3.6 government intervention

Question 1

what is the role of the competition and markets authority?

Answer 1

The Competition and Markets Authority (CMA) work to promote competition for the benefit of consumers and investigate mergers and breaches of UK and EU competition law, enforce consumer protection law and bring criminal cases against individuals who participate
in cartels.

Question 2

what power does the CMA have?

Answer 2

They are able impose financial penalties, prevent mergers taking place and force businesses to reverse actions already taken.

Question 3

when is a merger investigated by the CMA?

Answer 3

A merger is investigated if it will result in market share greater than 25% or if it meets the turnover test of a combined turnover of £70 million or more.

Question 4

what does the CMA try to prevent when a stop a merger?

Answer 4

The aim of preventing two large companies merging is so they do not exploit their customers by raising price, offering poorer quality service and reducing choice. It
can prevent firms from gaining monopoly power.

Question 5

what is the issue with the CMA and mergers?

Answer 5

the problem is that very few mergers are investigated each year. The CMA can suffer from regulatory capture and may not have all the information necessary to make a decision.

Question 6

what is regulatory capture?

Answer 6

regulatory agencies may come to be dominated by the interests they regulate and not by the public interest. Regulated industries devote large budgets to influencing regulators at federal, state, and local levels. By contrast, individual citizens spend only limited resources to advocate for their own rights.

Question 7

when is a monopoly anti-competitive?

Answer 7

if the firm exploits its dominant power to stifle competition

Question 8

where does most the regulation occur for monopolies?

Answer 8

the utilities which are natural monopolies

Question 9

how do the CMA regulate the prices of monopolies?

Answer 9

they can set price controls to force a monopsonist to operate under the profit maximization price. they usually use the RPI - X formula to do so.

Question 10

what is the RPI - X price cap?

Answer 10

the amount they can raise their prices by each year is denoted by the formula RPI - X

Question 11

what is the X in RPI - X?

Answer 11

the expected efficiency gains of the firm

Question 12

what is the RPI in RPI - X?

Answer 12

the retail price index is a measure of inflation

Question 13

what is the significance of RPI - X price cap?

Answer 13

it encourages the monopolies to be more efficient as if they can be more efficient then X they will be able to increase their profits. it also prevents excessive prices to the consumer

Question 14

what would be a better formula for RPI - X price cap?

Answer 14

RPI - X + K where K is the level of investment, this is important as if they need to construct new pipes for example they will be able to finance this through the increased prices so encourages the monopoly to be dynamically efficient

Question 15

what is an example of the RPI - X + K being used in the uk?

Answer 15

This is used in the water industry and has allowed investment of £130bn.

Question 16

what is the issue with the RPI - X price cap?

Answer 16

it is difficult to know where to set X due to rapid improvement in technology and because any information on what the efficiency gains will be have
to come from the firm, who could easily lie as there is asymmetric information. As a result, there may be sudden price falls or rebates for customers

Question 17

what is the benefits of the price cap on the monopolies?

Answer 17

maximum prices could be set where the price is equal to the MSC, ensuring monopolies are allocative efficient.

Question 18

what is “rate of return” regulation

Answer 18

In the USA, ‘rate of return’ regulation is used where prices are set to allow coverage of operating costs and to earn a ‘fair’ rate of return on capital invested, based on typical rates of return in a competitive market.

Question 19

what are the issues with rate of returns regulation?

Answer 19

it gives firms an incentive to employ too much capital in order to increase their profits. It is also criticized since a reduction in costs will not improve the firm’s situation and so there is little incentive to be efficient. regulators need sufficient knowledge of the industry and so will suffer from asymmetric information.

Question 20

how can the CMA ensure quality goods from monopolists and why would it work?

Answer 20

Monopolists will only produce high quality goods if this is the best way to maximise profits. The government can introduce quality standards, which will ensure that firms do not exploit their customers by offering poor quality.

Question 21

what is an example of quality standards?

Answer 21

the Post Office has to deliver letters on a daily basis to all areas and electricity generators are forced to have enough capacity to prevent blackouts.

Question 22

how can the CMA introduce performance standards?

Answer 22

Regulators can introduce yardstick competition, such as setting punctuality targets for train operating companies based on the best-performing European train operators. It is also possible to split up a service into regional sectors to compare the performance of one region against another; this is used in the water industry. They could set targets over price, quality, consumer choice and costs of production. It will help firms to improve their service and lead to gains for customers.

Question 23

what are the issues with performance standards?

Answer 23

The problem is that firms will resist the introduction of targets, so again it requires political will and understanding. They will also attempt to find ways to meet targets without actually improving , for example changing train timetables to prevent trains officially arriving late. Other firms will fail to meet their performance targets and so there will be no
improvements.

Question 24

what needs to occur for performance standards to be successful?

Answer 24

The government need to ensure that fines and other

deterrents are strong enough that firms at least work to ensure targets are met.

Question 25

what are windfall taxes?

Answer 25

these are taxes that are imposed after the event has occurred for example after monopolists have made extreme profits

Question 26

what is the effect of windfall taxes?

Answer 26

it should encourage the firms not to make excessive profits or to reinvest the profits. however it is not a long term solution and firms may begin to underreport their profits.

Question 27

what is the effect of breaking up a monopoly?

