Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Competition Policy

Save Save
Print Print
Edit Edit
Sign up to use all features for free. Sign up now
X
Illustration You have already viewed an explanation Register now and access this and thousands of further explanations for free
Economics

Did you know that the two famous supermarkets in the UK, Sainsbury’s and Asda, intended to merge in 2018? This merger was prohibited by the Competition and Markets Authority in 2019 as it would have resulted in reduced competition in the UK grocery store market.1 Want to learn more about why such power to prevent anti-competitive practices is required? Keep reading.

What is competition policy?

Competition policy is a tool that governments use to ensure that businesses play fair when interacting with consumers and each other. The purpose of these regulations is to level the playing field for similar enterprises in a given industry while also prohibiting them from acquiring an unfair advantage over their competitors. Simply put, they prevent companies from harming customers to earn profit.

Competition policy tries to restrain firms and businesses’ anti-competitive behaviour. That way, the government can ensure that consumers will always have different places to buy their goods and services. This helps bring the prices to an optimal level and keep the consumer protected from undesirable effects of anti-competitive practices.

The general principles of the UK competition policy

Competition policy helps nations around the world to ensure that there is no restriction to competition in the market. This is also the case for the UK. Its competition policy is there to prevent any anti-competitive behaviour that firms may exhibit.

The UK has a competition regulator called the Competition and Markets Authority (CMA). Their mission is to investigate the market and assess any merger or acquisition that may take place in the UK. Two main legislative frameworks paved the way for the establishment of the CMA: the Competition Act of 1998 and the Enterprise Act of 2002.

Other authorities that have similar functions to the CMA include Ofcom (communications regulator), Ofgem (gas and electricity regulator), and the Financial Conduct Authority (financial regulator). However, you should note that these authorities are not as broad as the CMA; they do only regulate individual sectors.

The general principles of UK competition policy include making sure that there is no collusion between firms and that no firms are abusing their market power.

Collusion between firms

Collusion occurs when two or more firms that would normally compete against one another team up to acquire an unfair market advantage by working together. These are often firms that don’t have many competitors and that provide the same goods. The colluding parties may decide to jointly affect the supply of an item on the market or agree on a set price level that would allow the partners to maximise their profits at the expense of consumers or other rivals. Investigating collusion in the market is often challenging as companies don’t always disclose these agreements.

Imagine if Apple and Samsung formed a secret agreement to level up their phone prices. As they have most of the market share, consumers would have to pay higher prices.

Market power abuse

Market power is the ability of a certain firm to influence the market prices either by restricting supply or altering the price, thereby affecting demand. An enterprise that has managed to accumulate market power is capable of manipulating the market price. Additionally, such enterprises often provide barriers to other new companies that want to enter the market, therefore, keeping competition limited.

One of the ways you can measure a firm’s market power is by using the Lerner index. The formula for the Lerner index is:

Where P is the price, and MC is the marginal cost. The index has a minimum value of 0 and a maximum value of 1. The firm can charge higher prices when the index is closer to 1.

EU competition policy

The EU’s competition policies are designed to serve similar purposes to those of the UK. Their ultimate goal is to:

  • Guarantee price competition in the market.
  • Work towards increasing the number of choices available to consumers.
  • Promote technological innovation and therefore efficiencies in the market.

There are four main competition policy instruments that the EU uses:

  1. Antitrust rules: these ensure that goods and services are offered at optimal price levels to consumers. They prevent any company from exhibiting anti-competitive behaviour.
  2. Merger rules: although mergers can help the market expand and companies scale up their production, if not monitored carefully, they can be harmful to competition. EU competition policy is there to prevent mergers that undermine competition.
  3. State aid rules: these prohibit companies from receiving state aid, with some exceptions. State aid can provide certain companies with unfair advantages over their competitors. However, if it is proven that the state aid received by a company helps towards the overall economic development, it is permitted.
  4. Cartel rules: the term cartel involves independent companies that join together to either fix prices or limit production so prices increase. EU competition policy has a separate specific antitrust enforcement for cartels.

The European Competition Network is the main body that enforces competitive policies. It is made of the competition authorities of member states as well as the Commission.

Benefits of competition policy

One of the most important benefits is that competition policy provides consumers with more options. Markets are not perfect, they never will be. But one thing they do accomplish is providing consumers with the possibility to choose between various products and services.

Competition policy allows for this by enforcing regulations to ensure that firms compete fairly. This helps to lower costs and enhance quality. The more market participants there are, the better it is for consumers who have more options.

  • Increased product quality: to attract more consumers and grow market share, companies must enhance the quality of the products and services they provide. There are many things that relate to quality. For instance, there can be certain items that last longer or perform better, or a company can simply choose to provide technical assistance to differentiate their products from competitors. Either way, we all benefit from this as companies will always be trying to find ways to stay ahead of the competition by offering better quality products.
  • More options: one of the most obvious benefits of competition policy is that it provides more choices to customers. Firms will constantly be looking to come up with new products that differentiate them from their competitors. This, in turn, provides more options for everyone.
  • Low prices: as competition policy encourages competition amongst many firms, one of the ways firms can survive the competition and capture a larger share of the market is by reducing prices to attract customers. This encourages other firms to lower prices as well so they can still compete in the market.
  • Innovation: when enforced properly, competition policy can push for more innovation. The competitive environment can create a market that fosters new ideas and forces companies to think outside the box to succeed.

