Business and Economic Environment

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Guildhall School of Business and Law
FE4055
Understanding
the Business and Economic
Environment
2020-21
Guildhall School of Business and Law
The Relationship Between
Government and Business
Guildhall School of Business and Law
Government Intervention
in the Market
Markets and the
Role of Government
Guildhall School of Business and Law
Markets and the Role of
Government
• Government intervention and social objectives
• The objective of social efficiency
• marginal social benefits and costs
• MSB > MSC ® produce (or consume) more
• MSC > MSB ® produce (or consume) less
• socially efficient output where MSB = MSC
• Equity
• concepts of fairness
• Trade-offs between equity and efficiency
Guildhall School of Business and Law
Types of Market Failure
• Market power
• lack of social efficiency
• consumer and producer surplus
• consumer surplus
• producer surplus
• total surplus
• deadweight welfare loss under monopoly
• the effect of monopoly
• on producer surplus
• on consumer surplus
• on total surplus
• measuring deadweight welfare loss
Guildhall School of Business and Law
Types of Market Failure
• Externalities
• external benefits and external costs
• external costs of production (MECP)
MSC > MPC: QPC > Q*
• external benefits of production (MEBP)
MSC < MC: QPC < Q*
• external costs of consumption (MECC)
MSB < MB: QPC > Q*
• external benefits of consumption (MEBC)
MSB > MB: QPC < Q*
Guildhall School of Business and Law
Types of Market Failure
• Public goods:
importance of two characteristics
• the degree of rivalry
• to what extent does consumption by one person prevent all
other consumers from enjoying the good?
• the ease of excludability
• how easy is it to prevent non-payers from consuming the good?
Guildhall School of Business and Law
Types of Market Failure
• Different categories of goods
• pure private good
• perfectly rival and excludable
• pure public good
• perfectly non-rival and non-excludable
• impure public goods
• partially non-rival and non-excludable
• common good/resource
• high degree of rivalry but difficult to exclude
• club good
• low degree of rivalry but possible to exclude
Guildhall School of Business and Law
Types of Market Failure
• The efficient level of output for a pure public good
• derivation of the market demand curve
• vertical v. horizontal summation of individual demand curves
• Free-rider problem
• consume the good without paying
• voluntary contributions
• likely to be below a person’s true valuation of the good
• QPC < Q*
Guildhall School of Business and Law
Types of Market Failure
• Ignorance and uncertainty
• asymmetric information
• impact on consumers
• impact on firms
• Immobility of factors and time lags
• Protecting people’s interests
• dependants
• merit goods
Guildhall School of Business and Law
Types of Market Failure
• Immobility of factors and time lags
• Protecting people’s interests
• dependants
• merit goods
Guildhall School of Business and Law
Government Intervention in the
Market
• Taxes and subsidies
• to correct for monopoly
• use of lump-sum taxes plus subsidies
• to correct externalities
• Pigouvian tax/subsidy
• advantages of taxes and subsidies
• can vary the rate according to the size of the market distortion
• long-run incentives
• disadvantages of taxes and subsidies
• infeasible to use different tax and subsidy rates
• lack of knowledge
Guildhall School of Business and Law
Government Intervention in the
Market
• Changes in property rights
• the problem of limited property rights
• extending property rights
• the Coase theorem
• limitations of this solution
• impractical in many situations
• problems of litigation
• questions of equity
Guildhall School of Business and Law
Government Intervention in the
Market
• Laws prohibiting behaviour that imposes
external costs
• advantages of legal restrictions
• disadvantages of legal restrictions
• Regulatory bodies
• regulatory bodies for privatised utilities
• Ofgem, Ofwat, etc
• Competition and Markets Authority
Guildhall School of Business and Law
Government Intervention in the
Market
• Price controls
• high minimum prices
• low maximum prices
• Provision of information
• Direct provision of goods and services
• justification
• public goods
• social justice
• large positive externalities
• dependants
• ignorance
Guildhall School of Business and Law
Firms and Social Responsibility
• Meaning of corporate social responsibility (CSR)
• Types of CSR activities
• environmental activities
• donating money/equipment/employees’ time to charities etc.
