Promoting active learning

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8 Government, the Firm and the Market
2
Reasons for Government Intervention

• Government intervention and social objectives
• The objective of social efficiency
• marginal social benefits and costs
• MSB gt MSC ? produce (or consume) more
• MSC gt MSB ? produce (or consume) less
• socially efficient output where MSB MSC
• Equity
• concepts of fairness
• Trade-offs between equity and efficiency

3
Types of Market Failure

• Externalities
• External costs of production MSC gt MC

4
External costs in production
Costs and benefits
O
Quantity
5
External costs in production
MSC
MC S
Costs and benefits
D
P
O
Q1
Quantity
6
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC

7
External benefits in production
MC S
Costs and benefits
D
P
O
Q1
Quantity
8
External benefits in production
MC S
MSC
Costs and benefits
D
P
O
Quantity
9
External costs and benefits in production
MSC
MC S
MSC
MC S
Costs and benefits ()
Costs and benefits ()
D
P
D
P
O
O
Q
Q
Q
Q
2
1
2
1
Quantity
Quantity
(a ) External costs
(b) External benefits
10
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC
• External costs of consumption MSB lt MB

11
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC
• External costs of consumption MSB lt MB
• External benefits of consumption MSB gt MB

12
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC
• External costs of consumption MSB lt MB
• External benefits of consumption MSB gt MB
• Public goods

13
Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC
• External costs of consumption MSB lt MB
• External benefits of consumption MSB gt MB
• Public goods
• non-rivalry

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Types of Market Failure

• Externalities
• External costs of production MSC gt MC
• External benefits of production MSC lt MC
• External costs of consumption MSB lt MB
• External benefits of consumption MSB gt MB
• Public goods
• non-rivalry
• non-excludability and the free-rider problem

15
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 gt MSC

16
A monopolist producing less than the social
optimum

O
Q
17
A monopolist producing less than the social
optimum

MC MSC
P1
P2 MSB MSC
MC1
AR MSB
MR
O
Q
Q2
Q1
18
Types of Market Failure

• Imperfect information
• by consumers
• by firms
• Protecting peoples interests
• dependants
• merit goods

19
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

20
Government Intervention in the Market

• Taxes and subsidies
• to correct externalities

21
Using taxes to correct a market distortion
Costs and benefits
O
Quantity
22
Using taxes to correct a market distortion
MSC
MC S
Costs and benefits
D
P
O
Q1
Quantity
23
Using taxes to correct a market distortion
MSC
MC S
Costs and benefits
P
D
O
Q1
Quantity
24
Government Intervention in the Market

• Taxes and subsidies
• to correct externalities
• to correct for monopoly

25
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

26
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

27
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)

28
Environmental Policy

• The environment and production
• Green taxes and subsidies
• use of green taxes around the world

29
Types of environmental taxes and charges
30
Types of environmental taxes and charges
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Types of environmental taxes and charges
32
Types of environmental taxes and charges
33
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

34
Environmental 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

35
Competition Policy

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

36
Profit maximising under monopoly

Qm
O
Q
37
Profit maximising under monopoly

MC
MR
Qm
O
Q
38
Competition Policy

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

39
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

40
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

41
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

42
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

43
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

44
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

45
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

46
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

47
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 CPIX formula

48
The Regulation of Business

• Advantages of UK regulation
• discretionary
• flexible
• incentives
• Disadvantages of UK regulation
• disincentives of changes to X
• complexity of regulation
• principalagent problems between regulator and
  industry managers

49
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