Government intervention in the market

Alvaro Ferreira6626
Flashcards by Alvaro Ferreira6626, updated more than 1 year ago
Alvaro Ferreira6626
Created by Alvaro Ferreira6626 about 6 years ago


Imperfect Competition and Policies

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Imperfect competition and competition policy Imperfect competition implies productive and allocative inefficiencies in production. (Unless dynamic efficient). UK and EU competition policy may do much to ensure firms act in the public's best interest
Competition Policy Methods that the UK and EU authorities use in order to make markets more efficient. This covers, monopolies, mergers, restrictive trade practices and promotion of new competition
Restrictive trade practices Methods use by firms to reduce competition in a market. These include: charging discriminatory prices, Resale price maintenance (manufacturers fix the price for retailers), Full line forcing (Forcing a retailer to sell the whole range rather than one product) and Refusal to supply to some retailers
Competition commission CC This is a government organisation responsible for implementing policy in relation to monopolies
Office for fair trading OFT A government organisation responsible for implementing aspects of competition policy. The indicators they use to monitor monopoly abuse are: Merger activity, Profit margins, ROCE to sales turnover and ratio of advertising to sales.
The competition act 1998 Dominant market position Where a firm or a group of firms work together and have 40% of the market share. The objections are that it might be productive and allocative inefficient, or Xinefficient (High prices-Low output)=SNP. However it could lead to lower prices if firm is dynamically efficient and benefits from EoS
What are the consequences for unfair trading practices? The OFT will refer to the CC for further investigation and cease particular trading practices. CC approaches: Compulsory breaking up, price controls, taxes, nationalisation, privatisation or deregulation.
Nationalisation Privatisation Deregulation This is where the state takes control over a firm Sales of government owned assets to the private sector Process of removing government controls
Public ownership VS privatisation Public ownership of essential utilities was vital to ensure production in times of crisis. Large economies of scale achievable for public owned firms than under private ownership.
Advantages of Nationalisation Firms controlled by the state can be more allocative efficient MC=AR. They look out for externalities. Don't stop operating if they are making a loss (Objective is not to profit maximise). Firms look at long term benefits E.g. HS2 Heavily subsidise could lead to low prices Don't have to worry about shareholders.
What are the disadvantages of nationalisation? Cost to the government and tax payer (Opportunity costs, money spent somewhere else). Inefficiencies arising from government ownership E.g. X-inefficient or diseconomies of scale, NHS overstaffing.
Privatisation Involves the transfer of assets or organisations from state ownership to the private sector. In the UK this has involved selling off nationalised industries. E.g. British Gas and BT
Privatisation takes a number of additional forms rather than the sale of nationalised industries Deregulation, removal or restrictions on the provision of a good. E.g. Bus service Sale of local authority assets. E.g. council houses to tenants Franchising and licensing. E.g. ITV channels Competitive tendering of services. E.g. refuse collection
Advantages of Privatisation Private firms are incentivised to cut costs to increase profits and therefore be more efficient. E.g. dynamic efficient. Promotes competition, breaks up monopolies. However, natural monopolies are difficult to split
Advantages of Privatisation Raises revenue for government by selling nationalised assets. This is a short term source of revenue. For example, George Osborne selling the 30% Royal Mail steak the government owned to reduce national debt
Disadvantages of Privatisation There might be worse allocation of resources if market is monopolised. MC=MR restricts output and is neither productive or allocative efficient. Could lead to a loss of economic welfare
Disadvantages of Privatisation (2) Closure of loss making services. E.g. Village stations which are not profitable Short-termism, danger that investments that are only profitable in the long term will not occur because shareholders want short term profits
Disadvantages of Privatisation (3) Externalities. Private firms don't take into account externalities from their activities. E.g. Pollution and scarred landscapes from coal extraction
Enterprise culture A way of life that emphasises the importance of individuals who create their own businesses and create wealth
Public private partnership Partnerships between the private and public sector to provide public services. E.g. street cleaning and refuse collection.
Private Finance initiative This is a form of public-private ownership where the private sector firms undertake the bulk of the work The advantages of PFI is that private sector partners tend to have greater expertise and services can be improved without increasing government borrowing
Regulation Setting rules and controls that restrict market freedom. Governments can use regulation to correct market failure. E.g. over production of negative externalities such as pollution. The aim is to achieve social optimum level of production and consumption. E.g. pollution permits
Regulation (2) Regulation can also be used to deter abuses of monopoly power. Rules and regulations imposed to promote health and safety at work and protect consumer rights
Deregulation Involves the removal of government controls on market activity. In the UK, access to BT's distribution infrastructure has been given to competitors and other markets have been opened up for household energy supply and mail services
The concept of Regulatory capture This is an argument in favour of deregulation. Suggests that the agencies set up to regulate industries/firms they are intended to oversee. The regulators then act in the industry's internet rather than that of consumers.
Market Failure Where the free market fails to allocate resources efficiently. There are possible cases of market failure: Negative/Positive externalities, public/demerit/merit goods, imperfect competition, immobility of factors of production and equity issues.
What does market failure leads to? Productive and allocative inefficiency. Productive inefficiency occurs when firms are not producing output at the lowest point in the ATC. Allocative inefficiency occurs when resources are not used to produce the goods and services that consumers demand
What methods of government intervention are used to improve the workings of markets? Government legislation and regulation. Direct state provision of goods and services (Including nationalisation) Fiscal policy intervention (Direct/Indirect taxation and subsidies) Improving the quality and availability of information
Government intervention? Is it always good? No. Government intervention can lead to government failure. This is when government intervention doesn't improve the allocation of resources or it leads to a worsening of the situation. E.g. Imperfect information, Regulatory capture, political self interest and unintended consequences
Negative Externalities Negative spillover effects to third parties not involved with the consumption or production of the good. Social costs exceed private costs
