Theme 3 Topic 6

Question 1

CMA

Answer 1

The Competition and Markets Authority is the UK Government regulator tasked with ensuring that the creation of monopoly power is avoided and that consumers are not exploited in markets

The main forms of consumer exploitation include higher prices, less choice and/or poor quality products

There are similar regulators in Europe (European Competition Commission) and in the USA (Antitrust Commission)

Question 2

CMA function

Answer 2

One way to control monopoly power is to prevent it from forming in the first place

A key function of the CMA is to monitor merger activity with the aim of preventing any single firm gaining more than 25% market share

If there are concerns about the merger then the CMA has the authority to stop it from happening, or they can allow it to go ahead but insist the new firm sells certain assets which would limit its market share

Question 3

CMA context point

Answer 3

in July 2022 the CMA launched an investigation (opens in a new tab) into the merger of two companies which produce foam used in bedding and cleaning products as they believed it would lead to higher prices and less choice

Question 4

CMA intervening in markets

Answer 4

In addition to controlling merger activity, the CMA continuously intervenes in markets in order to promote competition and to protect the interests of consumers

4 types :
1. Price regulation
2. Profit regulation
3. Quality standards
4. Performance targets

Question 5

Price regulation

Answer 5

Monopolies aim to produce at the profit maximisation level of output (MC=MR)

This results in higher prices and restricted output in the market

The CMA uses maximum prices to lower prices and increase output

One way in which they determine where the maximum price should be is to identify the point of allocative efficiency and set the maximum price where AR=MC

This strategy is often used on natural monopolies

Firms will make less supernormal profit than before, especially when any price increases are set below the rate of inflation: RPI - X

Question 6

Profit regulation

Answer 6

The CMA may choose to limit the supernormal profit a monopoly can earn

They do this by calculating the firm’s total costs and then adding a percentage of profit to it

However, it is a very contentious policy as

• Costs are difficult for the CMA to calculate
• Firms often try to inflate their perceived costs so as to make more profit than allowed
• Monopolies have no incentive to lower costs, so if costs are higher than they would be in perfect competition, consumers still end up paying higher prices
• Even with this policy in place, natural monopolies seem to post record profits year on year

Question 7

Quality regulation

Answer 7

One way to maximise profit is to reduce the quality of the raw materials, which reduces the quality of the end good/service

If there are no substitutes then this is a likely outcome

Regulators can step in to insist that certain quality standards are met

It can be difficult for them to know what the potential quality of a product is or what standards to impose
Firms push back on these quality standards as they reduce their supernormal profit

Question 8

Performance targets

Answer 8

Regulators can set performance targets so as to raise the quality of the service and improve customer satisfaction

This is often seen in the rail industry where targets are set based on the percentage of trains running on time

Question 9

Natural monopoly context

Answer 9

The UK water industry is a natural monopoly that was privatised in 1989

Question 10

Intervention to Promote Competition & Contestability

Answer 10

1. ProMotion of small businesses
2. Deregulation
3. Competitive tendering for government contracts
4. Privatisation

Question 11

Promotion of small businesses

Answer 11

providing tax incentives or subsidies to small firms can help increase the number of new entrants into industries and thus promote competition

Question 12

Deregulation

Answer 12

Government regulations can increase industry costs or act as a barrier to entry. Removing regulations can promote competition, which will also increase the contestability in the market

Question 13

Competitive tendering for government contracts

Answer 13

Occurs when the Government draws up a specification for a good/service it wants to provide & receives bids from private firms to provide it

As a major provider of goods/services in the economy, the government could choose to manufacture many products itself, and this would decrease competition.

By outsourcing the supply of these products, it generates more private sector activity and increases competition

Question 14

Privatisation

Answer 14

Firms are hesitant to enter an industry when the dominant firm is owned by the government and has access to all of the government’s resources.

