8 Government, the Firm and the Market

Reasons 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

Types of Market Failure Externalities External costs of production MSC > MC 6

External costs in production MC = S Costs and benefits D P Q1 O Quantity

External costs in production MSC MC = S Costs and benefits P D Q2 External cost O Q1 Social optimum Quantity

Types of Market Failure Externalities External costs of production MSC > MC External benefits of production MSC < MC 6

External benefits in production MC = S Costs and benefits P D O Q1 Quantity

External benefits in production MC = S MSC External benefit Costs and benefits P D Q1 Q2 O Social optimum Quantity

External costs and benefits in production MSC MC = S MC = S MSC External benefit Costs and benefits (£) Costs and benefits (£) P D P D External cost O Q Q O Q Q 2 1 1 2 Quantity Quantity (a ) External costs (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 6

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 6

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 6

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 6

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 6

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 7

A monopolist producing less than the social optimum MC £ AR MR P1 Q1 MC1 O Q Monopoly output

A monopolist producing less than the social optimum £ MC = MSC P1 P2 = MSB = MSC MC1 AR = MSB MR O Q1 Q2 Q Monopoly output Perfectly competitive output

Types of Market Failure Imperfect information by consumers by firms Protecting people’s interests dependants merit goods 7

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 8

Using taxes to correct a market distortion MC = S Costs and benefits D P Q1 O Quantity

Using taxes to correct a market distortion MSC MC = S Costs and benefits P D Q2 External cost O Q1 Social optimum Quantity

Using taxes to correct a market distortion MSC MC = S Optimum tax = MSC – MC Costs and benefits P D Q2 MC O Q1 Quantity

Government Intervention in the Market Taxes and subsidies to correct externalities to correct for monopoly 8

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 8

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 to use different tax and subsidy rates lack of knowledge 8

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) 8

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 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 Policy Laws and regulations Tradable permits 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 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 AR AC MR O Qm Q

Competition Policy Competition, monopoly and the public interest the abuse of market power higher prices and profits lack of incentive to innovate

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

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

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

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 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 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 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

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 16

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 16

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 19