Theme 3.6 Flashcards
What do the Competition and Markets Authority (CMA) work to achieve?
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, enforce consumer protection law and bring criminal cases against individuals who participate in cartels. They are able impose financial penalties, prevent mergers taking place and force businesses to reverse actions already taken.
How are mergers controlled in the UK and when will they be investigated?
● 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). The CMA will consider the likely competitive situation if the merger goes ahead compared to if it does not, and the merger will be approved if its potential benefits are greater than its cost.
● 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.
What is the aim of controlling mergers?
● 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.
● However, the problem is that very few mergers are investigated each year. The CMA can suffer from regulatory capture and may not have all the information necessary to make a decision.
What are examples of mergers which the CMA allowed or blocked?
Tesco’s takeover of Booker was allowed as the CMA believed the impact on competition would not be too high since supermarkets are in a hypercompetitive industry.
However, the European Commission blocked the merger of Ryanair & Aerlingus in 2010 as they would control more than than 80% of all Europe flights from Ireland.
Why do governments want to control monopolies?
Holding a dominant position in an industry is not wrong in itself but if the firm exploits this to stifle competition, they are deemed to be anti-competitive. Monopolies are allocative and productively inefficient and so it can be argued that they need to be controlled. Most of this regulation occurs for utilities, which are natural monopoles.
What is price regulation?
● Regulators can set price controls to force monopolists to charge a price below profit maximising price, using the RPI-X formula. X represents the expected efficiency gains of the firms and the aim is to ensure firms pass on their efficiency gains to consumers. This is used in the airport industry.
How does price regulation occur in the water industry?
They use ‘RPI-X+K’, where K represents the level of investment. This is used in the water industry and has allowed investment of £130bn.
What are the benefits of price regulation?
-It gives an incentive for firms to be as efficient as possible as if they can lower costs by more than X they will enjoy increased profit.
-It prevents excessive prices and ensures that gains are passed onto the consumer. This ensures that the deadweight loss to society will be as low as possible.
-Will also likely increase the output of goods with positive externalities.
What type of monopoly is price regulation often used on?
Natural monopolies, such as in the energy market. Prices are capped so that consumers aren’t exploited by extremely high energy costs, and it also helps to control inflation as rising energy costs will increase the costs of production in all industries.
What are the disadvantages of price regulation?
-The problem is that 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, for example the water industry was forced to cut prices by 10% in 2000.
-May also cause negative impacts on competition, as if the price is set too low new firms who cannot benefit from economies of scale will be able to make very little profits due to having high costs.
Where is the regulatory price often set?
The allocative efficient price, where AR=MC. This means there is no deadweight loss to society and ensures prices are as close to where they would be in a competitive market. Doing this will cause productive efficiency to be sacrificed however, and may lead to dynamic inefficient as a result.
How can maximum prices be used in price regulation?
Moreover, maximum prices could be set where the price is equal to the MSC, ensuring monopolies are allocative efficient. However, it is difficult for governments to know where they should set the price as they do not know the exact allocative efficient output. It can also increase dynamic inefficiency as firms are unable to maximise profit so may not invest.
What is profit regulation?
In the USA, ‘rate of return’ regulation is used where prices are set to allow coverage of operating costs and to earn a ‘fair’ rate of return on capital invested, based on typical rates of return in a competitive market.
How is profit regulation calculated?
They do this by calculating the firms total costs & then adding a percentage of profit to it
What are the disadvantages of profit regulation?
-Costs are difficult for the CMA to calculate
-Firms often try to inflate their perceived costs so as to make more profit than allowed
-Monopolies have no incentive to lower costs if they have already made their maximum legal profits, so if costs are higher than they would be in perfect competition consumers still end up paying higher prices
-Even with this policy in place, natural monopolies seem to post record profits year on year
What are the benefits of profit regulation?
This aims to encourage investment and prevents firms from setting high prices. However, it gives firms an incentive to employ too much capital in order to increase their profits.
How can governments use quality standards to regulate monopolies?
-One way to maximise profit is to reduce the quality of the raw materials which reduces the quality of the end good/service
-If there are no substitutes then this is a likely outcome
-Regulators can step in to insist that certain quality standards are met
What are examples of quality standards being introduced?
-The ambulance service must respond to at least 75% life-threatening 999 calls within 8 minutes.
-The Royal Mail universal standard obligation
What are the disadvantages of quality standards?
-The problem is that it requires political will and understanding to introduce.
-It can be difficult for them to know what the potential quality of a product is or what standards to impose
What are performance targets?
● Regulators can introduce yardstick competition, such as setting punctuality targets for train operating companies based on the best-performing European train operators. It is also possible to split up a service into regional sectors to compare the performance of one region against another; this is used in the water industry.
● They could set targets over price, quality, consumer choice and costs of production. It will help firms to improve their service and lead to gains for customers.
What are the disadvantages of performance targets?
-The problem is that firms will resist the introduction of targets, so again it requires political will and understanding.
-They will also attempt to find ways to meet targets without actually improving, for example changing train timetables to prevent trains officially arriving late.
-Can result in unintended consequences, e.g if there is set amount of GP appointments needed per hour, doctors could incorrectly diagnose patients as they’re rushing.
What is an example of an industry where performance targets are used?
The rail industry. They have targets of trains arriving in time, but in 2014 Network Rail missed 11/44 performance targets, and only 89.1% of trains arrived on time, meaning over 50,000 services were late.
What often has to occur for performance targets to be effective?
The government need to ensure that fines and other deterrents are strong enough that firms at least work to ensure targets are met.
How can windfall taxes help regulate monopolies?
If monopolies have made extremely high profits, then after these have been made taxes can be imposed to take them away. This will discourage monopolies from exploiting workers if they know it will likely result in profits being taxed away. Firms may begin to underreport their profits to avoid these taxes.
How can breaking up the monopolist regulate monopolies?
The government can split monopolies up into competing units, which should therefore lead to lower prices and profits as well as greater consumer choice. However, if this means economies of scale can no longer be used, prices could even rise for consumers.
How can subsidies be used to regulate monopolies?
In order to achieve allocative efficiency, the government could subsidise monopolies. This will reduce their MC and encourage them to produce at the point where MC equals the price. Subsidising monopolies would likely be very politically unpopular, and therefore this is unlikely to occur.
How can self regulation help regulate monopolies?
When monopolists come under threat from regulators, they will suggest that they can regulate themselves through codes of practice. Although this is beneficial for governments as they don’t have to spend time and money regulating themselves, monopolies will often be very lenient with the amount of changes they force themselves to make.
How can reducing barriers to entry regulate monopolies?
Reducing barriers to entry and using merger policies will prevent monopolies being formed in the first place. For natural monopolies, nationalisation can be used to protect consumers, where privatisation can increase efficiency, lowering costs.