Privatisation encourages new entrants to the industry as they feel they can compete more effectively with private firms, which perhaps have fewer resources available to them

e.g. In April 2022, the UK Government confirmed that Channel 4 would be privatised

Question 15

Protecting suppliers

Answer 15

Monopsony power is abusive towards suppliers and, over time, can change the nature of entire industries in an economy

• Governments can pass anti monopsony laws and issue fines if breaches occur
• They can encourage firms to self-regulate and trade fairly
• They can appoint a regulator to monitor the practices in the industry
• They can subsidise firms that are suffering from abusive monopsony power
• They can set minimum prices, which buyers have to pay suppliers

Question 16

Nationalisation

Answer 16

Occurs when the Government takes control & ownership of firms which were in the private sector

Can be used to break the market power of the abusive firm, resulting in better treatment of suppliers

In 2024, the Labour government pledged to nationalise the rail network within 5 years.

Question 17

Protecting employees

Answer 17

Wage bills for firms are often one of their highest costs as a proportion of expenditure

With a goal of profit maximisation, firms will always seek to reduce their wage expenditure, as this will result in higher profit

There is a role for government to protect workers who could be exploited by firms

The government uses the following methods to protect employees:

• NMW legislation
• Legislation on health and safety, working hours and employment conditions, e.g. maternity pay
• Permitting trade unions to operate in the economy (some countries limit them as they view them as anti-competitive e.g. Singapore)
• Encouraging firms to adopt best practice and draw up company codes of conduct towards their employees. (self regulation)

Question 18

The Impact of Government Intervention - prices

Answer 18

Affordable + stable prices

Question 19

The Impact of Government Intervention - profit

Answer 19

Permitting enough to keep firms in the industry (normal profit) but limiting how much they make so that household income is protected

Question 20

The Impact of Government Intervention - efficiency

Answer 20

Reducing wastage of valuable resources and one of the best ways to achieve this is by developing rigorous competition

Question 21

The Impact of Government Intervention - quality

Answer 21

Ensuring products are fit for purpose and contribute to a better standard of living

Question 22

The Impact of Government Intervention - choice

Answer 22

Wider choice improves the standard of living and also helps to improve product quality.

More choice also generates more economic activity and increases GDP.

Question 23

Limits to Government Intervention

Answer 23

Government intervention is not always effective. Two of the main reasons for this are the existence of regulatory capture and asymmetric information

Question 24

Regulatory capture

Answer 24

Regulatory capture occurs when firms influence the regulators to change their decisions/policies to align more with the interests of the firm

Firms spend millions lobbying regulators directly - or in many cases lobbying politicians who can issue instructions to the regulators

Some lobbying activity is corrupt and there is a fine line between influencing activity and bribing.

The UK Government has an agenda to improve the transparency of any lobbying activity

Naturally, regulatory capture can completely prevent fair outcomes in the markets concerned

Question 25

Lobbying

Answer 25

The process of engaging with decision makers in government to attempt to influence the decisions they make which impact the operating environment of the firm doing the lobbying. Often specialist firms (who are well connected in government) represent the interests of private firms in 2021 the former UK Prime Minister, David Cameron, was caught lobbying for a failed financial venture by a firm called Greensill Capital

Question 26

Asymmetric information

Answer 26

Often governments believe they are making the best decision in order to meet their aims Many times it is not the best decision due to the fact that the government or regulators either do not have the full and relevant information - or they do not understand the market they are trying to regulate e.g. many financial markets are fast moving and incredibly complex This existence of asymmetric information has been responsible for some spectacular government failures

Question 27

Asymmetric information + regulatory capture

Answer 27

When markets are more complex, asymmetric information and regulatory capture become more significant. The grocery market is less complicated to understand compared to the elevator market, which operated a cartel for many years in Europe from 1995 to 2004.

Question 28

Price cap formula

Answer 28

RPI - x is the change in nominal terms X is equal to the expected efficiency savings that monopolies will make due to their scale of production Real = nominal - inflation Profit = TR - TC if you can’t change your revenue, lower costs by exactly the amount of x RPI + k and the k is for capital

Question 29

PFI or PPPs

Answer 29

Means of obtaining private funds for public sector projects