Theme 3.6: Government Intervention Flashcards
What are the variants for price regulation?
RPI - X: allows prices to increase at the rate of RPI minus the efficiency gains that the regulator believes can be achieved by the firm
RPI + K: takes the RPI and allows the addition of ‘K’ which is the additional capital spending a firm has agreed with the regulator is necessary
Give the arguments in favour of price capping
- Prevents monopolies exploiting consumers with high prices
- Cuts in price of necessity items increases affordability for consumers (allocatively efficient and progressive)
- RPI - X price caps create an incentive for firms to lower costs in order to increase profits
Give the arguments against price capping
- Regulators need to have a good understanding of costs and rates of return in the industry, when in reality the monopolist has more information than the regulator and may attempt to present their costs as being higher than they actually are
- It creates little incentive to minimise costs: if they cover costs and earn a profit on capital employed it creates no incentive for the monopolist to reduce costs as they can be passed onto the consumer
List the methods of government intervention that can be used to regulate monopolies
- Quality standards
- Performance targets
- Nationalisation
- Breaking up the monopoly
How do quality standards regulate monopolies?
The government sets quality standards which the monopoly must meet, and issue fines if they are not met
Give real world examples of the government implementing quality standards on a monopoly
The UK Post Office has a legal obligation to provide a daily letter delivery service to rural areas, despite the fact that it is a loss making activity
Electricity companies are required to have enough capacity to prevent blackouts occuring
Evaluate the extent to which quality standards regulate monopolies
- Monopolies will try to resist quality standards
- Regulators need to ensure that standards aren’t set so high that they are restrictive to businesses
- Regulators need to have a strong understanding of the industry to impose meaningful quality standards
How do performance targets regulate monopolies?
- Similar in principle to quality standards
- Goverment sets targets for price, product quality or choice
Evaluate the extent to which performance targets regulate monopolies
Monopolists may find ways round meeting performance targets without actually making improvements
e.g. train companies could change timetables to appear that journeys are completed on time, even if journey times have not changed
Give real world examples of the government implementing performance targets on a monopoly
Train companies given targets for the percentage of trains that arrive on time
How does nationalisation regulate monopolies?
Moving a privately owned company into the public sector
This changes the company objective from profit maximisation to social objectives
It allows longer term considerations (such as investing) which might be ignored with a profit motive
Evaluate the extent to which nationalisation regulates monopolies
Government run companies may be susceptible to x-inefficiencies as there is less focus on minimising costs
How does breaking up a monopoly regulate monopolies?
Reduces monopoly power and increases competition by forcing a monopolist to sell off part of its business
Evaluate the extent to which breaking up monopolies regulates monopolies
Any economies of scale lost will push up costs of production and probably prices
Which body regulates competition in the UK?
Competition and Markets Authority (CMA)
“Promotes competition for the benefit of consumers”
* Investigates mergers to ensure they don’t lead to a ‘substantial lessening of competition’
* Investigates the abuse of market power
* Take action against anti-competitive behaviour
* Protect consumers from unfair trading practices
Regulating authoritiies in the UK can impose price caps and performance related criteria on industry
Give an example of the CMA blocking a merger
Sainsbury’s and ASDA, 2019
Give the impacts of merger regulation
- Choice: avoids the build up of monopolies which may reduce range of choice
- Price: regulation prevents consumer exploitation by powerful firms to move the price closer to allocative efficiency
- Costs: greater competition leads to a stronger incentive to keep x-inefficiencies to a minimum
- Innovation: greater competition provides a stronger incentive for firms to innovate (dynamic efficiency)
What are the ways that the government might intervene in markets to promote competition and contestability?
- Encouraging the growth of small businesses
- Deregulation
- Regulation
- Competitive tendering
- Privatisation
How does encouraging the growth of small businesses promote competition and contestability?
Government can try to increase the number of small businesses to increase competition
They could provide training and grants to potential new entrepreneurs, or encourage the growth of existing small businesses through tax incentives or subsidies
How does deregulation promote competition and contestability?
Removing government controls in order to promote competition and improve efficiency through lower costs, as fewer constraints on business allows for greater flexibility and reduces costly bureaucracy
Can lead to a problem of private firms focussing only on profitable sections of the industry
How does regulation promote competition and contestability?
