unit 3 revision alevel
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8/20/2019 Unit 3 Revision ALEVEL
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Unit 3 BusinessEconomics & Economicefciency
Competition Policy, Regulation and
Contestability
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Unit 3 Business Economics &Economic efciency
The exam
ContestabilityCompetition Policy
PriatisationRegulation
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!" The exam #
# $%UR 3 '()UTE* +%)- ./ !0
- T%T!+ 10 '!R2*
Supported choice:
8 questions for 4marks each
Total 32 marks
Spend no longer than40 minutes here
Data question: / ealuation
4 questions
Total 40 marks
Spend 50 minuteshere
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!" The exam 0
The supported choice4
5e6nition4 # mar7
5iagram4 # 8 3 mar7s
!nnotation4 # mar7
!pplication9calculation4 # 8 0 mar7s :urther analysis4 # 8 0 mar7s
2%s 8 # 8 0 mar7s
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!" The exam 3
The data response4
. mar7 ;uestion▪ purely knoledge and application marks
▪ remem!er to apply your knoledge to theindustry in the e"tract
< mar7 ;uestion▪ 4 marks for identi#cation$ e"planation and
analysis
▪ 4 marks for e%aluation & 2 good e%aluation points
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!" The exam .
The data response4
#0 mar7 ;uestion▪ De#nition'knoledge & ( mark
▪ )pplication$ analysis * diagram & 5 marks
▪ + marks for e%aluation
#= mar7 ;uestion▪ 8 marks for identi#cation$ e"planation and
analysis
▪ 8 marks for e%aluation & ,2 - 2 - 2 - 2. safest
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B" Contestability
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B" Contestability #
! per>ectly contestable mar7et hasno sun7 costs ?entry and exitbarriers@ and per>ect in>ormation?thus only normal pro6ts areearned@
/ontesta!ility a #rm1s potential too%ercome sunk costs and enter themarket and so share in its supernormalpro#ts
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B" Contestability 0
*un7 costs costs that a #rm mustincur to enter a market and areirreco%era!le if the #rm su!sequentlye"its
arkets ith high concentration$ and the
potential for a!use of monopoly poer$may not need regulation if the Tconsiders them contestable ith loe"it costs
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B" Contestability 3
Ahat are the determinants o>contestability
(6 Technological change26 7atural monopoly36 conomies of scale
46 9randing * ad%ertising le%els56 imit pricing+6 ;nformation asymmetry<6 =ights to distri!ution or ra materials
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B" Contestability .
;n 200+$ /oca/ola launched a sugarfreesoft drink called >/oke ?ero@ and spent A8mn on ad%ertising the !rand6 Bhich of the
folloing is most likely to make it diCcult forother #rms to enter the soft drink market
) The a!sence of consumer loyalty for /oca/ola6
9 Eigh sunk costs6
/ Strong go%ernment las on anticompetiti%epractices6
D Eigh le%els of contesta!ility6
) lo concentration ratio6
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B" Contestability
The !onuses to customers a%aila!lethrough supermarket loyalty cards$ suchas those oFered !y Tesco * Sains!ury1s$are likely to make the industry:
) ess integrated
9 ess contesta!le
/ ess concentratedD ess pro#ta!le
ore contesta!le
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B" Contestability =
;n Gune 2005 the uropean /ommissionreported that /oca/ola imposed e"clusi%ityagreements ith retailers to stock their soft
drinks6 ) moti%e to act in this ay is to:) increase the choice of soft drinks6
9 o!tain !ene#ts from horiHontal integration6
/ di%ersify into unrelated markets6
D o!tain !ene#ts from %ertical integration6
reduce concentration in the soft drinks market6
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B" Contestability 1
Example – Japanese electronics (Economist 11/09)
Gapanese companies ser%e <0I - of the orldide market in 30- technology sectors orth more than J( !illion apiece6 Gapan1schampions share certain characteristics6 They in%est handsomelyin =*D6 They often on their supply chains and some #rms e%enmake the %ery machines they use$ in order to control costs$remain independent of suppliers and maintain a deepunderstanding of their technology6 The components$ tools andmaterials in hich Gapanese #rms e"cel are highly customised6 ;t
is only !y orking closely ith clients o%er many years thatsuppliers gain insight into their future technical plans and aretrusted to learn a!out thorny pro!lems that a cle%er suppliermight sol%e6 oreo%er$ the knoledge cannot !e transmitted !yreading a patent !ut accumulates !y orking ith colleagues o%ermany years6
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B" Contestability <
To hat extent is this mar7etcontestable
De#ne contesta!ility%idence: Bhat are the sunk costs
