3.6 - Government intervention Flashcards
Government intervention
1
Q
Competition and Markets Authority (CMA)
A
- The UK Government regulator tasked with ensuring that the creation of monopoly power is avoided and that consumers are not exploited in markets
- The main forms of consumer exploitation include higher prices, less choice and/or poor quality products
2
Q
What are the two main aims of the competition and markets authority?
A
- promote competition
- ensure markets are efficient
> protects consumer interests by keeping prices low and widening consumer variety
3
Q
One way to control monopoly power …
A
- Is to prevent it from forming in the first place
- The CMA monitors merger activity with the aim of preventing any single firm gaining more than 25% market share
- If there are concerns about the merger then the CMA has the authority to stop it from happening, or they can allow it to go ahead but insist the new firm sells certain assets which would limit its market share
4
Q
Government intervention to control monopolies
A
- Price regulation
- profit regulation
- quality standards
- performance targets
5
Q
Government intervention to control monopolies: price regulation
A
- Monopolies aim to produce at the profit maximisation level of output (MC=MR)
- This results in higher prices and restricted output in the market
- The CMA uses maximum prices to lower prices and increase output
- One way in which they determine where the maximum price should be is to identify the point of allocative efficiency and set the maximum price where AR=MC
- This strategy is often used on natural monopolies
- Firms will make less supernormal profit than before, especially when any price increases are set below the rate of inflation: RPI - X
- RPI - X is the max % that firms can increase their prices by
6
Q
What is X in RPI - X?
A
The value of X is the amount in real terms that the price has to be cut by
7
Q
Advantages of RPI-X
A
- firms could increase profits by cutting their
costs by more than X.
> This encourages them to be more efficient, since they have an
incentive to lower their costs. - It also encourages competition in the market, which can prevent the firms abusing their monopoly power.
8
Q
Disadvantages of RPI - X
A
- it is hard to determine what the value of X should be.
- it could limit how much profit a firm can make, which might in turn limit how much
investment they do
> less inovation - risk of regulatory capture.
> this is when regulators start working in favour of the firm
9
Q
Government intervention to control monopolies: Profit regulation
A
- The CMA may choose to limit the supernormal profit a monopoly can earn
- They do this by calculating the firm’s total costs and then adding a percentage of profit to it
- Can reduce these profits by increasing rate if corporate tax
10
Q
Disadvantages of profit regulation
A
- It is a very contentious policy as costs are difficult for the CMA to calculate
> Firms often try to inflate their perceived costs so as to make more profit than allowed - Monopolies have no incentive to lower costs, so if costs are higher than they would be in perfect competition, consumers still end up paying higher prices
- Even with this policy in place, natural monopolies seem to post record profits year on year
11
Q
Government intervention to control monopolies: Quality standards
A
- One way to maximise profit is to reduce the quality of the raw materials, which reduces the quality of the end good/service
- If there are no substitutes then this is a likely outcome
- Regulators can step in to insist that certain quality standards are met
12
Q
Disadvantages of quality standards
A
- It can be difficult for regulators to know what the potential quality of a product is or what standards to impose
- Firms push back on these quality standards as they reduce their supernormal profit
13
Q
Government intervention to control monopolies: Performance targets
A
- Regulators can set performance targets so as to raise the quality of the service and improve customer satisfaction
- It helps the
firm to focus on increasing social welfare.
14
Q
Examples of quality standards in the real world
A
- Often seen in the rail industry where targets are set based on the percentage of trains running on time
- The NHS, which has monopoly power, also has performance targets, such as reducing waiting times
15
Q
Government intervention to promote competition and contestability
A
- enhancing competition between firms through
promotion of small business - deregulation
- competitive tendering for government contracts
- privatisation
16
Q
Intervention to Promote Competition & Contestability
> Promotion of small business
A
- providing tax incentives or subsidies to small firms can help increase the number of new entrants into industries and thus promote competition
17
Q
Intervention to promote competition & contestabilty
> Deregulation
A
- Government regulations can increase industry costs or act as a barrier to entry.
- Removing regulations can promote competition, which will also increase the contestability in the market
18
Q
Deregulation
A
The process of removing government controls from markets in order to increase competition
19
Q
Contestability
A
Occurs when there is freedom of entry into market and where costs of exit are low making it possible for new firms to enter and contest for market share
20
Q
Competitive tendering
A
Occurs when the government draws up a specification or a good/service it wants to provide and receives bids from private firms to provide it
21
Q
Intervention to Promote Competition & Contestability
> Competitive tendering for government contracts
A
- 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 - 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. - It also frees the government of maintenance, since the private sector might have the expertise and knowledge to fulfil the project and maintain the infrastructure.