Positive Externalities Positive spillover effect to third parties of a market transaction
Environmental market failure Negative externalities arising from production or consumption There are external costs of production in this market = to vertical distance CA. However, social equilibrium occurs when MSB = full cost of production where MSB crosses MSC at Q1. In a free market there would be allocative inefficiency because Q1 wouldn't be produced and price wouldn't reflect MC to society
Distributional effects Environmental externalities Create distributional problems. E.g. In the case of global warming, relatively poor citizens are more likely to be affected by this effect and there are inequities between those who contribute to global warming and those who suffer from it
Environmental distributional effects? What to do? Imposing a tax on the output of industrialised nations and with the revenue of the tax receipts it could be used to compensate citizens of developing nations for their welfare loss
What can the government do to correct environmental market failure? Market based measures, designed to modify the price mechanism. E.g Taxes and subsidies Government Regulation, incentives for firms to reduce harmful emissions. Pollution permits
Environmental Taxation A tax can be imposed on a good/service with has a negative impact upon the environment. Taxation is designed to internalise any externality by increasing the MPC so they pay some of the external costs. Environmental taxes seek to increase firms MPC until it equals MSC as shown on diagram tax of CA
Environmental Taxation (2) After taxing firms to correct externalities and output has moved to the social optimum level revenues from taxation could be used to fund spending on environmental clean ups or for the development of new technologies "green energy". E.g. London congestion charge
Carbon Tax Tax imposed on polluting firms according to the amount of emissions they release. The revenues could be invested in alternatives and it would create incentives for large firms to reduce emissions or to look for alternatives so that they maintain revenue and green image.
Arguments against the carbon tax Costs could be passed on to consumers rather than actually cutting emissions. This would only work if consumers remained loyal despite prices (PED was low) There is also no guarantee that the government would reinvest the revenue
Other problems with environmental taxation? Increasing taxes in the UK would reduce international competitiveness and encourage firms to offshore to countries with lower taxes. This would still increase global pollution. Countries with lighter environmental taxations are India and China
Alternatives to Environmental taxation? Pollution regulation The government could regulate the level of output and pollution in a market. It could set a quota that corresponds to the social optimum level or ban certain pollution generating activities like waste incineration.
Problems with pollution regulation The monitoring system this requires would cost the government a lot of money and it would be difficult to enforce. Regulation doesn't generate tax revenues that could be used to compensate the issues from polluting
Extending property rights to correct environmental failure Externalities can occur if property rights are not fully allocated. Resources such as the seas and air are not privately owned so nobody is responsible if they are over exploited. "Tragedy of Commons"
Tragedy of Commons This is the over exploitation of natural resources that are not owned by single individuals or organisations
Alternatives for regulation or taxation? Property Rights Creating a market in property rights. "Internalising" the externality by enabling firms trade their pollution permits could help limit the economic activity on the environment. Signalling, rationing and incentive functions of the price mechanism influence the behaviour of firms (Carbon Trading)
Pollution Permits Limit on the total level of pollution a firm can emit. This is Q1 where MSB=MSC. Permits are then issued in an action and polluting firms can bid as well as trade them with each other. They should therefore create an incentive to reduce their emissions to generate profit from trading them.
Kyoto Protocol International agreement signed by government representatives to deal with problems of climate change. The protocol allows carbon trading between industrialised countries. US accounts for third of all carbon emissions withdrew from the agreement and so did China and India, reducing the effectiveness of the agreement to reduce CO2
Cost Benefit Analysis An investment technique that takes into account all the private and external costs and benefits of an economic decision.
What does Cost Benefit Analysis involve? It involves the evaluation of major investment projects. It calculates shadow prices on costs and benefits where no market price is available. For example, the cost of losing agricultural land arising from new house building scheme
Stages to Cost benefit analysis (1) Identify all relevant costs and benefits arising from a particular project. These are divided into private costs, private benefits, external costs and external benefits. These are hard to quantify since projects may have wide-ranging consequences
Shadow Prices A price calculated to accurately reflect the costs and benefits to society of a good. Especially when no market price has been calculated
Stages to cost benefit analysis (2) Placing a monetary value on the various costs and benefits. This is easy where market prices are available. E.g. jobs/profit created by the construction of a building. For others, shadow prices must be calculated, E.g. monetary value on costs of accidents from the construction of the building.
Stages to cost benefit analysis (3) Using statistical forecasting techniques to estimate costs and benefits over many years (Projects that have long term impact where large scale capital expenditure is involved)
Stages to cost benefit analysis (4) Drawing together the data from the previous stages and compare the social costs against the social benefits. If social benefits exceeds the value of social costs then its worthwhile since it provides an overall net benefit to society
What are the limitations with cost benefit analysis? (1) It is difficult to place monetary values on certain costs and benefits. Another problem is that it may not fully reflect the distributional impacts of investment projects. E.g. A new shopping centre where external costs may be high whilst external benefits are more widely spread
What are the limitations to cost benefit analysis? (2) Public sector projects often tend to be controversial and may attract objection. The result of the CBA may be ignored for political reasons. CBA is an aid to decision-making and not a replacement for it
What are the limitations of cost benefit analysis? (3) It is very difficult to accurately place a value on public goods, such as the environment, where there is no market established for the valuation of property rights. Also difficult to place a value on human life even though there are insurance markets which do
Terminal 5 at Heathrow Airport Planning permissions were granted for the development of T5, It is believe that if Heathrow was not allowed to grow, many airlines would have relocated to Europe. Even though there are concerns about environmental problems it was built on a brownfield site and noise would be controlled
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