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Government,The Firm & The Market

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Government,the firm & the Market

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Government,The Firm & The Market

  1. 1. Government, the Firm and the Market
  2. 2. Reasons for Government Intervention <ul><li>Government intervention and social objectives </li></ul><ul><li>The objective of social efficiency </li></ul><ul><ul><li>marginal social benefits and costs </li></ul></ul><ul><ul><ul><li>MSB > MSC  produce (or consume) more </li></ul></ul></ul><ul><ul><ul><li>MSC > MSB  produce (or consume) less </li></ul></ul></ul><ul><ul><li>socially efficient output where MSB = MSC </li></ul></ul><ul><li>Equity </li></ul><ul><ul><li>concepts of fairness </li></ul></ul><ul><li>Trade-offs between equity and efficiency </li></ul>
  3. 3. Types of Market Failure <ul><li>Externalities </li></ul><ul><ul><li>External costs of production MSC > MC </li></ul></ul>
  4. 4. External costs in production O Costs and benefits Quantity Q 1 MC = S D P
  5. 5. External costs in production O MC = S D P MSC Costs and benefits Quantity Q 1 External cost Q 2 Social optimum
  6. 6. Types of Market Failure <ul><li>Externalities </li></ul><ul><ul><li>External costs of production MSC > MC </li></ul></ul><ul><ul><li>External benefits of production MSC < MC </li></ul></ul>
  7. 7. External benefits in production O D P MC = S Q 1 Costs and benefits Quantity
  8. 8. External benefits in production O MSC D P Costs and benefits Quantity MC = S Q 1 External benefit Q 2 Social optimum
  9. 9. O MC = S D P Q 1 Q 2 Costs and benefits (£) Quantity MSC (a ) External costs O D P Q 2 Q 1 Costs and benefits (£) Quantity MSC MC = S (b) External benefits External costs and benefits in production External cost External benefit
  10. 10. Types of Market Failure <ul><li>Externalities </li></ul><ul><ul><li>External costs of production MSC > MC </li></ul></ul><ul><ul><li>External benefits of production MSC < MC </li></ul></ul><ul><ul><li>External costs of consumption MSB < MB </li></ul></ul>
  11. 11. Types of Market Failure <ul><li>Externalities </li></ul><ul><ul><li>External costs of production MSC > MC </li></ul></ul><ul><ul><li>External benefits of production MSC < MC </li></ul></ul><ul><ul><li>External costs of consumption MSB < MB </li></ul></ul><ul><ul><li>External benefits of consumption MSB > MB </li></ul></ul>
  12. 12. Types of Market Failure <ul><li>Externalities </li></ul><ul><ul><li>External costs of production MSC > MC </li></ul></ul><ul><ul><li>External benefits of production MSC < MC </li></ul></ul><ul><ul><li>External costs of consumption MSB < MB </li></ul></ul><ul><ul><li>External benefits of consumption MSB > MB </li></ul></ul><ul><li>Public goods </li></ul>
  13. 13. Types of Market Failure <ul><li>Externalities </li></ul><ul><ul><li>External costs of production MSC > MC </li></ul></ul><ul><ul><li>External benefits of production MSC < MC </li></ul></ul><ul><ul><li>External costs of consumption MSB < MB </li></ul></ul><ul><ul><li>External benefits of consumption MSB > MB </li></ul></ul><ul><li>Public goods </li></ul><ul><ul><li>non-rivalry </li></ul></ul>
  14. 14. Types of Market Failure <ul><li>Externalities </li></ul><ul><ul><li>External costs of production MSC > MC </li></ul></ul><ul><ul><li>External benefits of production MSC < MC </li></ul></ul><ul><ul><li>External costs of consumption MSB < MB </li></ul></ul><ul><ul><li>External benefits of consumption MSB > MB </li></ul></ul><ul><li>Public goods </li></ul><ul><ul><li>non-rivalry </li></ul></ul><ul><ul><li>non-excludability and the free-rider problem </li></ul></ul>
