Lecture 10 Business and Government'

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Lecture 10 Business and Government.
ECW2731
Managerial Economics
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Weeks 7-8 Competition, market structures and
business decisions
Week 9 Pricing strategies and practices
Week 10 Business and Government.
Weeks 5 - 6 Production and Costs
Managerial Economics
Week 11 Capital budgeting
Weeks 3-4 Demand analysis and estimation
Week. 12 Research question Business and current
economic situation.
Week 2 Basic economics principles demand and
supply.
Week1 Introduction. The nature of managerial
economic decision making
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Objectives/questions
The impact of regulation, deregulation and
taxation policy on decision making,
competitiveness and efficiency.
Reasons for regulation. Regulatory response to
incentive and structural failures.
Anti-Trust Policies.
Problems with regulation
Deregulation debate and practices
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Reading
Read Mansfield, Chapter 19
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The definition and concept of regulation
A specific directive to any intervention in the
economy, either by direct control or by financial
inducements, which may cause individuals or
groups to pursue their interests in ways they
might not have chosen otherwise
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The definition and concept of regulation
The concept includes
Who regulates - Regulating institutions
(governmental bodies)
Instruments for regulation - Direct control or
financial inducement
Affected interest groups - consumers or
subgroups of them producers or subgroups of
them employees and subcontractors to the
industry producers and consumers of substitute
or complementary goods persons and/or
institutions on whom the industry has external
effect (suppliers, providers, etc) those,
involved in regulatory process (politicians,
lobbyists, etc)
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Why do governments regulate
For allocation purposes
For the correction of competitive imperfections
To correct the failure of markets to efficiently
use all resources
For the correction of the distribution of wealth
To ensure that the forces of competition
stimulate companies, in each market, to respond
to consumer wants and needs and to produce at the
least cost
Where the government uses and/or controls the use
of resources, they apply them to the users that
achieve the greatest value of satisfaction or the
fixed value but at the least cost
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What do governments regulate
Structure, conduct an performance of the industry
Consumer safety, property rights
Foreign investment and foreign ownership
involvement in national economy
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Theories of regulation
Towards classification of theories
Normative theories
Positive theories
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Theories of regulation
Towards classification of theories
Positive theories Answer the question How
does regulation work The role of regulation
policies in advantaging of different sectoral
groups
Normative theories Answer the question What
and how to regulate Approaches to and methods
for the correction of market failure
Public interest theory
The Pareto Principle
The problem of second best
Capture theories
Stiglers theory
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Theories of regulation
Normative theories
The Pareto Principle
The goal of regulation is maximum welfare of the
society
Societys resources will be used efficiently if
the result is maximum welfare.

• What is welfare?
• How to measure welfare?
• How to allocate welfare among the members of
  society?

The Pareto Principle Welfare is at maximum when
no change in the way resources are used of goods
and services are distributed can make anybody
better off without reducing welfare at least of
one person
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Theories of regulation
Normative theories
The Pareto Principle
The Pareto Principle is fulfilled if

• For each pair of goods and any pair of consumers
  MRSxy(Consumer
  A) MRSxy(Consumer B) MRSxy(Consumer C)
• MRSxyPx/Py
• MRTSKLPK/PL,
• and all producers operate at PMC

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Theories of regulation
Normative theories
The Pareto Principle
and if

• No public goods (Only the market mechanism can't
  determine the amount to be produced)
• No externalities
• No declining cost industries (Natural Monopolies)

The regulation is necessary to compensate
non-fulfilment of last three assumptions
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Theories of regulation
The problem of second best
Normative theories
The theory that neglects usefulness of any
normative approach ln the real life at least
one of Paretian conditions is not
fulfilled. Therefore the best solution -
Paretian optimum is impossible and should be
replaced with a second best one. However, there
are no any rules a normative theory for the
selection of second best and therefore The
science of making a regulatory decision is
replaced with art of politics, which can be
explained only by positive theories.
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Theories of regulation
Positive theories
Attempt to explain the nature and mechanisms of
regulation Based on multi-disciplinary
studies Include elements of economics, political
science, sociology and social psychology
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Theories of regulation
Public interest theory
Positive theories
The regulation is necessary to compensate
inequitable and/or allocatively inefficient
market outcomes to protect public interest
public interest consumer interest, employment
maintenance,
infrastructure maintenance, etc
The reason of failure of regulatory measures -
mismanagement
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Theories of regulation
Capture theories
Positive theories
The deficiency of public interest theory it
ignores differences in the interests of different
groups of the society (consumers, producers,
policy makers, etc).
Life-cycle theories
Private interest theories
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Theories of regulation
Capture theories
Positive theories
Life-cycle theories
Regulation intended to serve a particular public
interest. However, the groups of regulated
industries become able to affect their regulators
(governmental regulatory bodies)
or
Regulation was imposed by a majority political
group to serve public interest. However,
overtime it becomes serving the interest of the
supporters of that political group.
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Theories of regulation
Capture theories
Positive theories
Private interest theories
Stiglers theory
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Theories of regulation
Stiglers theory
Positive theories
Main ideas The regulation serves industry not
public interest A regulated industry is a
state-sanctioned cartel
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Theories of regulation
Stiglers theory
Positive theories
The Demand for Regulation

