Monopoly/Competition Policy Essay Points Flashcards
(20 cards)
Price Regulation/Controls
Types:
RPI
RPI - x
RPI ± k
Aim: To prevent monopolies from exploiting consumers and set maximum prices at the allocatively efficient point (P = MC).
RPI - x:
“-x” represents the expected increase in efficiency.
RPI ± k:
“+k” represents the additional profit needed to finance investment in capital goods.
Issues with Price Regulation
Evaluating Price Regulation
Challenges:
-The optimal level of “x” or “k” is unknown due to imperfect information.
-If “x” is too high, firms may be forced to shut down.
-If “x” is too low, the measure is ineffective, and the competitive target is not met.
-There is an opportunity cost of regulating (burden on the taxpayer).
-The incentive to meet the “-x” target may lead the regulator to continuously reduce “x”.
-Risk of regulatory capture.
(Regulation) Quality Control / Performance Targets
Legislative
Examples: Limiting train delays, preventing gas and electricity price increases for individuals over 65 in winter, setting targets for the number of GP visits per hour in the NHS.
Aim: To incentivize greater efficiency/quality/safety.
Issues with Quality Controls/Performance Targets
-Unintended Consequences:
e.g. Rushing GP appointments.
-Gaming the system (e.g., lying about expected journey lengths for trains).
Profit Control
Allows firms to cover costs plus a percentage rate of return on capital employed.
Rationale: Aims to compensate firms for the risk and investment in capital.
Mechanism: Adding a percentage onto the return from capital investment.
Allows firms to continue making profits
Not set prices too high, or gain govt revenue to provide offsetting benefits
Issues with Profit Control (3+)
Asymmetric Information: Monopolists have an incentive to over-report costs and capital employed to inflate allowable profits.
Disincentive to Efficiency: Firms are less motivated to control costs as they will be covered.
Over-Investment in Capital: Incentive to invest excessively in capital to increase the base for profit calculation.
More likely in monopoly/oligopoly where PI already high, managers can raise costs and have easier lives
Evaluation Paragraph
However, the implementation of profit controls faces significant challenges, particularly concerning information asymmetries. Monopolists, possessing superior knowledge of their cost structures and capital employed compared to regulators, have a clear incentive to strategically over-report these figures. This inflated reporting directly translates into higher allowable profits, undermining the very purpose of the control mechanism. Furthermore, the guaranteed return on capital can create a disincentive to efficiency. With the assurance that costs will be covered within the regulated profit margin, firms may become less vigilant in seeking cost-reducing innovations or streamlining their operations, potentially leading to higher prices and lower quality for consumers in the long run. Finally, profit controls can inadvertently encourage over-investment in capital. Firms may be incentivized to invest excessively in capital assets, even if not strictly necessary for efficient production, simply to enlarge the asset base upon which their allowable profit is calculated. This misallocation of resources can lead to productive inefficiency within the industry, ultimately diminishing the overall benefits intended by the regulatory intervention.
Taxing Monopoly Profits
Imposing taxes (e.g., windfall taxes) on the excess profits of monopolies.
Intended Benefit: To raise government revenue.
Cons of Monopoly Profit Taxation (e.g. Windfall Taxes)
(4)
May increase firms’ costs, potentially leading to higher prices and lower quantities.
+ Worsens monopoly outcomes: Could cause previously profit-satisficing monopolies to become profit-maximizing, potentially worsening consumer outcomes.
Tax evasion/avoidance: Incentives to underreport profits rise
Less innovation: May reduce the funds available for reinvestment in innovation and dynamic efficiency.
Merger Policy
Competition authorities investigate mergers that could create a market share greater than 25%.
Actions:
Blocking mergers that significantly harm public interest.
Requiring the merged entity to sell off stores or outlets in specific locations to maintain competition (e.g. Demerger)
Privatisation, Deregulation, and Reducing Trade Barriers
These are market-liberalizing policies aimed at promoting competition.
Privatization: Transferring ownership from the public to the private sector.
Deregulation: Reducing government rules and restrictions in a market.
Reducing Trade Barriers: Lowering tariffs and other obstacles to international trade.
Goal: To increase the number of firms and intensify competition, leading to more competitive outcomes.
Overall Monopoly Regulation Eval
-Level of Information
-Costs vs Benefits
-Regulatory Capture (risks/damage)
-Benefits of Monopoly
Nationalisation (Definition & Benefits)
Greater Potential for Economies of Scale: State-run monopolies in certain industries can achieve huge economies of scale, leading to productive efficiency, lower average costs, and potentially lower prices for consumers.
Service Provision Focus: Governments are assumed to prioritize maximizing social welfare and meeting society’s needs and wants. Nationalization should lead to allocative efficiency and low prices, maximizing consumer surplus.
Allocative Efficiency-Reduced Market Failures from Externalities: Governments consider the full social costs and benefits of production, leading to output levels closer to the socially optimum, minimizing overproduction and underproduction, and improving allocative efficiency.
