government intervention

Question 1

what is the role of the CMA?

Answer 1

• The Competition and Markets Authority (CMA) work to promote competition for the benefit of consumers and investigate mergers and breaches of UK and EU competition law
• They are able impose financial penalties, prevent mergers taking place and force businesses to reverse actions already taken

Question 2

how are mergers assessed in the uk?

Answer 2

In the UK, mergers are assessed in terms of the specific circumstances of each case, considering whether there will be a substantial lessening of competition (SLC)

Question 3

when will a merger be approved?

Answer 3

merger will be approved if its potential benefits are greater than its cost.

Question 4

why would a merger be investigated?

Answer 4

A merger is investigated if it will result in market share greater than 25% or if it meets the turnover test of a combined turnover of £70 million or more.

Question 5

what is the aim of preventing two large firms from merging?

Answer 5

the aim of preventing two large companies merging is so they do not exploit their customers by raising price, offering poorer quality service and reducing choice
It can prevent firms from gaining monopoly power

Question 6

what is the problem with the CMA?

Answer 6

• the problem is that very few mergers are investigated each year
• CMA can suffer from regulatory capture and may not have all the information necessary to make a decision

Question 7

why do monopolies need to be controlled?

Answer 7

• Monopolies are allocative and productively inefficient and so it can be argued that they need to be controlled
• if a firm exploits their dominant position in an industry by trying to stifle competition they are deemed to be anti competitive

Question 8

how are monopolies controlled?

Answer 8

Price regulation
profit regulation
performance targets

Question 9

how does price regulation control a monopoly and what is its aim?

Answer 9

• Regulators can set price cap to force monopolists to charge a price below profit maximising price, using the RPI-X formula
  firms are only allowed price increases each year at a rate that was a set amount below changes in inflation (RPI)
• X represents the expected efficiency
  gains of the firms which is determined by the government
• the aim is to ensure firms pass on their efficiency gains to consumers and improve consumer surplus
  forces firms to increase efficiency to maximise profits

Question 10

what could be a better system of controlling a monopolies price?

Answer 10

• a better system is ‘RPI-X+K’, where K is an estimate of how much is needed for capital investment
  RPI-X alone will not generate a big enough profit to sustain capital investment
• gives an incentive for firms to be as efficient as possible
  
  • if they can lower costs by more than X they will increased profit
  • It prevents excessive prices and ensures that gains are passed onto the consumer

Question 11

why is it difficult to know where X (from the RPI-X+K) equation?

Answer 11

• 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

Question 12

where is maximum prices set and what is its effect? + evaluation

Answer 12

• maximum prices could be set where the price is equal to MSC
  
  • ensures monopolies are allocatively efficient
  • however its difficult for govts to know where they should set the price as they dont know the exact allocative efficient output
  • can also increase dynamic inefficiency as firs are unable to maximise profits so they may not invest

Question 13

how is profit regulation used to control monopolies?

Answer 13

• monopolists will only produce high quality goods if this is the best way to maximise profits
• the govt can introduce quality standards
  
  • will ensure that firms dont exploit customers by offering poor quality
• however it requires political will and understanding to introduce
• prevents firms from making SNP from exploiting consumers

Question 14

how are performance targets used to control monopolies?

Answer 14

• regulators can introduce yardstick competition
  
  • e.g setting punctuality targets for train companies
• its also possible to split up a service into regional sectors to compare the performance of one region against another
• they could set targets over price, quality, consumer choice and costs of production
  
  • will help firms to improve their service/ quality
  • leads to gains for customers
    encourage dynamic efficiency

Question 15

what may a monopoly do to oppose a performance target?

Answer 15

• firms will resist the introduction of targets so there will be no improvements
  
  • the govt needs to ensure that fines and other deterrents are strong enough that firms work to ensure that targets are met (if penalties are cheaper than costs)
    unintended consequences
    other areas of business may be overlooked

Question 16

what other types of regulation are there for monopolists?

