Govt intervention - Controlling Monopolies: Price and Profit Regulation

Question 1

Where would the price ceiling be if the govt wants a monopoly to be allocatively efficient

Answer 1

MC=AR

Question 2

What is the formula if regulator like the CMA want a monopoly to charge below the profit maximising price

And define each part

Answer 2

RPI-X+K
RPI=Retail Price inflation
X= Expected efficiency improvements
K=Level of investment

Question 3

Advantages and disadvantages of the RPI-X+K

Answer 3

Advantages:
-encourages firm to reduce costs by more than X to enjoy higher profits
-encourages investment, higher quality

Disadvantages:
-difficult to know where X to set X due to rapid improvements in technology
-asymmetric information as firms could lie about their efficiency gains to regulators
-regulatory capture

Question 4

What is profit regulation

Answer 4

Government policies aimed at limiting or controlling the profits that firms can make, particularly in industries where firms have monopoly or oligopoly power.

Question 5

Purposes of profit regulation

Answer 5

-encourage investment
-prevents firms from setting high prices
-gives firms incentive to employ a lot of capital in order to increase their profits

Question 6

How is profit regulation calculated

Answer 6

Done by calculating the operating costs of the monopolist and adding a rate of return on capital employed

Question 7

Disadvantages of profit regulation

Answer 7

Disadvantages:
-there is little incentive to minimise costs
-monopolist has incentive to overemploy capital
-asymmetric information regarding profits
-regulatory capture