  15. 15. Types of Market Failure <ul><li>Market power </li></ul><ul><ul><li>market power can be used to raise the price above the perfectly competitive level </li></ul></ul><ul><ul><li>output below the socially efficient level </li></ul></ul><ul><ul><ul><li>MSB > MSC </li></ul></ul></ul>
  16. 16. A monopolist producing less than the social optimum O £ Q MC 1 Q 1 MC MR AR P 1 Monopoly output
  17. 17. A monopolist producing less than the social optimum O P 1 MC 1 MC = MSC Q 1 MR AR = MSB Q 2 P 2 = MSB = MSC £ Q Monopoly output Perfectly competitive output
  18. 18. Types of Market Failure <ul><li>Imperfect information </li></ul><ul><ul><li>by consumers </li></ul></ul><ul><ul><li>by firms </li></ul></ul><ul><li>Protecting people’s interests </li></ul><ul><ul><li>dependants </li></ul></ul><ul><ul><li>merit goods </li></ul></ul>
  19. 19. Business Ethics & Corporate Social Responsibility <ul><li>Firms and social responsibility </li></ul><ul><ul><li>are managers solely responsible to shareholders? </li></ul></ul><ul><ul><li>are they simply concerned to maximise profits? </li></ul></ul><ul><ul><li>broader social interests </li></ul></ul><ul><li>Business ethics </li></ul><ul><ul><li>a stakeholding society </li></ul></ul><ul><ul><li>corporate social responsibility </li></ul></ul><ul><ul><li>environmental scanning </li></ul></ul><ul><li>Economic performance and social responsibility </li></ul>
  20. 20. Government Intervention in the Market <ul><li>Taxes and subsidies </li></ul><ul><ul><li>to correct externalities </li></ul></ul>
  21. 21. Using taxes to correct a market distortion O Costs and benefits Quantity Q 1 MC = S D P
  22. 22. Using taxes to correct a market distortion O MC = S D P MSC Costs and benefits Quantity Q 1 External cost Q 2 Social optimum
  23. 23. Using taxes to correct a market distortion Q 1 O P Costs and benefits Quantity MC = S MSC D Q 2 MC Optimum tax = MSC – MC
  24. 24. <ul><li>Taxes and subsidies </li></ul><ul><ul><li>to correct externalities </li></ul></ul><ul><ul><li>to correct for monopoly </li></ul></ul>Government Intervention in the Market
  25. 25. <ul><li>Taxes and subsidies </li></ul><ul><ul><li>to correct externalities </li></ul></ul><ul><ul><li>to correct for monopoly </li></ul></ul><ul><ul><li>advantages of taxes and subsidies </li></ul></ul><ul><ul><ul><li>can vary the rate according to the size of the market distortion </li></ul></ul></ul>Government Intervention in the Market
  26. 26. <ul><li>Taxes and subsidies </li></ul><ul><ul><li>to correct externalities </li></ul></ul><ul><ul><li>to correct for monopoly </li></ul></ul><ul><ul><li>advantages of taxes and subsidies </li></ul></ul><ul><ul><ul><li>can vary the rate according to the size of the market distortion </li></ul></ul></ul><ul><ul><li>disadvantages of taxes and subsidies </li></ul></ul><ul><ul><ul><li>infeasible to use different tax and subsidy rates </li></ul></ul></ul><ul><ul><ul><li>lack of knowledge </li></ul></ul></ul>Government Intervention in the Market
  27. 27. <ul><li>Legislation </li></ul><ul><ul><li>to control activities causing externalities </li></ul></ul><ul><ul><li>to prevent firms giving inaccurate information </li></ul></ul><ul><ul><li>to prevent the abuse of monopoly power </li></ul></ul><ul><li>Regulatory bodies </li></ul><ul><ul><li>purely investigative </li></ul></ul><ul><ul><li>with powers to act (e.g. OFT) </li></ul></ul>Government Intervention in the Market
  28. 28. Environmental Policy <ul><li>The environment and production </li></ul><ul><li>Green taxes and subsidies </li></ul><ul><ul><li>use of green taxes around the world </li></ul></ul>
