government intervention in product markets

Question 1

Competition policy aims to ensure:

Answer 1

• Technological innovation which promotes dynamic efficiency
• Effective price competition between suppliers
• Safeguard and promote the interests of consumers through greater choice and lower prices

Question 2

Main Pillars of UK Competition Policy

Answer 2

• Anti-trust & cartels:
  o Eliminating agreements that restrict competition including price-fixing by firms with a dominant market position
• Market liberalisation:
  o Introducing competition in previously monopolistic sectors such as energy supply, retail banking, postal
  services, mobile telecoms and air transport
• Merger control:
  o Investigation of mergers and take-overs which could result in firms dominating the market

Question 3

Tax on monopoly profits

Answer 3

A one-off windfall tax on supernormal profits for firms with significant market power

Risk of tax avoidance / loss of capital investment spending

Question 4

Liberalization of markets

Answer 4

Break up monopolies – allow smaller businesses to enter and increased contestability

Smaller businesses may struggle to scale up and compete

Question 5

Introduce price capping policies

Answer 5

Encourages cost efficiency + increases consumer surplus

Monopolists may find revenues in other ways

Question 6

Nationalisation

Answer 6

Take some monopoly utilities back into public ownership

Possible loss of productive efficiency

Question 7

capped price must be set by the regulator below the normal profit maximising price

Answer 7

• A price cap lowers the monopoly (supernormal) profit
• stimulate attempts to improve cost efficiency
• leads to an improvement in allocative efficiency and consumer welfare
• May lead to the exit of some businesses from the industry which might actually reduce competition

Question 8

Arguments for Price Capping with a Monopoly

Answer 8

1. Capping is approp. way to curtail monopoly power of natural monopolies/ dominant firms preventing them making excessive profits at expense of consumers.
2. Cuts in real price levels are good for household and industrial consumers (leading to an increase in CS and higher real living standards in the LR)
3. Price capping helps to stimulate improvements in productive efficiency because lower costs are needed to increase a producer’s profits.
4. The price capping system a tool for controlling consumer price inflation.

Question 9

Arguments against Price Capping

Answer 9

1. Price caps have led to large numbers of job losses especially in the utility industries.
2. Setting different price capping regimes for each industry distorts the working of the price mechanism.
3. The industry regulator may not enough accurate information when setting the price caps for future years.
4. Capping prices means lower profits which in turn can lead to reduced capital investment by the utility businesses – ultimately consumer suffer if there is under-investment in utility infrastructure such as water and energy.

Question 10

Poorly enforced price capping can lead to

Answer 10

government / regulatory failure

Question 11

De-regulation of markets:

Answer 11

• attempts to liberalise a market to encourage new entrants
• usually involves some of the statutory barriers to entry

Question 12

Encouraging competition in a natural monopoly is difficult –

Answer 12

but one approach is to split an industry into the core network aspect and the final mile service to the consumer.

Question 13

advantages of de-regulation of markets

Answer 13

• more firms = bringing down prices
• competition = improved static efficiency
• competition = higher choice + output
• higher capital investment and productivity could lead to improve DE

Question 14

Arguments for privatisation:

Answer 14

1. Private companies have a profit incentive to cut costs and be more efficient and raise productivity.
2. Government gains revenue from the sale of assets.
3. If a state monopoly is replaced by a number of firms this will lead to lower prices. The competitiveness of the macro economy may improve.
4. Privatisation can create a shareholder democracy i.e. greater share ownership.

Question 15

Arguments against privatisation:

Answer 15

1. Social objectives are given less importance.
2. Some activities are best run by the state because they are strategic parts of the economy e.g. water supply, steel and railways.
3. Government loses out on dividends from any future profits. Public sector assets often sold too cheaply.
4. Shares are often bought / held by large institutions such as pension funds, insurance funds and others.

Question 16

Case for state ownership

Answer 16

1. Nationalized firms can target social objectives.
2. Firms might charge lower prices – not focused on pure profit maximisation / extracting consumer surplus.
3. Natural monopolies in the state sector can achieve economies of scale = gains in productive efficiency.
4. Can be used as a vehicle for hitting macroeconomic aims such as keeping inflation under control.

Question 17

Case against state ownership:

Answer 17

1. Absence of shareholder pressure might lead to diseconomies of scale and therefore higher prices.
2. Lack of market competition can lead to X-inefficiency.
3. Firms may lack an incentive to innovate – leading to a loss of dynamic efficiency.
4. Losses of state-owned firms are absorbed by taxpayers and can lead to higher budget deficits.

Question 18

gov. policies to promote small businesses

Answer 18

• incentives business to invest
• improve flow of finance
• encourage rate of business start ups
• facilitate business growth strategies

Question 19

Zero sum game

Answer 19

An economic transaction in which whatever is gained by one party must be lost by the other.

Question 20

Impacts of gov intervention on monopolies

Answer 20

Governments are able to ​prevent monopolies charging excessive prices ​and aim to ​limit their profit. They try to ensure that ​consumers pay fair prices, receive a good quality service and have a lot of choice through different methods of regulation and target setting. High regulation may force some firms out of the industry, which would reduce choice

Question 21

Impact on gov intervention on efficiency

Answer 21

They can increase ​efficiency in a market by increasing competition and contestability. By regulating prices, they ensure a business keeps their costs low and so prevent X-inefficiency. They try to increase ​dynamic efficiency by encouraging investment. However, if the government regulates too strongly, they can ​push costs up​ and led to inefficiency

Question 22

Example of regulatory capture

Answer 22

alleged capture of HMRC by Vodafone, who negotiated a tax reduction from £7bn to £1bn in 2009-10

Question 23

Asymmetric info for regulators

Answer 23

● This is where regulatory bodies have to ​use information provided to them by the industries ​when setting price targets etc. It is in the industry’s best interest to maximise their profits and so may provide inaccurate or limited information, meaning regulators are unable to set correct targets, prices etc.
● As a result, ​government failure may occur if regulation such as RPI-X or quality standards are not set correctly. The government will be unable to regulate the companies accurately