OxfordAQA International AS and A-level Economics: Competition policy, regulation (9640) – Revision Notes

These notes condense sections 3.3.3.11 and 3.3.3.12 of the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. Section 3.3 forms part of the extra International A2 content. For full explanations and worked examples, read the study guide. Then test yourself with the practice questions. Course links: hub, checklist and free diagnostics. All figures below are invented.

Definitions

Term	Meaning
Competition policy	Government action to prevent firms using market power against consumers or rivals
Abuse of dominant position	Conduct such as predatory pricing, exclusive dealing, tying or refusal to supply
Horizontal merger	Joins firms at the same stage of the same market
Vertical merger	Joins firms at different stages of one supply chain
Conglomerate merger	Joins firms in unrelated markets
Restrictive practice	An agreement or conduct that limits competition (price fixing, market sharing, bid rigging)
Cartel	A group of firms cooperating to fix price or output
Natural monopoly	A market where one firm has the lowest long-run average cost because fixed costs are very large
Price cap	A limit on the average price rise: inflation minus X
Rate-of-return control	A limit on profit as a share of capital employed
Public ownership	State ownership of firms or industries
Privatisation	Moving state-owned assets into private ownership by sale
Regulation	Rules enforced by an authority on price, quality, entry or conduct
Deregulation	Removal or loosening of those rules
Regulatory capture	A regulator ends up serving the industry it oversees, not the public

Formulas and calculations

Item	Method
n-firm concentration ratio	Sum the shares of the n largest sellers
Price cap	Allowed % change in price = inflation % minus X
Next price	Old price × (1 + allowed change / 100)
Allowed profit (rate of return)	Capital employed × allowed rate
Cartel deterrence	Expected fine = probability of detection × fine; compare with total gain
Fine needed to deter	Total gain / probability of detection
Sale multiple	Sale price / annual profit
Real change	(1 + nominal change) / (1 + general inflation) − 1

Reminder: price cap

Price 80, inflation 4.0%, X = 1.5. Allowed change = 4.0 − 1.5 = 2.5%. New price = 80 × 1.025 = 82.00.

Reminder: merger screen

Shares are 32, 24, 16, 12, 9 and 7. Four-firm ratio = 32 + 24 + 16 + 12 = 84%. If the firms with 12% and 9% merge, shares become 32, 24, 21, 16 and 7. The four-firm ratio is 32 + 24 + 21 + 16 = 93%.

Method in steps

Judge a merger

1. Identify the type and the market shares.
2. Find the change in concentration and whether the market is contestable.
3. Weigh cost savings and likely pass-through against less rivalry.
4. Consider conditions (for example selling assets to a new entrant).
5. Conclude and say what evidence would change your view.

Evaluate a privatisation

1. State the efficiency argument: profit incentive, private capital.
2. Check the market structure: is there competition, or a private monopoly?
3. Compare the sale price with the future income given up.
4. Consider the regulatory regime needed afterwards.
5. Conclude in the context of the industry.

Evaluate a regulatory tool

1. Say what the tool controls (price, profit, entry, quality).
2. Give the incentive effect on costs.
3. Give the information problem facing the regulator.
4. Say who gains and who loses, and add the risk of capture.

Competition policy at a glance

Tool	Benefit	Limitation or cost
Ban on abuse of dominance	Protects rivals and consumers	Proof of intent and cost is hard
Merger control	Prevents loss of rivalry	Blocks possible efficiency gains; forecasts are uncertain
Ban on cartels	Cuts price fixing	Secret conduct; low detection
Entry-barrier reduction	Raises contestability	Natural barriers remain
Price cap	Cuts price; rewards efficiency	Quality may fall; X is hard to set
Rate-of-return control	Limits profit	Over-investment; weak cost incentive

Costs of policy in general: running the authority, legal costs for firms, delays, mistaken decisions in both directions and loss of economies of scale.

Public ownership and privatisation

	For	Against
Public ownership	Natural monopolies; merit goods; strategic industries; long-term view	Weak cost incentive; political aims; taxpayer losses; poor information
Privatisation	Profit incentive; private capital; sale revenue; competition possible	Private monopoly; cheap sale; lost income; loss of unprofitable services

Key link: whether privatisation works depends mainly on whether competition or good regulation follows it.

