3.6

Question 1

Explain the role of the CMA

Answer 1

Competition and Markets Authority (CMA)
“Promotes competition for the benefit of consumers”
The UK’s overall regulator on competition
Remit:
Investigate mergers
Does it lead to a “substantial lessening of competition”?
Investigate abuse of market power
Take action against anti-competitive behaviour
Protect consumers from unfair trading practices

Question 2

Summarise details of 2 mergers CMA has prevented

Answer 2

Meta/Giphy - takeover of the Gif creation website could harm social media and advertising
JD/ Footasylum - merger could lead to less choice and a worse deal for customers

Question 3

Explain the impact of merger prevention by the CMA

Answer 3

Choice
Avoids the build up of monopolies which may reduce range of choice
Price
Regulation prevents exploitation of consumers by powerful firms (closer to allocative efficiency)
Costs
Greater competition provides a stronger incentives to keep x-inefficiencies to a minimum
Innovation
Greater competition provides a stronger incentive for firms to innovate (dynamic efficiency)

Question 4

2 types of price regulation

Answer 4

RPI – X
Allow prices to increase at the rate of RPI but subtract an amount reflecting the efficiency gains that the regulator believes can be achieved by the firm
RPI + K
Takes the RPI and allows the addition of ‘K’ which is the additional capital spending a firm has agreed with the regulator is necessary
Water industry is regulated using RPI – X + K

Question 5

3 arguments for price capping

Answer 5

It is an appropriate way of curtailing the monopoly power of dominant firms who abuse their position – prevents them from making excessive profits at the expense of the consumer
Cuts in price of necessity items increases affordability for consumers (particularly poorer households)
Price caps create an incentive for firms to lower costs in order to increase profits

Question 6

3 arguments against price capping

Answer 6

Price capping distorts the price mechanism – could create supply issues in the long run
Regulators may lack accurate information for setting price caps
Capping prices reduces profits which could lead to reduced investment (dynamic inefficiency)
Under-investment could harm long run infrastructure

Question 7

Profit regulation + benefits

Answer 7

Set a maximum level of profit that can be earned
Typically this is done by taking the operating costs and adding a rate of return on capital employed
Used extensively in the US to control electricity and water companies
Aims to encourage investment

Question 8

Profit regularisation cons

Answer 8

Regulators need to have a good understanding of costs and rates of return in the industry
The monopolist has more information than the regulator (asymmetric information) – it may attempt to present to regulators that costs are higher than they are
It creates little incentive to minimise costs
If they cover costs and earn a profit on capital employed it creates no gain to the monopolist to reduce costs as they are covered by the consumer

Question 9

Quality standards and the benefits of using it to control monopolies

Answer 9

Where quality is an issue, Gov can set quality standards to be met
Eg electricity companies may be required to have enough capacity to prevent blackouts occurring
Ensures companies don’t exploit their customers

Question 10

cons of quality standards

Answer 10

Monopolies will try to resist or water down any quality requirements
Regulators need to ensure that standards are not set so high that its restrictive to businesses
Regulators need to have understanding of the industry to impose meaningful quality standards

Question 11

Explain [performance targets and the benefits of using it to control monopolies

Answer 11

Similar to quality standards in principle
Gov may set targets for price, product quality or choice
Used in UK for rail travel

Question 12

Evaluate the impact of performance targets

Answer 12

Monopolists may find ways around meeting performance targets without actually making improvements
eg train companies could change timetables to appear that journeys are completed in time, even if journey times have not changed

Question 13

Explain nationalisation and the benefits of using it to control monopolies

Answer 13

Means taking a privately owned company and put it into public ownership
This changes the companies objective from profit maximisation to something more customer/ society focused
Allows longer term considerations (eg investment) which might be ignored with a profit motive

Question 14

Evaluate the impact of nationalisation

Answer 14

Government run companies could be susceptible to x-inefficiencies as there is less focus on keeping costs low
Also must be funded by tax payers so opportunity cost

Question 15

Explain how the promotion of small businesses helps to enhance competition

Answer 15

The UK government has established the ‘Red Tape Challenge’, which aims to simplify regulation for businesses. It is especially aimed towards small businesses. This aims to make it cheaper and easier to meet environmental targets and create new jobs.
Governments aim to improve access to finance and reduce barriers to entry, which will make it easier for smaller firms to enter the market.

Question 16

Explain how regulation helps enhance competition

Answer 16

The act of reducing how much an industry is regulated. It reduces
government power and enhances competition.
Excessive regulation is also called ‘red tape’. It can limit the quantity of output that a firm produces. For example, environmental laws and taxes might result in firms only being able to produce a certain quantity before exceeding a pollution permit.
Excessive taxes, such as a high rate of corporation tax, might discourage firms earning above a certain level of profit, since they do not keep as much of it. This might limit the size that a firm chooses, or is able to, grow to.

