Evaluate policies which a UK government could use to control the activities of oligopolists. (25 marks)

An oligopolistic market is one where mutliple firms coexist in order to provide similar goods or services. The firm’s in this market are however, price makers despite similarities in the products. This allows them change the price of their good or services by restricting or expanding the supply of their products on the market. Firms in an oligopolistic market are interdependent of one another, this is due to the substition nature of the products made by competing firms. They also show uncertainty towards one another, this is mainly due to the fact the firms are price makers. A government is likely to interfer and interact in an oligopolisitc market if they believe that the firms in the market are abusing their monoplistic power to an extent where the market becomes significantly allocatively ineffecient or if the firms in the market express to much X-inefficiency. Governments are likely to inact many policies through regulation, the breaking up of oligoplists and the encouragement of new firms to join the market; this could be through removing barriers of entry. However, governments may not intervene in the market due to the necessity of said good or service. Products which are not deemed as necessary are likely to be neglected to a later date, after intervention is important goods and services has taken place.

Governments can remove barriers of entry to join a market. This could be by changing the rules required in order to join the market or by decreasing the amount of sunk costs present when joining the market. This could be done by governments ammending rules ie. The qualifications required in order to work as a train driver, or by subsidising new firms which join the market; allowing them to buy the necessary capital equipment to be able to compete with other firms. Removing barriers of entries and exits will result in more firms being able to join or leave the market as a response to supernormal profit or economic loss. If entrepreneurs are able to move from another market into one which is dominated by oligopolists it will result in the control of oligopolist’s activities. This is the case as the market will be more contestable, thus resulting in oligopolists to decrease their price due to the uncertainty in the market. This will result in the firms working towards the point where the Average Revenue (AR) equals the Average Total Cost (ATC). This decrease in price; from P1 to P2, and increase in output; from Q1 to Q2, will result in the firms in the market to work closer to the allocatively efficient point (AR=ATC). However, one problem with making a firm work towards it’s allocatively efficient point is the fact that supernormal profit decreases the more allocatively efficient a firm is (Assuming the productive efficency of a firm remains constant). This will mean that firms will have less money for investment in research and development. This will result in the long-run potential of the firm to decrease alongside the dynamic efficency of the firm. This could result in greater problems with price and output in the future. This leads to the issue on the trade of between static efficiency and dynamic efficiency

Another way governments can prevent the abuse of monopoly power by oligopolistic firms is by breaking them up. The Markets and Competition Committee (MCC) can break up large firms into smaller ones or prevent the merging of firms if they believe it heavily affects the competitiveness of the market. By breaking up an oligopoly into two or more smaller firms the MCC are able to increase the amount of firms present in the market. This will result in the market being less concentrated and thus firms are less able to influence the market significantly as they have a lower percentage of market share. This will result in the firm becoming closer to a competitive market and thus will result in the output and price of the goods and services produced to become nearer to the allocative efficient point. This could also reduce the barriers of entry into the market; as looked at before, this is the case as smaller firms are less likely to be able to decrease their prices to a low level if required to kill of a competitor, in a predatory pricing manner. Thus this will increase the amount of firms in the market and once again making the firm more competitive. However, one of the major issues with breaking up a firm is the fact that the firm may no longer be able to experience economies of scale if broken up. This could be the case as in a natural monopoly where the minimum efficient scale (MES) is to large. This will result in the costs of the firm to increase from P1 to P2. This rise in costs will result in the price of said good or service to increase and thus result in the firm becoming less productively efficient. This could eventually lead to government failure if the price rise due to increased costs of production leads to a higher price then was present when the oligopolies existed.

Another method of government intervention could be by introducing a Regulator. A regulator works with firms monitoring the price and quality standards of a good or service. The regulator then ensures the firms follow a set of targets set out by the regulator and their team. A regulator may regulate prices by setting price caps. These price caps go as “RPI + K – X”, where the price of a good or service follows RPI inflation, the amount of investment required by the firm (K) and the amount of X-inefficiency present in a firm (X). These price caps ensure firms do not exploit their monopoly power by charging excessive prices whilst also ensuring that firms can invest for the future; resulting in dynamic efficiency. Price caps can also encourage firms to be more efficient as a firm may still be able to make supernormal profit or even more supernormal profit if they eliminate X-inefficiency. However, regulators do make mistakes and may deem that a firm is X-inefficient when in fact it isn’t. This can result in firms cutting spending on certain aspects of the firm to match the price cap. This could be the spending on safety investment; this could be a significant issue in some markets such as the train market as it could lead to a greater amount of crashes. Regulators work in a manner to protect the public interest by increasing consumer surpluses. However, many individuals have argued that regulators in many firms have become too friendly with the CEO’s of oligopolies. This has resulted in regulators being lenient with these firms, and thus are not acting in the public’s interest.