Protecting the Consumer.

We have seen in market failure that, left to it’s own devices, the free market can cause outrages to the consumer world. The ability of a monopolised market to set pretty much any price they want(or stagnate their product), the ability of a group of firms teaming together to raise prices, a giant dumping their waste on others farmland can all occur in a dog eat dog world.

Consumer Protection Policy….

Years ago, to improve the way firms behave, industrial policy was taken by government. This has now been advanced to competition policy, which is also seen as another supply side policy. The p0licy to keep firms ticking over nicely is divinded into 3:

  1. Monopoly Policy
  2. Merger Policy
  3. Restrictive Trading Policy


What is defined a monopoly by statute is a 25% market share, and the policy is that when a firm reaches this stage it is investigated by the Office of Fair Trading or Competition Commision.

Such acts as the Competition Act 1980 and the Antitrust Act in the US also shaped such policy. It must see that a domination is in the public interest, before allowing such domination. When the market is contestible this is less of an issue.

  • Pure Monopoly is a 100% market share
  • Weak Monopoly is where the firm, being the industry, has high competition from substitute product producers, usually price elastic.

Why We Allow Some Monopolies…..

Some industries have natural monopolies, where it would be impractical to have two competing firms, due to unneeded costs. Train, water and British Aerospace come to mind, and such firms which were owned by the government have been privatised in the last 30 years.

Regulator: Instead of breaking up such monopolies which could easily breach the public interest, the government regulates them, Ofwat and Ofgem, FSA come to mind. Controls are typically on price, and the consumer can benefit from their economies of scale instead of paying through the ear to drink.

Merger and Restrictive Trading Policy…

We need to define a Restrictive Trading Practice, and it’s name pretty much defines it. It is any act which is anticompetitive and of huge advantage to one. Things such as full line forcing and collusion between giants come under it. RTP are also regulated by the Office of Fair Trading and Competition Commission, and any act which causes a substantial lessening of competition is investigated into.

Merging is regulated by the European Union for two firms which both trade in at least 2 EU economies, which action is brought by the European Commission if it should be investigated.

Delegation: However, if we have two firms in one economy merging, the EU have delegated power to their government to decide what action to take. There is also investigation inot a merger that substantially lessens competition.

Is regulation always good…..

There are many arguments against regulation by free market economists.

Taxpayer Cost: Many preach it is costly, which it arguably is, and as it is run by the government it’s funding comes straight from the taxpayer. Costly, okay, as long as it works than it is fine..right? Well sometimes it is seen to be unnecessary, and imposes extra costs on firms to meet safety checks, such as Health and Safety Executives.

Regulatory Capture: (as has probably occured in the FSA during the credit bubble), The regulator can collude with the firm, thus causing costly regulation to be pointless and of no use to the consumer whom is funding it.

The Paradox of Deregulation: Some even say that more competitive practices would result from de-regulation, that red tape is seen as a barrier to entry(limited profit, safety checks etc deter entrants) and removing it would see a threat of competition, meaning prices etc would be kept in check automatically. This follows contestible market theory.

Lack of Consumer Knowledge..

Often in the past, the consumer has bought something without adequate knowledge of what they are buying and have suffered(an imperfectly competitive market). The government stepped in and said ‘enough’, using mainly statute to put the buyer in a better position.

Akerlof’s Lemons Theory

Assymetric Information: This preaches the harms of what economists call asymmetric information. It says where the seller knows more than the buyer as to what is traded, any good market breaks down, leaving the product traded to be of relatively poor quality.

Example, How it Works: Say we have an ice cream van salesman, the buyer does not know whether it will last another 100000 miles(peach), or only 1000(lemon). The buyer has to guess, and will pay halfway between what he would pay for a good’un and a bad’un.

The seller knows when he is selling a peach, and the mid price offered will be less than the salesman probably bought it for! So he will only sell a ‘lemon’ for what is offered. Eventually, the only thing traded will be ‘lemons’ and the price paid will eventually fall tot his level.

Nobel Prize 2001: George Akerlof was mentioned when explaining animal spirits, and he won a nobel prize for this.

The Buyer Must Know!!

So for many reasons, it is vital for the consumer to be informed pretty much as well as the seller.

The Sale of Goods Act is the major piece of protection. This is part of contract law and you hear Martin Lewis often mentioning it. Main Points:

Goods sold must be…..

  • As Described (s13.1)
  • Fit for Their Purpose(s14.3)
  • Of Satisfactory Quality(s14.2)
  • Sold By The Person With Ownership(s12.1)
  • Not Be Decayed When Contract is Made(s6)
  • Last A Reasonable Time

Enforcing bodies…..who are they and what do they do??

The main ones the government have made are the Office of Fair Trading and the Competition Commission.

Office of Fair Trading: The OFT is a consumer protection body who can represent the little man against the big man in court, where the little consumer will be unable to afford a good enough defence to stand any chance…a recent example is bringing action on behalf of the consumer against banks for giant overdraft charges in 2009.

Competition Commission is like a watchdog, not acting only on behalf of the consumer but also other firms too, if there are any anti-competitive practices. Both look to keep up the competition policy shown above.

The CC is more the investigating body, the OFT is more the enforcing body. Remember there are many more bodies, mainly in the utilities industries. Such examples are Ofwat in water, Ofcom in communications and Ofgem in energy.

Enforcing Policy: If anyone is causing a substantial lessening of competition, the commissions will simply contact the offender and tell them the consequences if they continue. What those are can be an ordering disintegration of a dominant firm/forcing to sell off assets, or serious fines, up to 10% of annual revenue(as happened to the price fixing cigarette firms in 2001-3) and more!

RPI Minus X Pricing

You know the monopoly utilities regulated by Ofwat/Ofcom etc, well this is the most typical control to stop those firms exploiting the consumer.

Inflation: With this, the price of the good can rise no faster than RPI inflation, with a little adjustment accounting for the firm’s cost changes/ behavior.

Leeway for Profit Growth: If the firm’s average costs fall, than the max price adjustment will probably be a near equal fall too, although a little leeway must be there so the firm has an incentive to cut costs. In most cases dynamic efficiency is ordered to serve a price cut. Use RPI-X method of reg in the exam, it helps impress!!!


One Response to Protecting the Consumer.

  1. Pingback: Thinktank « Zahablog's Economic Page

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