Answer 27

this should lower prices and increase the competition. however their may be a decrease in economies of scale which could result in increased prices

Question 28

how does the promotion of small business increase competition and contestability?

Answer 28

The government can give training and grants to new entrepreneurs and encourage small businesses through tax incentives or subsidies. This will increase
competition since there will be more firms within the market, and will offer a chance for more firms to join. It increases innovation and efficiency, since new firms are likely to provide new products and incumbent firms will no longer be able to be X-inefficient.

Question 29

how does deregulation increase competition and contestability?

Answer 29

This is the removal of legal barriers to entry to a previously protected market to allow private enterprises to compete. This will increase efficiency in the market by allowing greater competition as more firms can enter and conduct more activities than they could before. The government can also privatize industries, which will allow for competition in the market.

Question 30

what could be the negative effects of deregulation?

Answer 30

Licenses for specific industries are necessary to ensure standards are upheld. Some have argued that the deregulation of financial markets was a major contributor to the financial crisis in 2008.

Question 31

what is competitive tendering?

Answer 31

a system introduced in the UK during the 1980s to force publicly run organizations to request bids from a number of different firms for contracts to supply goods or services

Question 32

what are private financial initiatives?

Answer 32

the government can contract out the provision of a good or service to private companies e.g. private firms could be employed to run hospitals.

Question 33

who gets the contract under competitive tendering?

Answer 33

The firm offering the lowest price wins the contract, subject to quality guarantees.

Question 34

how does competitive tendering affect the efficency?

Answer 34

This helps to minimize costs for the government and ensures efficiency by allowing for competition in the market. The private sector will have more experience
running the projects, so it is likely they will be better managed.

Question 35

what is the enterprise act?

Answer 35

The Enterprise Act (2002) means firms engaging in these practices can be fined up to 10% of worldwide annual sales and those who organize cartels can face up to five years in prison and unlimited fines.

Question 36

what is an example of a market getting punished for collusion in the uk?

Answer 36

In 2011, the 9 supermarkets in the UK were found to be fixing the price of milk and cheese products and Tesco alone was fined for £10 million.

Question 37

how does restrictions on monopsony power protect suppliers and employees?

Answer 37

Monopsonists are able to exploit suppliers by reducing prices. The government can prevent these by passing anti-monopsony laws which make certain practices illegal and can introduce an independent regulator who will force monopsonists to buy fairly. Fines can be put in place for those who exploit their power and minimum prices may be introduced to ensure suppliers are paid a fair amount. Self-regulation can also be used, but this is weak.

Question 38

how does the government protect suppliers and employees?

Answer 38

The government protects employees through health and safety laws, employment contracts, redundancy processes, maximum hours at work and the right to be in a trade union. The government can also encourage firms to draw up codes of conduct relating to employment practice.

Question 39

what are the issues with high levels of workers rights?

Answer 39

The problem is that if workers’ rights are too strong, employers will be unwilling to take on new workers due to the extra cost of employing these workers.

Question 40

what is privatisation?

Answer 40

Privatization is the sale of government equity in nationalized industries or other firms to private investors

Question 41

what is the aim of privatisation?

Answer 41

The aim is to revitalize inefficient industries but can sometimes lead to higher prices and poor services.

Question 42

what is nationalisation?

Answer 42

Nationalization is when a private sector company or industry is brought under state control, to be owned and managed by the government.

Question 43

what are the advantages of privatisation?

Answer 43

It encourages greater competition, which reduces X-inefficiency and ensures low prices and high quality as firms realize they need to be competitive. Managers become more accountable, since they know poor performance will mean a fall in share prices and/or shareholders wanting them to be replaced. It reduces government interference which some see as a benefit in itself. This also means that firms can invest with greater certainty , instead of worrying about change when a government is elected every 5 years. it puts utilities into the hands of the people , since they can own shares. Workers will be more motivated as they know their hard-work will be rewarded by high dividends.

Question 44

what are the disadvantages of privatisation?

Answer 44

when there are natural monopolies it may be fairer for the government to own the firm since they won’t abuse their monopoly position. Some people argue that industries such as electricity, water and transport are important because they directly affect the success of other industries, and so therefore it makes more sense for the government to own them in order to coordinate them properly. There are problems over externalities and inequality. Some argue that it negatively affects that the public sector net cash flow as firms are underpriced when they are sold and the government no long receives a firm’s profit.

Question 45

what are the 5 advantages of a nationalisation?

Answer 45

1) Investment is needed for the long term , but in a private company investment is only short term as shareholders will see no benefit from long term investment. This may lead to a poor quality of service.
2) In the case of a natural monopoly, it is better for monopoly to be run by the state as they aim to maximise social welfare rather than a private business who will maximise profits. 3)The government will consider externalities. 4)The government will guarantee a minimum level of service for people who suffer the risk of being cut off from the service, due to the lack of potential profit from providing for them. 5)Some say it would be dangerous to allow key strategic industries to fall into private hands as this could have disastrous effects for the country.

Question 46

what are the 3 disadvantages of nationalization?

Answer 46

1)nationalized industries suffer from the principal-agent problem and moral hazard, as managers know that any loss they make will be covered by the government. 2)They will experience X-inefficiency and this could cause higher prices for consumers, especially since the industry will become a monopoly. 3)They will be influenced by government’s decisions and the government may not have enough money to invest.