Disadvantages of competition policy

Competition policy may bring about a multitude of benefits for consumers and society as a whole, but it also has some disadvantages.

Think about a small business that is on the market: competition will shrink their market share as there will be many enterprises aiming to also acquire their own share in the market.

Another disadvantage of competition policy is that it can create a surplus of goods and services. Inventory builds up when there are too many companies producing the same thing. When inventory levels reach unsustainable levels, companies may find themselves with too much capital invested in things that are just sitting on the shelf and insufficient cash on hand to cover crucial costs like rent or wages.

An example of this is what is called a Flooded Market. Imagine if there was a sudden increase in demand for shoes. All the shoe companies would start producing more and therefore building up their inventories to the point where all the demand would be met and many shoes would be left unsold. This would create a drop in the price of shoes as well as undesired effects such as waste.

Competition Policy - Key takeaways

  • Competition policies are tools at the hands of the government to ensure a competitive market.
  • Competition policies prevent companies from exhibiting anti-competitive behaviours.
  • The main body that enforces competition policies in the UK is the Competition and Markets Authority (CMA).
  • The general principles of UK competition policy include making sure that there is no collusion between firms and that no firms are abusing their market power.
  • There are four main competition policy instruments that the EU uses: antitrust rules, merger rules, state aid rules, and cartel rules.
  • The European Competition Network is the main body that enforces competition policies in the EU. It is made of the competition authorities of member states as well as the Commission.
  • The main benefits of competition policies include increased product quality, more options, low prices, and innovation.
  • The main disadvantages of competition policies include shrinking businesses' market share and surplus of production.

Sources

1. CMA, Anticipated merger between J Sainsbury PLC and Asda Group Ltd, 2019. (Summary of Final Report).

Competition Policy

Competition policy is a tool that nations use to ensure competition in the market.

The purpose of competition policy is to prevent firms from exhibiting anti-competitive behaviour, which harms consumers and other enterprises.

It enables businesses to compete fairly in the market. All businesses have equal access to the market. 

The conclusion of competition policy is to provide optimal prices, better quality products, and more choices to consumers.

Final Competition Policy Quiz

Question

What is competition policy?

Show answer

Answer

Competition policy is a tool that government use to ensure a competitive market.

Show question

Question

What are the two main principles of the UK competition policy? 

Show answer

Answer

The general principles of UK competition policy include making sure that there is no collusion between firms and that no firms are abusing their market power.

Show question

Question

What is the Competition and Market Authority UK?

Show answer

Answer

An independent body from the government, which enforces competition laws in the UK.

Show question

Question

Mention three other regulatory authorities in the UK.

Show answer

Answer

Ofcom (communications), Ofgem (gas and electricity), and the Financial Conduct Authority.

Show question

Question

What is the difference between the CMA and other regulatory authorities in the UK?

Show answer

Answer

Other authorities are not as broad as CMA in their function, they do only regulate individual sectors. 

Show question

Question

What is collusion between firms?

Show answer

Answer

Collusion between firms occurs when two or more firms that would normally compete against one another team up to acquire an unfair market advantage by working together. 

Show question

Question

What is market power?

Show answer

Answer

Market power is the ability of a certain firm to influence the market price either by using supply or demand.

Show question

Question

How do firms abuse their market power?

Show answer

Answer

Enterprises that have a significant amount of market power often provide barriers to other new companies that want to enter the market, therefore, keeping competition limited.

Show question

Question

What is the Lerner index?

Show answer

Answer

The Lerner index measures a firm's market power.

Show question

Question

Assume that Lerner's index is 0.90. What does this mean for the firm's market power?

Show answer

Answer

As 0.90 is very close to 1, this means that the firm has too much market power.

Show question

Question

What are the four main competition policy instruments that the EU uses?

Show answer

Answer

Antitrust rules, merger rules, state aid rules, and cartel rules.

Show question

Question

What is the main EU authority that enforces competition policies?

Show answer

Answer

The European Competition Network is the main body that enforces competitive policies. It is made of the competition authorities of member states as well as the Commission.

Show question

Question

What are the main benefits of competition policy?

Show answer

Answer

The main benefits of competition policies include increased product quality, more options, low prices, and innovation. 

Show question

Question

What are the main disadvantages of competition policy?

Show answer

Answer

The main disadvantages of competition policies include shrinking businesses' market share and surplus of production.

Show question

Question

How do competition policies help increase the quality of products?

Show answer

Answer

In order to attract more consumers and grow market share, companies must enhance the quality of the products and services they provide.

Show question

Question

How do competition policies provide more options for consumers?

Show answer

Answer

Firms will constantly be looking to come up with new products that differentiate them from their competitors.

Show question

Question

How do competition policies help foster innovation?

Show answer

Answer

The competitive environment can create a market that fosters new ideas and forces companies to think outside the box in order to succeed.

Show question

60%

of the users don't pass the Competition Policy quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.