Government Intervention- Theme 3

Question 1

How does government intervention control mergers?

Answer 1

Competition and and Markets Authority (CMA) determines whether a merger will impact adversely on competitiom. In other words if merger leads to a substantial lessening of competition , it’s likely to be blocked. This market share may allow a firm to exhibit characteristics of a monopoly and dominate the market.

Question 2

How does price regulation control monopolies?

Answer 2

Price capping used to regulate several privatised utilities in the uk. The price cap is an upper limit set on the increase that the firms can add to their retail prices. It takes into account the level of inflation measured by the retail price index and then takes account of possible efficiency gains or investment.

Question 3

What is the price cap formula?

Answer 3

RPI-X
This takes the RPI and subtracts a factor X determined by the regulator. X represents the efficiency gains that the regulator has determined can reasonably be achieved by the firm in question

Question 4

What is RPI + K

Answer 4

This takes RPI and allows for the addition of the K factor, which accounts for the additional capital spending that a firm has agreed with the regulator is necessary. This is used by water regulators to determine the price for each of the regional water companies.

Question 5

Advantages of price regulation.

Answer 5

• it allows a firm to keep any profits it makes through bringing about greater efficiency gains than the regulator has calculated are reasonable
• It also encourages competition in the market, which can prevent the firms abusing their monopoly power.

Question 6

Disadvantages of price regulation.

Answer 6

• it is hard to determine what the value of X should be. Moreover, it could limit how much profit a firm can make, which might in turn limit how much investment they do.
• There is also the risk of regulatory capture. This is when regulators start working in favour of the fir

Question 7

How is profit regulation used to control monopolies?

Answer 7

Method allows a firm to make a certain level of profit based on its capital stock before the remainder of the profit is taxed at 100%. This means that there’s no incentive to make efficiency gains that increase profits. Firms not rewarded for their success, they’re penalised for it and instead encouraged to make limited profit. Any excess profit spent on additional capital to increase the level of capital stock and therefore allowable profit while increasing level of efficiency.

Question 8

How does quality standards control monopolies?

Answer 8

regulators can observe quality of the goods and services of the firm. For example, in the gas and electricity markets, regulators ensure the elderly are treated fairly, especially in the colder months. Governments ensure minimum standards are met.

Question 9

How do performance targets control monopolies?

Answer 9

Regulator can set performance targets that it will monitor. These may be based on improvements in quality of service or reductions in number of complaints. Supported by system of fines should firm fail to meet performance targets or rewards should the firm meet them.

The NHS, which has monopoly power, also has performance targets, such as reducing waiting times. It helps the firm to focus on increasing social welfare.

Question 10

How is enhancing competition between firms through promotion of small business used to promote competition and contestability?

Answer 10

• UK government established the ‘Red Tape Challenge’, which aims to simplify regulation for businesses. Especially aimed towards small businesses. Aims to make it cheaper and easier to meet environmental targets and create new jobs.
• Small and Medium Sized Enterprises (SMEs) important for creating a competitive market. They create jobs, stimulate innovation and investment and promote a competitive environment.
• Governments aim to improve access to finance and reduce barriers to entry, which will make it easier for smaller firms to enter the market.

Question 11

How is deregulation and privatisation used to promote competition and contestability?

Answer 11

• By deregulating or privatising the public sector, firms can compete in a competitive market, which should also help improve economic efficiency.
• Excessive regulation is also called ‘red tape’. It can limit the quantity of output that a firm produces.
• Since they are operating on the free market, firms also have to produces the goods and services consumers want. This increases allocative efficiency and might mean goods and services are of a higher quality. Competition might also result in lower prices. However, firms which profit maximise in a competitive market might compromise on quality.

Question 12

Define deregulation.

Answer 12

Deregulation is the act of reducing how much an industry is regulated. It reduces government power and enhances competition

Question 13

Define privatisation.

