Theme 3.6: Regulation and competition policy

Question 1

4 Types of regulation

Answer 1

-Merger policy
-Price regulation
-Profit regulation
-Performance targets and quality standards

Question 2

Explain merger policy

Answer 2

-Blocking mergers which might give firms too much market power

E.g. When 3 mobile tried to buy O2, CMA were alerted because if they did merge they would have 31% market share (which is above 25% limit), it was blocked to prevent formation of a natural monopoly

However, investigation doesn’t mean it gets blocked all the time
E.g. Orange and T-Mobile merged to form EE (combined to 33% market share). CMA found little evidence that the merger would negatively impact consumers

Question 3

The CMA will investigate a merger if…

Answer 3

-2 firm’s have a combined market share of above 25%

E.g. When 3 mobile tried to buy O2, CMA were alerted because if they did merge they would have 31% market share (which is above 25% limit), it was blocked to prevent formation of a natural monopoly
However, investigation doesn’t mean it gets blocked all the time
E.g. Orange and T-Mobile merged to form EE (combined to 33% market share). CMA found little evidence that the merger would negatively impact consumers

-2 firm’s combined turnover is above £70 million
E.g. Merger between David Lloyd and virgin active was blocked because their combined turnover would be £1011 million

Question 4

Explain price regulation

Answer 4

Caping the prices firms can charge consumers

Question 5

Explain profit regulation

Answer 5

Taxing firms if they make too much supernormal profit

When the government takes 100% of a firm’s profit in tax, after they have reached a certain profit limit

Question 6

Explain performance targets and quality standards

Answer 6

-Imposing targets and standards so firms don’t provide dodgy goods or services
-CMA set targets and standards for firms to meet in order to sell their product

-Examples of performance targets include:
-Performance targets include, ScotRail, who have the performance target of 91.3% of its trains running on time!
-Performance targets also extend to the NHS - each hospital has the performance target of responding to accident and emergency patients in less than 4 hours.

Examples of quality standards include:
-The Food Standards Agency (FSA) give out a quality standard as do the British Standards Institute (BSI).

Question 7

What is meant by regulatory capture and give an example

Answer 7

When regulators begin to favour a company they are regulating

E.g. When regulators at BP become fond of the staff so they gave them a permit to drill in the Mexican gulf without checking if it was safe. Bp began to make large supernormal profits BUT two weeks later they had a massive oil spill which killed lots of wildlife and was bad for the environment

Question 8

Explain how profit regulation can encourage firms to invest in better capital

Answer 8

No one wants the government stealing all their profits. This encourages them to reinvest extra profit back into the company and improve the quality of service they provide.

Question 9

How can profit regulation be ineffective?

Answer 9

Completely taxing away a firm’s profit above a certain level, removes profit incentive. This makes firms less efficient and less productive as their costs increase which translates to higher prices for consumers, so consumer surplus decreases.
So CMA sticks to price regulation instead.

Question 10

4 ways to increase contestability

Answer 10

-Deregulation
-Privatisation
-Stopping anti-competitive practices
-Helping small businesses

Question 11

Explain deregulation

Answer 11

-Lowers the barriers to entry
-Encourages new firms to enter and compete with incumbent firms
-Leads to: lower prices, better customer service, increased efficiency

E.g.
Cab drivers in London used to need to be good at geography but now Uber entered the market and 50,000 people drive taxis in London now, without needing any qualifications

Question 12

Explain privatisation

Answer 12

When ownership is transferred from the government to the private sector

Question 13

Competitive tendering is when:

Answer 13

Competitive tendering is when the government outsources specific job contracts to the private sector. Private sector firms bid to win the contract, by offering the best deal - the highest quality for the lowest cost. The government then chooses the firm which offers the best value for money - and awards them the contract

Question 14

What are anti-competitive practices?

Answer 14

Anti-competitive (or restrictive) practices include anything a firm might do, to restrict competition.

Question 15

Anti-competitive practices include:

Answer 15

-Predatory pricing
-Price collusion
-Vertical integration

Question 16

In response to anti-competitive behaviour, the CMA can:

Answer 16

1. Set a fine up to 10% of annual revenue
2. Sentence CEOs to jail time
3. Name and shame the firm publicly

Question 17

3 ways to help small business grow

Answer 17

-Access to loans
-Research and development tax breaks
-Subsidies

Question 18

Explain how access to loans helps small businesses grow

Answer 18

-Businesses receive loans with super low interest rates
-It helps them expand and enjoy economies of scale which helps them compete with incumbent firms as they can decrease their LRAC, improving contestability

Question 19

Explain how Research and development tax breaks help small business grow

Answer 19

Small business receive reduced corporation tax rates if they use their profits for research and development to increase dynamic efficiency

Lower corporation tax will decrease a firm’s costs and increase their profits. Increases producer surplus

Question 20

Explain how subsidies help small business grow

Answer 20

Subsidies reduce a firm’s costs —> supply and compete at a lower price —> increasing price competitiveness —> Increasing contestability

Question 21

Nationalisation is when…

Answer 21

Nationalisation is when the private sector transfers ownership of a private sector firm to the government.

