Chapter 24
Teacher: Mehnaz Khan
Government Intervention in the Economy
Introduction to Externalities
•Externalities occur when economic activity impacts third parties not directly involved in the
activity.
•These can be negative or positive.
Negative Externalities (External Costs)
•Example: A business clears 200 hectares of rainforest to raise cattle.
• Results in loss of biodiversity and destruction of habitats.
• This environmental degradation is a negative externality.
Both production and consumption can lead to external costs. Positive Externalities
(External Benefits)
•Example: A business starts a recycling operation.
• Reduces environmental harm.
• Increases the reuse of resources.
• Benefits society and the economy as a whole.
Government Measures to Address Externalities
•Governments intervene to reduce external costs and promote
external benefits.
•Common tools include:
• Taxes
• Subsidies
• Fines
• Regulations
• Pollution permits
Government Actions to Promote Competition
1. Encouraging the Growth of Small Firms
•Why it matters: More small firms mean more competition, innovation, and consumer
choice.
•How it's done:
• Governments (both central and local) may provide start-up schemes to help fund
new businesses.
• They also offer advice and information on business management and finance.
• Lower taxes are often applied to small firms to reduce their financial burden.
2. Lowering Barriers to Entry
•What are barriers to entry? Legal or financial obstacles that make it hard for new firms to
enter a market.
•Government intervention: By reducing or removing these barriers, governments can open
up markets to more firms.
•Example: In the UK, local authorities used to control bus services. After the law changed,
private operators like Stagecoach were able to enter the market, increasing competition.
3. Introducing Anti-Competitive Legislation
Governments around the world create laws and regulations to stop businesses from reducing
market competition.
Example: India
•Regulatory Body: Competition Commission of India (CCI)
•CCI's main functions:
• Eliminate practices that reduce competition
• Promote and sustain competition
• Protect consumers
• Ensure freedom of trade
These regulations help ensure that markets remain open and competitive, and that consumers
are not exploited by dominant firms.
Limiting Monopoly Power
Why this matters
•Monopolies (where one firm dominates a market) can lead to:
• Higher prices
• Poor service
Example: China
•Regulatory Body: State Administration for Industry and Commerce (SAIC)
•In 2016, SAIC investigated Tetra Pak, a Swiss packaging firm:
• Found guilty of abusing its monopoly power.
• Forced customers to use their packaging materials.
• Prevented suppliers from working with competitors.
• Result: Fined US$97 million for anti-competitive behavior.
Example: UK
•Regulatory Body: Ofwat (Office of Water Services)
•Monitors monopolies in the water and sewage industry.
•Ensures that:
• Prices are fair.
• Service quality meets acceptable standards.
• Companies don’t exploit their dominant position.
4. Protecting consumer interests.
Why Consumer Protection Matters
Consumers expect quality products at fair prices along with good customer service. They
want accurate and clear information about the goods they buy. No one wants to buy
products that are:
•Dangerous,
•Overpriced, or
•Sold on false claims.
But here’s the issue: without government oversight, some firms might exploit consumers
through anti-competitive practices. Let’s look at a few examples:
Anti-Competitive Practices
1.Increasing prices beyond what a competitive market would allow.
2.Price fixing, where multiple firms agree to set a product’s price to eliminate competition.
3.Restricting consumer choices through market sharing (e.g., companies dividing the
market among themselves).
4.Raising barriers to entry, such as spending heavily on advertising, making it hard for
smaller firms to compete.
These practices limit competition and harm consumers by reducing choices and increasing
Consumer Legislation
In response, many countries have consumer protection laws that:
•Prevent false advertising and misleading claims,
•Prohibit the sale of products unfit for human use, and
•Ensure goods are fit for purpose (i.e., they do what they are supposed to do).
Consequences for Businesses
If businesses break consumer laws, they may:
•Be fined,
•And must compensate consumers for any losses.
Control of Mergers and Takeovers
Why and how governments control mergers and takeovers.
Mergers and takeovers can reduce competition in a market, potentially
harming consumers through higher prices, reduced choices, and weaker
innovation.
Government Oversight of Mergers and Takeovers
•Why governments get involved:
• To maintain market competitiveness.
• To protect consumer interests.
• To prevent monopolistic structures or excessive market power.
•Regulatory Bodies:
• Example: The European Commission (EU).
• They investigate large mergers and decide whether to:
• Approve,
• Block, or
• Approve with conditions.
Case Study 1: Telefonica and CK Hutchison (2016)
•Background:
•Telefonica wanted to sell O2 to CK Hutchison, owner of the network
Three.
•Deal value: £10.3 billion.
•Decision:
•Blocked by the European Commission.
•Reasoning:
•Post-merger, the UK would be left with only three major mobile
operators.
•Concern over reduced consumer choice and higher prices.
•Key Quote from the European Commission:
“The goal of EU merger control is to ensure that tie-ups do not weaken
competition at the expense of consumers and businesses.”
Case Study 2: Microsoft and LinkedIn (2016)
•Background:
• Microsoft acquired LinkedIn, a professional networking platform.
