3.6.1 Govt intervention+3.6.2 Impact of govt intervention

• Why do governments intervene in markets?

  Govts are likely to intervene in markets where there is a monopoly or a lack of contestability. Intervention should:

  -Reduce prices and protect consumers

  -Protect suppliers

  -Prevent excessive profits

  -Improve efficiency (all types)

  -Improve product quality

  -Improve consumer choice
• Why do governments investigate mergers?

  A merger may result in a monopoly. This could harm consumers, reduce competition and reduce efficiency.

  Therefore, competition authorities (e.g. the CMA in the UK) only approve mergers if they think that it is in the interest of consumers.
• Types of intervention governments use to control monopolies:

  -Price regulation

  -Profit regulation

  -Quality standards

  -Performance targets
• How does price regulation control monopoly power?

  Govts can force firms to sell at a P=MC. This ensures allocative efficiency and low prices for consumers, which ↑ CS.

  This method is most often used in markets where a firm provides an essential good, e.g. in the UK energy market.
• Disadv (-) of price regulation to control monopoly power

  -The govt doesn't know a firm's costs and revenue curves and therefore cannot calculate the allocatively eff level of output. Thus, they may end up setting the price cap too high and therefore allocative eff persists.

  -Price control reduce profits -> firms have less to invest in R&D to improve products and production processes -> dynamic ineff
• How does profit regulation control monopoly power?

  Govts set a max amount of profit that the monopolist can make. This should result in lower prices and improved allocative eff.
• Disadv (-) of profit regulation to control monopoly power

  -If there is asymmetric info, the govt may overestimate the monopoly's costs. Therefore, the monopolist may end up making more profit than the govt intended.

  -The monopolist does not have an incentive to control costs. They may still be able to make the max allowed level of profit by running the firm inefficiently and passing higher costs onto consumers through higher prices.
• How do quality standards & performance targets control monopoly power?

  -Without govt intervention monopolists may exploit consumers by providing low quality products.

  -Govts can attempt to resolve this by setting standards and targets

  E.g. Royal Mail has a legal obligation to deliver letters to rural areas, despite the fact that they make a loss doing this; train companies are set targets for the % of trains that run on time. Firms can be fined if they don't meet these standards.
• Disadv (-) of quality standards & performance targets to control monopoly power

  -Monopolists may find ways to 'game the system', e.g. by changing train timetables to make each journey longer and therefore make it appear that a greater % of trains run on time.

  -Opportunity cost to the govt of monitoring the behaviour of firms to ensure that they're meeting targets.
• Types of intervention govt can use to promote competition and contestability

  -Promoting small businesses

  -Deregulation

  -Competitive tendering

  -Privatisation
• How promoting small businesses improves competition & contestability

  Govts can provide training and grants to new entrepreneurs. They can also offer lower taxes or subsidies to new businesses.

  (-): Small businesses may struggle to compete w/ established monopolies even w/ govt support.
• How deregulation promotes competition & contestability

  Deregulation may reduce legal barriers to entry and therefore increase contestability.

  (-): Other barriers to entry (e.g. sunk costs, capital costs) may remain, so market may remain difficult to contest.
• How competitive tendering improve competition & contestability

  This occurs when the govt is financing the production of a good/service but doesn't want to produce the good (e.g. beds for the NHS).

  If the govt uses the same firm every time, they will become a monopoly supplier and may exploit the govt by charging high prices for low quality.

  Instead, govts use 'competitive tendering' - this means asking private firms to bid for the contracts to produce these goods. The govt will choose the firm that offers the best value for money.

  (-): Once the private firm has won the contract, they may provide a low quality product knowing that at this stage it's difficult for the govt to switch suppliers.
• How privatisation promotes competition & contestability

  This means splitting up a large nationalised firm into smaller private firms that will compete with one another

  (-): Often privatisation replaces a public sector monopoly w/ a private sector monopoly.
• Intervention govts take to protect suppliers

  Govt may wish to protect suppliers from exploitation from monopsonist buyers.

  They can put regulation in place to prevent this, e.g:

  -Minimum prices

  -Policies to promote competition for the monopsonist, e.g. subsidies for new entrants

  -Policies to prevent the formation of monopsonies, e.g. blocking mergers.
• Intervention govts take to protect employees

  -Regulation can include: health and safety at work, protection from unfair dismissal, minimum wage

  -Govts can also promote trade union memberships.
• Nationalisation:


  The process of transferring ownership of a firm from the private sector to the public sector.

  (Opposite of privatisation).
• Adv (+) and disadv (-) of nationalisation

  (+) Nationalised firms won't have profit max as an objective -> more likely to act in the interest of consumers

  (+) Employees benefit from greater job security and less inequality between the pay of managers and workers.

  (-) Lack of profit incentive -> inefficiency

  (-) Opportunity cost of buying the firm

  (-) Employees may not receive pay rises if govt cuts budget
• Limitations of govt intervention

  -Asymmetric info.

  -Regulatory capture - occurs when firms have influence over regulatory bodies.

  -Opportunity cost of funding regulatory bodies.

  -Lose the benefits of monopoly e.g. if monopolies can't make SNP -> dynamically inefficient