• Barriers to entry
• A direct subsidy
• State regulation affecting substitutes and
  complements
• State price fixing

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Theories of regulation
Stiglers theory
Positive theories
Supply costs

• Non-profit-maximising form of delivery.
  Equalisation of advantages from regulation
• The very cost of the bureaucracy of regulation
• The distribution of advantages outside the
  industry

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Regulation Australian context
Introduction to regulatory decision making
institutions and processes
A simple picture
Electorate
Pressure groups
Policy implementation feedback
Political parties
Parliament/cabinet
Public service
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Regulation Australian context
Introduction to regulatory decision making
institutions and processes
Public service The major policy departments
The Department of Treasury
The Department of Prime Minister and Cabinet
Departments regulating Industries, Technologies
and Regional Development
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Regulation Australian context
Introduction to regulatory decision making
institutions and processes
Public service The major policy departments
The Department of Treasury - economic adviser and
financial controller

• economic fiscal and monetary policy
• taxation
• prices
• superannuation, insurance
• borrowing money and public credit of the
  Commonwealth
• banking
• currency and foreign exchange
• investment in Australia

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Regulation Australian context
Introduction to regulatory decision making
institutions and processes
Public service The major policy departments
The Department of Prime Minister and Cabinet -
the primary source of policy advice to the Prime
Minister

• Assisting in the development of policy proposals
  for cabinet consideration
• Advising the Prime Minister on Business before
  cabinet and on major policy development and
  matters of domestic and international concern
• Preparing replies to the Prime Ministers
  correspondence

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Regulation Australian context
Introduction to regulatory decision making
institutions and processes
Public service The major policy departments
Department regulating Industries, Technologies
and Regional Development

• Liaison with commercial and industrial groups
• Advice to the Government on policy for the
  Development of Australian manufacturing,
  commerce, the small business sector and regional
  development
• Monitoring industrial environment
• Administering customs and tariff legislation

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Regulation Australian context
Introduction to regulatory decision making
institutions and processes
Public service The major policy departments
The Department of Primary Industries and Energy

• Agriculture
• Forestry
• Fishing
• Mineral resources

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Regulation Australian context
Development of trade practices legislation
Australia
Historically, developments of trade practices
legislation in any country has followed new
developments in economic systems which restricted
fair competition
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Regulation Australian context
Development of trade practices legislation
Australia
Australian Industries Preservation Act 1906

• Basically - antitrust legislation, similar to
  the American
• Reflected developments in monopolisation of that
  time

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Regulation Australian context
Development of trade practices legislation
Australia
Development of trade practices legislation
Australia
Australian Industries Preservation Act 1906

• Basically - antitrust legislation, similar to
  the American
• Reflected developments in monopolisation of that
  time

Trade Practices Act 1965
Antitrust legislation against Supply
restriction Predatory price cutting Using the
position of dominance to fix prices or other
terms of trade
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Regulation Australian context
Current legislation
Further development of the 1965
Act Collusions Boycotts Misuse of market
power Exclusive dealing Resale price
maintenance Anti-competitive price
discrimination Merges
Trade Practices Act 1974
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Deregulation and privatisation theory and forms.
Decrease in internal costs
Why to reform what is expected to be achieved?
Optimising the scale of production
Developing competitive initiatives
Direct enforcement
Establishing a government business enterprise
How to reform methods and approaches used
Corporatisation
Sales and tenders
Variety of "populist' approaches
Shock therapy versus gradual changes
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Why to reform what is expected to be achieved?
A regulation is efficient if the overall social
and/or economic effect of regulation exceeds the
costs of regulation
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The costs of regulation include
Why to reform what is expected to be achieved?

• The costs of employing the regulators
  (governmental bodies)
• The cost of additional information
  (questionnaires)
• The cost to firms in complying with regulations
  (environment protection)
• The cost to firms in not pursuing opportunities
  which might be open to them (participation in
  multi-media development)

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For better regulation no matter how
inefficient regulation is, there are certain
reasons why it should be maintained and,
therefore, improved to raise the efficiency
Why to reform what is expected to be achieved?
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The reasons why regulation is necessary and,
therefore, should be improved
Why to reform what is expected to be achieved?

