AQA A-level Economics: Competition policy, public ownership, regulation and government failure (7136)

This guide follows the AQA AS and A-level Economics specification (version 1.3, 29 June 2022), first taught from September 2015. It covers three parts of the sub-section called The market mechanism, market failure and government intervention in markets: competition policy (3.1.8.7), public ownership, privatisation, regulation and deregulation (3.1.8.8) and government failure (3.1.8.10). The combined PDF prints the A-level versions as 4.1.8.7, 4.1.8.8 and 4.1.8.10. Every firm, country and number below is invented, for illustration only.

Use it with the revision notes and the practice questions. The course hub is AQA A-level Economics, the printable checklist tracks progress, and the free 10-minute diagnostics show weak spots. For the wider microeconomics context, see the overview of this part of the course.

Outcomes at a glance

Section	What you must be able to do
4.1.8.7	Explain the general principles of UK competition policy, show some awareness of EU competition policy, and weigh the costs and benefits. Detailed competition law is not required.
4.1.8.8	Give arguments for and against public ownership, privatisation, regulation and deregulation, explain regulatory capture, and assess how these have worked in the UK.
4.1.8.10	Explain government failure as misallocation of resources, from inadequate information, conflicting objectives, administrative costs, distortions and unintended consequences.

The specification says real-world applications should be used to evaluate economic models. It also says that, because government failure is possible, intervention will not necessarily improve welfare even when there is market failure. That sentence is the spine of this topic.

Competition policy

Principles. Competition policy aims to protect consumers from the abuse of market power by keeping markets contestable. In the UK the Competition and Markets Authority (CMA) applies the policy. It rests on four ideas.

• Ban agreements that restrict competition, such as price-fixing cartels and market sharing.
• Prevent firms with a dominant position abusing it, for example by predatory pricing or by refusing to supply.
• Review mergers that could substantially reduce competition, and block them or require changes.
• Investigate whole markets that appear not to work well, and require remedies.

EU awareness. EU policy follows the same logic: it bans cartels and abuse of dominance, reviews large mergers with an EU dimension, and also limits state aid to firms, which stops governments distorting competition between member states. You need awareness, not detail.

Penalties and remedies. Fines are capped at a percentage of turnover. Other remedies include forcing a firm to sell part of its business, ordering behaviour changes, and personal sanctions on directors.

Worked example 1: should a merger be allowed?

Two bus operators in Town X may merge. Assume demand is P = 100 − Q (Q in thousand journeys a week, P in £), and that before the merger competition holds price equal to marginal cost (MC) of £60.

Before: Q = 100 − 60 = 40. Consumer surplus = ½ × 40 × 40 = £800 thousand. There is no producer surplus.

After, the merged firm is a monopolist. It claims cost savings that cut MC to £50.

• MR = 100 − 2Q = 50, so Q = 25, and P = 100 − 25 = £75.
• Consumer surplus = ½ × 25 × 25 = £312.5 thousand. Profit = (75 − 50) × 25 = £625 thousand. Total surplus = £937.5 thousand.

Total surplus rises by £137.5 thousand, but consumers lose £487.5 thousand of surplus and pay 25% more (75/60 = 1.25).

Now suppose the savings are only £2 (MC = £58). Q = 21, P = £79, consumer surplus = £220.5 thousand, profit = £441 thousand, total surplus = £661.5 thousand, a fall of £138.5 thousand.

The break-even saving is where total surplus equals £800 thousand. With MC = c, a monopolist sets Q = (100 − c)/2, and total surplus is 1.5 × Q². Setting this equal to 800 gives Q = 23.09 and c = £53.81, so MC must fall by more than £6.19.

Evaluation. The result depends on whose welfare counts. A regulator protecting consumers blocks both cases (price rises either way). One counting total surplus allows the first. Merger decisions also rely on forecasts of cost savings that firms have a reason to overstate.

Costs and benefits of competition policy

Benefits	Costs
Lower prices, more choice and quality for consumers	Enforcement and compliance costs for the state and firms
Deters collusion, so less deadweight loss	Errors: blocking a merger that would have raised efficiency, or missing a harmful one
Keeps markets contestable, supporting innovation	Uncertainty can deter firms from efficient mergers and from growing
Protects smaller rivals and new entrants	Slow cases: harm continues while a case is investigated

Worked example 2: does the fine deter?

A cartel of four firms gains £12 million a year for 3 years, so £36 million. Assume the fine is 10% of one year’s turnover of £150 million, so £15 million, and the chance of being caught is 20%. Expected fine = 0.2 × 15 = £3 million, far below £36 million. Even with certain detection, £15 million is less than the £36 million gain. Deterrence needs a higher chance of detection (for example whistleblower leniency), fines linked to the length of the offence, and personal penalties.

Public ownership and privatisation

Public ownership means the state owns and runs the firm. Privatisation transfers a state-owned enterprise to private owners.

For public ownership	Against public ownership
Natural monopolies (high fixed costs, so competition is wasteful) can be run for social benefit	Weak profit motive can cause X-inefficiency (costs above the minimum)
Positive externalities, merit goods and strategic industries (defence, energy security)	Political interference, and objectives that change with elections
Universal service and equity: loss-making routes can be kept	Soft budget constraint: losses covered by taxpayers, so less pressure to cut costs
Profits go to the public purse	Lack of capital for investment when it competes with schools and hospitals for funds

For privatisation	Against privatisation
Profit motive and shareholder or takeover pressure cut costs	A state monopoly may become a private monopoly and raise prices
Sale raises revenue and removes subsidies	Loss of future profits to the state; assets may be sold too cheaply
Can be combined with competition	Short-termism, and loss-making but socially valuable services dropped
Wider share ownership	Natural monopoly features remain, so regulation is needed

Worked example 3: privatising RailLink

The state-owned RailLink in Country A (illustrative) sells 4.0 million units at £60 with average cost of £50, so profit is £40 million. After privatisation, average cost falls 12% to £44.

