3.6.1 Government Intervention

Edexcel A-Level Economics (9EC0) | Theme 3.6.1

Specification Coverage: Edexcel unit 3.6.1 - Government Intervention. Students should be able to explain how the government and the CMA control monopoly power, regulate monopolies, promote competition and contestability, and protect suppliers and employees from market power.

Intervention to Control Monopoly Power

The Competition and Markets Authority (CMA) aims to promote competition and protect consumers.

Controlling Mergers

The CMA can prevent mergers or acquisitions that would create a firm with more than 25% market share or would substantially lessen competition.

It can block a merger completely or force firms to sell assets.

Regulating Existing Monopolies

This is especially important in natural monopolies.

Impact of nationalisation and privatisation diagram
Figure 1: In a natural monopoly, the average cost curve (AC) is downward sloping over the relevant range of output, meaning that a single firm can produce at a lower average cost than multiple firms. Nationalisation can lead to lower prices and higher output compared to a private monopoly, as the government may set prices closer to average cost (Pn) rather than the higher price (Pp) charged by a private monopoly. However, nationalisation may also reduce incentives for efficiency and innovation, while privatisation can increase efficiency but may lead to higher prices if the market is not effectively regulated.

Methods of Regulation

Method How It Works Evaluation
Price Regulation (RPI-X) Sets a maximum price. The firm can only raise prices by inflation minus an efficiency factor. Lowers prices and increases output, but it can be hard to set the correct value of X and may reduce investment.
Profit Regulation Limits the rate of return or profit a monopoly can earn. Curbs excessive profits, but may reduce incentives to cut costs and encourage inefficiency.
Quality Standards / Performance Targets Sets minimum service or quality standards, such as train punctuality targets. Prevents firms from reducing quality, but monitoring is difficult and it may raise costs.

Intervention to Promote Competition and Contestability

Governments may try to make markets more competitive and easier for new firms to enter.

  • Promotion of small businesses: grants, tax breaks, and business advice
  • Deregulation: removing barriers to entry, such as licensing rules, to increase contestability
  • Competitive tendering: putting government contracts out to open tender so firms compete for them
  • Privatisation: selling state-owned assets to the private sector to increase efficiency through profit incentives and competition

Privatisation can be criticised if it simply replaces a public monopoly with a private monopoly.

Intervention to Protect Suppliers and Employees

Protecting Suppliers from Monopsony Power

A dominant buyer, such as a supermarket, may force down the prices it pays to suppliers.

Possible government responses include:

  • CMA investigations
  • minimum price floors
  • stronger legal rights for suppliers
  • codes of practice

Protecting Employees

  • National Minimum Wage: a legally enforced wage floor
  • Employment legislation: rules on health and safety, maximum working hours, and unfair dismissal
  • Support for trade unions: collective bargaining to balance employer power

Exam Preparation

  • Explain the role of the CMA in controlling mergers and regulating monopolies.
  • Draw and analyse the effects of price regulation such as RPI-X on a natural monopoly.
  • Evaluate different methods of monopoly regulation, especially price caps and profit regulation.
  • Analyse policies designed to increase competition and contestability, such as deregulation and privatisation.
  • Explain how government intervenes to protect suppliers and employees.