• Consumer protection
• Environment protection
• The protection of competition (against
  monopolisation)
• Prevention of waste as the result of excessive
  competition - when natural monopolies are
  natural ones (newsagents in each area - are they
  natural monopolists?)
• Correction of inequities in income distribution
  (the cross-subsidisation of prices and various
  concessions)

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For deregulation Regulation is substantially
inefficient. Therefore, the policy of
deregulation should be conducted were it is
possible
Why to reform what is expected to be achieved?
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Why regulation is inefficient
Why to reform what is expected to be achieved?

• Barriers to competition (proscription drugs in
  Australia)
• Hidden costs (tariffs on inputs)
• Exclusion of or restrictions on new products
  (margarine in Victoria some decades ago)
• Delay in the introduction of new technologies
  (always, when an approval is required by law)
• Effects contrary to intended objective (regulated
  natural monopolies become cost inefficient and,
  therefore, prices increase instead of being
  maintaining at a lower level)

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Why to reform what is expected to be achieved?
Arguments for privatisation

• to develop profit-maximisation initiatives
• to make a privatised industry more
  competitive/efficient
• to reduces costs/prices
• to avoid over-investment and creation of excess
  capacities
• to test the activity of a firm by market forces

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Why to reform what is expected to be achieved?
Arguments for against privatisation

• Is it possible to promote competition within a
  natural monopoly structure?
• is it possible to make a privatised industry
  more competitive/efficient or to reduce
  prices/costs if the AC curve is sloping
  downwards?
• It is unreasonable to replace a public monopoly
  with a private monopoly.
• it is necessary to take into account all the
  costs of privatisation.
• The government gives up the revenue of government
  owned enterprise and therefore increases in the
  burden of taxation.

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Why to reform what is expected to be achieved?
Decrease in internal costs
Firm
LMC
Industry
Price
LAC
P1
P1
S1
P2

P2
Quantity
S2
Quantity
q2
q1
Q1
Q2
Desirable results Decrease in costs/increase in
productivity Decrease in price.
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Why to reform what is expected to be achieved?
Decrease in internal costs
Firm
LMC
Industry
Price
LAC
P1
P1
S1
P2

P2
Quantity
S2
Quantity
q2
q1
Q1
Q2
Undesirable short run consequences Decrease in
costs and increase in productivity - decrease in
employment - decrease in demand for factors.
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Why to reform what is expected to be achieved?
Optimising the scale of production

• The case of a small economy
• Optimal scale of production can be
• above the internal market capacity and/or
• above export ability of the country and/or
• contradict anti-trust legislation

but
Regulatory measures can cause unreasonable
fragmentation (spatial Restrictions or special
treatment of small business) Example blocking
QUATNAS-Air New Zealand merger
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Why to reform what is expected to be achieved?
Optimising the scale of production
Deregulation and/or privatisation Lifts
restrictions on merges/taking over - increase
towards optimal scale of production Disintegrates
monopolies - decrease towards optimal scale of
production
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Why to reform what is expected to be achieved?
Developing competitive initiatives
The expectation of Increase in quality and
progressiveness and/or increase in product
variety and/or decrease in price
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How to reform methods and approaches used
Direct enforcement
Direct enforcement - direct implementation of
reform by a governmental body with regard to an
official or private institution without
involvement of market forces
Earlier stages of deregulation of SEC Reforms in
industrial relations, taxation, Restrictive trade
practices legislation, etc
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How to reform methods and approaches used
Establishing a government business enterprise
A government owned firm which attempts to cover
the bulk of their expenses by sales of goods and
services to the general public - commercialisatio
n without changing ownership
Transition from a governmental body to a
government business enterprise attempting to
break even, whereas a general governmental
body provides a subsidised good or service
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How to reform methods and approaches used
Establishing a government business enterprise
Government Business Enterprises
Public trading enterprises
Australia Post The Water Board/ (later broken in
several regional monopolies) The Successors of
SEC before privatisation
Public financial enterprises
Former state banks
Statutory Marketing Authorities
The Australian Wheat Board
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How to reform methods and approaches used
Establishing a government business enterprise
Government Business Enterprises
Established as government business enterprises
Nationalised private enterprises
Commercialised governmental authorities
Telecom
British coal mines
The Successors of SEC (before privatisation)
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How to reform methods and approaches used
Establishing a government business enterprise
O B J E C T I V E S
To increase in efficiency and competitiveness,
where a more comprehensive reform is not
reasonable
Natural monopolies/ Public utilities Access
prising Externalities Defence
Commercialised governmental authorities
As an interim stage of a more comprehensive
reform
SEC
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How to reform methods and approaches used
Corporatisation
A government business enterprise which is being
transformed into a listed corporation however,
the majority of shares is owned by the government
Telstra (Mixed 51 Government owned)
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How to reform methods and approaches used
Sales and tenders
The next stage after corporatisation - the
government surrender control over the enterprise
Sale - to anybody who buys Tender -
competition of projects
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Deregulation Australian context
Hilmer report 1993
Further development of the 1974
Act and recognition of the necessity for some
other governmental policies and actions apart
from legal enforcement. Not only to forbid
something (passive policy), but Also to
undertake something (active policy)
Justification of reforms
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Recent developments in competition policy
Hilmer report 1993
National competition policy
Limiting Anticompetitive conduct of firms
Improvements of the 1974 Act
Reforming regulations which restricts competition
Telecommunications, aviation
Reforming the structure of natural monopolies
Electricity generation, etc
Third party access
Telecommunication
Restraining monopoly pricing behaviour and access
prising
Establishment of special authorities
Competition between government owned private
business
From governmental authority to official business
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Deregulation the Australian context
Hilmer report 1993
Limiting Anticompetitive conduct of firms
Improvements of the 1974 Act
To reconsider exemptions To remove distinctions
between goods and services (against collusions
in services)
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Regulatory restriction on competition should not
exceed what is required for public interest
Deregulation the Australian context
Hilmer report 1993
Reforming regulations which restricts competition

