A LevelEconomicsAQARevision NotesIndividuals, Firms, Markets & Market Failure8. The Market Mechanism, Market Failure & Government InterventionGovernment Intervention: Competition Policy

Government Intervention: Competition Policy (AQA A Level Economics)

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Claire France

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Competition Policy

  • Competition policy is government policy that aims to make markets more competitive and to ensure that the public interest is protected
  • The main forms of consumer exploitation by firms include higher prices, lack of choice and/or poor quality products
    • Competition policy aims to control anti-competitive mergers and monopolies, prevent restrictive trading practices and promote competition in markets
    • The Competition and Markets Authority (CMA) is the UK Government responsible for overseeing competition policy in the UK

Intervention to Control Mergers

  • The Competition & Markets Authority (CMA) 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 other regulatory bodies the UK which operate under the CMA such as the Civil Aviation Authority (CAA) or the Office of Gas and Electricity markets (OFGEM)
  • Within the EU, the European Commission seeks to restrict anti competitive behaviour within EU countries and with its trading partners
    • UK companies trading in the EU need to consider both UK and EU competition law
       
  • 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
      • E.g. In July 2022 the CMA launched an investigation into the merger of two companies which produce foam used in bedding and cleaning products as they believed it would lead to higher prices & less choice

Intervention to Control Monopolies

  • Monopolists can restrict output and raise prices to gain supernormal profit. This reduces consumer surplus and so is not in the best interest of consumers
  • In addition to controlling merger activity, the CMA continuously intervenes in markets in order to promote competition and protect the interests of consumers
     

Competition Policies in Monopoly Markets


Policy
Explanation

Compulsory break-up

  • Some would argue that monopolies should be forcibly broken-up
  • This has happened on rare occasions in the UK, to ensure that no single company controls the supply of electricity, or controls all the country’s major airports
    • E.g In 2009, the airport operator BAA was told to sell three of its airports

Price regulation

  • Monopolies aim to produce at the profit maximisation level of output and have higher prices and limited output in the market
  • Regulators set maximum prices to lower prices and increase output
  • Effective price regulation sets the maximum price at the level where there is allocative efficiency
    • E.g Fare rises for train operating companies in the UK are capped by the retail price index (RPI)

Profit regulation 

  • 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
  • It is a very contentious policy, as
    • Costs are difficult to calculate and firms often try to inflate their perceived costs so as to make more profit than allowed
    • There is 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 often post record profits year on year

Taxation

  • To limit excessive monopoly profits, windfall taxes may be implemented
  • This leads to an increase in the costs of production, resulting in higher prices and lower output
    • In the UK, energy firms such as BP and Shell paid tax on profits made from extracting gas and oil

Public (state) ownership

  • Publicly owned monopolies are more likely to operate in the best interests of society
  • Monopolies often abuse market power to make profits, an objective that is removed under state ownership

Intervention to Promote Competition & Contestability

  • The following policies can help promote more effective competition:

1. Promotion of small business

  • Providing tax incentives or subsidies to small firms can help increase the number of new entrants into industries and therefore promote competition. In 2022, the UK government introduced the Supporting Small Business (SBB) scheme which caps bill increases at £600 for some small businesses

2. Deregulation

  • Government regulations can increase industry costs or act as a barrier to entry. Deregulating a market can promote competition, which will also increase the market's contestability

3. Competitive tendering for government contracts

  • Instead of the government manufacturing goods and services itself, this is often outsourced to firms. This is done by outsourcing the supply of these products, this generates more private sector activity and increases competition

4. Privatisation

  • Firms are hesitant to enter an industry when the dominant firm is owned by the government. Privatisation encourages new entrants to enter the market as they feel they can compete more effectively with private firms. E.g. In 2022 the UK Government confirmed that Channel 4 would be privatised

Evaluation of Competition Policies

  • For competition policies to be effective, there needs to be continuous monitoring and reviewing of policies
    • It can be expensive and time consuming to ensure firms or industries are complying with competition policies
       

The Advantages & Disadvantages of Competition Policies


Advantages
Disadvantages

  • Increased competition may lead to a fall in market price
     
  • Firms will strive to provide better quality and a range of products and customer service or risk losing market share
     
  • Firms invest in R&D and increase innovation to improve production processes to lower costs over time
    • Both productive efficiency and allocative efficiency will occur as a result
    • This will benefit society as a whole as these new products and processes lead to improvements e.g. technical change that can be used across markets

  • Reduces creative destruction, where firms with monopoly power are dynamically efficient as they can provide huge investment in R&D leading to innovative products and production processes. This would have benefited society as a whole
     
  • Stop some firms, particularly natural monopolies, from realising huge economies of scale which could have been passed on to the consumer

  • May lead to government failure as the authorities create distortions in the market leading to inefficiencies

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    Claire France

    Author: Claire France

    Claire has taught A Level and GCSE Maths and Economics as well as teaching Economics at a University in the UK. She is an AQA examiner and a successful subject lead. She loves creating informative resources that engage learners and build their passion for the subject.