1.8.7 Competition Policy

Specification Coverage: AQA unit 1.8.7 - Competition Policy. Students should understand the general principles of UK competition policy and some awareness of EU competition policy. Students should also be able to evaluate the costs and benefits of such policies.

The Aims of Competition Policy

Competition Policy: Government interventions aimed at improving competitiveness in markets, and ensuring that consumer interests are protected.

Consumer interests can broadly be defined as:

  • Lower prices
  • Higher quality goods and services
  • Greater choice of goods and services

Competition policy is designed to prevent anti-competitive behaviour by firms, which can lead to market failure. Anti-competitive behaviour can include:

  • Collusion between firms to fix prices
  • Abuse of monopoly power
  • Restricting entry to a market

Organisations Responsible for Competition Policy

In the UK, the main organisation responsible for competition policy is the Competition and Markets Authority (CMA). The CMA is responsible for investigating mergers, markets, and the behaviour of firms. It can also enforce competition law and take action against firms that are found to be engaging in anti-competitive behaviour.

In the EU, the main organisation responsible for competition policy is the European Commission (EC). The EC is responsible for enforcing EU competition law and can take action against firms that are found to be engaging in anti-competitive behaviour.

Intervention to Control Monopolies

The government can intervene to control monopolies in a number of ways, including:

  • Price regulation: The government can set a maximum price that a monopoly can charge for its goods or services. This can help to prevent monopolies from charging excessively high prices and can help to protect consumer interests.
  • Profit regulation: The government can set a maximum level of profit that a monopoly can earn. This can help to prevent monopolies from earning excessive profits and can help to protect consumer interests.
  • Quality regulation: The government can set minimum quality standards for goods and services provided by monopolies. This can help to ensure that consumers are not exploited by monopolies that provide low-quality goods or services.
  • Breaking up monopolies: The government can take action to break up monopolies that are found to be engaging in anti-competitive behaviour. This can help to increase competition in the market and can help to protect consumer interests.
  • Nationalisation: In some cases, the government may choose to nationalise a monopoly in order to ensure that it is run in the public interest. This can help to protect consumer interests and can help to ensure that the monopoly is not engaging in anti-competitive behaviour.

Intervention to Control Mergers

The government can intervene to control mergers in a number of ways, including:

  • Blocking mergers: The government can block mergers that are found to be anti-competitive. This can help to prevent the creation of monopolies and can help to protect consumer interests.
  • Imposing conditions on mergers: The government can impose conditions on mergers that are found to be anti-competitive. For example, the government may require a firm to divest certain assets or to sell off certain parts of its business in order to increase competition in the market.

Intervention to Promote Competition

The government can intervene to promote competition in a number of ways, including:

  • Encouraging new entrants: The government can take action to encourage new firms by providing support for start-ups, reducing regulatory burdens, or offering financial incentives. This can help to increase competition in the market and can help to protect consumer interests.
  • Reducing barriers to entry: The government can deregulate certain industries or reduce regulatory burdens in order to make it easier for new firms to enter the market. This can help to increase competition in the market and can help to protect consumer interests.
  • Competitive tendering: The government can require public sector contracts to be awarded through a competitive bidding process. This can help to increase competition and can help to protect consumer interests.
  • Privatisation: The government can privatise state-owned enterprises in order to increase competition in the market. This can help to improve efficiency and can help to protect consumer interests.

Costs and Benefits of Competition Policy

Policy Benefits Costs
Price regulation Price caps (e.g. RPI − X) force prices down towards the competitive level, moving output closer to the allocatively efficient point (P = MC) and transferring welfare from producer to consumer. The X factor also gives firms an incentive to cut costs. The regulator suffers from asymmetric information and may set the cap too high (consumers still overpay) or too low (the firm makes losses and under-invests, harming dynamic efficiency). There is also a risk of regulatory capture.
Profit regulation Capping the rate of return prevents the monopoly from earning excessive supernormal profit at consumers' expense, improving equity in the distribution of income. Because higher costs can justify higher prices, firms have little incentive to be productively efficient and may "gold-plate" (over-invest in capital), leading to X-inefficiency.
Quality regulation Minimum service and quality standards stop a monopoly that faces no competitive pressure from cutting quality to save costs, protecting consumers who have no alternative supplier. Meeting the standards raises firms' costs, which may be passed on as higher prices, and the targets are costly to monitor and can be "gamed" by firms.
Breaking up monopolies Splitting a dominant firm into smaller competitors increases competition, lowering prices and improving allocative efficiency and choice. In a natural monopoly this sacrifices economies of scale, raising average costs and potentially prices. It is also costly and disruptive to carry out.
Nationalisation A state-owned firm can be run in the public interest rather than for profit, setting price at the allocatively efficient level and taking account of positive externalities. With no profit motive or competition there is little incentive to control costs, leading to X-inefficiency, and the taxpayer bears the funding burden and risk of political interference (government failure).
Blocking mergers Preventing a merger stops a rise in market concentration and monopoly power that would otherwise push up prices and reduce consumer choice. It also prevents the merged firm from exploiting economies of scale that could have lowered costs and prices, and the regulator may misjudge the effect due to imperfect information.
Imposing conditions on mergers Remedies such as forcing divestment of assets allow the efficiency gains of a merger to go ahead while limiting the increase in market power, protecting competition. The conditions are costly to design, monitor and enforce, and firms may find ways around them or the regulator may set the wrong remedy.
Encouraging new entrants Support for start-ups (grants, tax breaks) makes the market more contestable, and the threat of entry disciplines the incumbent's prices and spurs innovation. There is an opportunity cost to the taxpayer, support may prop up inefficient firms, and incumbents can still deter entry through limit pricing.
Reducing barriers to entry Deregulation raises contestability so that even the threat of entry keeps incumbents' prices and profits down and improves efficiency, without government having to spend money. Some barriers such as economies of scale and sunk costs cannot be removed, limiting its impact, and removing regulations may sacrifice important safety or quality protections.
Competitive tendering Making firms bid for a contract creates competition "for the market" where competition "in the market" is not possible, driving down the cost of provision and improving value for money for taxpayers. The winning firm may cut quality to cut costs, a small pool of bidders can collude, and writing and monitoring contracts is costly.
Privatisation Exposing a former state monopoly to the profit motive and competition can improve productive and dynamic efficiency, and the sale raises revenue for the government. A private monopoly may exploit consumers with higher prices unless tightly regulated, and the profit motive can lead it to ignore positive externalities and wider social objectives.

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