McTaggart Micro Ch15-1

Chapter
15:
Competitio
n Policy
McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia
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.
15-2
Social Interest or Special

Interest?
Natural monopoly is regulated.
Does regulation work in the interest of allthe public
interestor in the interest of the regulatedspecial
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?
15-3
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 inefficiencya situation called a
market failure.
Implement arrangements that redistribute income and wealth
15-4

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
15-5

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.
15-6

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.
15-7

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
15-8

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
15-9
The Political Marketplace
15-10

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.
15-11

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
15-12

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.
15-13

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
15-14

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.
15-15
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
agencys costs
Each agency adopts a set of rules for controlling prices
and other aspects of economic performance
15-16

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
15-17

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
15-18
Marginal Cost Pricing
Figure
15.2
Price & Cost (dollars per household

per month)
30
25
20
15
Loss per
household
Consumer
surplus
ATC
10
MC
D
10
Quantity (millions of households)
15-19

Average Cost Pricing Rule
Sets price equal to average total cost
Consumer surplus is less than under marginal cost pricing
15-20
Natural Monopoly:
Average Cost Pricing
Figure
15.3

per month)
30
25
20
15
10
Consumer
surplus
Producer
surplus
ATC
MC
Deadweight
loss
D
6
10
15-21

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
15-22
Inflating Costs
Figure
15.4

per month)
30
Profit is
maximised
25
20
15
ATC (inflated)
Economic
profit
MC
10
MR
0
ATC
D
8
10
15-23
Price Cap Regulation

per month)
30
Figure
15.5
Profit maximising
outcome
25
Price cap
outcome
20
Price Cap
15
10
ATC
Price cap
regulation lowers
price and increase
output
MR
4
MC
D
8
10
15-24

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
15-25

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.
15-26
Some Effects of the NCP on

Prices
Figure
15.6
15-27
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.
15-28
Cartel Regulation
If the regulation is in the public interest, price and quantity
will equal their competitive levelsand 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 levelsand the outcome is inefficient.
15-29

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
15-31
Trade Practices Law
The centrepiece of Australias 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.
15-32
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.
15-33
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
15-34
Price and Cost (dollars per tonne)
Public Ownership
Figure
15.8(a)
10
8
6
Subsidy per tonne:

Efficient output
Consumer
surplus
Tax
payment
ATC
MC
D
10
Quantity (billions of tonnes per year)
15-35

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
15-36

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)
15-37
Budget Maximisation
Price and Cost (dollars per tonne)
10
Figure
15.8(b)
Subsidy per tonne

efficient output but
maximising budget
ATC (inflated)
6
4
ATC
MC
D
0
10
Quantity (billions of tonnes per year)
15-38

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.
15-39

Privatisation
Privatisation
Largely because of increasing awareness and
understanding of the inefficiency of bureaucracies and
public enterprises, there has been a move toward
privatisation.
15-40
END
CHAPTER 15
15-41

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Chapter

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Social Interest or Special

The Economic Theory of

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

The Economic Theory of

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

Taxes and redistribution

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Political Marketplace

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

The Demand for Regulation

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

The Economic Theory of

Public Ownership and Privatisation

Regulating Monopoly and

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Regulating Monopoly and

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Natural Monopoly Regulation

If the Firm Incurs a Loss

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Marginal Cost Pricing

Price & Cost (dollars per household

Quantity (millions of households)

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Natural Monopoly Regulation

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Price & Cost (dollars per household

Quantity (millions of households)

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Natural Monopoly Regulation

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Price & Cost (dollars per household

Quantity (millions of households)

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Price Cap Regulation

Quantity (millions of households)

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Natural Monopoly Regulation

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Natural Monopoly Regulation

Social Interest or Capture

A study by the Australian Productivity Commission shows

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

Some Effects of the NCP on

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia

McTaggart, Findlay, Parkin: Microeconomics 2007 Pearson Education Australia