Why does the government intervene in markets to maintain competition?

Topic 3.3.11

Students should be able to:• Explain and evaluate measures aimed at enhancing

competition between firms and their impact on prices, output and market structure.

• Compare and evaluate the strengths and weaknesses of methods of regulation for example price capping, monitoring of prices and performance targets.

What is Competition Policy?

• The aims of competition policy are to promote competition; make markets work better and contribute towards improved efficiency in individual markets and enhanced competitiveness of UK businesses within the EU single market.

• Competition policy aims to ensure 1. Technological innovation which promotes dynamic

efficiency in different markets2. Effective price competition between suppliers3. Safeguard and promote the interests of consumers

through increased choice and lower price levels

Main Pillars of Competition Policy1. Anti-trust & cartels: – Elimination of agreements that restrict competition including price-

fixing by firms who hold a dominant market position2. Market liberalisation: – Introducing competition in previously monopolistic sectors such as

energy supply, retail banking, postal services, mobile telecommunications and air transport

3. State aid control: – Policy analyses state aid measures such as airline subsidies to

ensure that such measures do not distort competition in the Single Market

4. Merger control: – Investigation of mergers and take-overs between firms which could

result in their dominating the market

Anti-Competitive Behaviour

Price fixing and market sharing

Predatory pricing and limit pricing

Charging excessively high prices

Refusal to deal / discrimination

Patent misuse Protectionist policies limiting overseas trade

Regulatory Authorities in UK and the EU• Regulators are the rule-enforcers and they are appointed by

the government to oversee how a market works and the outcomes that result for producers and consumers

• The main competition regulator in the UK is the Competition and Markets Authority (CMA)

• The European Union Competition Commission is also an important body for the UK

• The CMA is an independent department with responsibility for carrying out investigations into mergers, markets and the regulated industries and enforcing competition and consumer law.

• From 1 April 2014 it took over the functions of the Competition Commission

Examples of Regulators in the UK

Water Monopolies

CMA Telecoms & Broadcasting

Financial Services

Rail Regulator General Energy Markets

What do the regulators actually do?1. Monitoring and regulating prices: Regulators aim to ensure that

companies do not exploit their monopoly power by charging excessive prices.

2. Standards of customer service: Companies that fail to meet specified service standards can be fined or have their franchise / license taken away

3. Opening up markets: The aim here is to encourage competition by removing or lowering barriers to entry. This might be achieved by forcing the dominant firm in the industry to allow others to use its infrastructure network. A key task for the regulator is to fix a fair access price for firms wanting to use the existing infrastructure

4. The “Surrogate Competitor”: Regulation can act as a form of surrogate competition – attempting to ensure that prices, profits and service quality are similar to what could be achieved in competitive markets.

Analysis: Natural Monopoly

• Industry demand is insufficient to exploit all of the economies of scale

• Only one business will reach the MES

Economies of scale

• LRAC is falling over all ranges of output• If price is set = to MC, then losses will be made• Makes sense for the core aspect of the industry

to be served by one business

Allocative efficiency and losses

Competition Policy & Natural Monopoly

• Core service e.g. rail network or distribution grids might be left in the hands of one business

Core “network” service

• Possible to introduce competition in other aspects of the industry

• Examples: All telecoms companies to use BT’s infrastructure; franchises for rail services

“Final mile” service to the consumer

Examples of Anti-Competitive Behaviour• Jan 2016: GSK has been under investigation since 2011 in a so-

called pay-for-delay case, where it is alleged to have paid several smaller pharmaceutical companies to delay selling their cheaper version of the antidepressant Paxil, also known as Seroxat

• Dec 2015: Telecoms firm Orange fined €350m (£254m) for abusing its market dominance in France

• Aug 2015: Pfizer and a UK company called Flynn Pharma found to have charged “excessive and unfair prices” for an anti-epilepsy drug — phenytoin sodium — inflating the NHS drugs bill by tens of millions of pounds

• April 2015: EU Competition Commission accused Google of illegally abusing its dominance in web search to steer European consumers to its own in-house shopping services

Competition Policy in the News• Nov 2015: School uniform prices raised by supplier contracts, says

CMA - the cost of school uniforms has risen by up to £10 an item owing to the use of exclusive suppliers for particular schools

• Oct 2015: TalkTalk calls on Ofcom to break-up BT - challenger calls for Openreach to be spun out of BT in a demerger

• Oct 2015: Mobile phone customers could pay more after Three's takeover of O2, Ofcom warns – the mobile giant would run almost half of the market, which could lead to higher consumer prices

• Aug 2015: Google rejects EU Competition Commission’s allegations that its shopping links service amounts to an anti-competitive abuse of its dominance of web search

• Aug 2015: Reckitt forced to license K-Y brand by competition regulator – CMA says competitor must be given time to develop a rival lubricant brand

Merger Investigations by the CMA• The Competition and Markets Authority is the

body given the power to investigate mergers and takeovers in the UK

• They can block an acquisition if they find that the integration of two businesses will lead to a “significant lessening of competition” in one or more markets at local, regional or national level

