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Unit 2.8:

Competition policy /Regulation

(Chapter 10 pg.322 - 332 & Smit)

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Define competition policy

Legislation passed for the stated purposeof controlling monopoly power and

preserving and promoting competition• Do you think we need competition policy? – Why or why not?

• SA: Competition Act no. 89 of 1998 – Highly concentrated markets!

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Figure 3.1, pg. 3

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Arguments against monopoly

(dominant firms)1. Allocative efficient:

– Pareto efficiency (P =MC)

– Perfect competition: P =MC.

• Consumer surplusmax

– Monopoly: P > MC

• Reduces consumerand producer surplus

• Deadweight loss =allocative inefficient

– Fig. 3.2

2. Redistribution:

– Monopoly gainsPmPcO3O1 atexpense of consumer

• Consumer pays higher

prices for fewer goods

– Unfair or sociallyunacceptabledistribution of incomeand wealth.

– Fig. 3.2

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Figure 3.2, pg. 5

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Continue…3. Production efficiency:

– Production efficiency:firm produces atminimum ATC.

– Achieved underperfect competition

• Why?

– Monopoly maximizesprofit – not efficiency!!

– Fig. 3.3, pg. 7

4. Rent seeking:• Monopolies more

profitable than perfectcompetition

• Incentive to attempt tocreate monopoly – activity called rentseeking.

• Options: – buy or create new

monopoly right. – Lobbing

– Influence political process.

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Fig. 3.3, pg. 7

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Fig. 10.25: Does a monopolysuppress innovation?

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Arguments in favour of monopolies1. Economies of scale & scope :

– Large scales ≈ produce at the lower ATC

– Increasing number of different goodsproduced.• Spread cost over a range of products to lower

cost per unit.

– Figure 3.4

• Pm < Pc and Qm > Qc

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Fig. 3.4, pg. 12

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Continue…2. Incentive to innovate:

– Innovation (research) is very expensive – dominantfirms can finance – Large firms are important in speeding the process of

diffusion of technological advances.

– Why can’t competitive firms innovate?

3. Dominant firms can compete in internationalmarkets.

– Small firms do not have the ability to competeagainst large international firms.

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Misconception of monopolies• Charge ANY PRICE = constrained by

demand .

• Guarantees LR and SR economic profit:demand can fall drastically

• Always has absolute economic powerand always abuses this power: mustalways consider potential competitionand foreign companies .

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Regulation of natural monopolies• Natural monopoly: one firm can supply the entire output demanded

at a lower cost than 2 or more firms can. – Occur because of economies of scale

• Exhibit 2 & 3, pg. 284 & 285

– Q1 = inefficient allocation of resources – Q2 = resource allocate efficiency exits – 2 options:

• Exiting firm can increase production to Q2 = will minimize

total cost• New firm can enter the market and produce Q3 (difference

between Q2 and Q1) = will not minimize total cost. – Natural monopolies can charge monopoly price

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Fig. 10.22: Natural monopoly

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Continue…2. Profit regulation

– Monopoly earn zero economic profit – Charge P = ATC (P2 and Q2)

• Called average cost pricing . – Problem: no incentive to lower cost

3. Output regulation – Mandate quantity of output that monopoly must

produce. – Assume Q3 – where P3 > ATC – Problem:

• Earn even higher economic profit by lowering costs• No direct competition & is protected from competitors.

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Fig 10.23: Cross subsidizing toincrease output

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Regulation (cont)3.Exclusive Contracting for a natural

monopoly- Contract to the lowest cost firm4.Enforcment of Competition policy5.Laissez-faire policy towards natural

monopoly – Fig. 10.24

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Fig. 10.24: Efficiency loss of a single price

monopoly and 2 price monopoly