Chapter 15:

1. Chapter 15: Competition Policy

2. Objectives After studying this chapter, you will be able to: • Explain how government arises from market failure and inequality and distinguish between the social interest and capture theories of regulation. • Explain how the regulation of monopoly and oligopoly influences prices, output, producer surplus, and consumer surplus. • Explain the effects of trade practices laws • Explain how public ownership influences prices, outputs, producer surplus, and consumer surplus.

3. Social Interest or Special Interest? • Natural monopoly is regulated. • Does regulation work in the interest of all—the public interest—or in the interest of the regulated—special interests? • Trade practices laws restricts the actions of monopolies and blocks mergers. • Do these laws serve the social interest of consumers or special interests of producers? • How do publicly owned firms operate? Do they serve the social interest more effectively than privately owned firms?

4. The Economic Theory of Government • Why Governments Exist • Governments exist for three major reasons: • To establish and maintain property rights. • Provide mechanisms for allocating scare resources when the market economy results in inefficiency—a situation called a market failure. • Implement arrangements that redistribute income and wealth

5. The Economic Theory of Government • The Economic Roles of Government • Classified into five main areas: • Competition policy • Externalities regulation • Provisions of public goods • Use of common resources • Income redistribution

6. The Economic Theory of Government • Competition Policy • A major activity of government is to regulate monopoly and to enforce laws that prevent cartels and other restrictions on competition. • Externalities Regulation • External costs and benefits are consequences of an economic transaction between two parties that are borne or enjoyed by a third party. • A chemical factory that dumps waste into a river that kills the fish downstream imposes an external cost. • External costs and benefits prevent the market allocation of resources from being efficient.

7. The Economic Theory of Government • Provision of Public Goods • Public goods are goods that are consumed by everyone and no one can be excluded from the benefits that arises from its provision. • The market economy fails to deliver the efficient quantity of public goods because of the free-rider problem.

8. The Economic Theory of Government • Use of Common Resources • The market economy fails to use common resources efficiently because no one has an incentive to conserve what everyone else is free to use • Taxes and redistribution • The market economy delivers an unequal distribution of income and wealth which many regard as unfair. The government redistribute income to make the distribution of income more equal

9. The Economic Theory of Government • Public Choice and the Political Marketplace • Public choice theory applies the economic way of thinking to the choices that people and governments make in a political marketplace. • The actors in the political marketplace are: • Voters • Firms • Politicians • Bureaucrats

10. The Political Marketplace

11. The Economic Theory of Government • Political Equilibrium • A political equilibrium is the outcome of the choices of voters, politicians, and bureaucrats. • It is a situation in which the choices of the three groups are compatible and no group can improve its own situation by making a different choice.

12. The Economic Theory of Government • Regulation and Deregulation • In the political marketplace for regulation and deregulation, there is a demand, a supply and a political equilibrium • The Demand for Regulation • People and firms demand the regulation that makes them better off and they express this through political activity

13. The Economic Theory of Government • The Supply of Regulation • Politicians supply the regulations that increase their campaign funds and that keep them in office • Equilibrium Regulation • The social interest theory of regulation states that politicians supply the regulation that achieves an efficient allocation of resources. • The capture theory of regulation states that regulation is in the self interest of producers.

14. The Economic Theory of Government • National Competition Policy: A Quick Overview • The 1995 National Competition Policy (NCP) • Introduced new forms of regulation to control monopoly power in the provision of electricity, gas and water • Undertook a review of laws that restrict competition in the professions, transport, communication, insurance, child care and gambling

15. The Economic Theory of Government • Trade Practices Law • In 1995 the NCP included a major revision of the Trade Practices Act. • Public Ownership and Privatisation • NCP change of attitude towards public and private ownership • Public ownership is the ownership of a firm or industry by government or a government controlled agency • Privatisation– the sale of government-owned enterprise to private owners.

16. Regulating Monopoly and Oligopoly • The Regulatory Process • Regulatory agencies differ in many detailed ways, but all have features in common. • Each agency is run by bureaucrats who are experts in the industry it regulates (often recruited from the industry). • Governments allocate the financial resources that pay an agency’s costs • Each agency adopts a set of rules for controlling prices and other aspects of economic performance

17. Regulating Monopoly and Oligopoly • Natural Monopoly Regulation • Natural monopoly occurs when one firm can supply the entire market at a lower price than two or more firms. • A natural monopoly experiences economies of scale no matter how high an output it achieves • Examples: telephone, electricity and water

18. Natural Monopoly Regulation • Regulating Monopoly in the Social Interest • Regulation in the social interest sets the price equal the marginal cost, referred to as marginal cost pricing rule • The sum of consumer surplus and producer surplus—total surplus is maximised. • If the Firm Incurs a Loss • Price discrimination • Two-part tariff

19. Loss per household ATC Marginal Cost Pricing Figure 15.2 30 Consumer surplus 25 20 15 Price & Cost (dollars per household per month) 10 MC D 0 2 4 6 8 10 Quantity (millions of households)