Question 22

Examples of regulatory capture

Answer 22

• Alleged capture of HMRC by Vodafone, who negotiated a tax reduction from £7bn to £1bn in 2009
• BP given free permits to drill for oil in Mexico. No checks had been made and BP suffered an Oil spill. the Gulf wildlife was ruined

Question 23

Case for Nationalisation in rail industry

Answer 23

-Natural monopoly and market failure: High fixed costs and economies of scale make multiple rail service providers inefficient and leads to a wastage of economic resources. Private ownership leads to allocative inefficiency but public ownership can move price closer to social optimum - helping make tail travel more affordable - increasing consumer surplus - improving mobility of labour - potentially improving the supply of labour

-Merit goods (externalities) : Although rail services are excludable, they deliver positive externalities such as regional connectivity and de-carbonization). Nationalisation can correct under-provision of rail services that might occur under profit-driven firms / franchises.

Question 24

Case against nationalisation in rail industry

Answer 24

-Public sector is X-inefficient: Without profit incentives or the threat of competition, there may be less pressure to innovate or control operating costs, leading to productive inefficiency which leads to and increase in AC which may be funded by tax-payers money.

-Crowding out and innovation constraints: State dominance in rail may crowd out private sector innovation and investment. Without contestable markets, innovation may stagnate, reducing dynamic efficiency in the long run, less R and D less consumer choice and utility

Question 25

Schumpeterian innovation

Answer 25

When contestability of a market drives innovation

Question 26

Case for nationalisation of steel plant

Answer 26

-Preserving employment - Steel plants often major employers in vulnerable regions. Nationalisation helps protect livelihood and avoid negative multiplier effects of industrial collapse and external costs from structural unemployment ---> protects workers from being cut by private firms as a method to cut costs -Strategic industry and national security: Steel is an input for critical sectors in the UK such as defence and construction. State ownership ensures strategic autonomy, especially during geopolitical instability or supply chain disruptions, reducing the UK's overreliance on exports

Question 27

Case against nationalisation of a loss making steel plant

Answer 27

-Could lead to principle agent problem as managers experience moral hazard knowing they can be x-inefficient and make losses because the government will fill the gap / subsidise -Temporary vs Long term strategy: Public ownership may be justified as a short-term tool, but without a long-term strategy, it risks becoming a 'zombie industry' reliant on continuous subsidy -Opportunity and fiscal sustainability: Financial burden of maintaining a loss-making plant involves opportunity costs - funds might deliver higher social returns if allocated to sectors like education, healthcare or renewable energy

Question 28

Case for privatisation Thames water

Answer 28

Government was x-inefficient: In the 1970s–80s, the state-owned water industry suffered from chronic underinvestment, leaking infrastructure, and poor water quality. Government lacked funds to modernise the sector. Publicly owned firms often lack profit incentives, leading to X-inefficiency (waste, low productivity). Before privatisation, investment was £2.5 billion per year in water and sewerage infrastructure. After privatisation, it was £5.5 billion per year. Market-Based Investment and Regulation: Government wanted to shift the cost of investment to the private sector while maintaining consumer protection through regulation (Ofwat). Water infrastructure is a natural monopoly. Instead of nationalised monopoly, the government opted for privatised monopoly + economic regulation. At privatisation in 1989, Thames Water was floated on the London Stock Exchange. Its initial share offering raised £2 billion for the government.

Question 29

Case against privatisation of Thames water

Answer 29

Underinvestment / dynamic inefficiency: Despite early improvements, Thames Water later became highly financialised, prioritising shareholder returns. From 2006 to 2023, it accrued £14+ billion in debt, largely due to private equity ownership. This limited funds available for infrastructure and led to environmental failures, including widespread sewage dumping. In 2023, Thames Water released more than 72 billion litres of untreated sewage into rivers and seas as a method of cutting costs to increase profit margins and shareholder dividends. The profits were not being reinvested into pipes and infrastructure to better improve the service as they were profit maximising, and didn't have social welfare as a key goal. Regulatory capture: Excessive debt allowed: Thames Water’s parent companies loaded the firm with over £10–14 billion in debt, while still extracting billions in dividends. Critics argue Ofwat failed to challenge these financial structures effectively. Thames Water was fined multiple times (e.g. £20 million in 2017 for pollution), but critics argue fines were too small to deter repeated environmental damage, like sewage dumping in rivers.