;s there asymmetric information
Bhat are the le%els of pro#ts
)re any #rms poised to enter
;f there1s a regulator$ it suggests it1s uncontesta!leK
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B" Contestability D
To hat extent is this mar7etcontestable
%aluation:
)rgue the opposite ay & it iscontesta!leLL6
agnitude of factors & use e"tract'data
;s contesta!ility changing in the longrun
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C" Competition Policy
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C" Competition Policy #
The %fce o> :air Trading, %:T4Mromote competition * protect the
consumer interestMre%ent a!use of monopoly poerMre%ent restricti%e practices=efer in%estigations to /ompetition
/ommission=egulate industries
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C" Competition Policy 0
The %fce o> :air Trading, %:Tpoers4
ines up to (0I NO annual turno%er ;mprison directors for up to 5 yearsnter and search !usinesses for
e%idence9lock mergersBhistle !loing rearded
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C" Competition Policy 3
The Competition Commission4 ;n%estigate mergers P 25I market share ;n%estigate dominant #rms P 40I market share
;n%estigate restricti%e practices: /artels'collusion & price #"ing or coordinated
in%estment
Mredatory * limit pricing
=estriction supply to distri!utors ull line forcing
/reation arti#cial entry !arriers & ad%ertising$ !randproliferation
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C" Competition Policy .
;n 200<$ the uropean // instructedicrosoft to make freely a%aila!le someof its patented technical information tori%als6 The most likely eFect on themarket is to:
) increase concentration6
9 increase contesta!ility6/ strengthen computer patents6
D increase entry !arriers6
increase icrosoft1s pro#ts6
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C" Competition Policy
)n in%estigation into store cards !y the // in200+ found that most retailers ere chargingannual interest rates of 30I$ far greater than
the rate required to co%er costs6 The //proposed measures to reduce interest ratesand so make the retail store card market:
) less contesta!le6
9 more allocati%ely eCcient6/ more concentrated6
D more pro#ta!le6
less regulated6
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C" Competition Policy
;n Decem!er 2004$ the N // !lockedthe proposed merger !eteen the stateoned gas and electricity industries inrance6 The most likely moti%e as to
) ena!le !oth industries to achie%e S6
9 pre%ent a further increase in entry !arriers6
/ a%oid diseconomies of scale ith mergers6D increase pro#ts in !oth #rms6
protect producer surplus in each industry6
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C" Competition Policy =
But larger 6rms
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C" Competition Policy 1
Promotecompetition so4
)llocati%e
eCciency * soloer prices
Mroducti%eeCciency * soloer costs
Qreater /S * noelfare loss
9etter choice
But larger 6rmscan4
Qenerate
economies of scaleand loer prices =ein%est pro#ts
into = * D
,dynamiceCciency.
atch largeo%erseas
competitors /rosssu!sidise
lossmakingser%ices'goods
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C" Competition Policy <
Ealuation to consider4)rgue the opposite %ie6
Eo contesta!le is the market ;s there any e%idence thatcompetition can increase in shortrun
Eo do incum!ents respond Mricears or aggressi%e ad%ertising etc6
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5" PriatisationEaluation to consider4)rgue the opposite %ie6Eo contesta!le is the market;s there e%idence that competition can increaseEo do incum!ents respond Mrice ars or aggressi%e ad%ertising etc6
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5" Priatisation #
Priatisation is the transfer ofeconomic acti%ity out of the pu!lic
sector and into the pri%ate sector inorder to:
;mpro%e producti%e eCciency
;ncrease competition * loer prices
;mpro%e choice and quality
;ncrease inno%ation
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5" Priatisation 0
The go%ernment appointed QoldmanSachs to sell oF Tote in )pril 20086 Toteons 540 shops %alued at A320 !n6 Themost likely reason to sell oF Tote is:) encourage more gam!ling6
9 reduce industry contesta!ility6
/ a%oid an T in%estigation6D achie%e !ene#ts from pri%atisation6 open up the industry to >hit * run@competition6
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5" Priatisation 3
Public priate partnerships ?PPP@4
) partnership here pri%ate sector #rms deli%er
pu!lic ser%ices or proRects on !ehalf of thepu!lic sector6
Mu!lic sector operations are contracted out topri%ate #rms$ ho are more considered to !e
more eCcient and specialised at these ser%ices6 Competitie tendering introduces
competition !eteen #rms as they !id forcontracts$ thus dri%ing don costs6
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5" Priatisation .