Can ‘force’ competition to occur, particularly for industries that are natural monopolies where competition is unlikely to occur without intervention
e.g. the competition in the electricity market
Price regulation can encourage competition if it discourages price fixing behaviour: firms have to compete more on non-price factors
How does competitive tendering promote competition and contestability?
Government provides many services, many directly, but also contract out the provision to a private company
If the government contracts out a good or service to the same company every time then it is effectively creating a monopoly
Competition can be encouraged through competitive tendering (gov. invites bids from private sector firms and awards a contract to the firm offering the lowest price)
How does privatisation promote competition and contestability?
Doesn’t reduce monopoly power, but could create a greater incentive to cut costs and increase efficiency
If the cost reductions outweigh the extra profit that is captured, consumers will gain
How might government intervention protect suppliers?
Preventing the abuse of monopsony power: firms with very strong buying power may be able to abuse this position and exploit suppliers
e.g. Groceries Code Adjudicator (GCA) ensures that retailers treat their suppliers fairly, investigates complaints from suppliers, arbitrates in disputes, fines of up to 1% of sales or imposing conditions such as deadlines for payments to suppliers
How might government intervention protect employees?
Employees may be vulnerable to exploitation by employers
Legislation provides rules on health and safety, employment contracts, maximum working hours, redundancy rules and trade union rules, which firms could be prosecuted for if they break
Government could provide greater scope for trade unions to operate, thereby providing greater representation for workers’ concerns
Nationalisation could lead to greater job security
Which government policies help to achieve allocative efficiency?
- Price regulation
- Subsidy on the product
Which government policies help to achieve productive efficiency?
- Subsidies of key raw materials
- Policies which increase productivity
Which government policies help to achieve dynamic efficiency?
- Subsidies / tax breaks on investment
- Reduced tax on profits from new patents
- Strengthening patent laws
Which government policies help to achieve x-efficiency?
- Reducing barriers to entry
- Tax breaks for SMEs
- RPI-X price capping
How do government policies increase allocative efficiency?
- Monopoly firms operate at P > MC
- Both policies reduce the equilibrium price
- The lower price is closer to P = MC
How do government policies increase productive efficiency?
- In both cases, costs fall
- Both policies shift the AC and MC curves down
How do government policies increase dynamic efficiency?
- Increased incentive to innovate or invest
- Subsidies / tax breaks make spending on innovation more affordable
How do government policies increase x-efficiency?
- More competition means firms have a stronger incentive to be cost competitive
- RPI-X cap target x-inefficiencies directly
Why might government policies to increase allocative efficiency be unsuccessful?
Lowering price could create long term supply issues e.g. price cap on electricity could lead to more power cuts in the long run
Why might government policies to increase productive efficiency be unsuccessful?
Unrealistic for government to spend on subsidising materials
Long time lag for cost gains from productivity
Why might government policies to increase dynamic efficiency be unsuccessful?
Doesn’t fully address the funding e.g. lack of means
Stronger patents create greater monopoly power
Why might government policies to increase x-efficiency be unsuccessful?
Gov. limited inwhich barriers they can lower
Hard for regulator to identify value of x-inefficiencies
What is regulatory capture and how does it limit government intervention?
A form of government failure where the government agency operates in favour of the producers rather than consumers
* Consumer interests will be harmed if the regulators fail to hold suppliers accountable and enforce minimum standards of service
* Prices will be higher, leading to lower real incomes and regressive effects on lower income households
What are the causes of regulatory capture?
Asymmetric information
Under-resourced agencies, where they may not have sufficient funding to properly scrutinise an industry
Information gaps: those working for a regulator may not understand the complexities of an industry e.g. financial services not understanding risk
Explain asymmetric information and how it limits government intervention
Government and regulators generally have less information about the firm and industry than the firms themselves: firms may intentionally mislead the regulators to portray an appearance of being in a worse financial position than they actually are
Unless the government is able to overcome this asymmetry, they may be too lenient on firms
Explain lack of information and how it limits government intervention
The regulator / government has a general lack of information which limits their ability to effectively regulate
e.g. x-inefficiencies for RPI-X price capping, the need for infrastructure development in RPI+K price capping, identifying P = MC if attempting to find the allocatively efficient output
