Government Intervention and Market Failure

Government intervention may seek to correct for the distortions created by market failure and to improve the efficiency in the way that markets operate

• Pollution taxes to correct for externalities
  
• Taxation of monopoly profits (the Windfall Tax)
  
• Regulation of oligopolies/cartel behaviour
  
• Direct provision of public goods (defence)
  
• Policies to introduce competition into markets (de-regulation)
  
• Price controls for the recently privatised utilities

For further information refer to:
http://www.tutor2u.net/economics/content/topics/marketfail/market_failure.htm

Monopoly Resulting in Market Failure

When monopoly firms charge a single price, the price exceeds marginal cost. Hence, there are mutually beneficial transactions not consummated in the market. That is, there are potential transaction for which the demand price exceeds the marginal cost of production. These foregone transactions are both socially and privately bad.

A separate problem, which is not, a “market failure” in the efficiency sense of the term is simply that prices are high. This is a distributional issue, but it’s potentially an important one. Policymakers tend to care when resources are transferred from consumers to producers. Any firm with market power, if it employs a single price, will cause some deadweight loss. This problem is somewhat offset, by the variety benefits associated with the firm’s differentiated product. When a monopolist can keep other firms out of the market, monopoly can have important dynamic efficiency consequences. The biggest concern is that a firm that controls a market may prevent new, and better, technologies from emerging and taking hold.

What strategies can firms employ to correct the inefficiency associated with monopoly?

The simplest solution to the problem is for firms to price discriminate, charging different consumers different prices according to their willingness to pay.

Reference:
http://rider.wharton.upenn.edu/~waldfogj/Q&A_Session_6.pdf

Essential Facilities

The concept of essential facilities is important to the application of competition law in the telecommunications sector. In the sector, an essential facility is generally defined as one which has the following characteristics:

• It is supplied on a monopoly basis or is subject to some degree of monopoly control
  
• It is required by competitors (e.g. interconnecting operators) in order to compete
  
• It cannot be practically duplicated by competitors for technical or economic reasons.

Definitions of essential facilities have been developed by a number of national regulations and multilateral agencies. See Box 1-4 for a sample. 

Box 1-4:

Essential Facilities – WTO Definition

Essential facilities mean facilities of a public telecommunications transport network or service that: are exclusively or predominately provided by a single or limited number of suppliers cannot feasibly be economically or technically substituted in order to provide a service

The complete WTO Regulation Reference Paper is reproduced in Appendix A. The Reference Paper indicates when and how signatory countries must ensure that essential facilities are provided to competitors.

The phrase bottleneck facility is sometimes used as a synonym for essential facility. However, the term "bottleneck" puts the emphasis on the facility being a necessary part of a communications link, the supply of which is restricted, rather than on the ability of competitors to replicate the facility.

Common examples of essential facilities are network access lines (local loops) and local exchange switching. Local loops are the circuits between a customer's premises and the first "node" or exchange which connects the customer with the PSTN. It can be seen that in many countries, local loops fall within the definition of essential facilities because they are:

1. required by competitors in order to compete for the business of end customers
   
2. predominantly supplied by the incumbent
   
3. technically or economically difficult to substitute, at least on a widespread basis

A telecommunications operator that controls an essential facility often has both the incentive and the means to limit access to the facility by competitors. It becomes a matter of public interest to ensure that essential facilities are available to competitors on reasonable terms. Without such access, competition will suffer, and the sector will operate less efficiently than it could.

Consider, for example, how much more efficient it is to have a variety of different ISPs, international operators and other telecommunications service providers use the same network access lines and local switches to reach subscribers in a locality. This is far more efficient than having each operator construct network access lines to serve the same locality.

The determination of which telecommunications network resources constitute essential facilities has great practical importance. Too narrow a definition can impede competition by preventing competitors from being able to obtain necessary network components on appropriate terms. Too broad a definition can stimulate uneconomic entry or provide insufficient incentives for competitors to invest in and develop alternative network infrastructure.

Various approaches to defining essential facilities are discussed in later chapter of this course. That section considers which facilities an incumbent operator should be required to unbundled and provide to competitors, the balance of this course illustrates the use of the concept of essential facilities in competition policy as it applies to the telecommunications sector.