• Unregulated: the owner raises price to £66 (up 10%) and sells 3.5 million. Profit = 3.5 × (66 − 44) = £77 million.
• With a price cap at £58 (down 3.3%) volume is 4.1 million. Profit = 4.1 × (58 − 44) = £57.4 million.

The efficiency gain is real in both cases, but who gets it depends on regulation. Unregulated, owners gain and consumers lose. Capped, consumers share the gain.

UK application. The UK privatised many utilities in the 1980s and 1990s and created independent regulators for network industries. To assess the effect on economic performance, compare cost, price, investment, quality and service coverage before and after, and ask how far competition or the regulator, rather than ownership, explains the change.

The sale price also matters. At a discount rate of 6%, £40 million a year forever is worth 40/0.06 = £666.7 million. Selling for £500 million gives away £166.7 million of value to buyers. The simple calculation ignores that the state could itself improve efficiency.

Regulation and deregulation

Regulation is rules set by the state or a regulator, and in the UK includes independent regulators for utilities such as energy, water, telecoms and rail. Tools include price caps, quality standards and service obligations.

A price cap often takes the form of the change in an inflation index minus X, where X is an efficiency target.

Worked example 4: an inflation-minus-X cap

The price starts at £100, X = 2 percentage points, and inflation over five years is 4%, 3%, 5%, 2% and 4%. Permitted rises are 2%, 1%, 3%, 0% and 2%. The price path is 102.00, 103.02, 106.11, 106.11, 108.23. Real prices fell because the rises stayed below inflation.

If the firm really cuts costs by 5% a year but X is only 2, it keeps the extra 3 points. On costs of £80 million that is £2.4 million of windfall profit. The regulator cannot see true costs, which is the information problem.

For regulation	Against regulation
Limits monopoly pricing and protects consumers	Compliance and administrative costs
Corrects externalities, sets safety and quality	Information gap, so caps can be too loose or too tight
Can mimic competition	Tight caps may reduce investment and quality

For deregulation	Against deregulation
Lowers entry barriers and costs, so more competition	Safety, quality and environmental harm
Less red tape, faster innovation	Monopoly power can return
Saves regulator costs	Consumers with poor information are exposed

Regulatory capture occurs when a regulator comes to serve the industry it regulates instead of the public. Causes: reliance on the firms for information, a revolving door of staff between regulator and industry, lobbying, and the fact that firms care intensely while consumers are dispersed. Results: weaker rules, higher prices and barriers to entry that protect incumbents. Safeguards: independent funding, transparency, cooling-off periods for staff and the right of appeal.

Government failure

Government failure occurs when intervention leads to a misallocation of resources, so that welfare is lower than it could be. There are five main sources.

• Inadequate information. Governments cannot know exact costs and benefits.
• Conflicting objectives. Governments want growth, jobs, revenue, equity and votes at once.
• Administrative costs. Running, monitoring and enforcing schemes uses resources.
• Distortions. Intervention can create, not remove, a gap between price and marginal cost.
• Unintended consequences. Responses that the designers did not expect.

Worked example 5: a tax set too high

In Country B (illustrative), the market for good Z has demand (marginal private benefit) P = 90 − Q and marginal private cost P = 10 + Q. Each unit imposes an external cost of £20, so marginal social cost is 30 + Q.

• Unregulated market: Q = 40, P = £50. At 40, social cost is £70, so each unit costs society £20 more than it is worth. Welfare loss = ½ × 20 × 10 = £100.
• Social optimum: 90 − Q = 30 + Q, so Q = 30. A tax of £20 achieves this.
• If the government overestimates the external cost and sets a tax of £40: 90 − Q = 50 + Q gives Q = 20. At 20, benefit is £70 and social cost is £50, so too little is produced. Welfare loss = ½ × 20 × 10 = £100.

The tax creates exactly the same loss as no tax. The cause is inadequate information. Add administrative costs and the intervention is worse than doing nothing.

Unintended consequences. A high tax may drive buyers to illegal supply or cross-border shopping; subsidies may be captured by suppliers through higher prices; protecting a firm from failure encourages risk-taking.

Evaluation. Government failure does not mean the market should be left alone. Compare actual market failure with realistic government failure. Look at the size of each, whether the instrument is flexible, how reversible it is, and how long it takes to work.

Common errors

• Treating competition policy as only about monopolies. It also covers cartels, mergers and market investigations.
• Saying privatisation always raises efficiency. Without competition or regulation it may just raise prices.
• Describing regulatory capture as corruption. It is a pattern of influence and information dependence.
• Stating that government failure means markets work better. It means the state must be judged against realistic alternatives.
• Listing causes without a chain. Link each cause to a misallocation.

Official syllabus

AQA, AS and A-level Economics specification (7135 and 7136), version 1.3, 29 June 2022, first teaching from September 2015: sections 3.1.8.7, 3.1.8.8 and 3.1.8.10 (printed as 4.1.8.7, 4.1.8.8 and 4.1.8.10 in the combined PDF).