Answer 13

Privatisation means that assets are transferred from the public sector to the private sector. In other words, the government sells a firm so that it is no longer in their control. The firm is left to the free market and private individuals.

Question 14

How is competition tendering for government contracts used to promote competition and contestability?

Answer 14

• government provides some goods and services because they are public or merit goods, and they’re underprovided in free market. The government could contract out this provision, so that private firms operate things such as roads or hospital.
• firm which offers lowest price and best quality of provision wins government contract. This saves government money, since public sector can be bureaucratic and inefficient. Private sector has an incentive to reduce their costs, since they operate in a competitive market.
• also frees government of maintenance, since private sector might have expertise and knowledge to fulfil the project and maintain the infrastructure.

Question 15

How do restrictions in monopsony power of firms protect suppliers and employees?

Answer 15

The CMA investigates supermarkets to determine whether or not they’re exploiting their market dominance and extracting unfair prices from their suppliers. They could be fined if they’ve behaved in a way that’s anti-competitive.

Question 16

How does nationalisation protect suppliers and employees?

Answer 16

• occurs when private sector assets sold to public sector. In other words, government gains control of an industry, so it’s no longer in hands of private firms.
• By nationalising an industry, natural monopolies are created. This is because it is inefficient to have multiple sets of water pipes, for example. Therefore, only one firm provides water.
• Some nationalised industries yield strong positive externalities. For example, by using public transport, congestion and pollution are reduced.
• Nationalised industries have different objectives to privatised industries, which are mainly profit driven. Social welfare might be a priority of a nationalised industry.

Question 17

What’s the impact of government intervention on prices?

Answer 17

• Governments can prevent monopolies charging consumers excessive prices, which might result in a loss of allocative efficiency.
• Limiting how much a firm can increase its prices by also encourages the firm to become more efficient. This is so that they can lower their costs and increase their profit margins.
• If corporation tax is high, firms might pass the extra cost onto consumers, resulting in higher prices, rather than losing their own profits.

Question 18

What’s the impact of government intervention on profit?

Answer 18

If governments impose strict price caps, investment could be limited, since amount of profit that firm makes is restricted.
However, recent fall in UK corporation tax from 21% to 20% will help firms keep more profits. The size of the fall can be evaluated- is 1% a significant fall?

Question 19

What’s the impact of government intervention on efficiency?

Answer 19

Private sector firms are more likely to operate profit maximising level of output and price. A public sector firm is more likely to operate at the allocatively efficient level of output (AR=MC). Therefore, government intervention might lead to an increase in economic efficiency, since the objectives change from profit maximisation to maximising social efficiency.

Question 20

What’s the impact of government intervention on quality?

Answer 20

Governments can ensure firms meeting minimum targets, which ensures firms focus on increasing social welfare. For example, firms in the gas and electricity markets are regulated to ensure vulnerable groups, such as the elderly, are kept warm during colder months.
Firms which profit maximise might compromise on quality. However, if private sector firms have the expertise and knowledge which the government might not have, then they might be able to produce goods and services of a higher quality.

Question 21

What’s the impact of government intervention on choice?

Answer 21

• If governments regulate monopolies and encourage start-up and growth of SMEs, consumer choice in the market widens, since more firms competing.
• A stringent price ceiling might force some suppliers out of markets, which reduces quantity supplied and narrows choice for consumers.
• If governments can reduce price of a good or service, it could allow those on low and fixed incomes to access goods and services they previously could not afford to.

Question 22

How is regulatory capture a limit to government intervention?

Answer 22

There is risk of regulatory capture. This is when regulators start acting in the interests of the company, due to impartial information, rather than in consumer interests. This information disadvantage is a problem for regulators.

Question 23

How is asymmetric information a limit to government intervention?

Answer 23

The problem of asymmetric information can make it hard to determine what level a price cap should be imposed at.
It is hard to determine government policies when intervening where there is market failure, since the extent to which the market fails involves a value judgement. Without sufficient information, governments could make poor decisions and it could lead to a waste of scarce resources.