• Any restriction on competition must be clearly
  demonstrated to be in the public interest
• New proposals on the restriction of competition
  should be a subject of increased public scrutiny
  and, if are adopted, should be reconsidered in
  not more than 5 years
• Reviewing all existing regulations if they are
  not lifted, then they should be reconsidered in
  not more than 5 years
• Any review should be undertaken from the whole
  economy not a particular industry perspective.
• Questions
• Who undertakes review?
• What is "public interest"?

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Deregulation the Australian context
Hilmer report 1993
Third party access

• Tendering licenses (in the area of public
  utilities),
• where
• Increase in competitiveness is desirable but
• Excessive fragmentation is inefficient.
• So far, requires an additional regulatory body
• AUSTEL
• Regulator General

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Establishment of Australian competition
commission to administer relevant aspects of the
competition policy (Later it had become the
ACCC)
Deregulation the Australian context
Hilmer report 1993
Restraining monopoly pricing

• enforcement of rules
• administration of the prices oversight mechanism
• regulation review etc

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Deregulation the Australian context
Hilmer report 1993
Competition between government owned private
business
From governmental authority to official business
Equalisation of systems of taxation of the
private corporate sector and official
business. Necessary but not sufficient. The
case of the power industry deregulation across
different states in Australia.
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Privatisation of natural monopoly
Natural monopolies

• The nature of the industry is very high level of
  costs and sloping downwards AC curve, so that
  there is no an optimal scale of production.

Cost
AC1
AC
Q
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Privatisation of natural monopoly
Natural monopolies

• The nature of the industry is very high level of
  costs and sloping downwards AC curve, so that
  there is no an optimal scale of production.
• Or the optimal scale of production is beyond the
  capacity of the market.

D
Cost
AC
Q
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Privatisation of natural monopoly
Natural monopolies

• To break the firm into small ones if the natural
  monopoly component can be extracted
• to impose a regulation - against excessive
  profit
• to establish a GBE

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Privatisation of natural monopoly
Natural monopolies

• To break the firm into small ones if the natural
  monopoly component can be extracted

The Deregulation of Electricity Generation
Industry in Victoria
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
Deregulation horizontal disaggregation
Privatisation
Deregulation vertical disaggregation
Privatisation
Deregulation horizontal disaggregation
THE STAGES OF DEREGULATION AND PRIVATISATION OF
POWER INDUSTRY IN VICTORIA
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
Deregulation vertical disaggregation
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
P, Cost
P, Cost
MC
AC0
AC0
AC1
AC1
P1
P0
P0
D
D
MR
Q
Q
Qo
Qo
Q1
The aim and the result of reform is increasing
incentive to improve internal efficiency. The
price is still controlled by the government. As
the result of decreasing average cost, the
revenue is increasing, whereas the output remains
unchanged.
The aim and the result of reform is increasing
incentive to improve internal efficiency and the
deregulation of price. The structure of the
industry remains monopolistic. The revenue of the
firm is affected by increasing price, decreasing
average cost and decreasing output.
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
Deregulation horizontal disaggregation
Deregulation vertical disaggregation
Deregulation horizontal disaggregation
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
Price, Cost
Quantity
A. The average cost of the official monopoly
is one of possible combinations of the average
costs corresponding to each of the units
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
P
Quantity
B. The average of cost of brake-even combinations
of the units outputs at a given price.
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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria

• Type of competition as the result of
  disintegration
• "war"
• price leadership
• repeated game strategy
• collusion

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Privatisation of natural monopoly
The Deregulation of Electricity Generation
Industry in Victoria
Price, Cost
1 - common marginal cost 2 - average cost of the
first firm 3 - average cost of the optimal
combination of firms' output 4 - average cost of
the second firm 5 - demand curve.
Pe
1 2 3 4
P
5
Quantity
Qe