Imperfectly competitive markets such as monopolies, ones acting in a monopolistic fashion, and oligopolies, can often be proved to be harmful to the consumer due to their high prices and little efficiency. Government competition policies are put in place to regulate and reduce the ability of these markets to do so. government policies try and tackle the problem through price capping, taxing profits and even breaking up monopolies. Some policies are more useful than others but the effectiveness of the policy depends on the situation of the market.
One way to regulate activities of imperfectly competitive markets is by price capping. Price capping is a limitation on the percentage amount that a firm can raise its prices of the goods or services it is providing to the consumer. Monopolies can afford to raise price levels due to their control over pricing and quantity and when this occurs, some consumers with elastic demand will not be able to afford 3439766409744the product or service. This along with an over all loss in welfare, creates a dead weight loss and increases producer sovereignty.
Price capping is done by subtracting the potential efficiency gains of a firm to the Retail Price Index (RPI). These gains are judged on your potential productive, allocative and x efficiency, which in imperfectly competitive markets are optional. The higher the potential the firm has, the lower the ability to increase your prices. This is in aim to increase the firms efficiency, which is in the consumer sincerest and increases competition in the market.
Many new recently privatised industries such as gas and electricity and water, have governing regulatory bodies which decide on the potential efficiencies. In the water industry, K, standing for capital investment, was added to the RPI-X equation. K is the amount of investment that the water firm needs to implement. Thus, if water companies need to invest in better water pipes, they will be able to increase prices to finance this investment.
Price capping enables the regulator to set fair price increases to different industries depending on their competitiveness. It creates an incentive to cut costs as well as promotes competition and prevents abuse of monopoly power. Even though this does help to regulate imperfectly competitive markets, the fact that specific caps are put on specific markets leaves room for poor judgement and unfair capping. There is danger of regulatory capture, where regulators become too soft on the firm and allow them to increase prices and make supernormal profits, and the opposite may also happen where the regulators are too hard on the firm, and reduce their profit margin so much to the point that there is no dynamic efficiency possible for the future. it is very costly and difficult to decide what the level of X should be, and this also applies to judging K, in the water industries case. There is also the chance that firms with the advantage of K, may not use the extra profits for capital investment.
Price capping does not take into account the market fluctuations at certain times. As it reduces price of the product, the production process may also be altered and may need to be cut due to less revenue coming in, this can lead to a reduced quality of the product and even unemployment. Price capping has to be done with great research and a fair governing body so that not one firm is more disadvantaged than the other. it is effective in both the long and short term and possibly the best solution as it aims to not harm the firm to and extent where it cant cope, while incentivising it to be more dynamically efficient and therefore also aiding the consumer.
Another regulatory strategy is taxing monopoly profits. This is not a method widely used in the UK, apart from on a few occasions using a windfall tax. the 1997 windfall tax was implicated in order to…