3.6.1 Government intervention

Question 1

What markets are regulatory bodies commonly found in?

Answer 1

Monopoly or oligopoly markets.

These bodies have varying responsibilities, including regulating prices, monitoring safety and product standards and encouraging competition.

Question 2

Examples of regulatory bodies in the UK

Answer 2

• OFWAT regulates the water industry.
• OFCOM regulates the communication industries.
• OFGEM regulates the gas and electricity markets.

Question 3

What methods do regulatory bodies have to regulate firms?

Answer 3

• Price capping
• Rate of return (regulating profits)
• Performance targets (and fines)

Question 4

Who are the CMA?

Answer 4

A UK government department, responsible for strengthening business competition and reducing anti-competitive behaviour.

Question 5

Goals of the CMA

Answer 5

• Investigate mergers and anti-competitive behaviour.
• Increase the contestability of appropriate markets.
• Protects the interests of consumers and firms.
• Bring about criminal proceedings against colluding cartels.
• Encourage regulatory bodies to use their power.

Question 6

What does the CMA look at?

Answer 6

• Mergers & acquisitions - they monitor mergers and takeovers so they can prevent those that aren’t beneficial to the efficiency of the market or to consumers. They may choose to stop a merger than would give a firm too high a market share (over 25%) and make it a monopoly, or that would give a firm too much monopoly power.
• Agreements between firms – often agreements between firms are anti-competitive and cause market inefficiency.
• The opening of markets to competition – when markets that were controlled by the government are opened up to competition. E.g. if a government-owned transport service is privatised, the government might want to ensure the existing firm is open to free market competition and doesn’t dominate the market as a private monopoly.

Question 7

What can the CMA impose?

Answer 7

They can block mergers and impose fines on firms guilty of anti-competitive behaviour.

Question 8

Evaluation of competition policy

Answer 8

The effectiveness of competition policy is affected by the information available to the European Commission or the CMA. The regulatory bodies decide whether behaviour in different markets is anti-competitive or unfair to the consumer based on the information they have.

If the information available to the government is reliable, then it should be able to intervene in the market in a way that will improve efficiency, allocate resources more efficiently and improve fairness to the consumer. If the information is imperfect, then it could lead to government failure.

Competition policy and its implementation (through regulation) have costs, but in general these costs are outweighed by the benefits. If the costs outweigh the benefits, this is an example of government failure.

Question 9

Methods of government intervention used to improve competition

Answer 9

• Privatisation
• Nationalisation
• Regulation
• Deregulation
• Promoting small businesses

Question 10

How can governments promote small businesses?

Answer 10

Governments may choose to increase competition by promoting smaller businesses. This is likely to involve tax breaks or subsidies for small firms, or helping entrepreneurs get they investment they need to start a new business.

Reducing regulations and ‘red tape’ is a good way to encourage new, smaller businesses to start up.

Increasing competition in this way should lead to greater choice and lower prices for consumers.

Question 11

Privatisation

Answer 11

The transfer of the ownership of a firm/industry from the public sector to the private sector.

Question 12

Which politician famously privatised industries?

Answer 12

Conservative PM, Margaret Thatcher, used privatisation to sell off many nationalised industries in the 1980s and 1990s, including British Airways, Jaguar, British Gas, British Steel, British Coal, etc…

Question 13

Why might economists argue that privatisation would be more efficient?

Answer 13

A privatised firm would be open to free market competition. Private firms have shareholders and will have to maximise profits to keep shareholders happy. They primarily do this by increasing prices and cutting costs.

Question 14

Why might economists argue that nationalised firms/industries are inefficient?

Answer 14

Because they lack competition and that can lead to market failure.

Governments can increase competition through privatisation.

Question 15

What is a publicly owned firm/industry?

Answer 15

A publicly owned firm/industry is owned by the government.

The firm/industry will usually act in the best interests of consumers – so prices tend to be low and output tends to be high. This is possible because they don’t have to make profits.

Question 16

Most recent example of privatisation

Answer 16

When the Coalition government privatised Royal Mail in 2013.

Question 17

Deregulation

Answer 17

The process of removing or reducing regulations.

It removes some barriers to entry, so it can be used to increase competition in markets and target market failure – particularly in monopolistic markets.

Deregulation is often used alongside privatisation – privatising an industry effectively removes the legal barriers to entry that prevent other firms entering the market.

Question 18

Give an example of deregulation in the UK

Answer 18

The 1982 deregulation of the mortgage market.

Thatcher’s Government removed controls over lending and which institutions could lend. The competition greatly increased the accessibility of home ownership for many people but has subsequently seen a large fuel in demand and price increases.

Question 19

Advantages of deregulation

Answer 19

• Improves resource allocation – removing regulations means the market becomes more contestable, so new firms are more likely to enter the market. The threat of competition from new firms, or the actual entry of new firms into the market, means prices fall closer to the Marginal Cost (MC) and output increases.
• It can be used alongside privatisation of public monopolies to increase competition and efficiency in a market.
• Improves efficiency by reducing the amount of ‘red tape’ and bureaucracy.

Question 20

Disadvantages of deregulation

Answer 20

• It’s difficult to deregulate some natural monopolies (e.g. the railways). These require large infrastructures (e.g. a rail track network). These infrastructures are expensive to build an maintain, and there’s only a need for one of them (it would be absurd to have two identical train tracks running parallel to each other just so different companies could use it).
• Deregulation can’t fix other market failures such as negative externalities or immobile factors of production.
• Deregulation might mean there’s less safety and protection for consumers.