  29. 29. Types of environmental taxes and charges
  30. 30. Types of environmental taxes and charges
  31. 31. Types of environmental taxes and charges
  32. 32. Types of environmental taxes and charges
  33. 33. Environmental Policy <ul><li>Green taxes and subsidies (cont.) </li></ul><ul><ul><li>choosing the tax rate </li></ul></ul><ul><ul><ul><li>tax rate should equal the marginal external cost </li></ul></ul></ul><ul><ul><li>advantages of taxes and subsidies </li></ul></ul><ul><ul><ul><li>allows market to operate </li></ul></ul></ul><ul><ul><ul><li>can vary with the size of the externality </li></ul></ul></ul><ul><ul><li>disadvantages of taxes and subsidies </li></ul></ul><ul><ul><ul><li>infeasible to use different tax rates </li></ul></ul></ul><ul><ul><ul><li>lack of knowledge on extent of externality </li></ul></ul></ul>
  34. 34. Environmental Policy <ul><li>Laws and regulations </li></ul><ul><ul><li>the command-and-control approach </li></ul></ul><ul><ul><li>advantages </li></ul></ul><ul><ul><ul><li>simple to operate </li></ul></ul></ul><ul><ul><ul><li>safe approach when size of externality not known </li></ul></ul></ul><ul><ul><li>d isadvantages </li></ul></ul><ul><ul><ul><li>requires robust monitoring and enforcement </li></ul></ul></ul><ul><ul><ul><li>lack of incentives for firms to do better </li></ul></ul></ul><ul><li>Tradable permits </li></ul><ul><ul><li>how tradable permits work </li></ul></ul><ul><ul><li>assessing tradable permits </li></ul></ul>
  35. 35. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul>
  36. 36. Profit maximising under monopoly £ Q O Q m MR MC
  37. 37. Profit maximising under monopoly £ Q O MC Q m MR AC AR AC AR Total profit
  38. 38. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul><ul><ul><ul><li>lack of incentive to innovate </li></ul></ul></ul>
  39. 39. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul><ul><ul><ul><li>lack of incentive to innovate </li></ul></ul></ul><ul><ul><li>market power can also bring benefits </li></ul></ul>
  40. 40. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul><ul><ul><ul><li>lack of incentive to innovate </li></ul></ul></ul><ul><ul><li>market power can also bring benefits </li></ul></ul><ul><ul><ul><li>economies of scale </li></ul></ul></ul>
  41. 41. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul><ul><ul><ul><li>lack of incentive to innovate </li></ul></ul></ul><ul><ul><li>market power can also bring benefits </li></ul></ul><ul><ul><ul><li>economies of scale </li></ul></ul></ul><ul><ul><ul><li>investment and innovation </li></ul></ul></ul>
  42. 42. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul><ul><ul><ul><li>lack of incentive to innovate </li></ul></ul></ul><ul><ul><li>market power can also bring benefits </li></ul></ul><ul><ul><ul><li>economies of scale </li></ul></ul></ul><ul><ul><ul><li>investment and innovation </li></ul></ul></ul><ul><ul><li>approaches to competition policy </li></ul></ul>
  43. 43. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul><ul><ul><ul><li>lack of incentive to innovate </li></ul></ul></ul><ul><ul><li>market power can also bring benefits </li></ul></ul><ul><ul><ul><li>economies of scale </li></ul></ul></ul><ul><ul><ul><li>investment and innovation </li></ul></ul></ul><ul><ul><li>approaches to competition policy </li></ul></ul><ul><ul><ul><li>banning various activities </li></ul></ul></ul>
