3.6.1b - Government intervention Flashcards
4 methods of government intervention to control monopolies
o price regulation
o profit regulation
o quality standards
o performance targets
Define competition policy
Any policy which seeks to promote competition & efficiency in markets
and industries
Define anti-competitive practices
strategies such as predatory priceing and collusion that are designed to limit the degree of competition inside a market
Define CMA
Main competition policy body in the UK. Their main stated aim is to make
markets work well for consumers, businesses and the economy
Purpose of industry specific regulator bodies?
Water: water services regulation authority (OFWAT)
Telecome (office of communications - OFCOM)
Energy: office of gas and electricity markets (OFGEM)
Rail (office of rail regulation- ORR)
Financial services: financial conduct authority (FCA)
Objective of price regulation
bring price closer to allocatively efficient outcomes (P=MC) (important for utilities as these essential goods should be affordable)
Define rpi-x
This formula encourages efficiency within regulated businesses by taking
the retail price index (i.e. the rate of inflation) as its benchmark for the allowed changes in prices and then subtracting X – an efficiency factor – from it.
Define profit regulation
Profits in markets where businesses have monopoly power may be regulated through interventions such as price capping or windfall taxes on monopoly profits.
What is RPI - X and who uses it
- ofgem and ORR
- max price firms can set is RPI - X where x refers to expected efficiency gains
aims of RPI - X
1) Restrain price rises for essential services.
2) Incentivise utility providers to increase efficiency
How does RPI -X aim to force producers to make efficiency gains?
A firm’s total profit is equal to total revenue minus total cost. 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.
why are monopolies less likely to make efficiency gains compared to other firms
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.
advanatges of RPI - X
- It protects consumers by restraining producers’ ability to raise prices. This is important for goods and services that are:
o considered essential
o produced by firms that have significant monopoly power - 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.
Disadvantages of RPI -X
1) Accurately setting X is difficult and requires time and manpower. Regulators from the likes of OFGEM and OFWAT must thoroughly research firm’s costs and potential efficiency gains. costs a lot to gather informaton and investigate and this cost is beared by taxpayer - opportunity cost
2.Without access to a good level of information it may be extremely difficult for regulators to set X. If regulators lack legal powers and if punishment for poor disclosure is weak, there is a strong risk that information will be withheld.
3.If X is set too low, there is more incentive for firms to make efficiency gains. Set x too high and firm are less likely to make profit so some firms may choose to leave market (unintended consequences
4) regulatory capture - regulator acts in favour of firms so regulation doesn’t promote competitive outcomes
Who uses RPI - X + K regulation
water industry where k is the amount of investment water firms needs to implement to maintain a high quality service which is crucial to clean water for example
How does RPI -X create an incentive
If a firm cut costs by more than X, they can increase their profits. Arguably there is an incentive to cut costs.
What is profit regulation and where is it used?
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. One form of profit regulation is rate of return regulation.
Explain rate of return regulation
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. This is not an accident. The regulator wants to incentivise investment as productivity gains and general maintenance are vital for utilities such as water
This occurs when the government look at the profit that is made by a firm and then decide the reasonable level of profit that they should earn given the rate of return on capital employed.
Disadvantages of rate of return regulation
- little pressure for firms to be productively efficient since costs will be covered as guaranteed by regulatord.
- There is a danger that firms overload on capital investment in order to earn higher profit. (over employ capital)
- This could involve investment done for the sake of it rather than for maintenance or improving quality
- assyemtric information
What are perfomance targets
Performance targets are used to regulate monopolies and also incentivise improvements in public organisations such as schools and hospitals. An example is given below.
Office of Rall and Road: Sets out quality standards such as the number of times a train company is allowed to be late.
What are quality standard
Quality standards are minimum standards of service a regulator requires a monopolist or public body to meet. Examples are given below.
1. A&E services across the UK are given four hours in which to treat and discharge or admit or transfer a patient.
2. OFGEM requires leccy providers to restore power supplies within 24hrs after a storm and 12 hours in normal weather if failure in system.
3) emergency calls must be answered and reached by ambulances within 8 minutes or less
4) max number of delays a train company can have
5) gps have a target of patients to see to within the hour
6) in AE, patients must be seen, checked, triaged within 4 hours
7) electricity generators are forced to have enugh capacity to prevent blackouts
What is the logic behind using quality and performance targets to regulate monopolies?
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 i.e. standards act as a surrogate for competition.
What is the advantage of performance targets and quality standards?
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.
cons of performance targets and quality standards
1) Without sufficient sanctions in place firms may not be motivated to meet the targets/standards. e.g Network Rail failed to deliver on the performance targets for their long distance sector in 2013-14.
- There is a risk that people game the system e.g. surgeons avoiding difficult surgeries in order to maintain a high success rate.
- 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. GPs diagnose incorrectly and dont do job
How else can governments regulate profits
- Windfall taxes on excessive profits (gov decides level of profit whihc is to be excessive)
- gov taxes these profits at a higher rate
- prevents firms from gaining too muhcc monopoly power but reduces incentive to improve efficiency
aims of competition regulation
- prevent excessive pricing
- promote comp
- esnure quality, standards, choice
- regulate natural monopolies
- promote tech innovation
cons of windfall taxes
- worsen monopoly outcomes
- tax evasion/avoidance
- under reporting of profit
- less innovation
how to evaluate gov policy
- level of information
- costs vs benefits
- regulatory capture
- benefits of monopoly
- source of gov failure
examples of problems with setting x in rpi-x
The problem is that 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, for example the
water industry was forced to cut prices by 10% in 2000.