• They have the power to give a merger the go-ahead providing certain conditions are met such as the enlarged firm selling off some of their businesses or assets to protect competitive forces

Merger Clearances in 2015

British Telecom and EEWe provisionally think that the retail mobile market in the UK, with 4 main

mobile providers and a substantial number of smaller operators, is competitive. As BT is a smaller

operator in mobile, it is unlikely that the merger will have a significant

effect on competition. By the same token, it is unlikely that the merger

will have a significant effect on competition in the retail broadband

market, where EE is only a minor player. (CMA Report 2015)

Merger in the UK Gym Industry

14 August 2015: The CMA has cleared the acquisition by Pure Gym Limited of the LA fitness

business

Merger Investigations by the CMA

17 December 2015: The CMA has cleared

the anticipated merger of Betfair Group plc

and Paddy Power plc

13 October 2015: The CMA has cleared

the acquisition by Sheffield City Taxis Limited of certain

assets and business of Mercury Taxis

(Sheffield) Limited.

19 October 2015: The CMA has accepted undertakings in lieu of

reference for the anticipated acquisition by Muller UK &

Ireland Group LLP of the dairy operations of Dairy Crest

Group plc

Müller has agreed to sell to Medina Dairy Limited the option to require Müller to process up to 100 million litres of milk each year in Dairy Crest’s Severnside dairy for supply to national grocery retailers. The option is for a period of at least 5 - and up to 8 - years.

Poundland / 99p Store Merger Cleared

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25 August 2015: The CMA has provisionally cleared Poundland Group plc’s anticipated acquisition of 99p Stores Ltd

Cineworld / Picturehouse Merger (2013)The conclusion of the inquiry in 2013 into Cineworld’s acquisition of Picturehouse was that there could be a substantial lessening of competition in the 3 areas – Aberdeen, Bury St Edmunds and Cambridge. Cineworld and Picturehouse faced limited competition in these areas, so the acquisition could lead to higher prices for local cinema goers. Cineworld was required to sell one of the cinemas it owns in each of these areas to an operator approved by the Competition and Markets Authority. The new operator would be expected to continue running it as a cinema and would also need to demonstrate that they had the appropriate expertise and experience. In March 2015, the CMA approved The Light as a suitable purchaser of the cinema in Cambridge which met its criteria.

Price Fixing and UK Competition Law• UK competition law prohibits almost any attempt to fix prices – you cannot 1. Agree prices with competitors or agree to share markets or limit

production to raise market prices.2. Impose minimum prices on different distributors such as shops. 3. Agree with your competitors what purchase price you will offer your

suppliers. 4. Cut prices below cost in order to force a weaker competitor out of the

market i.e. predatory pricing• Under the Competition Act 1998 and Article 81 of the EU Treaty, cartels are

prohibited. Any business found to be a member of a cartel could be fined up to 10 per cent of its worldwide turnover.

• In addition, the Enterprise Act 2002 makes it a criminal offence for individuals to dishonestly take part in the most serious types of cartels. Anyone convicted of the offence could receive a maximum of five years imprisonment and/or an unlimited fine.

Legal Collusion / Business Cooperation• Not all instances of collusive behaviour are deemed to be illegal by

the European Union Competition Authorities. • Practices are not prohibited if the respective agreements

"contribute to improving the production or distribution of goods or to promoting technical progress in a market.”

1. Development of improved industry standards of production and safety which benefit the consumer – a good example is joint industry standards in Europe for mobile phone chargers

2. Information sharing designed to give better information to consumers

3. Research joint ventures and know-how agreements which seek to promote innovative and inventive behaviour in a market. The EU has introduced a “R&D Block Exemption Regulation” for this

State Aid• By giving certain firms or products favoured treatment to the

detriment of other firms or products, state aid disrupts normal competitive forces.

• Under current EU state aid rules, a company can be rescued once• Any restructuring aid offered by a national government must be

approved as being part of a feasible and coherent plan to restore the firm’s long-term viability

• Government aid designed to boost research and development, regional economic development and the promotion of small businesses is normally permitted

• In 2014, the EU competition authorities ordered RyanAir to pay back €10m in illegal state aid on the grounds that state aid gave them unfair advantage & distorted competition on several routes

Main UK Industry Regulators• Ofwat – (water services regulation authority) – responsible

for economic regulation of the privatized water and sewerage industry in England and Wales

• Ofcom – the UK's communications regulator• Ofgem - Office of Gas and Electricity Markets - regulator for

the electricity and downstream natural gas markets in Great Britain. Office of the Rail Regulator – UK agency for regulation of the country's railway network

• Financial Conduct Authority – the FCA regulate firms and financial advisers so that markets and financial systems remain sound, stable and resilient.

Price Intervention in the EU and the UK• Not all prices are set by the free-

market forces of supply and demand. • In Britain, a number of prices are

affected by regulators who may impose a pricing formula on suppliers

• Good examples are rail fares, the cost of postage stamps and water bills.