• fair and ethical treatment of employees
• fair and ethical treatment of suppliers
Guildhall School of Business and Law
Firms and Social Responsibility
• Some different views of corporate social responsibility
• insider-initiated philanthropy or the classical view
• delegated philanthropy
• interests of different stakeholders
• investors
• customers
• employees
• other stakeholders
• overcoming short-termism view
• The impact of CSR on economic performance
• difficulties in trying to define and measure CSR
• difficulties in trying to measure firms’ performance
• the simultaneous impact of a mix of different motives
Guildhall School of Business and Law
Government and the
Firm
Policies towards Monopolies
and Oligopolies – Competition Policy
Guildhall School of Business and Law
Competition Policy
• Competition, market power and the public interest
• controlling structures or practices?
• Power is not necessarily a bad thing. The question is whether
is is abused.
• The targets of policy
• collusion, restrictive practices
• abuse of monopoly power
• mergers
• UK policy closely follows EU policy
Guildhall School of Business and Law
Competition Policy
• Tackling the abuse of market power: monopoly
policy
• exploitative abuse
• exclusionary abuse
• exclusivity rebates/discounts
• tying
• predatory pricing
• refusal to supply and margin squeeze
• vertical restraints
Guildhall School of Business and Law
Competition Policy
• Growth of market power through M&As: merger
policy
• benefits and costs of mergers
• what is the effect on competition?
• Oligopolistic collusion: restrictive practice policy
• practices that are the target of policy
• horizontal price fixing
• market sharing
• limiting production: e.g. quotas for individual firms
• bid rigging
• information sharing
Guildhall School of Business and Law
Competition Policy in the EU
• EU restrictive practices policy: Article 101 – focus on behaviour
• size of the basic fine depends on
• percentage of relevant sales
• market share of participating firms and geographical area of affected sales
• duration multiplier: length of time firm has engaged in anti-competitive practices
• whether it is guilty of engaging in such practices in the past
• whether it is the ring leader
• fines are capped to 10% of annual turnover
• reductions can be made for a
• Leniency Notice (Types 1A, 1B and 2): reduces size of fine
• or Settlement: 10% reduction if firms accept Commission’s decision
Guildhall School of Business and Law
Competition Policy in the EU
• EU monopoly policy: Article 102 – also focuses on
behaviour
• no minimum market share is specified
• examples of abuses of market power include
• charging ‘high’ prices
• limiting production
• practices can be banned and firms fined
• to continue, investigated business must prove that:
• any efficiencies are the direct result of the exclusionary conduct
• the same efficiencies could not be achieved by the firm being less
anti-competitive
• the efficiencies produced outweigh any of its negative effects
• the conduct does not result in removal of competition in the
market
Guildhall School of Business and Law
Competition Policy in the EU
• EU merger policy: 2004 regulations
• prohibited if they would significantly impede
competition in the EU
• criteria use to assess if the merger is
• large: turnover thresholds
• has an ‘EU dimension’
• notification of a merger followed by preliminary
investigation by the EC (phase 1)
• in some cases a more in-depth investigation is required
(phase 2)
• assessment of the process
Guildhall School of Business and Law
Competition Policy in the UK
• UK competition policy
• current approach based on
• 1998 Competition Act
• Chapter 1 mirrors Article 101
• Chapter 2 mirrors Article 102
• 2002 Enterprise Act
• 2013 Enterprise and Regulatory Reform Act
• Competition and Markets Authority (CMA) established
in 2014 to replace the OFT and the CC
Guildhall School of Business and Law
Competition Policy in the UK
• UK restrictive practices policy
• 1998 Act – fines calculated and implemented in a similar way
to the EU
• penalties up to 10% of a firm’s turnover
• Type A, B and C immunity (corresponding to Type 1A, 1B and 2 in
EU)
• 2002 Act – a criminal offence to engage in cartel agreements
• only two successful prosecutions between 2002 and 2017
• 2013 Act – made legal amendments to try to make it easier to
bring successful prosecutions
• assessing the policy
Guildhall School of Business and Law
Competition Policy in the UK
• UK monopoly policy
• two stage process
• does a firm have a position of dominance?
• does it have a market share ³ 40%?
• problems of defining the market
• are there significant barriers to entry?
• if yes, then do the firm’s practices constitute an abuse of its
position of dominance?
