3.6 Government Intervention

Question 1

Why would gov. intervene when there’s monopoly power?

Answer 1

• Monopoly power = higher prices and lower output compared to competitive conditions
• Protects consumers

Question 2

CMA?

Answer 2

• UK gov. department responsible for promoting competition and preventing anti-competitive practices (e.g. collusion and predatory pricing)

Competition and Markets Authority

Question 3

Surrogate competition?

Answer 3

• When an industry has a high degree of market concentration, gov. regulates these industries to replicate competition (i.e. a need to maintain high quality)

e.g. OFCOM, FCA, ORR, OFGEM, OFWAT

Question 4

Price regulation?

Answer 4

• Used to regulate natural monopolies in the UK
• Aim is to bring price closer to allocatively efficient P = MC

Esp. important for essentials e.g. utilities so they are affordable

Question 5

What are the two forms of price regulation?

Answer 5

• RPI - X
• RPI + X

Question 6

How does RPI - X work?

Answer 6

• X is expected efficiency gains
• Regulator investigates costs of firms in industry to find X
• RPI - X is the maximum price rise in the industry
• Lowers prices –> so incentivises increased efficiency

Question 7

Disadvantages of RPI - X?

Answer 7

• Accurately setting X is difficult (requires time, information and a number of competent staff)
• If X too low = less incentive for efficiency gains
• If X too high = firms less likely to make profit = some will leave the market

Question 8

Profit regulation?

Answer 8

• Setting limits on the amount of profit a firm can make

e.g. rate of return regulation

Question 9

Rate of return regulation?

Why?

Answer 9

• Allows firms to cover costs and earn a return based on amount of capital they use
• More capital = higher amount of profit earned

To incentivise investment = productivity gains = essential for utilities

Question 10

Advantages of rate of return regulation?

Answer 10

• Firms are incentivised to increase capital investment = important for maintainance and improving quality

Question 11

Disadvantages of rate of return regulation?

Answer 11

• Little pressure for firms to be productively efficient as costs guaranteed to be covered
• Firms may overload on capital investment

Question 12

Performance targets?

Answer 12

• Used to regulate monopolies + incentivise improvements in public organisations e.g. schools, hospitals, police

Question 13

Quality standards?

Answer 13

• Minimum standards of service a regulator requires a monopolist/public body to meet

e.g. A&E given 4hrs to treat/discharge/admit/transfer a patient

Question 14

Advantages of performance targets and quality standards?

Answer 14

• Acts as a surrogate for competition

Question 15

Disadvantages of performance targets and quality standards?

Answer 15

• Without sufficient sanctions = firms may be unmotivated to meet targets/standards
• Risk of gaming the system (e.g. surgeon avoiding difficult surgery to have high success rate)
• Unintended consequences - (e.g. police officer spending more time completing paperwork than protecting the public)

Question 16

When would a CMA investigate a merger?

Answer 16

If EITHER conditions are met:
* Combined firm would have market share >25%
* Combined firm would have a turnover >£70m

Question 17

What conditions are necessary for effective merger control?

Answer 17

• Competent regulators
• Accurate and up-to-date information
• Sufficienct time to thoroughly investigate

Question 18

How does RPI + K work?

Answer 18

• Used by OFWAT to regulate water industry
• K is capital investment, RPI + K = price cap
• Incentivises capital investment = better maintenance and higher quality

Question 19

SME?

Answer 19

• Small and medium enterprise

Question 20

Start-ups?

Answer 20

• A company initiated by an entrepreneur to develop a scaleable business model

Question 21

Why do most govs seek to support SMEs and start-ups?

Answer 21

• If gov makes it easier for entrepreneurs to set up businesses/existing ones to grow = ↑ number of firms challenging established firms = consumers benefit from ↑choice and ↑quality

Question 22

Benefits that SMEs and start-ups bring

Answer 22

• ↑ competition
• ↑ jobs
• ↑ choice
• Source of exports
• ↑ innovation
• May be more flexible and quick in responding to changes in market conditions/customer wants and needs (larger firms take longer - hierarchy to go through)

Question 23

Problems that SMEs and start-ups face

Answer 23

• Credit - banks view as greater risk
• Business skills - some may have lack of skills/experience
• Recruitment - finding competent staff difficult even for large firms

Question 24

What can gov do to support SMEs and start-ups?

