The impact of government intervention
Price and choice
As shown from the diagram above, the desired effect of government intervention is to promote more desirable market outcomes for consumers. The main type of government intervention that has this effect is the implementation of price caps. Through this source of regulation the government are able to cap the price of goods/services within the market at the point at which competitive market outcomes can be achieved. This can be seen on the diagram whereby firms within the market are forced to produce at a point where average revenue is equal to marginal revenue which is the point at which firms within competitive markets operate at. The shift from a monopoly outcome (MC=MR) to a more competitive one has forced down prices for consumers (P1 to P2) and increased their choice of goods/services (Q1 to Q2). Overall this leads to a gain in consumer welfare.
Efficiency
In addition to lower prices and greater choice, government intervention can also be used to increase the efficiency of firms within the market. This can be seen on the diagram as firms move from a profit maximising point of production to one of allocative efficiency. As a result of this, consumer satisfaction is maximised and resources are efficiently allocated due to the fact that the market is in equilibrium where supply (MC) is equal to demand (AR).
Furthermore, government intervention such as deregulation also makes markets more competitive. As such, firms need to become more efficient in order to survive in the market and remain price competitive. This means that supernormal profits that are made by firms are more likely to be reinvested back into the business. As a result of this, the likelihood of firms within the market achieving dynamic efficiency increases.
Profit
The introduction of profit regulation or price caps will reduce the profits received for firms within the market. As a result of this, supernormal profits may not be achievable. However, such policies can put greater emphasis on firms to become more efficient. For example, profit regulation often takes into account the return on capital employed. Therefore, by investing in more capital, firms can achieve a greater level of profit.
Quality
The main two types of government intervention that have the greatest effect on the quality of goods/services produced by firms is minimum quality standards and performance targets. First of all, minimum quality standards ensure that consumers are protected from poor quality goods/services through legislative means and any breach of rules by firms will result in a fine.
Furthermore, performance targets ensure that firms continually provide goods/services which are of a high standard. For example, targets such as a cap on the number of trains allowed to be delayed daily will ensure that standards within the rail industry don’t slip and that consumer satisfaction is maximised. Any number of train delays above the performance target is likely to result in punishment for the firm in the form of a fine, thus incentivising rail companies to reduce the number of delays they experience.
Limits to government intervention
Regulatory capture
When appointing people to regulate industries, those approved often have worked in the industry before. Although this may be good in terms of them knowing what rules firms may break and general experience within the industry, it can lead to the problem of regulatory capture. This occurs when a firm gets in contact with a regulator in order to persuade them to implement less stringent regulations. As a result of this, the regulation itself does not end up doing the job it is intended to and uncompetitive outcomes remain.
Asymmetric information
Firstly, it can be very difficult for the government to gain similar or the same level of information that a firm has about their business. Therefore, without this information the decision of whether or not to investigate a firm and if so whether or not their involved in anti-competitive practices very difficult to determine… Read more