Government Regulation On Business

 1. Market Competition And Market Failure 

Two efficiency conditions must be met: 

1. Productive efficiency 2. Allocative efficiency

1. Productive efficiency

•  Exists when suppliers produce goods & services at the lowest possible total cost to society 
•  Occurs when firms operate along their expansion paths in both the short-run & long-run

2. Allocative efficiency

▪ Requires businesses to supply optimal amounts of all goods & services demanded by society 

• Producing goods and services to an output that maximizes total economic welfare (satisfaction and consumer preferences). Allocative efficiency is theoretically reached when no-one can be made better off without making someone else worse off. 

▪ Optimal level of output is reached when the MB of another unit to consumers just equals the MC to society of producing another unit

•  1. Private efficiency is achieved where marginal private benefit equals marginal private cost: MB = MC

• 2. Social efficiency is achieved where marginal social benefit equals marginal social cost:  MSB = MSC

Economists argue that under certain circumstances the achievement of private efficiency will result in social efficiency. There are two major conditions have to be fulfilled for this:

•  Achieved by markets in perfectly competitive equilibrium 
• There must be no externalities

1.  Achieved by markets in perfectly competitive equilibrium

Producer Surplus

 ▪ Total revenue (i.e. total expenditure) is P × Q 

▪ Total variable cost is the area under the MC curve

Thus, under perfect competition, the market will ensure that total surplus, sometimes called total private surplus, is maximised. 

At this output, MU = P = MC.

2. There must be no externalities 

• Externalities are additional costs or benefits to society, over and above those experienced by the individual producer or consumer. 
• Example: Pollution. It is a cost that society experiences from production, but it is not a cost that the individual producer has to pay. 
• In the absence of externalities, the only costs or benefits to society are the ones that the individual producer or consumer experiences: i.e. marginal social benefit (MSB) is the same as marginal private benefit (MB), and marginal social cost (MSC) is the same as marginal private cost (MC).

FACTS: 

• Competitive markets can achieve social economic efficiency without government regulation 

• But, not all markets are competitive, and even competitive markets can sometimes fail to achieve maximum social surplus 

MARKET FAILURE 

Exists when a market fails to achieve social economic efficiency and, consequently, fails to maximize social surplus 

• Three possible targets of competition policy: 

•  Abuse of the existing power of monopolies and oligopolies: monopoly policy
•  The growth of power through mergers and acquisitions: merger policy 
• Oligopolistic collusion: restrictive practice policy 
• ➢ Absent market failure, no efficiency argument can be made for government intervention in competitive markets
• Market failure may also occur because consumers lack perfect knowledge ➢Perfect knowledge includes knowledge about product prices, qualities, and any hazards 
• Market power can emerge because of imperfectly informed consumers 
•  Consumers may over- or under-estimate quality of goods & services ➢If they over-value quality, they will demand too much product relative to the allocative efficient amount ➢If they under-value quality, they will demand too little

Privatization And Regulation

• Market forces

 ➢The first argument is that privatization will expose these industries to market forces, from which will flow the benefits of greater efficiency, faster growth and greater responsiveness to the wishes of the consumer. 

➢There are three parts to this argument 

• 1. Greater competition in the goods market 
• 2. Greater competition for finance 
• 3. Accountability to shareholders

1. Greater competition in the goods market 

• ▪ If privatization involves splitting an industry into competing parts (for example, separate power stations competing to sell electricity to different electricity distribution companies), the resulting competition may drive costs and prices down. 

2. Greater competition for finance 

• ▪ After privatization a company has to finance investment through the market: it must issue shares or borrow from financial institutions. In doing so, it will be competing for funds with other companies, and thus must be seen as capable of using these funds profitably

3. Greater competition in the goods market

•   Shareholders want a good return on their shares and will thus put pressure on the privatized company to perform well. If the company does not make sufficient profits, shareholders will sell their shares. The share price will fall and the company will be in danger of being taken over. The market for corporate control thus provides incentives for private firms to be efficient.
•   There has been considerable takeover activity in the water and electricity industries, with most of the 12 regional electricity companies and several of the water companies being taken over, often by non-UK companies

Other Reason to Privatization

Reduced government interference. 

1. In nationalized industries, managers may frequently be required to adjust their targets for political reasons. At one time they may have to keep prices low as part of a government drive against inflation. 

2. Managers may have to raise their prices substantially in order to raise extra revenue for the government and help finance tax cuts. 

3. Managers may find their investment programmes cut as part of a government economy drive. ➢Privatization frees the company from these constraints and allows it to make more rational economic decisions and plan future investments with greater certainty.

 Financing tax cuts. 

• ➢The privatization issue of shares earns money directly for the government and thus reduces the amount it needs to borrow. Effectively, then, the government can use the proceeds of privatization to finance tax cuts.