonly seen?
The water industry.
What does the diagram referenced illustrate about price regulation?
It shows the maximum price level at the point of allocative efficiency.
What is the desired effect of price regulation on monopolies?
To force monopolies to produce at a point where consumer satisfaction is maximized.
What are the expected outcomes of price regulation on price and quantity?
Lower price (PM to PQ) and an increase in the quantity of goods/services produced (QM to QC).
What challenge does the government face in determining the value of X?
It is hard to determine what the value of X should be, which could lead to government failure.
How could limiting profit impact a firm’s investment and efficiency?
It might limit how much investment they do and reduce dynamic efficiency.
What is regulatory capture?
When regulators start working in favour of the firm
This can lead to a conflict of interest where the regulatory body prioritizes the firm’s benefits over public interest.
What is rate of return regulation?
A type of profit regulation where the government determines a reasonable level of profit based on the rate of return on capital employed
This encourages firms to increase their capital employed.
What happens if a firm makes excessive profits according to rate of return regulation?
The government is likely to regulate the firm and reduce the profit through means such as taxation
This is to ensure profits are proportionate to the size of the firm or capital employed.
In which country has rate of return regulation been extensively used?
USA
It is primarily used to control utility companies such as electricity and water companies.
What is a major problem with rate of return regulation?
It requires regulators to have a good understanding of costs and rates of return in the industry
Without this understanding, regulators can be misled by monopolists.
What incentive does a monopolist have regarding cost predictions?
To predict to regulators that future costs will be higher
This creates a situation of asymmetric information.
What is asymmetric information in the context of regulation?
When the monopolist has more information than the regulator
This can lead to monopolists earning more profit than if they accurately predicted costs.
Do monopolists have an incentive to minimize costs?
No
They are allowed to cover their costs and earn a profit, regardless of the actual costs incurred.
What happens to customer costs if monopolists are allowed to cover their costs by raising prices?
Costs will be covered by the customer
This means customers bear the burden of higher costs without any incentive for the monopolist to reduce them.
How might the Government intervene to ensure firms meet minimum standards?
(In the Gas and Electric Industries)
Legislative means
How has the Government intervened in the Gas/Electric industries to ensure minimum standards?
- The Govt. has banned gas and electric companies from cutting off supplies to pensioners during winter
- This is due to the fact that many Pensioners may not be able to afford the rising prices set by these companies,
How has the Government intervened in the Postal industry to ensure minimum standards? (2)
- The UK Postal Service (Royal Mail) has a legal obligation to deliver letters on a daily basis to rural areas.
- This is despite the fact that deliveries to rural areas are loss making.
How might Monopolists attempt to resist the imposition of quality standards?
1) Suggest Self Regulation
2) Lobbying to water down quality standards, making compliance less costly.
3) Argue that over time, quality standards will come with new products, making regulations unnecessary.
What do Government need to have in order to impose quality standards on monopolists?
- Political Will - The Government won’t be able to implement regulation if there is opposition from Parliament.
- Understanding of the industry - so that regulation is meaningful
Why might the Government implement Performance Targets for Firms?
To ensure that they are operating in the consumer’s interest and that competitive outcomes are achieved.
How has the Government implemented Performance Targets in the Rail Industry?
- Performance targets are often set whereby a train company is only allowed to have a certain number of delays on a daily basis.
- Going past this figure may result in fines being issued
Why would Monopolists be concerned about not meeting performance targets? (2)
- Fines - The monopoly firm will incur penalties as they have failed to fulfill their legal obligations established by the government.
- Bad Publicity - May empower the entry of new competitors into an industry, or create popular demand for greater regulation against a firm.
An example of how bad publicity has impacted a monopoly firm
Thames Water, a regional monopoly, has in recent years faced calls by the general public to be renationalised by the UK Government, due to concerns over its environmental violations and having incurred significant debts.
What will Monopolists attempt to do if Performance Targets are set?
Find ways to ‘game the system’
How have Monopoly firms in the Rail industry found ways to ‘game the system’ to meet performance targets?