Evaluation
- This can be evaluated by considering how the private sector might not meet the specification of the contract. Moreover, the private sector firm might try and cut
costs by lowering wages, and they are less likely to have social welfare as a priority.
22
Q
Privatisation
A
The transfer of ownership and control of firms/assets from the state (public sector) to the private sector
23
Q
Intervention to Promote Competition & Contestability
> privatisation
A
- 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.
- private sector gives firms incentives to
operate efficiently, which increases economic welfare. - This is because 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
Evaluation
- However, firms which profit maximise in a competitive market might
compromise on quality
- By selling the asset to the private sector, revenue is raised for the government. However, this is only a one-off payment.
24
Q
Intervention to protect suppliers
A
- Restrictions of monopsony power on firms
- Monopsony power is abusive towards suppliers and, over time, can change the nature of entire industries in an economy
> Governments can pass anti monopsony laws and issue fines if breaches occur
> They can encourage firms to self-regulate and trade fairly
> They can appoint a regulator to monitor the practices in the industry
> They can subsidise firms that are suffering from abusive monopsony power
> They can set minimum prices, which buyers have to pay suppliers - Nationalisation
> This occurs when private sector assets are sold to the public sector. In other words, the government gains control of an industry, so it is no longer in the hands of private
firms
> By nationalising an industry, natural monopolies are created - Nationalised industries have different objectives to privatised industries, which are mainly profit driven.
- Social welfare might be a priority of a nationalised industry.
> resulting in better and fairer treatment to suppliers and employees
25
Protecting employees
- Wage bills for firms are often one of their highest costs as a proportion of expenditure
- With a goal of profit maximisation, firms will always seek to reduce their wage expenditure, as this will result in higher profit
- There is a role for government to protect workers who could be exploited by firms
26
The government uses the following methods to protect employees:
- National minimum wage legislation
- Legislation on health and safety, working hours and employment conditions, e.g. maternity pay
- Permitting trade unions to operate in the economy (some countries limit or ban the existence of unions as they view them as anti-competitive e.g. Singapore)
- Encouraging firms to adopt best practice and draw up company codes of conduct towards their employees. This is a form of self-regulation
27
profit cap
- a limit on profits as a
percentage of total revenue
28
when are profit caps usually introduced
- Profit cap is usually
introduced in industries where supernormal
profits are regarded as excessive / profit cap may
be necessary where little competition exists or
where collusion is possible
29
impacts of profit caps on consumers and the firm being capped.
* Impact on consumers: lower prices because firms may aim to sales maximise rather than profit maximise and so
households may be better off in real terms
> However, There may be upward effects on price for consumers as firms become more x-inefficient or reduce total investment.
- may increase consumption
- domestic firms that consume this good may become more
competitive due to lower costs of production
rising consumer surplus.
- Impact on suppliers:
lower revenue and
so lower profits / less funds for investment and so risk of supplies in future / falling share
prices and dividends / change in objective e.g.
from profit maximisation to sales maximisation.
30
evaluate the use of profit caps on energy suppliers
* There may be upward effects on price for
consumers as firms become more x-inefficient or
reduce total investment.
* Depends on the level of profit cap on energy firms
/ how long it may be applied: if it is 1.25% it may
be too harsh compared to other industries such
as supermarkets.
* It is a vertically integrated industry – so energy
companies can make profits in the generation of
electricity and gas.
* Energy firms appear to have made huge profits
over previous years and so may be able to cope
with lower profits.
* Energy firms may increase sales revenue and so
profit values may still be high.
* Energy suppliers experience low levels of risk in
their retail operations so necessary rewards are
lower.
* Unintended consequences such as a reduction in
new entrants to the industry and less
competition, risk of power shortages due to under
investment or excess demand.
* Multinational owners may use transfer pricing to
avoid profit cap.
31
In March 2013, the government agreed to a £288 million private finance initiative (PFI) hospital contract, to replace the Alder Hey Children's hospital in liverpool. What is the most likely reason that a PFI contract was used?
This method would not lead to an immediate increase in government borrowing
32
Private finance initiative (PFI) contracts
- Major infrastructure/ buildings/ projects/ large scale contracts are issued by governments to private firms.
- It is then leased or rented to the public sector over 25-30 years.
