Theme 3 CC4 - GOVT Intervention to control monopolies and mergers

Question 1

Give 4 limitations of mergers/takeovers
(Reasons for govt intervention)

Answer 1

1. Greater market concentration and monopoly power with loss of allocative efficiency.
2. Higher prices for consumers, less choice, loss of consumer surplus
3. Less competition leads to a drop in quality of G&S
4. Job losses through rationalisation

Question 2

Give 4 benefits to mergers

Answer 2

• Reduce overcapacity in a market
• Greater profit may enhance R&D leading to greater dynamic efficiency
• EOS leading to cost savings, could lead to lower prices for consumers
  -UK firms better able to compete globally
• Higher producer surplus if prices/profits rise

Question 3

Evaluate merger control

Answer 3

Regulatory failure may occur with ‘wrong’ decision made for economic agents if:
- imperfect information
- Regulator influenced to act in interest of one of the firms
- Cost of investigations is high (Waste of resources)

Question 4

What are the 4 govt intervention policies to control monopolies?

Answer 4

1. Price regulation
2. Profit regulation
3. Quality standards
4. Performance targets

Question 5

Explain Price regulation

Answer 5

• One of the main methods used by UK Govt to regulate privatised monopolies e.g. 2015 price controls on train fares and on water supply.
• Price capping - an upper limit for the price increase that a firm can add to their retail prices.
• Fixed for a set period but can be removed if industry opened up to competition.

Question 6

What are the 2 formulas used for price caps

Answer 6

1. RPI (Retail price index) - X
   - X represents efficiency gains that the regulator has determined can be achieved by the firm.
2. RPI + K
   - K factor accounts for additional capital spending that a firm has agreed with the regulator is necessary.

Question 7

Evaluate price controls

Answer 7

• How does regulator know where to set X and K. It is difficult for the govt to know where the cost and revenue curves lie and what is AE level of output.
• Company may have better information about costs than the regulator leading to asymmetric information. This may result in prices being kept high and regulator becoming a victim of regulatory capture.
• Efficiency gains may be achieved through reducing the quality of the goods
• Price controls may lead to dynamic inefficiency due to reduced profits to reinvest into R&D.

Question 8

Explain profit regulation

Answer 8

• Maximum level of profit the can be earnt (Absolute or relative terms)
• Govt should set a level of profit such as monopolist makes no more profit than if industry were perfectly competitive.

Question 9

What is the impact of profit regulation? (Evaluation)

Answer 9

1. Unlike price capping, there is no incentive to make efficiency gains that increase profits and instead are incentivised to let their costs rise which will be covered by consumers.
   - Firms are not rewarded for their success but penalised for it by limiting profit.
2. Firms encouraged to overstate value of their capital employed to ensure they can increase rate of return on their investment and increase profits.

Question 10

Explain quality standards

Answer 10

A profit max monopolist is focused on profit and not quality. Therefore govts can intervene by setting quality standards. It is in monopolies interest to resist quality standards and so may suggest self-regulation.

Question 11

Explain performance targets

Answer 11

• Regulator sets targets that must be achieved e.g. improvement in quality, prices, customer choice, costs.
• May face fines if fail to achieve

Question 12

What is the impact of performance targets on firms/customers?

Answer 12

Firms: - Improvements in efficiencies e.g. productive
- Improved reputation from better quality service
- May target mroe cstomers from better choice/prices/quality.

Customers:
- Lower prices,greater choice, ^Consumer surplus

Question 13

Evaluate performance targets

Answer 13

• Monopolists may resist imposition of performance targets if not meeting results leads to bad publicity and fines.
• Monopolists may find ways of bypassing performance targets e.g. changing train timetables so train journeys become officially longer to meet percentage of trains on time. Therefore these targets may have to be changed often when exploited
• Penalties may benefit customers e.g. train operator must give refunds if late by more than a certain amount.

Question 14

Give 4 ways government intervention promotes competitition/contestability?