- To minimise the % of trains that are delayed, some Regional Rail Firms have changed the train timetable so that train journeys become officially longer
- This means that these Firms can avoid incurring penalties, whislt also not improving their services (by simply raising overall journey times to account for operational inefficiencies).
What do Government need to have in order to impose Perfomance Targets on monopolists?
- Political Will - The Government won’t be able to implement regulation if there is opposition from Parliament.
- Understanding of the industry - so that regulation is meaningful
- Adaptability - The government may have to alter performance targets frequently as Monopolists attempt to ‘game the system’
How might Governments promote small businesses to enhance competition?
- Deregulation - Making it so getting established in an industry is cheaper
- Finance for small businesses - Gives indivduals the credit they need to enter the industry.
Why do governments seek to promote small businesses?
- Increase contestability by lowering barriers to entry and reducing market share of large firms
- This will lead to competitive outcomes in markets, which will benefit consumers.
What has the UK Government done to enhance small businesses?
‘Red Tape Challenge’ (2011)
- Aimed to simplify regulation for businesses
- Aimed towards small businesses, who found it hard to meet environmental targets.
What are SMEs?
Small and Medium Sized Enterprises
* Businesses that fall below certain thresholds in terms of employees, turnover, or assets.
- In the UK, SMEs are categorised as Micro Businesses, Small Businesses, and Medium-Sized Businesses
Why are SMEs important for creating a competitive market? (3)
- Provide diverse goods and services in their markets
- Challenge the dominance of larger firms by encouraging fairer pricing.
- Help prevent monopolies in a market
What was Schumpeter’s idea of ‘creative destruction’
- The idea that new entrepreneurs are innovative, which challenges existing firms
- The more productive firms then grow, whilst the least productive are forced to leave the market
- Results in an expansion of the economy’s productive potential
What is Deregulation?
- The process of reducing legal barriers to entry (red tape) into a market
- This is done in order to incentivise more firms to enter the market and increase competition.
What is the Main Goal of Deregulation?
- To create Market Outcomes that benefit Consumers
- e.g. lower prices, greater quantity of goods/services produced, higher quality standards of products produced, better service, etc.
What are Market Efficiencies?
Market efficiencies refer to the extent to which market prices reflect all available, relevant information about the value of assets or goods.
What does an efficient market look like?
- Prices adjust quickly to new information
- Opportunities for arbitrage (profiting from price differences) are minimised.
- Buyers and Sellers can trade without excessive transaction costs.
How can Deregulation increase Market Efficiencies? (3)
- Reduced compliance costs - Allows firms to allocate resources to more productive areas such as innovation
- Enhanced Flexibility - Firms can quickly adapt to market conditions and consumer demands, reducing inefficiencies
- Driving Innovation - Without excessive restrictions, businesses are more likely to experiment and innovate, increasing market efficiency.
Why is a profit making firm likely to become dyanmically efficient due to deregulation?
- Entry of New Firms into Market
- Profit-Making Firm must lower their costs over time to remain competitive
- Thus firm becomes dynamically efficient, as it invests in new processes, develops new products, and reduces costs.
Why is a profit-making firm likely to become X-efficient due to deregulation?
- Entry of New Firms into Market
- Firm cannot afford to act in a wasteful manner otherwise they will be driven out of market
- This is because their high costs will prevent them from matching the lower prices of their competitiors.
- Thus they must try to become X-efficient
Why might Excessive Taxes dissaude firms from growing?
e.g. High Rates of Corporation tax
- Firms keep less of their profits if they earn above specific thresholds (e.g. 25% for profits <£250,000).
- This means that limits are placed on the size that a firm chooses, or is able to, grow to.
What is competitive tendering?
- Competitive tendering occurs when the government invites private firms to supply a good/service for a certain period
- e.g. contracting a private firm to build a school
Who introduced competitive tendering in the 1980s?
Margret Thatcher
What are the aims of competitive tendering?
