3.6.1 Government intervention


    a) Government intervention to control mergers
    The Competition and Markets Authority (CMA) is main competition regulator in UK
    Key aims for competition policy:
    • To maintain and promote competition • Ensure markets are efficient • Protect consumer interests by keeping prices low and widening consumer choice • Monitoring and promoting balanced distribution of industry and employment • Maintaining and promoting competitive activity in overseas markets by companies in UK
    The competition authorities investigate potential mergers between two large firms, if they would dominate market by merging
    If merger (or takeover) is deemed to create a larger firm with monopoly power – likely to be prevented

    b) Government intervention to control monopolies:
    Governments intervene in market to control monopolies and prevent abuse of monopoly power
    Due to potential for market failure and loss of consumer surplus – can result from a monopoly exploiting the market
    Transfer of wealth from consumers to producers isn’t necessarily considered an economic problem
    But reduction in overall economic welfare resulting from monopoly power is a disadvantage
    Price regulation
    Governments can prevent monopolies charging customers excessive prices, to stop loss of allocative efficiency
    Governments might use RPI-X – form of price capping
    Usually used for privatised industries like the utility companies
    Value of X is amount in real terms that price has to be cut by
    • RPI might be 5% for a particular year • If X is set at 2%, then the firm can only increase prices by 5% – 2% = 3%
    Examples of regulators able to employ a price cap as part of their regulation
    • OFGEM – regulates gas and electricity markets • OFWAT – regulates water industry • ORR – regulates rail services
    • Firms could increase profits by cutting their costs by more than X • Encourages them to be more efficient since they have an incentive to lower their costs • Encourages competition in the market – can prevent firms abusing their monopoly power
    • Hard to determine what value of X should be • Could limit how much profit a firm makes – in turn limits how much investment they do • Reduces incentives from a firm to earn a certain level of profit • Risk of regulatory capture – when regulators start working in favour of the firm
    RPI +/- K
    In the water industry, firms are limited by RPI +/- K
    K represents how much investment the firm needs to undertake

    Profit regulation
    Governments can control profits firms earn by ensuring they aren’t excessive
    In UK, firms pay corporation tax (reduced rate from 21% to 20% in 2015 to encourage investment) on any profits they earn
    Quality standards
    Regulators can observe quality of the goods and services of the firm
    E.g. in the gas and electricity markets, regulators ensure elderly are treating fairly, especially in the colder months
    Governments ensure minimum standards are met
    Performance targets
    Governments set targets on organisations, like schools, to ensure a minimum target is being met
    Aims to regulate their quality
    E.g. NHS, which has monopoly power, also has performance targets like reducing waiting times
    • Helps the firm to focus on increasing social welfare

    c) Government intervention to promote competition and contestability:
    Enhancing competition between firms through promotion of small business
    UK government established ‘Red Tape Challenge’ – 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) are 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 – will make it easier for smaller firms to enter the market
    ‘Creative destruction’ – new entrepreneurs will innovative – challenges existing firms
    The more productive firms will then grow, whilst the least productive are forced to leave market
    This results in an expansion of the economy’s productive potential

    Deregulation and Privatisation
    By deregulating or privatising the public sector, firms can compete in a competitive market – should help improve economic efficiency
    Deregulation – reducing how much an industry is regulated
    • Reduces government power and enhances competition
    Excessive regulation is also called ‘red tape’
    • Can limit quantity of output a firm produces
    Examples of excessive regulation
    • Environmental laws and taxes might result in firms only being able to produce a certain quantity before exceeding a pollution permit • Excessive taxes (high rate of corporation tax) might discourage firms earning above a certain level of profit, since they don’t keep as much– might limit size a firm chooses, or is able to, grow to
    Privatisation – assets are transferred from the public sector to the private sector
    Government sells a firm so it’s no longer in their control
    The firm is left to free market and private individuals
    E.g. British Airways was privatised in UK and now operates in the competitive market
    Free market economists argue private sector gives firms incentives to operate efficiently – increases economic welfare
    Because firms operating on the free market have a profit incentive, which firms which are nationalised don’t
    Since they’re operating on the free market, firms also have to produce goods and services consumers want
    Increases allocative efficiency and means good and services are of a higher quality
    Competition might also result in lower prices but firms which profit maximise in a competitive market might compromise on quality
    By selling asset to private sector, revenue is raised for the government – but only a one-off payment
    Royal Mail was privatised in the UK – done by allowing Royal Mail to float on the stock market
    • At the offer price, the government owned 30% of the shares

    Competitive tendering for government contracts
    The government provides some goods and services because they are public or merit goods, and they are underprovided in the free market
    Government could contract out of this, so private firms operate things like roads or hospitals
    The 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
    The private sector has an incentive to reduce their costs, since they operate in a competitive market
    Frees government of maintenance, since private sector might have expertise and knowledge to fulfil the project and maintain the infrastructure
    But the private sector might not meet the specification of the contract
    Also, private sector might try and cut costs by lowering wages – less likely to have social welfare as a priority

    d) Government intervention to protect suppliers and employees:
    Restrictions on monopsony power of firms
    Monopsony power of supermarkets has led to many farmers losing profits
    Farmers lose out to supermarket price wars, because supermarkets keep negotiating lower prices from farmers, to lower their own prices and compete with other supermarkets
    Supplying firms are unlikely to make more than normal profit
    Governments can regulate this to ensure farmers receive a fair deal
    • E.g. UK farmers might recieve grants and subsidies to support their production • CMA might investigate supermarket buying power to ensure they aren’t abusing their monopsony power
    When private sector assets are sold to the public
    The government gains control of an industry – no longer in hands of private firm
    UK Railway industry nationalised after 1945
    By nationalising an industry, natural monopolies are created because it’s inefficient to have multiple sets of water pipes, for example, so only one firm provides water
    Some nationalised industries yield strong positive externalities
    • E.g. by using public transport, congestion and pollution are reduced
    Nationalised industries have different objectives to privatised industries (mainly profit driven)
    • Social welfare might be a priority of a nationalised industry
    Diagram shows where nationalised and privatised firms operate
    Privatised firms operate at Q1PQ – profit maximising level of output and price
    Nationalised firm is more likely to operate at Q2P2 – allocatively efficient level of output (AR = MC)



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