Government,the Firm andthe Market

Government,the Firm andthe Market

Reasons for Government InterventionReasons for Government Intervention

Government intervention and social objectives

The objective of social efficiency marginal social benefits and costs

MSB > MSC produce (or consume) more MSC > MSB produce (or consume) less

socially efficient output where MSB = MSC

Equity concepts of fairness

Trade-offs between equity and efficiency

Government intervention and social objectives

The objective of social efficiency marginal social benefits and costs

MSB > MSC produce (or consume) more MSC > MSB produce (or consume) less

socially efficient output where MSB = MSC

Equity concepts of fairness

Trade-offs between equity and efficiency

Types of Market FailureTypes of Market Failure

Externalities

External costs of production MSC > MC

Externalities

External costs of production MSC > MC

Q1

External costs in productionExternal costs in production

O

MC = S

DP

Co

sts

and

be

nef

its

Quantity

O

MC = S

DP

MSC

Co

sts

and

be

nef

its

Quantity

External cost

Q1Q2

Social optimum

External costs in productionExternal costs in production

Types of Market FailureTypes of Market Failure

Externalities

External costs of production MSC > MC

External benefits of production MSC < MC

Externalities

External costs of production MSC > MC

External benefits of production MSC < MC

External benefits in productionExternal benefits in production

O

DP

MC = S

Q1

Co

sts

and

be

nef

its

Quantity

O

MSC

DP

Q1

External benefit

Co

sts

and

be

nef

its

Quantity

MC = S

Q2Social optimum

External benefits in productionExternal benefits in production

O

MC = S

DP

Q1Q2

Cos

ts a

nd b

enef

its (

£)

Quantity

MSC

External cost

(a ) External costs

O

DP

Q2Q1

Cos

ts a

nd b

enef

its (

£)

Quantity

MSCMC = S

External benefit

(b) External benefits

External costs and benefits in productionExternal costs and benefits in production

Types of Market FailureTypes of Market Failure

Externalities External costs of production

MSC > MC External benefits of production

MSC < MC External costs of consumption

MSB < MB

Externalities External costs of production

MSC > MC External benefits of production

MSC < MC External costs of consumption

MSB < MB

Types of Market FailureTypes 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

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 FailureTypes 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

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 FailureTypes 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

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 FailureTypes 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

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 FailureTypes 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

Market power

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

output below the socially efficient level

MSB > MSC

MC1

Q1

MC

MRAR

A monopolist producing less than the social optimumA monopolist producing less than the social optimum

O

P1

£

Monopoly output

Q

O

P1

MC1

MC = MSC

Q1

MRAR = MSB

Q2

P2 = MSB

= MSC

£

QMonopoly output Perfectly competitive output

A monopolist producing less than the social optimumA monopolist producing less than the social optimum

Types of Market FailureTypes of Market Failure

Imperfect information

by consumers

by firms

Protecting people’s interests

dependants

merit goods

Imperfect information

by consumers

by firms

Protecting people’s interests

dependants

merit goods

Business Ethics & Corporate Social ResponsibilityBusiness 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

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 MarketGovernment Intervention in the Market

Taxes and subsidies

to correct externalities

Taxes and subsidies

to correct externalities

Q1O

MC = S

DP

Co

sts

and

be

nef

its

Quantity

Using taxes to correct a market distortionUsing taxes to correct a market distortion

O

MC = S

DP

MSC

Co

sts

and

be

nef

its

Quantity

External cost

Q1Q2

Social optimum

Using taxes to correct a market distortionUsing taxes to correct a market distortion

Q2

MC

Q1O

P

Co

sts

and

be

nef

its

Quantity

Optimum tax = MSC – MC

MC = SMSC

D

Using taxes to correct a market distortionUsing taxes to correct a market distortion

Taxes and subsidies to correct externalities

to correct for monopoly

Taxes and subsidies to correct externalities

to correct for monopoly

Government Intervention in the MarketGovernment 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

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 MarketGovernment 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 to use different tax and subsidy rates

lack of knowledge

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 to use different tax and subsidy rates

lack of knowledge

Government Intervention in the MarketGovernment 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)

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)

Government Intervention in the MarketGovernment Intervention in the Market

Environmental PolicyEnvironmental Policy

The environment and production

Green taxes and subsidies

use of green taxes around the world

The environment and production

Green taxes and subsidies

use of green taxes around the world

Types of environmental taxes and chargesTypes of environmental taxes and charges

Types of environmental taxes and chargesTypes of environmental taxes and charges

Types of environmental taxes and chargesTypes of environmental taxes and charges

Types of environmental taxes and chargesTypes of environmental taxes and charges

Environmental PolicyEnvironmental Policy

Green taxes and subsidies (cont.)

choosing the tax rate

tax rate should equal the marginal external cost

advantages of taxes and subsidies

allows market to operate

can vary with the size of the externality

disadvantages of taxes and subsidies

infeasible to use different tax rates

lack of knowledge on extent of externality

Green taxes and subsidies (cont.)

choosing the tax rate

tax rate should equal the marginal external cost

advantages of taxes and subsidies

allows market to operate

can vary with the size of the externality

disadvantages of taxes and subsidies

infeasible to use different tax rates

lack of knowledge on extent of externality

Environmental PolicyEnvironmental Policy

Laws and regulations the command-and-control approach advantages

simple to operate safe approach when size of externality not known

disadvantages requires robust monitoring and enforcement lack of incentives for firms to do better

Tradable permits how tradable permits work assessing tradable permits

Laws and regulations the command-and-control approach advantages

simple to operate safe approach when size of externality not known

disadvantages requires robust monitoring and enforcement lack of incentives for firms to do better

Tradable permits how tradable permits work assessing tradable permits

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits

Competition, monopoly and the public interest the abuse of market power

higher prices and profits

Profit maximising under monopolyProfit maximising under monopoly

MR

£

Q O

MC

Qm

£

Q O

MC

AC

Qm

MR

AR

AC

AR

Total profit

Profit maximising under monopolyProfit maximising under monopoly

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale investment and innovation

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale investment and innovation

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale investment and innovation

approaches to competition policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale investment and innovation

approaches to competition policy

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale investment and innovation

approaches to competition policy banning various activities

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack of incentive to innovate

market power can also bring benefits economies of scale investment and innovation

approaches to competition policy banning various activities

Competition PolicyCompetition Policy

Competition, monopoly and the public interest the abuse of market power

higher prices and profits lack 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, monopoly and the public interest the abuse of market power

higher prices and profits lack 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 PolicyCompetition Policy

UK competition policy the OFT and the Competition Commission

restrictive practices policy

legislation under 2002 Enterprise Act

criminal 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

UK competition policy the OFT and the Competition Commission

restrictive practices policy

legislation under 2002 Enterprise Act

criminal 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

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

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

Competition PolicyCompetition Policy

The Regulation of BusinessThe 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

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

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

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 BusinessThe 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

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

The Regulation of BusinessThe Regulation of Business