Question 17

Explain how competition tendering helps enhance competition

Answer 17

The government provides some goods and services because they are public or merit goods, and they are underprovided in the free market.
The government could contract out this provision, so that private firms operate things such as roads or hospital.
The firm which offers the lowest price and best quality of provision wins the government contract. This saves the government money, since the public sector can be bureaucratic and inefficient.
The private sector has an incentive to reduce their costs, since they operate in a competitive market.

However private sector may not meet the specification of the contract. Moreover, the private sector may try to cut costs by lowering wages and they are less likely to have social welfare as a priority

Question 18

Explain how privasitiation helps to enhance competition

Answer 18

Privatisation means that assets are transferred from the public sector to the private sector. In other words, the government sells a firm so that it is no longer in their control. The firm is left to the free market and private individuals.
Firms operating on the free market have a profit incentive, which firms which are nationalised do not.
Since they are operating on the free market, firms also have to produces the goods and services consumers want. This increases allocative efficiency and might mean goods and services are of a higher quality. Competition might also result in lower prices. However, firms which profit maximise in a competitive market might compromise on quality.

Question 19

Government intervention to protect suppliers

Answer 19

This is about preventing the abuse of monopsony power
Firms with very strong buying power may be able to abuse this position and exploit suppliers

Groceries Code Adjudicator (GCA)
Ensures retailers treat their suppliers fairly
Investigates complaints from suppliers
Arbitrates in disputes
Powers include fines of up to 1% of sales or imposing conditions - e.g. deadlines for payments to suppliers

Evaluation- many firms will not be willing to report it as many firms may consequently stop buying from this supplier

Question 20

Government intervention to protect employees

Answer 20

Employees may be vulnerable to exploitation by employers
Legislation provides rules on health and safety, employment contracts, maximum working hours, redundancy rules and trade union rules.
Firms can be prosecuted for breaking these rules
Government could provide greater scope for trade unions to operate, thereby providing greater representation for workers’ concerns
Nationalisation could lead to greater job security

Question 21

Explain how governments can protect suppliers and employees by nationalising key industries

Answer 21

Nationalised industries have different objectives to privatised industries, which are mainly profit driven. Social welfare might be a priority of a nationalised industry.

Question 22

Allocative efficiency
Requirements for firm to be efficient
Government policies that help to achieve efficiency
How do the policies achieve this?
Evaluation (why might they not work effectively?)

Answer 22

P=MC
(AR=MC)

Policies which reduce price towards P=MC:
Price regulation
Subsidy on product

Monopoly firms have P>MC
both policies reduce the equilibrium price
lower price is nearer P=MC

Lowering price could create long term supply issues
E.g. price cap on electricity could lead to more power cuts in Long Run

Question 23

Product
Requirements for firm to be efficient
Government policies that help to achieve efficiency
How do the policies achieve this?
Evaluation (why might they not work effectively?)

Answer 23

Lowest AC

Policies encouraging lower costs of production:
Subsidies of key raw materials
Policies which increase productivity

costs should fall in both cases
both policies have the effect of shifting MC & ac curves down

Unrealistic for government to spend on subsidising materials
Long time lag for cost gains from productivity

Question 24

Requirements for firm to be efficient
Government policies that help to achieve efficiency
How do the policies achieve this?
Evaluation (why might they not work effectively?)

Answer 24

Innovation/R&D
Means - profit
Incentive - competition

Policies which encourage innovation:
Subsidies/tax breaks on investment
Patent box – reduced tax on profits from new patents
Strengthening patent laws

Incentive to innovate/invest is increased
Subsidies/tax breaks make spending on innovation more affordable

Doesn’t fully address the funding issue - i.e. lack of means
Stronger patents create greater monopoly power

Question 25

Requirements for firm to be efficient
Government policies that help to achieve efficiency
How do the policies achieve this?
Evaluation (why might they not work effectively?)

Answer 25

Keeping cost wastage to a minimum
Competitive Incentive

Promotion of competition to reduce cost wastage
Reducing barriers to entry
Tax breaks for SMEs
RPI-X price capping

More competition means firms have a stronger incentive to be cost competitive
RPI-X cap targets x-inefficiency directly

Govt limited in which barriers they can lower
hard for regulator to identify value of x-inefficiencies

Question 26

What is regulatory capture and explain why it might undermine the government’s efforts to control dominant firms

Answer 26

It is when a government agency operates in favour of producers rather rather than consumers
May occur as regulatory agencies are under-resourced, have asymmetric info, are bribed/influenced, for example some regulators are senior personnel that come from the regulated industry, compromising their impartiality and making it more likely that will make decisions which favour the firms

Question 27

What is asymmetric info and explain why it might undermine the government’s efforts to control dominant firms

Answer 27

Government and regulators will generally have less information about the firm and industry than the firms themselves
Firms may feed the government limited information to portray an appearance of being in a worse financial position than they actually are
Unless the government is able to overcome this asymmetry they may be too lenient on firms