IB Economics 2.11.11 Government Intervention in Response to Abuse of Significant Market Power Notes

Three Tools Against the Abuse of Market Power

1. A firm abuses its market power when it uses anti-competitive practices to shut out rivals and lift its own private benefit.
2. That conduct removes the pressure of competition, so the firm has less reason to keep costs down or to innovate, and output settles below the level that would serve society best.
3. Governments step in to prevent or correct this abuse, and they reach for three main tools.
   1. Legislation and regulation set the rules firms must follow.
   2. Government ownership puts the state in charge of supplying an essential service.
   3. Fines punish anti-competitive behaviour once it is detected.

Legislation and Regulation

1. Many governments write the rules of fair competition into law, called competition policy, which sets out what firms may and may not do.
2. Making practices like collusion or predatory pricing illegal raises the cost of abusing market power and deters firms from trying it.
3. When abuse is detected, the law can go further and reshape the firm itself.
   1. Breaking up a dominant firm into smaller ones restores rivalry, pushing prices down and output up toward the efficient level.
   2. Unbundling stops a firm forcing customers to buy tied products together, so buyers regain the choice to purchase each separately.
4. Enforcement is hard, because anti-competitive practice has no clear boundary and collusion is arranged in private and difficult to prove.

Government Ownership

1. In markets for essential services, the government can step in as the supplier itself rather than let a private monopoly form.
2. A private monopoly restricts output to maximise profit, but a state supplier is not chasing profit, so it can set output at the socially optimal level where price equals marginal cost, $P = MC$.
3. Public ownership can also bring stability, because the state keeps supplying the service even when it would not be the most profitable thing to do.
4. But state supply carries costs, because without competitive pressure it may run less efficiently and has little incentive to innovate.
   1. Political pressures can also pull its decisions away from what the market needs.

Fines

1. A government can leave a firm in private hands and still punish anti-competitive conduct with a financial penalty.
2. The fine raises the expected cost of abusing market power, which gives the firm an incentive to compete fairly.
   1. The revenue also flows to the government, which can spend it on services like education or healthcare.
3. A fine only works if it is large enough to matter, because a firm that earns more from abuse than the fine costs will keep breaking the rules.
   1. Setting the right amount is hard, since each firm gains from abuse by a different amount.

Price Regulation: Capping What a Natural Monopoly Can Charge

1. The hardest case is a natural monopoly, where one firm supplies the whole market at the lowest cost, so breaking it up would only force costly duplication of the network.
2. Instead the government leaves one supplier in place and caps the price it can charge, pushing price down and output up toward what competition would have delivered.
3. Two rules guide the cap.
   1. Average cost pricing sets the maximum price where demand meets average total cost, so the firm covers its costs and earns only normal profit while output rises.
   2. Marginal cost pricing sets price where demand meets marginal cost, which is allocatively efficient, but because a natural monopoly's average cost is still falling the firm then makes a loss that a government subsidy must cover.
4. A regulator rarely knows the firm's true costs, so a cap set too high protects buyers little, while one set too low can deter the investment the network needs.
5. In the UK, Ofgem and Ofwat cap what energy and water network firms can charge, using RPI-X controls that force prices down in real terms each year.
   1. RPI-X also lets the firm keep any savings it makes below the cap, which rewards efficiency while still passing lower prices to consumers over time.