3.6.1 - Government intervention

Question 1

What does monopoly power result in (downside) ?

Answer 1

Monopoly power results in higher prices and lower output than under competitive conditions.

Question 2

What can monopoly power lead to (government) ?

Answer 2

Consequently, there is a case for governments to intervene to protect the interests of consumers

This is especially important for natural monopolies, and utilities, as these are essential goods and services.

Question 3

What are anti - competitive practices ?

Answer 3

Strategies such as predatory pricing and collusion that are designed to limit the degree of competition inside a market.

Question 4

What is competition policy ?

Answer 4

Any policy which seeks to promote competition and efficiency in markets and industries.

Question 5

What are the Industry Specific Regulatory Bodies ?

Answer 5

Water: The Water Services Regulation Authority (OFWAT)

Telecoms: The Office of Communications (OFCOM)

Financial Services: Financial Conduct Authority (FCA)

Rail: Office of Rail Regulation (ORR)

Energy Markets: Office of Gas and Electricity Markets (OFGEM)

Question 6

Why is price regulation used ?

Answer 6

Price regulation is used to regulate natural monopolies in the UK.

The objective is to bring price closer to the allocatively efficiency (P = MC)

Question 7

When is the use of price regulation important ?

Answer 7

This is important for utilities such as gas and water because there is a need to make them affordable since they are essential.

Question 8

What are the two main forms of price regulation ?

Answer 8

RPI – X and RPI + X

Question 9

What is RPI – X?

Answer 9

RPI – X is a form of price regulation used as a price cap by OFGEM and the ORR.

The maximum prices firms are allowed to make is RPI – X where X refers to expected efficiency gains

Question 10

Give an example of the use of RPI - X ?

Answer 10

If one year RPI was 2.4% and the regulator calculated that expected efficiency gains (X) was 1.5%, RPI – X would be 0.9% i.e. the maximum price rise in the industry would be 0.9%.

Question 11

What does RPI – X aim to achieve?

Answer 11

1. Restrain price rises for essential services.
2. Incentivise utility providers to increase efficiency.

Question 12

How does RPI – X aim to force producers to make efficiency gains?

Answer 12

RPI – X lowers the price of the good/service thereby limiting total revenue.

Therefore, to maintain or increase profit a firm must reduce costs i.e. become more efficient.

Question 13

Why are monopolies less likely to make efficiency gains than other types of firms?

Answer 13

They face an absence or lack of competitive pressures. This means there is less incentive to cut costs are they are unlikely to lose customers regardless of the actions they take.

Question 14

How does the regulator calculate X?

Answer 14

The regulator investigates the costs of firms in the industry to gain an understanding of possible efficiency gains.

Question 15

What are the advantages of RPI – X?

Answer 15

• It protects consumers by restraining producers’ ability to raise prices.
• It gives an incentive for firms to be as efficient as possible as if they can lower costs by more than X they will enjoy increased profit. It prevents excessive prices and ensures that gains are passed onto the consumer.

Question 16

What are the disadvantages of RPI – X?

Answer 16

1. Accurately setting X is difficult and requires time and manpower.
2. Without access to a good level of information it may be extremely difficult for regulators to set X.
3. If X is set too low, there is less incentive for firms to make efficiency gains.
4. If X is set too high, firms are less likely to make profit. Some firms may choose to leave the market.

Question 17

What is profit regulation and where is it used?

Answer 17

An alternative to price regulation is profit regulation.

This is used to regulate utilities in the US.

It involves regulators setting limits on the amount of profit firms can make.

Question 18

Give one form of profit regulation

Answer 18

One form of profit regulation is rate of return regulation.

Question 19

How does rate of return regulation work?

Answer 19

The regulator allows firms to cover costs and earn a return based on the amount of capital they use.

Therefore, the more capital a firm employs the higher amount of profit it can earn.

Question 20

What is the advantage of rate of return regulation?

Answer 20

Firms are incentivised to increase capital investment which is vital for maintaining and improving quality.

Question 21

What are the disadvantages of rate of return regulation?

Answer 21

There is little pressure for firms to be productively efficient as the regulator guarantees that costs will be covered.

There is a danger that firms overload on capital investment in order to earn higher profit.

Question 22

What are performance targets?

Answer 22

Performance targets are used to regulate monopolies and also incentivise improvements in public organisations such as schools and hospitals

Question 23

What are quality standards?

Answer 23

Quality standards are minimum standards of service a regulator requires a monopolist or public body to meet.

Question 24

What is the logic behind using quality and performance targets to regulate monopolies?

Answer 24

The incentive to improve quality is provided by the need to meet, or exceed, consumer expectations and stay ahead of rivals.

For a pure, or natural, monopoly, this incentive is absent as there are no competitors and a captive market.

By setting quality standards and performance targets regulators aim to motivate monopolies to meet a minimum standard of provision

Question 25

What is the advantage of performance targets and quality standards?

Answer 25

If set correctly they may act as a surrogate for competition by forcing firms to behave as if they were in a contestable market e.g. aiming for high quality.

Question 26

What are the disadvantages of performance targets and quality standards?

Answer 26

1) Without sufficient sanctions in place firms may not be motivated to meet the targets/standards.

2) There is a risk that people game the system

3) There could be unintended consequences e.g. police officers spending lots of time completing paperwork to prove that they are meeting standards rather than protecting the public.

Question 27

In the UK, who is responsible for investigating mergers ?

Answer 27

In the UK, the CMA is responsible for investigating mergers.

Question 28

Does the CMA investigate all mergers? If not, which ones does it investigate?

Answer 28

The CMA investigates mergers is either of the following conditions are met:

• The combined firm would have a market share of over 25%
• The combined firm would have a turnover of over £70m.

Question 29

What is turnover ?

Answer 29

How much money a business earns in a period of time

Question 30

What conditions are necessary for effective merger control?

Answer 30

• Competent regulator
• Accurate and up-to-date information
• Sufficient time to thoroughly investigate