• assessment of the policy
Guildhall School of Business and Law
Competition Policy in the UK
• UK merger policy
• framework set out in 2002 Act
• no requirement for firms to pre-notify the CMA (differs from
EU policy)
• investigation by CMA based on
• turnover test (³ £70m)
• market share test (³ 25%)
• Phase 1 and Phase 2 of the process
• assessment based on ‘substantial lessening of competition’
criteria
• decision
• unconditional clearance of merger
• conditional clearance of merger: firms have to take certain actions
• prohibition of merger
Guildhall School of Business and Law
Competition Policy: Comparative
Assessment
• Assessment of EU and UK policy
• agreement that focus should be on behaviour and its effects rather
than just market structure
• merger policy remains the most controversial area – claims that it is
too lenient
• Specific issues with UK merger policy include
• criteria – broad ‘public interest’ v. ‘substantial lessening of
competition’
• the lack of any requirement for firms to pre-notify authorities
about a proposed merger
• Effects of Brexit on alignment of UK with EU policy
Guildhall School of Business and Law
Policies towards Research & Development
• Importance of R&D to business
• Targets of technology policy
• invention
• innovation
• diffusion
• Technological change and market failure
• R&D free riders
• monopoly power
• duplication
• risk and uncertainty
Guildhall School of Business and Law
Policies towards Research & Development
• Forms of intervention
• the patent system
• public provision
• R&D subsidies
• co-operative R&D
• diffusion policies
• other policies
• Technology policy in the UK and EU
• UK policy
• EU policy
• R&D Scoreboard
Guildhall School of Business and Law
Policies towards Training
• Training and economic performance
• labour productivity
• productivity gap between countries partly depends on
differences in skills
• innovation and change
• importance of adaptability and skills of the workforce
• costs of production
• skills shortages create labour bottlenecks and increase
production costs
Guildhall School of Business and Law
Policies towards Training
• Training and market failure
• potential positive externality
• Under-investment by employees
• imperfect information on impact of training on their
future earnings
• low wages while training: may be difficult to borrow
money
• imperfect competition in employment of trained
workers: may drive wages below trained workers MPP
Guildhall School of Business and Law
Policies towards Training
• Under-investment by employers
• imperfect information on benefits of training
• fear of labour being poached: more of a problem when:
• wages of trained workers are low
• skills are transferable to jobs with other employers
• other firms can see the outcome of training (e.g. through
certification)
Guildhall School of Business and Law
Policies towards Training
• Approaches to training policy
• remove regulations so that firms can pay trainee wage
below MRP
• subsidies for training
• direct provision by the government
• encouraging workers to stay with their employer
• industry-wide training programmes by firms
• Training policies adopted in specific countries
Guildhall School of Business and Law
Policies towards Training in the UK
• UK training policy
• large number of initiatives over the years
• yet relatively poor level of skills in the UK
• qualifications
• NVQs (1991): relatively low return to employee
• Wolf Review (2011)
• Independent Panel on Technical Education (2016)
• institutional bodies
• Education and Skills Funding Agency
Guildhall School of Business and Law
Policies towards Training in the UK
• Apprenticeships in the UK
• earlier schemes
• modern apprenticeships
• Train to Gain
• expanding and reforming apprenticeships
• case for expanding the scheme
• case for reforming the scheme
• relevance of training
• level of training
• short duration of many of the schemes
• methods of assessment
Guildhall School of Business and Law
Policies towards Training in the UK
• Recent reforms
• Trailblazers initiative (2013)
• Institute for Apprenticeships (2017): responsible for
• supporting new Apprenticeship Standards with Trailblazer groups
• developing an maintaining criteria or approval of Apprenticeship
Standards
• accepting or rejecting Apprenticeship Standards submitted by
Trailblazer groups
• advising government on maximum level of funding for each
Standard
• Apprenticeship Levy
• how the scheme works
• impacts of the scheme
Guildhall School of Business and Law
Environmental Policy
• The environment as a resource
• an amenity to be enjoyed
• as a source of primary products e.g. raw materials
• as a place to dump waste
• Conflicts between these different uses
• drilling for shale gas
• burning fossil fuels
Guildhall School of Business and Law
Environmental Policy
• Market failures
• externalities
• MSC ≠ MSB
• the environment as a common resource
• difficult to exclude non-payers and high degree of rivalry in its use
• ignorance
• people may not appreciate the full environmental costs of their
actions
• intergenerational problems