Macroeconomic Control:
-Wage Control: Governments can manipulate public sector wages to control inflation.
-Employment Levels: During recessions, the public sector can increase employment to lower unemployment rates.
Nationalisation Cons (7)
Diseconomies of Scale
Large state-run monopolies can suffer from coordination, communication, and motivation problems, leading to increased average costs and lower productive efficiency, potentially resulting in higher prices.
Lack of Incentive to Minimize Costs: Without a profit motive, state-run companies may lack the incentive to minimize costs, leading to complacency, wasteful production, and overall higher production costs (X-inefficiency and productive inefficiency).
Dynamic Inefficiency: Lower supernormal profits in nationalized industries compared to privatized ones can lead to less reinvestment in technology, innovation, and research & development, hindering long-term benefits for consumers.
High Costs to the Taxpayer
Nationalization is expensive, involving purchasing assets and covering operational costs, burdening taxpayers, especially during periods of austerity or high national debt. Opportunity costs arise as the money could have been used in other areas.
Lack of Competition: The absence of competitive pressure in state-dominated industries can lead to higher prices, lower quantities, and monopoly outcomes due to a lack of drive for efficiency.
**Greater Risk of Moral Hazard **:Politicians or state-control managers making risky decisions do not personally bear the costs of failure, which are instead borne by the taxpayer through bailouts or covering losses.
Political Priorities Overriding Commercial Issues:
Political considerations, such as upcoming elections, might lead to delaying necessary long-term investments in state-run industries, even if they are commercially sound and socially beneficial.
Evaluating Nationalisation
Depends on…
Funding vs. Delivery (9:12 - 9:38): Weigh the high costs of nationalization against the potential for better delivery of essential public services compared to the private sector.
PPPs vs. Full Nationalization (9:39 - 10:26):
Consider if Public-Private Partnerships offer a better balance by combining private sector efficiency with public service goals, potentially avoiding the full costs of nationalization.
Strong Regulation of Private Sector (10:32 - 10:39): Argue whether robust regulation of private industries could achieve similar outcomes to nationalization without the need for public ownership.
Competition in the Private Sector (10:43 - 11:13): Suggest that if there is sufficient competition in the private sector, nationalization might be unnecessary. However, it might be considered for highly concentrated markets where regulation fails.
Size and Objectives of Private Sector Firms (11:13 - 12:21):
Size: Large private firms benefiting from economies of scale might be preferable to potentially oversized nationalized entities suffering from diseconomies of scale.
Objectives: If private firms prioritize allocative efficiency or corporate social responsibility, the arguments for nationalization based on profit-maximizing behavior are weakened.
Arguments For Privatisation (6)
1. Efficiency gains (pot. PE, AE, XE)
The main argument for privatisation is that private companies have a profit incentive to cut costs and be more efficient. If you work for a government run industry managers do not usually share in any profits. However, a private firm is interested in making a profit, and so it is more likely to cut costs and be efficient. Since privatisation, companies such as BT, and British Airways have shown degrees of improved efficiency and higher profitability.
2. Lack of political interference
It is argued governments make poor economic managers. They are motivated by political pressures rather than sound economic and business sense. For example, a state enterprise may employ surplus workers which is inefficient. The government may be reluctant to get rid of the workers because of the negative publicity involved in job losses. Therefore, state-owned enterprises often employ too many workers increasing inefficiency.
3. Short term view (Reduced Myopia)
A government many think only in terms of the next election. Therefore, they may be unwilling to invest in infrastructure improvements which will benefit the firm in the long term because they are more concerned about projects that give a benefit before the election. It is easier to cut public sector investment than frontline services like healthcare.
4. Shareholders
It is argued that a private firm has pressure from shareholders to perform efficiently. If the firm is inefficient then the firm could be subject to a takeover. A state-owned firm doesn’t have this pressure and so it is easier for them to be inefficient.
5. Increased competition
Often privatisation of state-owned monopolies **occurs alongside deregulation **– i.e. policies to allow more firms to enter the industry and increase the competitiveness of the market. It is this increase in competition that can be the greatest spur to improvements in efficiency. For example, there is now more competition in telecoms and the distribution of gas and electricity.
However, privatisation doesn’t necessarily increase competition; it** depends on the nature of the market**. E.g. there is no competition in tap water because it is a natural monopoly. There is also very little competition within the rail industry.
6. Government will raise revenue from the sale
Selling state-owned assets to the private sector raised significant sums for the UK government in the 1980s. However, this is a one-off benefit. It also means we lose out on future dividends from the profits of public companies.
Potential Risks of Privatisation
Similar to cons of more competitive outcomes
3 Simple. 6 Econhelp
1. Natural Monopoly Risk
Explanation: In industries where high fixed costs make it inefficient to have multiple firms (like water or electricity grids), privatization can simply replace a public monopoly with a private one.
Problem: A private monopoly, driven by profit, might exploit consumers by setting higher prices than a publicly owned entity that could prioritize affordability.
