Government, The Firm And The Market

8 Government, the Firm and the Market

Reasons for Government Intervention ■

Government intervention and social objectives

■

The objective of social efficiency ✜

✜

■

✦ MSB

> MSC → produce (or consume) more

✦ MSC

> MSB → produce (or consume) less

socially efficient output where MSB = MSC

Equity ✜

■

marginal social benefits and costs

concepts of fairness

Trade-offs between equity and efficiency

Types of Market Failure ■

Externalities ✜

External costs of production MSC > MC

External costs in production

Costs and benefits

MC = S

P

D

O

Q1 Quantity

External costs in production

Costs and benefits

MSC

P

MC = S

D External cost

O

Q2 Social optimum

Quantity

Q1

Types of Market Failure ■

Externalities ✜

External costs of production MSC > MC

✜

External benefits of production MSC < MC

External benefits in production

Costs and benefits

MC = S

P

O

D

Q1 Quantity

External benefits in production

Costs and benefits

MC = S MSC

External benefit P

O

D

Q1 Quantity

Q2

Social optimum

External costs and benefits in production

D

P External cost

O

Q2

Q1

Quantity

(a ) External costs

MC = S MSC Costs and benefits (£)

Costs and benefits (£)

MSC MC = S

External benefit P

O

D

Q1

Q2

Quantity

(b) External benefits

Types of Market Failure ■

Externalities ✜

External costs of production MSC > MC

✜

External benefits of production MSC < MC

✜

External costs of consumption MSB < MB

Types of Market Failure ■

Externalities ✜

External costs of production MSC > MC

✜

External benefits of production MSC < MC

✜

External costs of consumption MSB < MB

✜

External benefits of consumption MSB > MB

Types of Market Failure ■

Externalities ✜

External costs of production MSC > MC

✜

External benefits of production MSC < MC

✜

External costs of consumption MSB < MB

✜

External benefits of consumption MSB > MB

■

Public goods

Types of Market Failure ■

Externalities ✜

External costs of production MSC > MC

✜

External benefits of production MSC < MC

✜

External costs of consumption MSB < MB

✜

External benefits of consumption MSB > MB

■

Public goods ✜

non-rivalry

Types of Market Failure ■

Externalities ✜

External costs of production MSC > MC

✜

External benefits of production MSC < MC

✜

External costs of consumption MSB < MB

✜

External benefits of consumption MSB > MB

■

Public goods non-rivalry ✜ non-excludability and the free-rider problem ✜

Types of Market Failure ■

Market power ✜

market power can be used to raise the price above the perfectly competitive level

✜

output below the socially efficient level ✦ MSB

> MSC

A monopolist producing less than the social optimum £ MC

P1

MC1

MR O

Monopoly output

Q1

AR Q

A monopolist producing less than the social optimum £ MC = MSC

P1 P2 = MSB = MSC

MC1

MR O

Monopoly output

Q1

Q2

AR = MSB Q Perfectly competitive output

Types of Market Failure ■

■

Imperfect information ✜

by consumers

✜

by firms

Protecting people’s interests ✜

dependants

✜

merit goods

Business Ethics & Corporate Social Responsibility ■

■

■

Firms and social responsibility ✜

are managers solely responsible to shareholders?

✜

are they simply concerned to maximise profits?

✜

broader social interests

Business ethics ✜

a stakeholding society

✜

corporate social responsibility

✜

environmental scanning

Economic performance and social responsibility

Government Intervention in the Market ■

Taxes and subsidies ✜

to correct externalities

Using taxes to correct a market distortion

Costs and benefits

MC = S

P

D

O

Q1 Quantity

Using taxes to correct a market distortion

Costs and benefits

MSC

P

MC = S

D External cost

O

Q2 Social optimum

Quantity

Q1

Using taxes to correct a market distortion

Costs and benefits

MSC

MC = S

Optimum tax = MSC – MC

P

D

MC

O

Q2 Quantity

Q1

Government Intervention in the Market ■

Taxes and subsidies ✜

to correct externalities

✜

to correct for monopoly

Government Intervention in the Market ■

Taxes and subsidies ✜

to correct externalities

✜

to correct for monopoly

✜

advantages of taxes and subsidies ✦ can

vary the rate according to the size of the market distortion

Government Intervention in the Market ■

Taxes and subsidies ✜

to correct externalities

✜

to correct for monopoly

✜

advantages of taxes and subsidies ✦ can

vary the rate according to the size of the market distortion

✜

disadvantages of taxes and subsidies ✦ infeasible ✦ lack

to use different tax and subsidy rates

of knowledge

Government Intervention in the Market ■

■

Legislation ✜

to control activities causing externalities

✜

to prevent firms giving inaccurate information

✜

to prevent the abuse of monopoly power

Regulatory bodies ✜

purely investigative

✜

with powers to act (e.g. OFT)