Answer 14

1. Promotion of small businesses (SMEs)
2. Deregulation
3. Competitive tendering for govt contracts
4. Privatisation

Question 15

Explain promotion of SMEs as a policy of increasing contestability
- Impact
- How is it done?

Answer 15

• Small firms are often more innovative (‘creative destruction’) and more economically efficient
• New firms can challenge existing firms in an industry and so increase its competitiveness

Can be done by:
-Lowering rate of corporation tax, give subsidies
- VAT relief for small businesses
- Act as a guarantor for bank loans

Question 16

Explain Deregulation as a policy of increasing contestability give case study example

Answer 16

• This is the removal of legal barriers to entry to a previously protected market to allow private enterprises to compete. This will increase efficiency in the market by allowing greater competition as more firms can enter and conduct more activities than they could before.

e.g. royal mail delivered to all with no other competition allowed until 2006 which then allowed for competition. Royal mail then privatised in 2013

Question 17

Give 2 advantages of deregulation

Answer 17

• Increased competition encourages firms to be economically efficient, leading to lower costs and prices for consumers.
• Govt regulation often involves excessive costs of bureacracy

Question 18

Give 2 disadvantages of deregulation

Answer 18

• It can be difficult to create effective comp in an industry which is a natural monopoly - high barriers to entry. Deregulation may create a private firm with monopoly power.
• Could lead to a comprimise of public services with poorer quality provision.

Question 19

Explain Competitive tendering as a policy of increasing contestability
Give case study example

Answer 19

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 can be produced by the private sector and then bought by the public sector.

• Contracting out (subcontracting): getting private sector firms to produce the g&s, which are then provided by the state for its citizens. (PFI)
• Competitive tendering: introducing comp amongst private sectors, which bid for work contracted out by public sector.

E.g. Serco cheapest bid for running community/probhation service for state. Poorly run, understaffed and oversubscribed - couldn’t take attendance properly.

Question 20

Give 2 advantages of competitive tendering /contracting out

Answer 20

• Specialist knowledge, expertise and equipment
• Bidding process secures best possible price if efficient.

Question 21

Give 2 disadvantages of competitive tendering /contracting out

Answer 21

• Scope for collusion and poor value for taxpayer money
• Loss of internal skills and expertise

Question 22

Explain Privatisation as a policy of increasing contestability
Give case study example

Answer 22

• The transfer of a business, industry or service from public to private ownership and control. E.g. BP, BT, British gas, BA, NATS, Royal mail

Question 23

Give 3 arguments in favour of privatisation

Answer 23

• It encourages greater competition, which reduces X-inefficiency and ensures low prices (productively efficient) and high quality/choice as firms realise they need to be competitive.
• Greater incentive to innovate (SNP= ^dynamic efficiency ) so firms can compete better with better products or production processes etc
• Relies on the invisible hand (free market resource allocation) which reduces govt interference (less resources used, less taxpayer burden)

Question 24

Give 3 arguments against use of privatisation

Answer 24

1. Creates a private monopoly that is inefficient - increased prices, lack of investment, lower consumer surplus
2. when there are natural monopolies it may be fairer for the government to own the firm since they won’t abuse their monopoly position.
3. Some people argue that industries such as electricity, water and transport are important because they directly affect the success of other industries, and so therefore it makes more sense for the government to own them in order to coordinate them properly.
4. Reduced econs of scale by splitting services - also wasteful duplication of resources

Question 25

What are public private partnerships (PPP)? Explain, give example

Answer 25

• A partnership between the public sector and the private sector where the companies collaborate to deliver services.
• One type is Partial privatation where state retains a part share e.g. NATS
• Another type is Private finance initiative (PFI) where private sector finances a project and state pays for service to be run, pays private firm back over LT.

Question 26

What are ways of government intervention to protect suppliers and employees?

Answer 26

• Restrictions on monopsony power of firms
• Nationalisation

Question 27

Explain restrictions on monopsony power to protect suppliers/employees

Answer 27

Monopsonists are able to exploit suppliers by reducing prices as suppliers have no choice but to sell to supermarkets for example.
- The government can prevent these by passing anti-monopsony laws which make certain practices illegal and can introduce an independent regulator who will force monopsonists to buy fairly.
- Fines can be put in place for those who exploit their power and minimum prices may be introduced to ensure suppliers are paid a fair amount. Self-regulation can also be used, but this is weak.