Question 21

Competitive tendering

Answer 21

The government provides certain goods and services, but encourages bidding from private sector companies to get taxpayers’ value for money.

In order to encourage competition amongst firms seeking government contracts, the government implements a process known as competitive tendering.

This is where governments draw up a specification for the good/service and invites private sector firms to bid for the contract to deliver it. The firms offering the lowest price, subject to quality, are chosen for the contract.

This can lead to price rigging, where firms collude to push up the price of a government contract.

Question 22

Nationalisation

Answer 22

Where governments take control of a privately run industry.

Question 23

Positive impacts of nationalisation

Answer 23

• Governments can ensure a nationalised industry better provides the goods and services needed by the country.
• Governments can set the output and prices of an industry at a level that most benefits society.
• Nationalised industries can be more easily regulated so they act in the best interests of consumers.
• Governments can pay public sector workers a fair wage.
• A nationalised industry will have greater economies of scale than an industry populated by several private firms.
• A nationalised industry can pay suppliers fair prices (which a monopoly is much less likely to do).

Question 24

Main argument against nationalisation

Answer 24

Nationalised industries can be inefficient because they’re not driven to reduce costs and make profit.

Question 25

Methods the government could use to protect suppliers

Answer 25

Authorities can **pass anti-monopsony laws** which make certain practices illegal. The CMA can also investigate and prevent certain mergers which may create a new – and potentially harmful – monopsony. An **independent regulator can be appointed**, who can force them to change their buying practices through regulations and fines. Can **encourage monopsonies to regulate themselves** by drawing up their own codes of practice. Although this is a very weak method of intervention.

Question 26

Methods the government could use to protect employees

Answer 26

Employees of firms are vulnerable to exploitation. Profit maximising firms wish to pay the lowest wage and give as few benefits as possible. **Legislation** – particularly EU legislation – has been used to protect employees from exploitation. Examples of schemes include: - **Minimum wage** - **Health and Safety** - **Employment contracts** - **Redundancy rules and regulations** There is the **right to be a member of a Trade Union**, who protect employees in a particular sector. The government has created a legal framework in which Trade Unions operate.

Question 27

How does regulatory capture make government intervention less effective?

Answer 27

* Firms can influence the bodies that regulate them. * This is primarily done through bribery or threats of legal action. In regulatory bodies, many of their senior personnel are from firms they are supposed to be regulation – creating a clear conflict of interest.

Question 28

How does asymmetric information make government intervention less effective?

Answer 28

Releasing the minimum amount of information which the regulator requires is common. This can hide poor conduct from the regulator, making it difficult for them to discover what is truly happening and impose sanctions.

Question 29

Aim of government intervention with market structures is to...

Answer 29

* Lower prices * Regulate profits * Prevent supernormal profits * Increase efficiency * Increase choice

Question 30

Issues with setting regulations

Answer 30

* There are **costs to setting these regulations**, although this is often outweighed by income from fines. * **Regulations are not consist across the board **– some regulatory bodies are more effective than others. * **Regulatory capture and lobbying** – regulatory bodies can be influenced by firms.

Question 31

How can governments regulate profits?

Answer 31

By **imposing windfall taxes** on what it deems to be excessive profits – this means the government will tax those profits at a higher rate. Windfall taxes help to prevent firms from gaining too much monopoly power but it reduces their incentive to improve efficiency. Some argue it **discourages innovation** or companies award big **bonuses to their executives** to avoid windfall taxes on profits.

Question 32

Performance targets | (A type of regulation)

Answer 32

Setting performance targets can also help to maintain competition, but this needs to be enforced with a penalty (e.g. fine).

Question 33

Examples of performance targets

Answer 33

Examples of performance targets include: - Firms might be given certain standards of customer service they need to achieve. - NHS departments are given targets for the number of patients they should treat.

Question 34

Who sets performance targets?

Answer 34

Performance targets are set by regulatory bodies, and could relate to output levels, quality, services or upgrades. * For example, the ORR imposes substantial fines if Network Rail fails to meet set targets. £1.5m fine per 0.1% if falls below target. * Network Rail were fined £1.5m when they failed to meet deadlines to upgrade London Bridge station.

Question 35

Disadvantages of performance targets

Answer 35

Health and safety, quality of service and other areas not included in targets might be overlooked in order to reach the performance targets.

Question 36

Price caps

Answer 36

This is done to stop firms from charging prices that are considered to be too high. Price caps limit price rises, making a market fairer to consumers.

Question 37

Example of price caps

Answer 37

OFGEM set an energy price cap, which is reviewed twice a year.

Question 38

Benefits of price caps

Answer 38

- Price caps also provide an **incentive for firms to increase efficiency** (the more efficient they are, the more profit they keep), and consumer benefit from improved services. - The government or a regulator could also monitor prices to ensure they **stay reasonable and fair** to consumers. - Governments may introduce regulations to **ensure quality standards** – such as in food production or construction work.

Question 39

What are the main reasons for the regulation of monopolies?

Answer 39

Governments can use regulation to **prevent a firm from gaining monopoly power** or **to increase competition** by reducing the monopoly power a firm already has.