5.7. MONOPOLY POLICIES
It needs to be noted that it depends on how the monopoly chooses to use their monopoly power. A monopoly could choose to abuse its power by restricting output and raising price or could choose to benefit society by reaping the rewards of economies of scale, innovating… it just depends how the monopoly chooses to act. Naturally governments are concerned that monopolies may abuse their power so have a series of policies at their disposal. There are a series of authorities in the UK who monitor the behaviour of firms. There are a variety of policies that authorities can adopt and they will be explained on this page.
Price Caps
The government has created regulatory bodies to limit the amount that firms are able to raise their price. We have OFGEM for gas and electricity, OFWAT for tap water and many more. These authorities have a choice of two strategies:
The government has created regulatory bodies to limit the amount that firms are able to raise their price. We have OFGEM for gas and electricity, OFWAT for tap water and many more. These authorities have a choice of two strategies:
- The first is RPI-x. Where x is the efficiency saving that the firm should make and RPI in the level of inflation. This option is used when the regulator believes that efficiency savings can be made and the firm is charging too much to consumers. For example, suppose that inflation was 4% and the expected efficiency saving by the firm is 1% (x), this would mean that in nominal terms prices can rise by 3% (4-1), which is a fall in real terms by 1. An advantage of this system is that if firms cut costs by more than x they are able to experience higher profits. This provides an incentive for firms to become more efficient. However, there are also negatives. One is that it is costly to determine what the level of x should be and determining x is can be arbitrary. Are the regulators being fair by allowing firms to produce enough profit (for investment and dividends) and at the same time protecting consumers’ interest (is the regulator being too soft or too strict?).
- Another method is the RPI-/+ K. Like before RPI is the inflation rate and K is the level of investment that the firm needs to conduct. If they need investment in new water treatment plants and pipes, is it fair to allow them to charge a higher price to consumers to pay for these improvements?
Breaking Up the Monopoly
This is a very extreme case and is used when a firm becomes too powerful. However, there is no guarantee that new split up firms will not choose to collude and still continue to reduce output, which raises price.
This is a very extreme case and is used when a firm becomes too powerful. However, there is no guarantee that new split up firms will not choose to collude and still continue to reduce output, which raises price.
Merger Policy
A competition commission is set up to see if mergers are allowed to take place if the merger pushes the firm over 25% of the market share. The competition commission uses a pragmatic approach whereby it reviews each case to see whether the merger is in the public interest or not. This policy prevents the government from having to break the monopoly back up in the future.
A competition commission is set up to see if mergers are allowed to take place if the merger pushes the firm over 25% of the market share. The competition commission uses a pragmatic approach whereby it reviews each case to see whether the merger is in the public interest or not. This policy prevents the government from having to break the monopoly back up in the future.
Regulation of Quality of Service
Regulators constantly examine how good the service is to consumers. With the gas industry they make sure that old people are treated appropriately and that they are not cut off in winter.
Regulators constantly examine how good the service is to consumers. With the gas industry they make sure that old people are treated appropriately and that they are not cut off in winter.
Rate of Return Regulation
The regulator will evaluate the size of the company and see what would be a reasonable level of profit for it to make in comparison to its value. If profit levels are too high then the regulator may choose to enforce price cuts or impose a one off tax.
However, this can encourage firms to ‘cost pad’, whereby they allow costs to increase so profit levels aren’t deemed excessive. For example, a firm could pay its employees higher salaries, which increases the costs thus reducing the profits to a non-excessive level. In addition there is no incentive to become as efficient as possible if your profits are going to be taken away and we always want firms to strive to be efficient as possible as productivity gain increases the welfare of society. Also, this approach is very subjective; what is an acceptable level of return for a firm? How much is the company worth? Etc…
The regulator will evaluate the size of the company and see what would be a reasonable level of profit for it to make in comparison to its value. If profit levels are too high then the regulator may choose to enforce price cuts or impose a one off tax.
However, this can encourage firms to ‘cost pad’, whereby they allow costs to increase so profit levels aren’t deemed excessive. For example, a firm could pay its employees higher salaries, which increases the costs thus reducing the profits to a non-excessive level. In addition there is no incentive to become as efficient as possible if your profits are going to be taken away and we always want firms to strive to be efficient as possible as productivity gain increases the welfare of society. Also, this approach is very subjective; what is an acceptable level of return for a firm? How much is the company worth? Etc…
Abuse of Monopoly Power
The office of fair trade can investigate any abuse of monopoly power, such as colluding with other firms, using pricing structure like predatory pricing etc…
The office of fair trade can investigate any abuse of monopoly power, such as colluding with other firms, using pricing structure like predatory pricing etc…