3.6.1 - government intervention Flashcards
how does the government control mergers
● 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.
● 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.
how are price caps used to control monopolies
● 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.
● Arguably, a better system is ‘RPI-X+K’, where K represents the level of investment. This is used in the water industry and has allowed investment of £130bn.
● 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.
● 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.
● 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.
how does the government use profit regulations to control monopolies
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.
● 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.
● It is also criticised since a reduction in costs will not improve the firm’s situation and so there is little incentive to be efficient. As with ‘RPI-X’ it also means that regulators need sufficient knowledge of the industry and so will suffer from asymmetric information.
windfall taxes are used when a monopoly make an abnormal amount of profit therefore are taxed higher. however may lead to firms lying about the profit they make.
how does the government use quality standards to regulate monopolies
● Monopolists will only produce high quality goods if this is the best way to maximise profits. The government can introduce quality standards, which will ensure that firms do not exploit their customers by offering poor quality.
● For example, the Post Office has to deliver letters on a daily basis to all areas and electricity generators are forced to have enough capacity to prevent blackouts.
● The problem is that it requires political will and understanding to introduce.
how does the government use performance targets to regulate monopolies
● 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.
● 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.
● Other firms will fail to meet their performance targets and so there will be no improvements. Network Rail failed to deliver on the performance targets for their long distance sector in 2013-14. 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 the government promote competition by promoting small businesses
● The government can give training and grants to new entrepreneurs and encourage small businesses through tax incentives or subsidies. This will increase competition since there will be more firms within the market, and will offer a chance for more firms to join.
● It increases innovation and efficiency, since new firms are likely to provide new products and incumbent firms will no longer be able to be X-inefficient.
● The Red Tape Challenge aims to decrease regulation, particularly for small businesses. There are also schemes, such as the Enterprise Investment Schemes and Seed Enterprise Investment Scheme, which provide tax relief for people who buy shares in small companies to help them grow.
how can the government promote competition by using deregulation
● 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. The Deregulation Act of 2015 aims to continue deregulation.
● The government can also privatise industries, which will allow for competition in the market.
● However, it can have some negative effects, leading to poor business behaviour. Licenses for specific industries are necessary to ensure standards are upheld. Some have argued that the deregulation of financial markets was a major contributor to the financial crisis in 2008.
how can the government use competitive tendering to promote competition
● 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, such as the sheets in NHS hospitals, are produced by the private sector and then bought by the public sector.
● A similar thing can be done with services; the government can contract out the provision of a good or service to private companies e.g. private firms could be employed to run hospitals. These are called Private Finance Initiatives (PFI)
● Competition can be introduced into the market as the government will request competitive tenders by drawing up a specification for the good or service and inviting private firms to bid for the contract to deliver it. The firm offering the lowest price wins the contract, subject to quality guarantees.
● This helps to minimise costs for the government and ensures efficiency by allowing for competition in the market. The private sector will have more experience running the projects, so it is likely they will be better managed.
● However, it may not always be the most cost effective way and the process of collecting bids is costly and time-consuming. The private sector may not aim to maximise social welfare in the same way the government would and could use cost-cutting methods that reduce quality.
how can the government use privitisation to promote competition
● Privatisation is the sale of government equity in nationalised industries or other firms to private investors. The aim is to revitalise inefficient industries but can sometimes lead to higher prices and poor services.
