3.6.1 Government Intervention Flashcards
Who are the CMA?
The Competition and Markets Authority (CMA)
- The UK’s 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
What is the main function of the CMA?
A key function of the CMA is to monitor 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
How do the CMA intervene in monopoly markets using Price Regulation?
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
On a diagram - do a horziontal price cap line!
What is RPI - X ?
RPI - X is a price regulation formula used in the UK, especially for natural monopolies like water and energy companies.
- It shows how monopolies can raise their prices with regards to inflation but also the efficiency savings they will also make as time goes on
BEST EXAMPLE OF A PRICE CAP V IMPORTANT
Define natural monopoly?
A natural monopoly is a type of monopoly that arises when a single firm can supply the entire market at a lower cost than two or more competing firms could — usually because of very high fixed costs and strong economies of scale.
Usually energy / water companies.
How do the CMA intervene in monopoly markets using Profit regulation?
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
The regulator (e.g. CMA) sets a “cost-plus” price cap, i.e.:
Allowed price = total costs + fair rate of return (a set % profit margin)
ESSENTIALLY PRICE REGULATION BUT USING PROFITS / COSTS
How can the CMA intervene to use performance targets?
Regulators can also set performance targets so as to raise the quality of the service and improve customer satisfaction
- This is often seen in the rail industry where targets are set based on the percentage of trains running on time
Why is profit regulation by the CMA a contentious policy?
- 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
How do the CMA intervene when monopolies cut quality to cut costs?
Regulators can step in to insist that certain quality standards are met
- It can be difficult for them 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
What is the issue with monopolies and quality of products?
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
How can governments intervene to promote competition and contestability through the promotion of small business?
- Promotion of small business: providing tax incentives or subsidies to small firms can help increase the number of new entrants into industries and thus promote competition.
How can privatisation promote competition / contestability?
Privatisation:
Firms are hesitant to enter an industry when the dominant firm is owned by the government and has access to all of the government’s resources.
Privatisation encourages new entrants to the industry as they feel they can compete more effectively with private firms, which perhaps have fewer resources available to them.
E.g. In April 2022, the UK Government confirmed that Channel 4 would be privatised
What is competitive tendering for government contracts and how does it promote competition and contestability?
- Competitive tendering for government contracts: as a major provider of goods/services in the economy, the government could choose to manufacture many products itself, and this would decrease competition but it often doesnt.
By outsourcing the supply of these products, it generates more private sector activity and increases competition as firms compete to win contracts to - say for instance - build a new road.
How can deregulation promote competition / contestability?
- Deregulation: 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
How can the government intervene to Protect Suppliers
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 of the buyer can also be used to break the market power of the abusive firm, resulting in better treatment of suppliers (weak)
Arguments for nationalisation of the rail service:
Arguments against the nationalisation of the rail service:
- Improved service and accountability
- Public ownership could prioritise service quality and reliability over profit.
- The government is directly accountable to voters, unlike private firms.
- Any operating profit can be reinvested into the network instead of paid out as dividends to shareholders.
- A unified system could improve timetable integration, investment planning, and long-term infrastructure strategy.
Arguments against the nationalisation of the railway service?
- Very expensive for the government (In 2024, the Labour government pledged to nationalise the rail network within 5 years.)
- A nationalised firm doesn’t face the same pressure — it’s not driven by competition or profit, so there’s less urgency to improve efficiency.
How can the governement intervene 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)
What is the issue regarding firms and employees that needs intervention?
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