• Deal value: US$26.2 billion.
•Decision:
• Approved by the European Commission, but with conditions.
•Conditions imposed:
• PC manufacturers/distributors must be allowed not to install LinkedIn on Windows.
• Users must be able to remove LinkedIn if it is pre-installed.
•Purpose of Conditions:
• Ensure fair competition.
• Prevent Microsoft from using its Windows dominance to unfairly promote LinkedIn.
Discussion Questions
1.Why might a government allow some mergers but not others?
2.What are the potential risks to consumers when there are fewer firms in a market?
3.Should companies like Microsoft be allowed to bundle services like LinkedIn into their
products?
Government Intervention in the Labour Market – The Role of Minimum Wage
What is Minimum Wage?
•Definition: The minimum amount per hour that most workers are legally entitled to be paid.
•Acts as a legal wage floor—wages cannot go below this level.
Why Governments Set a Minimum Wage
•To protect workers from exploitation.
•To ensure a basic standard of living for employees.
•To reduce in-work poverty.
•To promote fairness and equity in the labour market.
Implementation and Enforcement
•Legislation: Governments pass laws to enforce minimum wage rules.
•Review Bodies: In some countries, a government-appointed body reviews and adjusts minimum
wage rates annually.
•Penalties:
• Employers who pay below the minimum wage can be fined.
• Employers must also repay workers the money owed at current wage rates.
Impact of Minimum Wage Policies
Positive Effects:
•Increases earnings for low-income workers.
•Can boost morale and reduce turnover.
•Encourages fair competition among businesses.
Potential Challenges:
•May increase costs for businesses, especially small ones.
•Could lead to reduced hiring or job losses if businesses can’t afford the
higher wages.
•Might cause inflation if businesses pass on the cost to consumers.
Discussion Questions
1.Why is it important to have a minimum wage in modern economies?
2.What could happen if there were no minimum wage laws?
3.Do you think the minimum wage should be the same across all regions? Why or why not?
Reasons for a Minimum Wage
1. Increase Incomes of Low-Paid Workers
•Main purpose: Raise living standards for the lowest-paid individuals.
2. Help Disadvantaged Groups
•Women, ethnic minorities, and low-income families often benefit the most.
•Promotes equality and fairness.
•Aims to narrow the income gap between rich and poor.
3. Reduce Welfare Dependency
•Workers with low incomes often receive welfare benefits from the government.
•A higher minimum wage reduces their need to claim welfare.
•This can save public money and increase tax revenues from higher incomes.
4. Increase Worker Motivation
•Workers may work harder if they know they are being fairly compensated.
•Higher wages can lead to greater productivity in the workforce.
5. Encourage Investment in Productivity
•Employers may respond to higher wage costs by:
• Training workers to increase output.
• Investing in machinery to replace inefficient labour.
•Both strategies can enhance productivity and support economic growth.
The Impact of a Minimum Wage on Wages and Employment
1. Using Supply and Demand Analysis
•Labour market theory suggests an equilibrium wage (W₁) where supply and
demand for labour meet.
•If the government sets a minimum wage (W₂) above W₁:
• Workers must be paid at least W₂.
• More workers will want to work at this higher wage.
• However, fewer jobs will be available (firms reduce hiring).
2. Possible Consequences
•At W₂, employment falls from QL₁ to QL₂.
•Result: Unemployment increases because supply exceeds demand.
•This is a theoretical outcome—real-world effects can vary depending on
economic conditions.
Do Minimum Wages Cause Job Losses?
Evidence from the UK:
Let’s examine the UK experience.
•The minimum wage was introduced in the UK in
1999.
•At that time, the employment rate for people aged
16–64 was 71.9%.
•Despite concerns, employment did not fall. In fact,
it rose over time.
📊 Refer to Figure 24.3:
•Employment increased steadily, reaching 74.5% by
2016.
•There was a slight dip between 2008 and 2011,
dropping to 70.2% in 2011. However, this aligns with
the global financial crisis, not the minimum wage.
•After the dip, employment rates recovered and
continued to grow.
This suggests that minimum wages in the UK did not
lead to job losses.
Evidence from the USA:
Now let’s look at data from the United States.
•A study by the Economic Policy Institute (EPI) focused on the 1996/97 minimum wage
increases.
•It found that raising the minimum wage did not reduce employment.
In fact:
•The low-wage labor market actually improved.
•There were lower unemployment rates and higher average wages.
•The job market performed better than in previous years.
However, it's important to keep in mind:
•Both the UK and US were experiencing economic growth during these periods.
•This means demand for labor was already increasing, which may have helped offset any
potential negative effects.
Discussion Question for Students:
•Can you think of any situations where raising the minimum wage might lead to job losses?
•What other factors might influence whether the minimum wage helps or harms the labor
market?
Discussion Questions
1.Do you think the benefits of a minimum wage outweigh the potential
job losses?
2.How could a government set a minimum wage that balances fairness
with economic efficiency?
3.What might be the long-term impacts of rising minimum wages on
business investment and automation?