Answer 16

windfall taxes
breaking up the monopolist
subsidies
self-regulation

Question 17

how could the govt promote competition and contestability?

Answer 17

promotion
deregulation
competitive tendering

Question 18

how does promotion of small businesses promote competition and contestability?

Answer 18

• govt can give training and grants t new entrepreneurs and encourage small businesses through tax incentives or subsidies
  
  • will inc competition as there will be more firms in the market
  • will offer a chance for firms to join
• increases innovation and efficiency
  
  • new firms are likely to provide new products and incumbent firms will no longer be X-efficient
    aim to help small businesses compete more effciently

Question 19

how does deregulation promote competition contestability?

Answer 19

• this is the removal of legal barriers to entry to a previously protected market/ lowers barriers to entry
  
  • allows private enterprises to compete
  • will increase efficiency in the market by allowing greater competition and removes bureacracy
    
    • more firms can enter and conduct more activities than they could before
• govt can also privatise industries
  
  • will allow for competition in the market
    improves resource allocation as the market becomes more contestable -> price falls closer to MC and output increases

Question 20

how may deregulation lead to poor business behaviour and how can this be evaluated

Answer 20

• may lead to cutting corners as firms may prioritise short run profits over health and safety if regulations on working conditions are reduced
• some have argued that the deregulation of financial markets was a major contributor to the financial crisis in 2008

However … companies no longer need to utilise resources to meet regulations which can be invested into R+D instead

Question 21

why does the government have to provide certain goods and services?

Answer 21

• The government has to provide certain goods and services because they are merit or public goods
  
  • but this does not mean that the state has to be the producer of all these goods and services
  • Goods, such as the sheets in NHS hospitals, are produced by the private sector and then bought by the public sector

Question 22

what can the government do with the provision of a good or service?

Answer 22

• the government can contract out the provision of a good or service to private companies
  
  • e.g. private firms could be employed to run hospitals
  • These are called Private Finance Initiatives (PFI)

Question 23

how can competition be introduced into the market by competitive tendering and what are the effects?

Answer 23

• Competition can be introduced into the market as the government will request competitive tenders by drawing up a specification for the good or service and inviting private firms to bid for the contract to deliver it
  
  • The firm offering the lowest price wins the contract, subject to quality guarantees

Question 24

how does competitive tendering help to minimise costs for the govt

Answer 24

• This helps to minimise costs for the government and ensures efficiency by allowing for competition in the market
  
  • The private sector will have more experience running the projects, so it is likely they will be better managed

Question 25

what are the limitations of competitive tendering?

Answer 25

• it may not always be the most cost effective way and the process of collecting bids is costly and time-consuming
• The private sector may not aim to maximise social welfare in the same way the government would and could use cost-cutting methods that reduce quality
• its important that they prevent firms from taking part in anti-competitive prices e.g collusion, predatory pricing
  
  • problem: difficult to prove overt collusion and tacit collusion

Question 26

how can workers rights be used to protect suppliers and employees?

Answer 26

• The government protects employees through health and safety laws, employment contracts, redundancy processes, maximum hours at work and the right to be in a trade union
• The government can also encourage firms to draw up codes of conduct relating to employment practice

Question 27

what could be the problem with workers rights?

Answer 27

The problem is that if workers’ rights are too strong, employers will be unwilling to take on new workers → extra cost of employing these workers

Question 28

what is privatisation?

Answer 28

Privatisation is the sale of government equity in nationalised industries or other firms to private investors

Question 29

what is the aim of privatisation?

Answer 29

The aim is to revitalise inefficient industries but can sometimes lead to higher prices and poor services

Question 30

what is nationalism?

Answer 30

Nationalisation is when a private sector company or industry is brought under state control, to be owned and managed by the government

Question 31

what are the advantages of privatisation?