• immediate benefits for present generation vs costs on future
generations
Guildhall School of Business and Law
Environmental Policy
• Problems with policy intervention
• valuing the environment
• financial costs to other users
• revealed preference
• contingency valuation
• other problems
• spatial issues
• temporal issues
• irreversibility issues
Guildhall School of Business and Law
Environmental Policy
• Market-based policy options
• extending private property rights
• charging for the use of the environment
• environmental (‘green’) taxes and subsidies
• Problems with market-based policy options
• identifying socially efficient rate
• demand inelasticity
• redistributive effects
• impact on international competitiveness
• effects on employment
Guildhall School of Business and Law
Environmental Policy
• Non-market-based policies
• command and control (CAC) systems
• technology-based standards
• ambient-based standards
• social-impact standards
• assessing CAC systems
• lack of incentives
• voluntary agreements
• education
Guildhall School of Business and Law
Environmental Policy
• Tradable permits – a CAC and market system
• cap on total volume of pollution
• allocating allowances to individual plants and factories
• ‘grandfathering’
• trading under a cap-and-trade system
• example – the EU Emissions Trading Scheme
• advantages
• how trading can reduce costs
• cheaper than CAC system
• comparison with green taxes/charges
Guildhall School of Business and Law
Environmental Policy
• Environmental policy in the UK
• Climate Change Levy (CCL)
• Climate Change Agreement
• Renewables Obligation (RO)
• Energy Company Obligation (ECO)
• carbon price floor
• Environmental policy in the EU
• EU Environment Action Programme
• Seventh Programme (2014–2020)
• Emissions Trading Scheme
Guildhall School of Business and Law
Transport Policy
• Congestion problems and the impact on society
and business
• The allocation of road space
• demand for road space
• a derived demand
• determinants of demand
• price, income, price of substitutes, price of complements,
tastes/utility
• the price and income elasticities of demand
• supply of road space
• short run
• long run
Guildhall School of Business and Law
Transport Policy
• Social optimum level of road usage
• marginal social benefit
• marginal social cost
• congestion costs: time
• congestion costs: monetary
• environmental costs
• socially efficient level of road usage
• Identifying a socially optimum level of road building
• use of cost–benefit analysis
Guildhall School of Business and Law
Transport Policy
• Policy 1: direct provision
• the road solution
• objective of equity
• congestion may not be solved: may encourage more road use
• environmental impact of new roads
• public transport
• Policy 2: regulation and legislation
• restricting car access
• bus and cycle lanes
• no entry to side streets
• pedestrian-only areas
• parking restrictions
Guildhall School of Business and Law
Transport Policy
• Policy 3: changing market signals
• extending existing taxes
• road pricing
• variable tolls
• area changes / supplementary licences
• London Congestion Charge
• variable electronic road pricing
• Singapore
• subsidising alternative means of transport
Guildhall School of Business and Law
Privatisation and Regulation
• History of privatisation
• forms of privatisation
• Arguments for privatisation
• market forces
• greater competition in the goods market
• greater competition for finance
• accountability to shareholders
• reduced government interference
• financing tax cuts
• increased share ownership
Guildhall School of Business and Law
Privatisation and Regulation
• Arguments against privatisation
• natural monopolies
• the public interest
• externalities
• fairness and social justice
• weak post-privatisation regulation
Guildhall School of Business and Law
Privatisation and Regulation
• Identifying optimum price and output
• Regulation in practice:
• regulatory offices
• the RPI – X formula
• RIIO
• Advantages of UK regulation
• discretionary
• flexible
• both RPI – X and RIIO provide incentives for firms to be efficient
• comparison with US system of regulating profits
Guildhall School of Business and Law
Privatisation and Regulation
• Disadvantages of UK regulation
• RPI – X system
• did not encourage firms to deliver high quality service
• five-year duration period too short
• problem of underestimation or overestimation of scope for
cost reductions
• disincentives of changes to X
• RIIO goes some way to tackling these
• excessive power of regulator?
• alternatively, regulatory capture
• complexity of regulation
Guildhall School of Business and Law
Privatisation and Regulation
• Increasing competition in the privatised industries
• allowing competition where there is no natural
monopoly
• limited extent of true natural monopoly
• allowing access to grids by competitors
• forbidding suppliers to be grid owners
• capping market share of established firms
• competitive franchising to make monopolies contestable
• Is competition effective?
• some move back towards price controls

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