Key Idea: The inherent structure of a natural monopoly limits the benefits of competition that privatization usually aims to achieve.
2. Public Interest: Essential Services?
Explanation: Certain essential services (healthcare, education, public transport) are argued to be fundamentally about serving the public good, not generating profit.
Problem: Introducing a profit motive in these sectors can lead to decisions that prioritize financial gain over service quality or accessibility (e.g., reduced patient care to cut costs).
Counter-Argument Consideration: The point about doctors not trying harder for bonuses is debatable; incentives can influence behavior in various ways, though ethical considerations are paramount in healthcare.
3. Government Loses Potential Dividends:
Explanation: When profitable state-owned companies are sold off, the government no longer receives a share of their profits (dividends).
Problem: This revenue now goes to private shareholders, potentially reducing the funds available for public spending or tax relief.
Economic Consideration: This needs to be weighed against potential tax revenues generated by the privatized companies and the overall efficiency gains (if any) from privatization.
4. Problem of Regulating Private Monopolies:
Explanation: Privatizing natural monopolies necessitates the creation of regulatory bodies to prevent them from abusing their market power.
Problem: This means the government still needs to be heavily involved, similar to when the industries were publicly owned. The effectiveness and cost of this regulation can be significant issues.
Question of Efficiency: It raises the question of whether the costs and complexities of regulating private monopolies are justified compared to managing public monopolies.
5. Fragmentation of Industries:
Explanation: Privatization can sometimes lead to the breakup of previously integrated public services into separate entities (as seen with the UK rail network).
Problems:
Lack of Clear Responsibility: This fragmentation can create confusion about who is accountable for safety and service quality.
Increased Complexity: It can lead to inefficiencies and added burdens for consumers (e.g., complex and expensive rail ticketing).
Coordination Challenges: Different private entities might not effectively coordinate their operations, leading to a less seamless service.
6. Short-Termism of Firms (Worse Quality/Standards/Cost-cutting)
Explanation: Private companies, especially those with shareholders, can be under pressure to deliver short-term profits.
Problem: This focus on immediate gains might lead to underinvestment in crucial long-term projects (e.g., renewable energy infrastructure) that are vital for the future but might not yield quick returns.
Comparison to Government: While the point acknowledges that governments can also be short-sighted, the pressures from shareholders can exacerbate this issue in private firms.
Additional contextualising conclusion
In conclusion, these disadvantages highlight potential downsides of privatization, particularly in sectors that are natural monopolies or provide essential public services. They raise important questions about the balance between profit motives and public good, the effectiveness of regulation, and the long-term consequences of transferring ownership from the state to private entities.
Simple 3:
1) Limited Competition? (Productive & Allocative Inefficiency)
2) Loss-making services cut even if socially desirable
3) Loss of Natural Monopoly & Loss of EoS Benefits (Linked to Productive Inefficiency)
Evaluating Privatisation
Simple:
1) Level of competition post-privatisation
2) Level of government regulation
Evaluation of privatisation
It depends on the industry in question. An industry like telecoms is a typical industry where the incentive of profit can help increase efficiency. However, if you apply it to industries like health care or public transport the profit motive is less important.
It depends on the quality of regulation. Do regulators make the privatised firms meet certain standards of service and keep prices low?
Is the market contestable and competitive? Creating a private monopoly may harm consumer interests, but if the market is highly competitive, there is greater scope for efficiency savings.
Can you create incentives in a nationalised firm? For example, performance-related pay could replace the profit incentive.
Arguments for Deregulation
1) Increases choice/AE
-Deregulation decreases the legal barriers to entry meaning that more firms will enter the market. This increases choice. This also gives more of an incentive to become allocatively efficient (MC=AR)
2) Incentivises productive efficiency and X efficiency
-Deregulation would mean that there would be an incentive for firms to minimise costs to therefore maximise profits. This known as productive efficiency (producing at lowest point of the AC curve). It would also incentive firms to be X effienct (reducing any waste)
3) Dynamic efficiency
-Profits are likely to be made in contestable markets, which means that firms are able to reinvest their profits to get ahead in a competitive market
Arguments against Deregulation (3)
1) Loss of natural monopoly
-Deregulation and letting firms enter the market means that if there was a natural monopoly (where it is most efficient for one firm to be in a market), that would be lost. This means that new firms would experience high average costs, therefore low productive efficiency, and also wasted resources.
2) Formation of oligopolies and local monopolies
-There still are some other non-legal barriers to entry, meaning that oligopolies may be able to form. Also, there could be local monopolies. An example of this is the bus industry in the UK, where one bus company dominates a certain area.
3) Risk of Lower Standards/Quality Control
-e.g. UK Red Tape Challenge allows easier compliance with environmental targets for SMEs
Evaluating Deregulation (3)
- Short run VS long run (will the market be competitive in the long run? maybe not with local monopolies)
- Height of other barriers to entry (technical, strategic barriers to entry)
- Level of government regulation (to control oligopolies and monopolies)