  44. 44. Competition Policy <ul><li>Competition, monopoly and the public interest </li></ul><ul><ul><li>the abuse of market power </li></ul></ul><ul><ul><ul><li>higher prices and profits </li></ul></ul></ul><ul><ul><ul><li>lack of incentive to innovate </li></ul></ul></ul><ul><ul><li>market power can also bring benefits </li></ul></ul><ul><ul><ul><li>economies of scale </li></ul></ul></ul><ul><ul><ul><li>investment and innovation </li></ul></ul></ul><ul><ul><li>approaches to competition policy </li></ul></ul><ul><ul><ul><li>banning various activities </li></ul></ul></ul><ul><ul><ul><li>examining each case on its merits </li></ul></ul></ul>
  45. 45. Competition Policy <ul><li>UK competition policy </li></ul><ul><ul><li>the OFT and the Competition Commission </li></ul></ul><ul><ul><li>restrictive practices policy </li></ul></ul><ul><ul><ul><li>legislation under 2002 Enterprise Act </li></ul></ul></ul><ul><ul><ul><li>criminal to engage in cartel arrangements </li></ul></ul></ul><ul><ul><ul><ul><li>price fixing, limiting supply, sharing out markets, collusive tendering, agreements to pay low prices to suppliers </li></ul></ul></ul></ul><ul><ul><ul><li>OFT has discretion with other types of agreement </li></ul></ul></ul><ul><ul><ul><ul><li>vertical price fixing, agreements to exchange information </li></ul></ul></ul></ul><ul><ul><ul><li>powers of the OFT </li></ul></ul></ul><ul><ul><ul><li>difficulties in rooting out collusion </li></ul></ul></ul>
  46. 46. <ul><li>UK competition policy (cont.) </li></ul><ul><ul><li>monopoly policy </li></ul></ul><ul><ul><ul><li>Chapter 2 prohibition of 1998 Competition Act </li></ul></ul></ul><ul><ul><ul><ul><li>market-share criterion </li></ul></ul></ul></ul><ul><ul><ul><ul><li>market contestability </li></ul></ul></ul></ul><ul><ul><ul><li>anti-competitive practices </li></ul></ul></ul><ul><ul><ul><ul><li>charging excessively high prices, price discrimination, predatory pricing, vertical restraints </li></ul></ul></ul></ul><ul><ul><ul><li>test: do such practices restrict competition? </li></ul></ul></ul><ul><ul><li>merger policy (2002 Enterprise Act) </li></ul></ul><ul><ul><ul><li>role of OFT and Competition Commission </li></ul></ul></ul><ul><ul><ul><li>criteria for judgment </li></ul></ul></ul><ul><li>Assessment of competition policy </li></ul>Competition Policy
  47. 47. The Regulation of Business <ul><li>Regulation and the privatised industries </li></ul><ul><ul><li>nationalisation and privatisation </li></ul></ul><ul><li>Regulation in practice: </li></ul><ul><ul><li>use of general competition policy </li></ul></ul><ul><ul><li>specific regulation </li></ul></ul><ul><ul><ul><li>regulatory offices </li></ul></ul></ul><ul><ul><li>price-cap regulation </li></ul></ul><ul><ul><ul><li>the CPI–X formula </li></ul></ul></ul>
  48. 48. <ul><li>Advantages of UK regulation </li></ul><ul><ul><li>discretionary </li></ul></ul><ul><ul><li>flexible </li></ul></ul><ul><ul><li>incentives </li></ul></ul><ul><li>Disadvantages of UK regulation </li></ul><ul><ul><li>disincentives of changes to X </li></ul></ul><ul><ul><li>complexity of regulation </li></ul></ul><ul><ul><li>principal–agent problems between regulator and industry managers </li></ul></ul>The Regulation of Business
  49. 49. <ul><li>Policies to increase competition </li></ul><ul><ul><li>allowing competition where there is no natural monopoly </li></ul></ul><ul><ul><ul><li>limited extent of true natural monopoly </li></ul></ul></ul><ul><ul><li>allowing access to grids by competitors </li></ul></ul><ul><ul><ul><li>forbidding suppliers from being grid owners </li></ul></ul></ul><ul><ul><li>competitive franchising to make monopolies contestable </li></ul></ul><ul><li>Still need for regulation to prevent abuse of monopoly power </li></ul>The Regulation of Business

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