Question 28

Explain nationalisation as a way of protecting suppliers/employees

Answer 28

• The transfer of firms or assets from private sector ownership to state ownership.
• Nationalisation aims to change goals of firm, industry focuses on maximising social welfare not private profit max objectives.

Question 29

Give 3 advantages of nationalisation

Answer 29

• Lower costs (productively efficient) from EOS by merging numerous previously private firms. Also no advertising costs if natural monopoly.
• If natural monopoly, better management under state control as can maximise net social benefit compared to private business who aims to profit max. Govt also consider externalities.
• Fairer distribution of resources - lower prices for public services etc, government can guarentee a minimum level of service for people at risk of being cut off from service.

Question 30

Give 3 disadvantages of nationalisation

Answer 30

• Large upfront costs to buy out shareholders of possibly multiple firms
• Government failure can lead to inefficient management/allocation of resources
• Constraints on raising finance - either funded by tax revenues and/or borrowing
• Principle-agent problem and moral hazard (covered by government)
• Lack of investment if govt don’t have enough to invest. e.g. NHS lack fo funding/comp

Question 31

What is the impact (ADV/DISADV) of govt intervention on Prices and profits? 2 Each

Answer 31

+ Governments are able to prevent monopolies charging excessive prices (RPI-X) 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.

-High regulatioin may force firms out industry, reducing consumer choice.
-Also, prices could rise in LR if lower profits, inefficiency and less reinvestment.
-Dermerger lead to DOS

Question 32

What is the impact (ADV/DISADV) of govt intervention on efficiency?

Answer 32

+ Increase economical efficiency for firms by ^comp/contestability. E.G. price controls ensure allocative efficiency is achieved (especially public sector that aim to max social welfare). Performance targets may improve efficiciency
+ They try to increase dynamic efficiency by encouraging investment.
+ Public sector cut costs (productive efficiency) due to EOS

-However, if the government regulates too strongly, they can push costs up and lead to productive inefficiency.
-Reduced profits and therefore dynamic efficiency less likely
-X-inefficient due to no incentive to be efficient as no competition

Question 33

What is the impact (ADV/DISADV) of govt intervention on quality

Answer 33

+ Should be increased quality as public sector aims to maximise social welfare
+ Competitive tendering means firms have to up their game to win
+ Quality standards should ensure greater quality

-Privatisation could lead to corner cutting to profit max meaning lower quality
-If public sector, no comp could lead to reduced quality, also may not have same knowledge/expertise as private sector reducing quality of a good or service.

Question 34

What is the impact (ADV/DISADV) of govt intervention on choice?

Answer 34

+ Deregulation means greater competition and therefore more choice for consumers
+ Performance targets may aim to improve consumer choice

-If public, govt less likely to offer choice, since there is only one company producing the goods or in contestable markets (where there is no product diff).

Question 35

What are the limits of government intervention?

Answer 35

1. Regulatory capture
2. Asymmetric information

Question 36

Explain regulatory capture and why it can happen

Give example

Answer 36

Where the regulator of an industry ends up acting for the firm rather than regulating it and acting in interest of consumers.
-This can happen because:
1. Regulators become friendly with the firms they are dealing with - spending more time with them and become more sympathetic to their viewpoint, giving generous terms of regulation.
2. Inefficiencies of public sector - Less incentive for regulator to work hard and act like surrogate competition as they do not get to keep any reduced profit. Compared to business owner who will want to max profits and work harder against regulator.
3. Corruption - e.g. firms giving bribes to regulators

e.g. One example is the alleged capture of HMRC by Vodafone, who negotiated a tax reduction from £7bn to £1bn in 2009-10.

Question 37

Explain asymmetric information as a limit to govt intervention

Answer 37

● The regulator may rely on information provided to them by the industries/firm when setting price/cost 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.