• In the UK rail industry, some fares are unregulated allowing train operating companies to set their own prices.

• But around half of the fares charged for rail travellers are set by the rail regulator.

The EU has capped mobile phone

roaming charges

Many rail fares in the UK are heavily

regulated

Price Capping Regimes in the UK• Price capping is now being phased out as most utility markets

have become more competitive.• Price capping is an alternative to rate-of-return regulation, in

which utility businesses are allowed to achieve a given rate of profit on capital.

• In the UK, price capping has been known as "RPI-X". This takes the rate of inflation and subtracts expected efficiency savings X. So for example, if inflation is 5% and X is 3% then an industry can raise prices on average by only 2% per year

• In the water industry, the formula is "RPI - X + K", where K is based on capital investment requirements designed to improve water quality and meet EU water quality standards.

Arguments for Price Capping1. Capping is an appropriate way to curtail the monopoly

power of “natural monopolies” or dominant firms preventing them from making excessive profits at the expense of consumers

2. Cuts in the real price levels are good for household and industrial consumers (leading to an increase in consumer surplus and higher real living standards in the long run).

3. Price capping helps to stimulate improvements in productive efficiency because lower costs are needed to increase a producer’s profits.

4. The price capping system can be a tool for controlling consumer price inflation in the UK although inflation has been very low in the UK in recent years.

Arguments against Price Capping1. Price caps have led to large numbers of job losses in the

utility industries2. Setting different price capping regimes for each industry

distorts the working of the price mechanism3. The industry regulator may not enough accurate

information when setting the price caps for future years4. Capping prices means lower profits which in turn can lead

to reduced capital investment by the utility businesses – ultimately consumer suffer if there is under-investment in utility infrastructure

Mobile Phone Price Caps in the EU

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EU Price caps on text messages (SMS)

EU Price caps on mobile data roaming

After intervention by the EU Competition Commission, from 15 June 2017, those travelling within the EU will be able to use their mobile internet abroad at no extra charge.

UK Rail Fares

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Around 45 per cent of UK rail fares are subject to regulation (since 2015 this is limited to the rate of RPI inflation. All other fares are set at a commercial rate by the train operating companies such as First Great Western and Virgin Trains

Price Capping – High Prices – High Profits

MC

Price and Cost

Output

AC

MR

AR

Profit Max: MC=MR

P1

Q1

C1

Supernormal Profit

Price Capping Reduces Monopoly Profits

MC

Price and Cost

Output

AC

MR

AR

Profit Max: MC=MR

P1

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Supernormal Profit

Capped Price

Q2

C2

Impact of Price Capping on a Market

To be effective, the cap must be set below the normal profit maximising price

A price cap lowers the monopoly (supernormal) profit made by dominants firms in the market

May stimulate attempts to improve cost efficiency

In theory – it leads to an improvement in allocative efficiency and consumer welfare

May also lead to the exit of some businesses from the industry which might actually reduce competition

Overview of Price Capping on a MarketA maximum price also involves a normative judgement on behalf of the government about what that price should be

Benefits• A useful surrogate for

competition• Holds prices down –

consumer welfare gains

• Incentives for businesses to cut costs to maintain profits

Downsides• Reduces profits – less

money for capital investment

• May dissuade new entrants

• Firms might raise prices in other ways

Alternatives• Measures to reduce

entry barriers in an industry

• Higher taxes on monopoly profits e.g. a windfall tax

Policies to Increase Contestability• Increasing the contestability of markets is widely regarded as an

important supply-side economic policy

Deregulation of an industry Open up monopoly networks

Tough rules on predatory pricing Policies on international trade

Judging Effectiveness of Regulation

Real prices Size of profits Jobs Performance targets

Research spending

Productivity Environmental indicators

Investment in new capacity

Whistle-Blowing and UK Cartel Policy• The Competition Act allows for businesses who are

members of cartels to become a whistle-blower and inform on other members of a price-fixing agreement

• “We are prepared to offer lenient treatment to businesses that come forward with information about a cartel in which they are involved. Under our leniency programme, members of cartels may have their financial penalty reduced substantially or they may be able to avoid a penalty altogether.

• “To qualify for leniency, a business must cooperate fully with our investigation and stop their involvement in the cartel from the time they come forward”Source: Competition and Markets Authority

Possible Causes of Regulatory Failure

Regulators may limit innovation in fast-growth markets

Capping prices might prevent new firms entering a market

Regulation becomes bureaucratic & costly

May lack the powers to be truly effective in

protecting consumers

Regulator might be “behind the curve”

with new technologies

Frequent rule changes can stifle business

investment

Why does the government intervene in markets to maintain competition?

Topic 3.3.11

Students should be able to:• Explain and evaluate measures aimed at enhancing

competition between firms and their impact on prices, output and market structure.

• Compare and evaluate the strengths and weaknesses of methods of regulation for example price capping, monitoring of prices and performance targets.