To promote free market outcomes such as lower prices and greater quality within the public sector
What problem does competitive tendering aim to solve?
The absence of the profit motive in public sector organisations
Why do public sector organisations lack efficiency?
They do not make a profit and therefore lack the incentive to operate efficiently and reduce costs
How do private firms participate in competitive tendering?
They bid for the right to offer a good/service
What criteria do firms need to meet to win a government contract?
Offer to produce the good/service at the lowest price and greatest standard of quality
What effect does competitive tendering have on costs?
It forces down costs for the government.
What problem can arise from private firms in competitive tendering?
Cutting corners and not sticking to the original specifications
What is a potential consequence of private firms cutting corners?
Poor quality goods/services to be produced
Fill in the blank: Competitive tendering was introduced to solve the problems arising from the absence of the _______ in public sector organisations.
profit motive
What is privatisation?
Privatisation occurs when government run organisations are sold off to the private sector with the intention of increasing market efficiency.
The process aims to leverage the profit motive of private firms to enhance efficiency.
What is the primary motive of private firms compared to government run organisations?
The primary motive of private firms is profit, incentivising them to lower costs to remain competitive.
This profit motive contrasts with government run organisations that do not prioritize profit.
How does privatisation affect market efficiency?
Privatisation can lead to increased efficiency as private firms are more likely to be X efficient, allowing lower prices for goods/services.
‘X efficient’ refers to the ability to minimize costs and maximize output.
Does privatisation necessarily increase competition in a market?
No, privatisation does not necessarily increase competition if barriers to entry remain high or if a nationalized firm is not split into competing firms.
High barriers can prevent new entrants, maintaining a single firm in the market.
What is an example of a firm that was privatised and now operates in a competitive market?
British Airways was privatised in the UK and now operates in a competitive market.
This example illustrates how a previously nationalized entity can adapt to a competitive environment.
What argument do free market economists make regarding the private sector?
Free market economists argue that the private sector provides incentives for firms to operate efficiently, increasing economic welfare.
This contrasts with nationalised firms that lack profit incentives.
What is allocative efficiency, and how does it relate to privatisation?
Allocative efficiency occurs when firms produce goods and services that consumers want, potentially leading to higher quality.
This efficiency is enhanced by the competitive nature of the free market.
What might be a downside of firms profit maximising in a competitive market?
Firms which profit maximise in a competitive market might compromise on quality.
This trade-off can affect consumer satisfaction and product standards.
What financial benefit does the government gain from privatisation?
By selling the asset to the private sector, revenue is raised for the government.
This revenue is typically a one-off payment rather than a continuous income stream.
How was the Royal Mail privatised in the UK?
The Royal Mail was privatised by allowing it to float on the stock market, with the government owning 30% of the shares at the offer price.
This method of privatisation allows public investment while retaining some government influence.
What is the main regulatory body in the UK that restricts abusive monopsony power?
Competition and Market Authority
What did the Groceries Code Adjudicator find regarding Tesco in 2015?
Tesco breached their code of conduct by delaying payments to suppliers
What was the consequence for Tesco after being found in breach of conduct?
Bad publicity and fall in share price forced them to improve relationships with suppliers
Name one action that government can take to restrict monopsony power.
Pass anti-monopsony laws which make certain practices illegal
What is one role of an independent regulator in managing monopsony power?
Force monopsonists to change their buying practices through a code of practice
True or False: Self-regulation is considered the strongest option for managing monopsony power.
False
What must independent regulators be to ensure effectiveness?
Genuinely independent and not run by monopsonist representatives
Fill in the blank: Independent regulators must be able to impose large enough _______ to deter future misbehavior.
fines
What is a potential weakness of self-regulation by monopsonists?
They may draw up a code of practice that allows continued exploitation of suppliers
How can independent regulators ensure they receive necessary information from monopsonists?
They must be able to compel monopsonists to hand over information about their relations with suppliers
What is nationalisation?
Nationalisation occurs when an industry is taken into public ownership by the government.
