Market Power & Government Intervention (DP IB Economics)

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The Advantages and Disadvantages of Market Power

  • Market power refers to a situation in which a firm has the ability to influence prices, output levels, or other market outcomes due to its significant market share or unique competitive advantage

The advantages of firms having market power include improved brand recognition, money to invest in R&D, and economies of scale

The advantages to firms of having market power
 

  • The advantages and disadvantages of market power can vary depending on the specific industry, market dynamics, and the behaviour of the firms involved

  • Government intervention and anti monopoly policies play a crucial role in ensuring fair competition, protecting consumers, and addressing potential negative consequences associated with market power
      

An Explanation of the Advantages Offered by Market Power


Advantage


Explanation

Higher Profits

  • Firms with market power can often set prices above their marginal costs, allowing them to earn abnormal profits
     

  • Higher abnormal profits improve the reputation of the company amongst its shareholders and make it easier for the firm to access greater finance

Research, Development & Innovation

  • Higher profits provide the means and incentive for firms to invest in research and development, innovation, and expanding their operations
     

  • This may result in a better quality product for consumers

Economies of Scale

  • Larger firms can take advantage of economies of scale to lower their average costs
     

  • With lower costs, firms can leave price levels the same and enjoy higher profits - or firms can lower prices and pass on the cost benefits to their customers

Branding and Reputation

  • Market power enables firms to build strong brands and reputations

    • This can create customer loyalty and trust
       

  • Established brands often have a competitive advantage, allowing firms to charge premium prices 

Strategic Decision-Making

  • Firms with market power have more strategic options in terms of their business decisions
     

  • They can pursue long-term goals, undertake mergers and acquisitions, engage in vertical integration, and explore new markets
     

  • This strategic freedom can lead to increased market dominance and sustained profitability.

An Explanation of the Disadvantages Created by Market Power


Advantage


Explanation

Reduced Competition

  • A firm with significant market power is likely to limit the entry of new competitors or engage in anti-competitive practices that stifle competition

  • This can lead to higher prices, reduced consumer choice, and decreased efficiency in the market

 Lack of Innovation & Efficiency

  • In the absence of competition, firms may have less motivation to improve their products, lower costs, or invest in research and development

  • This can harm consumer welfare and hinder overall industry progress

Regulatory & Legal Risks

  • Firms with significant market power often face increased scrutiny and regulation from anti-monopoly authorities
     

  • These firms may be subject to legal actions, fines, or forced divestitures if their market power is deemed anti-competitive

The Use of Legislation & Regulation to Reduce Market Power

  • Legislation involves the creation of new laws by government
     

  • Regulation involves enforcing the laws

    • This is usually assisted by the creation of regulatory agencies such as the Environmental Protection Agency (EPA) in the USA or the European Competition Commission
       

  • Legislation and regulation play a critical role in reducing market power and promoting fair competition within industries
     

  • Governments implement laws and regulations to prevent anti-competitive practices and protect consumers, workers and the environment

  • Overregulation can stifle competition and deter investment, while insufficient regulation can lead to market dominance and anti-competitive behaviour

Common Approaches used in Legislation & Regulation to Reduce Market Power


Approach


Explanation


Example

Creating a Competition Regulator

  • One way to control monopoly power is to prevent it from forming in the first place

  • A key function of agencies is to monitor merger activity with the aim of preventing any single firm gaining more than 25% market share

    • If there are concerns about the merger then the regulator has the authority to stop it from happening
       

  • Competition regulators also intervene by placing maximum prices, especially when monitoring natural monopolies

  • The Competition & Markets Authority (CMA) is the UK Government regulator tasked with ensuring that the creation of monopoly power is avoided
     

  • There are similar regulators in Europe (European Competition Commission) & in the USA (Antitrust Commission)

  • E.g. in July 2022 the CMA launched an investigation into the merger of two companies which produce foam used in bedding & cleaning products as they believed it would lead to higher prices & less choice

Protecting Suppliers

  • Monopsony power is abusive towards suppliers & over time can change the nature of entire industries in an economy
     

  • Governments can pass anti monopsony laws and issue fines if breaches occur
     

  • They can set minimum prices which buyers have to pay suppliers

  • Autorité de la concurrence (Competition Authority in France) launched an investigation in 2018 on big retailers for unfair practices in the food sector

  • They fined several supermarket chains for using abusive commercial practices against their suppliers, such as unilaterally changing contract terms and imposing excessive payment delays
     

  • These actions aimed to protect suppliers from unfair treatment and ensure fair competition within the industry.

Protecting Employees

  • Wage bills for firms are often one of their highest costs as a proportion of expenditure
     

  • With a goal of profit maximisation firms will always seek to reduce their wage expenditure as this will result in higher profit
     

  • There is a role for government to protect workers who could be exploited by firms
     

  • The government uses the following methods to protect employees

  • National minimum wage legislation
     

  • Legislation on health & safety, working hours & employment conditions e.g. maternity pay
     

  • Permitting trade unions to operate in the economy (some countries limit or ban the existence of unions as they view them as anti-competitive e.g. Singapore)

The use of Government Ownership to Reduce Market Power

  • Nationalisation can occur for various reasons, including

    • Governments may choose to nationalise industries or companies that are considered strategically important for national security or economic stability e.g energy and telecommunications

    • Nationalisation can be implemented to ensure the provision of essential services to the public such as healthcare or education

    • Nationalisation can be used to promote economic development, address market failures, or redistribute wealth by bringing key industries under state control
       

The Advantages & Disadvantages of Nationalisation


Explanation


Advantages


Disadvantages

  • Nationalisation occurs when the Government takes control and ownership of firms which were in the private sector

  • This can generate efficiencies, especially when delivering utilities (gas, water, electricity) to the national population

  • It creates more equity in society as all citizens have the same access to the same resource at the same price e.g. Norway nationalised much of the oil industry when oil was first discovered in 1972. The profits belong to the citizens

  • The business can generate significant revenue for the government

  • Government firms can often run very inefficiently

  • There is an opportunity cost associated with the money required to run it

  • The Government may lack the expertise to run the business

The use of Fines to Reduce Market Power

  • Fines are usually imposed by regulators in specific markets

  • In Europe, firms are fined 10% of their sales revenue for breaching anti-competitive practices

    • These fines can be significant as many firms have profit margins of less than 10%
       

Advantages of Using Fines

  • Corrects anti-competitive behaviour

  • Generates additional revenue for the government to redistribute
      

Disadvantages of Using Fines

  • Monopoly firms have high profits and use these to take legal action against regulators

    • The court cases often take years to settle

    • The firms settle out of court and pay reduced fines

    • The level of the fine is often less than the profit generated by the anti competitive behaviour so does not necessarily change their behaviour

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