Answer 31

• encourages greater competition
  
  • reduces X-inefficiency
  • ensures low prices and high quality as firms realise they need to be competitive
• managers become more accountable
  
  • they know poor performance will mean a fall in share prices/ shareholders wanting them to be replaced
• in both the LR and SR it can reduce public sector net cash requirement (PSNCR)
  
  • as the initial sale of shares raises revenue for the govt
  • they no longer have to cover any of the firms losses
• reduced govt interference
  
  • also means firms can invest with greater certainty instead of worrying about change when a govt is elected every 5 years
• utilities into the hands of the people
  
  • they can own shares
  • workers will be more motivated as they know their hard work will be rewarded with high dividends

Question 32

what are the issues with privatisation?

Answer 32

• when there are natural monopolies it may be fairer for the govt to own the firm since they wont abuse their monopoly position
• some argue that industries such as electricity, water and transport are important as they directly affect the success of other industries
  
  • therefore makes more sense for govt to own them
• however there are issues over externalities and inequality
  
  • some say that it negatively affects the public sector net cash requirement as firms are under-priced when they are sold and the gov no longer receives a firms profit

Question 33

what are the advantages of nationalism?

Answer 33

• investment is needed for the long term but in a private company investment is only short term as shareholder see no benefit from long term investment
  
  • may lead to poor quality of service
• in the case of a natural monopoly is may be better for it to be run by the state who will aim to maximise social welfare rather than maximise profits
• govt will consider externalities
• govt will guarantee a minimum level of service for people who suffer the risk of being cut off from the service due to the lack of potential profit from providing for them
• some say its dangerous for key industries to fall into private hands as this could have negative effects for the country

Question 34

what are the disadvantages of nationalism?

Answer 34

• nationalised suffer from principal-agent problem and moral hazard
  
  • as managers know that any loss they make will be covered by the govt
• they will experience X-inefficiency
  
  • this could lead to higher prices for consumers since the industry will become a monopoly
• they will be influenced by govts decisions and the govt may not have enough money to invest

Question 35

why may it be better for the consumer if a monopoly is owned by the govt?

Answer 35

• gov will maximise welfare
• if firm is private they may decide to profit maximise
  
  • will produce where MC=MR
  • making supernormal profit
• however if it was nationalised it will produce where AR=MC → allocatively efficient output

Question 36

what may nationalism lead to for the industry?

Answer 36

nationalism leads to higher output at lower prices but causes a loss for the industry which the govt would need to cover

Question 37

draw a natural monopoly diagram to show where the govt and where the firm will produce?

Answer 37

• orange section- supernormal profit if privatised
  
  • P1 Q1
• purple section- if nationalised would produce at P2 Q2
  
  • loss

Question 38

what are the aims of competition policy

Answer 38

prevent excess pricing
promote competition
ensure quality, standards and choice
regulate natural monopolies
promote technological innovation

acts in public interest

Question 39

how can you evaluate price regulation

Answer 39

regulators may over or under estimate the value of X - asymmetric info - how do they know what X is
could cause job losses as firms try to cut costs
limits on profit can lower investment
regulatory capture
costly for regulators to do this which is a burden on tax payers (regulators are paid to do this)

Question 40

RPI-X+K

Answer 40

could increase quality due to increased investment
ev how do they know the level of K
if overestimated - no incentive to lower costs

Question 41

how do you draw a price cap on a monopoly diagram

Answer 41

Question 42

how can you evaluate a profit cap

Answer 42

reduces investment -> reduces innovation, less dynamic efficiency, reduce quality
reduce corporation tax revenue for the government
less incentive for firms to enter the market (as profit acts as a signal for firms to enter the market) which could lower competition
firms could lie about the amount of profit they make and firms could bypass the regulation
difficult to monitor as regulators would have to look at every firms accounts

Question 43

how can regulators use quality standards to regulate a monopoly

Answer 43

regulators can observe the quality of goods and services and ensure a minimum standard is met
performance targets for the firm

Question 44

how can you evaluate the govt enhancing competition between small firms through promotion of small businesses

Answer 44

opportunity cost