Which industry was first nationalised in 1948?
The rail industry.
When was the rail industry privatised again?
In 1993.
What advantage does nationalisation provide in terms of economies of scale?
Greater economies of scale can be achieved as there is only one organisation providing goods/services within the industry.
Why is the rail industry considered a natural monopoly?
Because a greater level of economies of scale can be achieved.
What is the primary objective of private firms compared to nationalised industries?
Profit.
What type of efficiency are nationalised industries more likely to achieve?
Allocative efficiency.
What do governments emphasize in the provision of goods/services in nationalised industries?
Market outcomes that are beneficial to the consumer.
Fill in the blank: Nationalised industries are more likely to produce at the _______ level of output.
[socially optimum]
What effect does producing at the socially optimum level of output have on negative externalities?
It reduces negative externalities.
What are employees of firms vulnerable to?
Exploitation
Why do profit-maximizing firms wish to pay low wages?
To maximize profit
What can workers do to protect themselves from firms with poor reputations?
Choose not to be employed by them
What is one way government protection can be achieved for workers?
Legal protection under UK and EU law
What types of legislation are included in the legal protection for employees?
- Health and safety at work
- Employment contracts
- Maximum hours at work
- Redundancy procedures
- Right to belong to a trade union
What can firms face if they break employment laws?
Prosecution
What can individual employees in the UK do if their rights are violated?
Sue for compensation in industrial tribunals
What role do trade unions play in employee protection?
They provide significant protection from employers
What is the government’s role concerning trade unions?
Create a legal framework for their operation
How can the government encourage better employment practices?
Encourage firms to draw up codes of conduct
True or False: Voluntary codes of conduct are a strong way to protect employees.
False
What is the function of a Price Cap and what is it’s intended outcome?
- Caps the price of goods/services within the market at the point at which competitive market outcomes can be achieved (MC=AR=D, aka. allocative efficiency).
- This not only leads to lower prices, but it also forces firms to produce a higher quantity, increasing consumer welfare through a greater choice of goods/services.
What impact will Profit regulation and Price Caps have on firms?
- Reduce Profits (Potentially making Supernormal Profits unachieveable)
- More pressure on firms to become efficient.
- e.g. Profit Regulation takes into account the return on capital employed. Therefore, by investing in more capital, firms can achieve a greater level of profit.
How can Government Intervention, in practice be limited and ineffectual?
- Large Firms employing thousands of people are more likely to influence Govt. Policy than a small business.
- This results in Regulatory Capture.
How does Regulatory Capture occur?
- Regulators for industries have often worked in those industries before.
- Thus, firms within the industry may get in contact with the regulator to persuade them to implement less stringent regulations.
- As a result of this, regulations fail to achieve goals and uncompetitive outcomes remain, creating a netloss for society.
What is asymmetric information?
A situation where one party has more or better information than the other, making it difficult for the less informed party to make decisions.
Why is it difficult for the government to investigate firms?
The government often lacks the same level of information that firms have about their business.
What can result from the government’s lack of information about firms?
Poor outcomes for consumers and suppliers due to improper intervention decisions.
What problems can arise from government intervention due to asymmetric information?
Miscalculations in profit levels and price caps.
How do firms manipulate their reported costs?
Firms often overstate their costs and capital employed to increase perceived profits.
What can happen if the government miscalculates the correct level of profit for firms?
It may lead to inappropriate profit levels being allowed.
What challenges arise when determining price caps due to asymmetric information?
Difficulty in establishing a price cap that is either too lenient or too strict.
What are the consequences of setting a price cap too low?
It may force firms out of the market, reducing competition and potentially leading to a monopoly.
What happens if the price cap is set too high?
It will have little impact on market outcomes.
What is a potential overall effect of asymmetric information on the market?
A misallocation of resources and a market far from a socially optimum level of production.
Fill in the blank: Asymmetric information can lead to the government intervening when they shouldn’t or not intervening when they _______.
should
True or False: Asymmetric information only affects government intervention and not market competition.
False
