Unit 2.

8:

Competition policy /
Regulation
(Chapter 10 pg.322 - 332 & Smit)

Define competition policy

Legislation passed for the stated purpose
of 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!

Comparison between monopoly and

perfectly competitive outcomes.
Figure 3.1
Perfect competition:
P = MR and P = MC

Monopoly:
Supply curve?
P > MR and P > MC

Conclusion:
Price: Pm > Pc
Output: Qm < Qc

Figure 3.1, pg. 3

Arguments against monopoly

(dominant firms)
1. Allocative efficient:
Pareto efficiency (P =
MC)
Perfect competition: P =
MC.
Consumer surplus
max
Monopoly: P > MC
Reduces consumer
and producer surplus
Deadweight loss =
allocative inefficient
Fig. 3.2

2. Redistribution:
Monopoly gains
PmPcO3O1 at
expense of consumer
Consumer pays higher
prices for fewer goods

Unfair or socially
unacceptable
distribution of income
and wealth.
Fig. 3.2

Figure 3.2, pg. 5

Continue
3. Production efficiency:
Production efficiency:
firm produces at
minimum ATC.

4. Rent seeking:
Monopolies more
profitable than perfect
competition

Achieved under
perfect competition
Why?

Incentive to attempt to
create monopoly
activity called rent
seeking.

Monopoly maximizes
profit not efficiency!!

Options:

Fig. 3.3, pg. 7

buy or create new

monopoly right.
Lobbing
Influence political process.

Fig. 3.3, pg. 7

Continue
5. No incentive to
innovate:
Why?

7. Sub-standard (poor)
quality of products:
No substitutes

6. Managerial
inefficiencies:
No competition

8. Political power:
Large firms has
significant economic and
political power

Inefficient high-cost firms

can survive.

Fear of dictating
economic policy.

Fig. 10.25: Does a monopoly

suppress innovation?

Arguments in favour of monopolies

1. Economies of scale & scope:
Large scales produce at the lower ATC
Increasing number of different goods
produced.

Spread cost over a range of products to lower

cost per unit.

Figure 3.4

Pm < Pc and Qm > Qc

Fig. 3.4, pg. 12

Continue
2.

Incentive to innovate:
Innovation (research) is very expensive dominant
firms can finance
Large firms are important in speeding the process of
diffusion of technological advances.
Why cant competitive firms innovate?

3.

Dominant firms can compete in international

markets.
Small firms do not have the ability to compete
against large international firms.

Misconception of monopolies

Charge ANY PRICE = constrained by

demand.

Guarantees LR and SR economic profit:

demand can fall drastically

Always has absolute economic power

and always abuses this power: must
always consider potential competition
and foreign companies.

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

Fig. 10.22: Natural monopoly

Continue
1. Goverment ownership and management

P = MC

X-inefficient
2.Government regulation of private monoply

Profit regulation

Fig.10.22
Gold-plated water cooler effect

Cross subsidy effect

3.Different ways to regulate a natural monopoly.

1.

Price, output or profit regulation

Exhibit 10.22

Price regulation

Set P = MC (P1 and Q1)

Also called marginal cost pricing

Problem: ATC > P = monopoly makes a loss!

Solution: provide subsidy or monopoly would go out of business.

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.

Fig 10.23: Cross subsidizing to

increase output

Regulation (cont)
3.Exclusive Contracting for a natural
monopoly
- Contract to the lowest cost firm
4.Enforcment of Competition policy
5.Laissez-faire policy towards natural
monopoly
Fig. 10.24

Fig. 10.24: Efficiency loss of a single price

monopoly and 2 price monopoly