The act was put in place to deliver benefits in the form of greater efficiency and enhanced welfare by promoting and ensuring competitive markets. There are limits however, to the effectiveness of government intervention in markets. As previously outlined, monopoly markets fail because of both allocative and cost inefficiencies. Regulation that eases allocative inefficiency at the expense of cost efficiency is inappropriate because the costs of intervention will outweigh the benefits. Figure 1.2 Regulated Monopoly Reconsider the case of the monopolist.
Regulation cuts out excess profit and reduces the price closer to the marginal cost.
The monopolist would have to take measures to avoid a loss if price were to be set equal to marginal cost. Consequently, a monopolist may be tempted to avoid the loss of profits by overstating the costs of production. Effectively, this diminishes the effectiveness of government intervention. The effectiveness of regulation can be diminished by a firms avoidance of penalties but government intervention also incurs costs, both to the government and to external parties. The internal cost to the government includes direct expenditures on the resources used in the provision of goods, administration costs and the opportunity cost associated with these resources.