Government intervention occurs when the government interferes with decision making by firms and individuals through regulatory action in an attempt to overcome market failure.
Government intervention to control mergers
The competition and markets authority often investigate mergers that result in a market share of around 25% or more in order to prevent uncompetitive outcomes in the market. If they believe that the merger will result in outcomes that are not in the public’s interest, then they will block the merger. Overall, this organisation aims to prevent firms from exploiting customers in forms such as high prices, low quantity and low quality standard, all of which have the potential to take place through large market share ownership.
Government intervention to control monopolies:
There are 3 types of price caps all of which vary in strictness to match the amount of regulation required in the industry. The first price cap is based on the inflation measurement retail price index. This price cap allows firms to only increase their prices by the level of RPI inflation. So if RPI was 2%, the firm would be able to increase their prices by 2%, helping to cover inflationary increases in the firm’s costs. Therefore, although a price rise may take place, in real terms, prices have stayed the same.
The next price cap is RPI-X with X representing a certain percentage. This method is used if the government want to restrict price increases by a lower percentage than that of the retail price index. Implementing this type of price cap encourages firms to increase their efficiency. By doing so the firm will still make a substantial profit (given that they cut their costs by more than the value of X) despite only being able to increase their prices by a percentage below the rate of RPI.
The final price cap is RPI +/- K where K is equal to a percentage that allows the firm to make a large enough profit for capital investment. As this is dependent on the profit made at the firm’s current price level, the value K can either be negative or positive. This type of price regulation is seen most in the water industry.
The desired effect of price regulation can be seen on the diagram above. This shows the maximum price level at the point of allocative efficiency. Through price regulation the government is able to force monopolies to produce at a point at which consumer satisfaction in maximised. The effect of this can be seen through a lower price (PM to PQ) and an increase in the quantity of goods/services produced (QM to QC).
One type of profit regulation used is called rate of return regulation. This occurs when the government look at the profit that is made by a firm and then decide the reasonable level of profit that they should earn given the rate of return on capital employed. As such, this encourages firms to increase their capital employed. If a firm is making profits that are not proportionate to the size of the firm or capital employed, then the government are likely to regulate the firm and reduces the profit they make through means such as taxation.
The government often intervenes through legislative means to ensure that firms meet a minimum standard. For example, gas and electric companies are not allowed to cut off the gas/electricity supply for pensioners in the winter months despite not paying their gas/electricity bill.
Performance targets can be implemented in order to ensure that firms are operating in the consumer’s interest and that competitive outcomes are achieved. For example, in the rail industry, performance targets are often set whereby a train company is only aloud to have a certain number of delays on a daily basis. Going past this figure may result in fines being issued.
Government intervention to promote competition and contestability
Enhancing competition between firms through promotion of small business
The promotion of small business can come from government intervention in forms such as deregulation as well as an improvement in the access to finance for small businesses. Both of which will incentivise smaller firms to enter the market and therefore increase contestability. Overall, this will lead to more competitive outcomes within markets.
Deregulation occurs when the legal barriers to entry (otherwise known as red tape) into a market are reduced in order to incentivise more firms to enter the market and increase competition. The main goal of this is to create market… Read more