Regulation, deregulation and capture

	For	Against
Regulation	Protects consumers; handles information gaps; controls natural monopoly	Compliance cost; slow; information gap
Deregulation	Entry; lower prices; choice; fewer costs	Safety and quality; exploitation; short-term risk

Capture: causes are information dependence, lobbying, and staff moving between regulator and firm. Effects are lenient caps and protected incumbents. Remedies are staff rotation, published evidence and independent appeals.

More worked reminders

Reminder: cartel and fine

A cartel earns an extra 15m a year for 3 years, so the gain is 15 × 3 = 45m. With detection probability 0.2 and a fine of 30m, the expected fine is 0.2 × 30 = 6m, far below 45m, so the cartel remains worthwhile. Deterrence needs a fine of 45 / 0.2 = 225m.

Reminder: pricing a natural monopoly

With demand P = 20 − 0.1Q, fixed cost 400 and marginal cost 4, three outcomes arise.

Pricing rule	Quantity	Price	Profit
Unregulated (MR = MC)	80	12.00	240
Marginal cost (P = MC)	160	4.00	-400 (needs subsidy)
Average cost (P = AC)	about 129	about 7.10	0

The regulator chooses between efficiency (marginal cost pricing) and financial viability (average cost pricing).

Chains of reasoning

Why a price cap can improve efficiency: cap limits the price, so the firm can raise profit only by cutting costs; lower cost lets it keep more profit; the regulator later resets X, so the gain is shared with consumers.

Why a price cap can backfire: X set too tight, so profit is squeezed; firm cuts quality or investment; service worsens over time; consumers lose despite a low price.

Why privatisation may disappoint: state monopoly becomes private monopoly; no rivals, so no pressure on cost; price rises unless a regulator intervenes; the regulator may be captured.

Why deregulation may help: entry barriers fall; new firms compete on price; incumbents cut costs; price falls and choice rises, provided safety and quality can still be checked.

Why capture matters: the regulator relies on the firm for data; the firm lobbies; decisions favour the firm; prices stay high; the case for regulation weakens, so evaluation should ask how independent the regulator is.

Quick self-test

1. Define regulatory capture.
2. A utility’s price is 60. Inflation is 5.0% and X is 3. What is the new price?
3. Capital employed is 250m and the allowed rate of return is 6%. What is allowed profit?
4. Shares are 30, 26, 17, 11, 9 and 7. The firms with 11% and 9% merge. What is the new four-firm ratio?
5. A cartel’s fine is 5% of turnover of 80m. What is the fine?
6. Name two abuses of a dominant position.
7. A nominal price rises 6% while general prices rise 4%. What is the real change, to one decimal place?
8. A state firm earning 25m a year is sold for 400m. What is the sale multiple?
9. Why can rate-of-return control raise costs?
10. A fare falls from 8.00 to 6.80. What is the percentage change?

Answers

1. The regulator serves the interests of the industry it oversees instead of the public.
2. Allowed change = 5.0 − 3 = 2.0%; 60 × 1.02 = 61.20.
3. 250 × 0.06 = 15m.
4. New shares 30, 26, 20, 17, 7; four-firm ratio = 30 + 26 + 20 + 17 = 93%.
5. 0.05 × 80 = 4m.
6. Any two of predatory pricing, exclusive dealing, tying, refusal to supply.
7. 1.06 / 1.04 − 1 = 0.0192, so +1.9%.
8. 400 / 25 = 16.
9. Allowed profit rises with capital, so the firm gains by over-investing, and cutting costs earns it nothing extra.
10. (6.80 − 8.00) / 8.00 = −15%.

Examiner insights

• Answers gain credit for applying the tool to the case given, not for naming every tool.
• A one-sided list of advantages and disadvantages rarely shows judgement; say which effect is bigger and when.
• Set calculations out line by line, so a slip in the last step does not hide sound working.
• Distinguish a limit on the average price rise from a fixed price.

Where marks are usually lost

• Treating size as the offence, rather than abuse.
• Stating that privatisation always lowers price.
• Omitting to compare the sale price with income given up.
• Confusing a price cap (incentive to cut costs) with rate-of-return control (incentive to over-invest).
• Describing capture without naming who benefits.
• Merger answers that ignore pass-through of cost savings.
• Calculating a percentage change from the wrong base.
• Conclusions that repeat points and judge nothing.

Official syllabus

OxfordAQA International AS and A-level Economics (9640) Specification, version 1.2, OxfordAQA. First teaching September 2020; International AS exams from May/June 2021; International A-level exams from May/June 2022.