Judging competition policy and government failure

Overview

How the effects of intervention on prices should be assessed, how the effects of intervention on employment should be assessed and how the effects of intervention on output should be assessed.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   Compare the four broad approaches available to a government dealing with an uncompetitive market.

   Model answer

   Structural remedies change who owns what, by breaking up firms or blocking mergers, and are permanent but drastic and costly where scale economies are real. Regulatory remedies control price, quality and access, which delivers results directly but requires information the regulator lacks and must be maintained forever. Ownership remedies, nationalisation or privatisation, change the firm's objective, which is powerful but replaces one set of weaknesses with another. Conduct remedies, banning specific practices and improving information, are cheap and broad but leave the market power itself untouched. Each addresses a different part of the problem, which is why they are usually combined.

2. 2

   Analyse how the effects of intervention on prices should be assessed.

   Model answer

   The relevant comparison is between the price after intervention and the price that would otherwise have prevailed, not the price before it, since costs and demand move for other reasons. It matters whether the price fall is genuine or has been achieved by reducing quality or unbundling charges that reappear elsewhere. It matters whether it is sustainable, since a price forced below the level that funds renewal will be reversed later. And it matters who benefits, because a lower average price achieved by removing cross-subsidy can leave some customers worse off while the average improves.

3. 3

   Analyse how the effects of intervention on employment should be assessed.

   Model answer

   Intervention that raises output raises employment in the industry, while intervention that forces cost reduction lowers it, and most remedies do both at once so the net effect is uncertain. Assessment must also look beyond the industry: lower prices for an input raise output and employment in the industries that use it, and lower prices for households raise real incomes and therefore spending elsewhere. Job losses from intervention are visible and concentrated while the gains are dispersed, which is why the employment argument against intervention usually sounds stronger than it is.

4. 4

   Analyse how the effects of intervention on output should be assessed.

   Model answer

   The test is whether output has moved towards the level at which the value of the last unit to consumers equals the cost of producing it. Remedies that lower price by relaxing the restriction on supply, such as a price cap above marginal cost, opening entry or public ownership with a cost-based price rule, raise output towards that level. Remedies that raise the firm's marginal cost, such as a per-unit tax, reduce output further and make matters worse. Output should also be judged over time, since intervention that deters investment reduces the capacity available later.

5. 5

   Analyse how the effects of intervention on economic welfare should be assessed.

   Model answer

   Welfare is the sum of consumer and producer surplus, so transfers between them cancel and only the change in the total counts. The measurable gain from a remedy that expands output is the deadweight loss removed, which in the worked case of a price cap at £55 was £112.50. From that must be deducted the resources the intervention itself consumes, the cost of any subsidy financed by distorting taxes elsewhere, and any loss of productive or dynamic efficiency it causes. Distribution is not part of the welfare total but is a legitimate separate consideration, since the same transfer matters more when it falls on households spending most of their income on essentials.

6. 6

   Why is it difficult to judge whether an intervention succeeded?

   Model answer

   The comparison required is with what would have happened without it, which cannot be observed. Prices, output and employment change for many reasons at once, so any movement after an intervention has several possible causes. The effects on investment and innovation appear only over many years, long after any assessment is made. And the information needed to judge the firm's costs comes largely from the firm itself.

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