Answer 24

• Provide info on how to set up a business
• Deregulate to make it easier to enter markets
• Streamline the process for setting up and running a business
• Provide training to ↑ business skills
• Educational reform to ↑ skills of overall workforce
• Provide business mentoring services

Question 25

**Competitive tendering?**

Answer 25

* Process in which **private-sector firms compete** to win **contracts** to perform tasks on **behalf of the gov.** | e.g. school catering, hospital construction ## Footnote Introduces profit-motive to economic activity previously done by state = ↑ efficiency and quality

Question 26

**Benefits** of competitive tendering?

Answer 26

* Private sector will be responsible for allocating more resources in the economy = market forces **improve quality and choice** = **lower prices** = **taxpayer benefits**

Question 27

**Downsides** of competitive tendering?

Answer 27

* If gov heavily focussed on price = firms may **reduce quality** to win * **Firms have high bargaining power** due to large size and experience = taxpayer may end up with poor value for money * Contracts from UK gov only have a few bidders = **limited competition**

Question 28

**Privatisation?**

Answer 28

* When a whole industry changes from being run by the **public sector to the private sector** | e.g. rail, water, energy in UK ## Footnote Change enacted by gov.

Question 29

How can **privatisation increase efficiency?**

Answer 29

* **Profit-motive** and **competition** = firms will seek to **reduce costs** and ↑ **quality** to ↑ **profit** ∴ = ↑ efficiency

Question 30

**Disadvantages** of privatisation?

Answer 30

* **Poor regulation/natural monopoly conditions** = little benefit for **consumer** - e.g. inflation price rises in rail and energy markets * **Social costs and benefits** likely to be ignored - e.g. closure of rural transport networks = reduced connectivity * Gov. loses out on **source of revenue** - public assets **sold too cheaply** asw. - e.g. Royal Mail

Question 31

**Advantages** of privatisation?

Answer 31

* **Stronger incentive to cut costs** and be more efficient and ↑ productivity * Gov gains from **revenue from sale** of assets * If state monopoly replaced by several firms = ↑ competition = ↓ prices and ↑ quality

Question 32

**PFI?**

Answer 32

* Private Finance Initiative * Gov. takes competitive bids then buys whole investment project, then **pays back the costs over a set period of time**

Question 33

**Advantages** of PFI?

Answer 33

* **Efficiency** * **Extra investment** - gets private sector funds that gov wouldn't be able to finance = can kickstart more projects * **Delivery** - private sector not paid until asset delivered * **Dynamic efficiency**

Question 34

**Disadvantages** of PFI?

Answer 34

* Debt costs * Inflexibility/poor value for money * Risk * Admin costs * Dependence

Question 35

Difference between **competitive tendering** and **PFI?**

Answer 35

**CT** = independent firms **bidding** for projects vs **PFI** = private company handles up-front costs and **leases** project to gov.

Question 36

**Deregulation?**

Answer 36

* Removal of government regulations ## Footnote UK: Financial market, public transport, postal services

Question 37

**Aim** of deregulation?

Answer 37

* **Reduces barriers** to entry and exit = market **more contestable** = more firms in market = increased **competition**

Question 38

**Advantages** of deregulation?

Answer 38

* ↑ contestability = **↑ quality, ↑ innovation and ↓ price**

Question 39

**Disadvantages** of deregulation?

Answer 39

* Market stability - can lead firms to take excessive risks = **financial market failure** * **Public safety** - e.g. Grenfell Tower

Question 40

What can regulators do to **protect suppliers?**

Answer 40

* **Fines + jail sentences**- to discourage buyers from exploitative practises e.g. delaying payments * **↑ Contestability** (on buyer side e.g. supermarkets) - reduce monopsony power of buyers * **Minimum prices** - counteracts monopsony bargaining power

Question 41

What can regulators do to **protect workers?**

Answer 41

* **Minimum wage** * **Legislation** to improve working conditions * **Fines + jail sentences** - for employers who break labour laws ## Footnote Counters monopsony powers of employers

Question 42

**Regulatory capture?**

Answer 42

* Regulatory agencies may be **dominated by industries** they are regulating = agency acts in way that benefits industry instead of public

Question 43

Regulatory capture **causes?**

Answer 43

* **Bribery** * **Familiarality** * **Revolving door** - regulators often go on to work for companies they previously regulated and get paid large salaries e.g. George Osborn on £800K at Blackrock

Question 44

Regulatory capture **impacts?**

Answer 44

* **↓ Quality** * **↑ Price** - e.g. if RPI+X set higher - (**regressive** effect, will impact lower income households the most) * **External costs** ignored * **Asymmetric information**