Priate :inance (nitiatie ?P:(@4
Mri%ate sector #rms #nance$ maintain andlease infrastructure ,hich as pre%iouslypu!licly oned and funded. to the pu!licsector6
"amples: etronet * ondon Nnderground
idland "pressay * + toll road
/onstruction of many prisons and 7ES hospitals
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5" Priatisation
The bene6ts4 oer costs * greater
producti%e eCciency Nse of specialised #rms
can deli%er higherquality product
/onstruction ithin!udget * on time
ease reduces need forlarge pu!lic spending =isks of proRect
transferred to pri%atesector
But there are concerns4 ack of competition may
raise pri%ate pro#ts and
not !e cost eFecti%e /ost cutting can !e at
the e"pense of quality ittle risk as risk
ultimately lia!le on
pu!lic sector arge procurement *
administration costs Qo%ernments can !orro
more cheaply
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E" Regulation
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E" Regulation #
=egulation aims to mimic the eFectsof competition and so:
Nse price caps to keep prices lo nsure pro#ts rein%ested
nsure product and ser%ice quality ishigh through performance indicators
Take into account e"ternalities
Mromote competition
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E" Regulation 0
Mricecaps:
=M;: >@ e"pected eCciencyimpro%ements
=M; - O : >O@ additional capital
e"penditure
=M; - : >@ reUects una%oida!le cost
increases
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E" Regulation 3
Eousehold ater !ills are regulated!y fat according to =M; - O6 ;n
200<$ =M; as 36VI and O set at36(I6 This meant ater !ills) decreased in nominal terms !y 068I
9 increased in !oth real and nominal
terms/ increased !y no more than the rateof inUation e"cluding mortgage
repayments
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E" Regulation .
)n ad%antage of using =M; & to regulate apri%atised monopoly is it allos the #rms to) raise prices !y less than mortgage interest
payments9 keep supernormal pro#ts achie%ed !yadditional eCciency impro%ements/ raise the price of goods the #rm does not
e"portD makes only normal pro#ts do no more than !reake%en
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E" Regulation
fcom ended more than tenty years ofprice controls for telephone calls on 9T in200+6 The most likely reason for this is that
) 9T is no longer required to raise prices !yless than mortgage interest payments9 pro#t capping is ineFecti%e in protectingconsumer interests
/ 9T1s prices ha%e increased a!o%e inUationD signi#cant competition no e"ists technological change is set to increase
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E" Regulation =
Wu6 "amine the likely impact of price capsLL6
De#ne price caps
Nsed to regulate natural monopoliesL66 Types of price caps used)nalyse the !ene#ts: ;ncrease producti%e eCciency
oer real prices Mre%ent pro#teering at consumer1s e"pense
und necessary in%estment
5 year price caps allo planning ahead
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E" Regulation 1
Wu6 "amine the likely impact of pricecapsLL6
%aluation: =egulatory capture
)symmetric information
Mro!lems of setting price caps & regulatoryfailure
=isks of une"pected shocks ,although =M; - .
/omparison ith other types regulation
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E" Regulation <
Wu6 "amine the likely impact ofperformance targets on LL6
De#ne performance targets & regulatoracts as surrogate competition by tryingto improve standards of customer
service)pplication to data or e"amples & next
day delivery targets for Royal Mail ornumber of trains on time
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E" Regulation D
Wu6 "amine the likely impact of performancetargets on LL6
7eed to increase in%estment
but higher SR costs or into wrong technology ;ncrease allocati%e eCciency
but at expense of higher prices7eed to change orking practices
but can have problems with trade unionsay loer producti%e eCciency
but investment could deliver LR improvement ay reduce pro#ts
but not if already meeting targets
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E" Regulation #
;n the NS$ limits ha%e !een placed on pro#ts ofpri%atised utilities relati%e to the %alue of theircapital assets6 Bhat are the disad%antages of
,rate of return. regulation) irms ill under%alue their capital
9 Wuality may decline as the regulator forcescosts don/ irms can make unlimited supernormal pro#tsD irms ha%e little incenti%e to !ecomeproducti%ely eCcient irms are encouraged to make e"cess pro#ts topay out as di%idends to shareholders
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