20. Natural Monopoly Regulation • Regulating Monopoly in the Social Interest • Average Cost Pricing Rule • Sets price equal to average total cost • Consumer surplus is less than under marginal cost pricing

21. Consumer surplus Producer surplus Deadweight loss Natural Monopoly:Average Cost Pricing Figure 15.3 30 25 20 15 Price & Cost (dollars per household per month) ATC 10 MC D 0 2 4 6 8 10 Quantity (millions of households)

22. Natural Monopoly Regulation • Regulating Monopoly in the Social Interest • Rate of Return Regulation • a regulated firm must justify its price by showing that the price enables it to earn a specified target percent rate of return on its capital

23. Profit is maximised ATC (inflated) Economic profit Inflating Costs Figure 15.4 30 25 20 Price & Cost (dollars per household per month) 15 ATC MC 10 MR D 2 4 6 8 10 0 Quantity (millions of households)

24. Price cap outcome Price Cap Price cap regulation lowers price and increase output Price Cap Regulation Figure 15.5 30 Profit maximising outcome 25 20 Price & Cost (dollars per household per month) 15 ATC MC 10 MR D 0 2 4 6 8 10 Quantity (millions of households)

25. Natural Monopoly Regulation • Regulating Monopoly in the Social Interest • Price Cap Regulation • A price cap regulation is a price ceiling – a rule that specifies the highest price the firm is permitted to set • Gives a firm an incentive to operate efficiently and keep costs under control

26. Natural Monopoly Regulation • Regulating Monopoly in the Social Interest • Social Interest or Capture • Does the regulator get captured or does regulation work to serve the social interest? • A study by the Australian Productivity Commission shows that prices in many regulated monopolies have fallen.

27. Some Effects of the NCP on Prices Figure 15.6

28. Cartel Regulation • Cartel Regulation • A cartel is a collusive agreement among a number of firms that is designed to restrict output and achieve a higher profit for cartel members. • Cartels are illegal in Australia. • A cartel that acts like a monopoly earns maximum economic profit, but there is a strong incentive for each member of a cartel to cheat on the cartel arrangement.

29. Cartel Regulation • If the regulation is in the public interest, price and quantity will equal their competitive levels—and the outcome will be efficient. • If the cartel captures the regulator, it uses regulation to prevent cheating so that price and output equal their monopoly levels—and the outcome is inefficient.

30. Regulating Monopoly and Oligopoly • Making Predictions • Who gains from cartel regulation, the producer or the consumer? • Australian taxi markets appear to be regulated in the producers interest • Deregulation under the NCP has generally benefited the consumer

31. Trade Practices Law • The centrepiece of Australia’s trade practices law is the Trade Practices Act 1974 • Major revision of the Act as part of NCP in 1995 • The 1995 Act established the Australian Competition and Consumer Commission (ACCC) • The provisions of the Trade Practices Act and activities of the ACCC generate much debate.

32. Trade Practices Law • Five major activities of the ACCC are: • Horizontal agreements: collusion • Misuse of market power • Vertical restrains • Mergers • Consumer protection • Social Interest or Special Interest? • The Trade Practices Law has evolved to protect the social interest and to restrain anticompetitive practices.

33. Public Ownership and Privatisation • Efficient Public Ownership • To be efficient, a publicly owned corporation must produce the quantity at which price equals marginal cost. • To operate at this manner a publicly owned enterprise has to be subsidised. The subsidy must be collected from taxation rather than through the price of the good or service

34. Subsidy per tonne: Efficient output Consumer surplus Tax payment ATC MC D Public Ownership Figure 15.8(a) 10 8 6 Price and Cost (dollars per tonne) 4 2 0 2 4 6 8 10 Quantity (billions of tonnes per year)

35. Public Ownership and Privatisation • A Bureaucratic Model of a Public Ownership • The economic theory of bureaucracy is based on the assumption that bureaucrats aim to maximise their departmental budgets • Two alternative cases of budget maximisation: • Budget maximisation with marginal cost pricing • Budget maximisation at a zero price

36. Public Ownership and Privatisation • Budget Maximisation with Marginal Cost Pricing • With marginal cost pricing, the public corporation produces the efficient quantity. • But with budget maximisation, they have an incentive to inflate their costs and become inefficient. Managers hire more workers than are needed to move efficient quantity, and the average total cost shifts upward to ATC (inflated)

37. Subsidy per tonne efficient output but maximising budget ATC (inflated) Budget Maximisation Figure 15.8(b) 10 8 6 Price and Cost (dollars per tonne) 4 ATC 2 MC D 0 2 4 6 8 10 Quantity (billions of tonnes per year)

38. Public Ownership and Privatisation • Budget Maximisation at a Zero Price • If a government department provides its goods and services free, using general taxation to pay for them, consumer surplus will be maximised. • It also creates a deadweight loss.

39. Public Ownership and Privatisation • Privatisation • Largely because of increasing awareness and understanding of the inefficiency of bureaucracies and public enterprises, there has been a move toward privatisation.

40. END CHAPTER 15