Environmental Policy ■

The environment and production

■

Green taxes and subsidies ✜

use of green taxes around the world

Types of environmental taxes and charges

Types of environmental taxes and charges

Types of environmental taxes and charges

Types of environmental taxes and charges

Environmental Policy ■

Green taxes and subsidies (cont.) ✜

choosing the tax rate ✦ tax

✜

rate should equal the marginal external cost

advantages of taxes and subsidies ✦ allows ✦ can

✜

market to operate

vary with the size of the externality

disadvantages of taxes and subsidies ✦ infeasible ✦ lack

to use different tax rates

of knowledge on extent of externality

Environmental Policy ■

Laws and regulations ✜

the command-and-control approach

✜

advantages ✦ simple ✦ safe

✜

to operate

approach when size of externality not known

disadvantages ✦ requires ✦ lack

■

robust monitoring and enforcement

of incentives for firms to do better

Tradable permits ✜

how tradable permits work

✜

assessing tradable permits

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher

prices and profits

Profit maximising under monopoly £

MC

MR O

Qm

Q

Profit maximising under monopoly £

MC Total profit

AC

AR

AC

AR MR O

Qm

Q

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher ✦ lack

prices and profits

of incentive to innovate

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher ✦ lack

✜

prices and profits

of incentive to innovate

market power can also bring benefits

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher ✦ lack

✜

prices and profits

of incentive to innovate

market power can also bring benefits ✦ economies

of scale

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher ✦ lack

✜

prices and profits

of incentive to innovate

market power can also bring benefits ✦ economies

of scale

✦ investment

and innovation

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher ✦ lack

✜

✜

prices and profits

of incentive to innovate

market power can also bring benefits ✦ economies

of scale

✦ investment

and innovation

approaches to competition policy

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher ✦ lack

✜

✜

prices and profits

of incentive to innovate

market power can also bring benefits ✦ economies

of scale

✦ investment

and innovation

approaches to competition policy ✦ banning

various activities

Competition Policy ■

Competition, monopoly and the public interest ✜

the abuse of market power ✦ higher ✦ lack

✜

✜

prices and profits

of incentive to innovate

market power can also bring benefits ✦ economies

of scale

✦ investment

and innovation

approaches to competition policy ✦ banning

various activities

✦ examining

each case on its merits

Competition Policy UK competition policy ✜

the OFT and the Competition Commission

✜

restrictive practices policy ✦ legislation ✦ criminal

under 2002 Enterprise Act

to engage in cartel arrangements

• price fixing, limiting supply, sharing out markets, collusive tendering, agreements to pay low prices to suppliers ✦ OFT

has discretion with other types of agreement

• vertical price fixing, agreements to exchange information ✦ powers

of the OFT

✦ difficulties

in rooting out collusion

Competition Policy ■

UK competition policy (cont.) ✜

monopoly policy ✦ Chapter

2 prohibition of 1998 Competition Act

• market-share criterion • market contestability ✦ anti-competitive

practices

• charging excessively high prices, price discrimination, predatory pricing, vertical restraints ✦ test:

✜

do such practices restrict competition?

merger policy (2002 Enterprise Act) ✦ role

of OFT and Competition Commission ✦ criteria for judgment ■

Assessment of competition policy

The Regulation of Business ■

Regulation and the privatised industries ✜

■

nationalisation and privatisation

Regulation in practice: ✜

use of general competition policy

✜

specific regulation ✦ regulatory

✜

offices

price-cap regulation ✦ the

CPI–X formula

The Regulation of Business ■

■

Advantages of UK regulation ✜

discretionary

✜

flexible

✜

incentives

Disadvantages of UK regulation ✜

disincentives of changes to X

✜

complexity of regulation

✜

principal–agent problems between regulator and industry managers

The Regulation of Business ■

Policies to increase competition ✜

allowing competition where there is no natural monopoly ✦ limited

✜

extent of true natural monopoly

allowing access to grids by competitors ✦ forbidding

✜

■

suppliers from being grid owners

competitive franchising to make monopolies contestable

Still need for regulation to prevent abuse of monopoly power