Regulation &
Competition Policy

Correct: B. The CMA’s statutory duty is to promote competition for the benefit of consumers. It investigates mergers, conducts market studies, and enforces competition law — but it can approve mergers if they don’t harm competition, and it does not set utility price caps (that is done by sector regulators such as Ofwat, Ofgem, and Ofcom). Revenue maximisation is a Treasury function, not a competition policy objective.

Correct: B. RPI-X formula: maximum price rise = RPI – X = 5% – 2% = 3% per year in nominal terms. This means prices rise more slowly than inflation — a real-terms price reduction of 2% per year. The X factor is set by the regulator to reflect expected efficiency improvements the firm can make. If the firm cuts costs faster than X, it keeps the extra profit — this is the key incentive mechanism of RPI-X.

Correct: B. Rate of return regulation allows firms to earn a fixed percentage return on their capital base. This creates a perverse incentive: if the firm over-invests in capital (buys more equipment, “gold-plates” its network), the regulated asset base grows, and so does the total permitted profit (same % × larger base). Result: productively inefficient over-capitalisation. Economists Harvey Averch and Leland Johnson identified this in 1962. RPI-X was designed partly to avoid this problem.

Correct: B. Regulatory capture (George Stigler, 1971) is when the regulated firm, rather than the public, effectively controls the regulator. Mechanisms include: the “revolving door” (regulators seek jobs in the industry they regulate); information asymmetry (firms provide most of the regulator’s data); political lobbying. Example: Ofwat is accused of regulatory capture — allowing water companies to pay £72bn in dividends and load £60bn+ in debt while failing to enforce adequate leakage and sewage standards.

Correct: B. The CMA’s Phase 2 investigation found the merged entity would have been the UK’s largest supermarket, reducing competition in local grocery markets (around 460 stores where the two chains overlapped) and petrol retailing. Despite the firms’ argument that efficiency gains would lower prices, the CMA concluded that competitive harm to consumers outweighed claimed efficiencies. The block showed the CMA’s willingness to use merger control aggressively in consumer-facing markets.

Correct: B. The economic concept behind windfall taxes is the taxation of economic rent — returns above normal profit not arising from productive effort. Energy firms’ profits soared because wholesale gas and electricity prices spiked due to the Russia-Ukraine war supply shock, not because firms invested more or improved productivity. The government argued these were unearned rents that could be taxed without deterring productive activity. The 35% levy raised ~£2.8bn in its first year, partly funding the Energy Price Guarantee.

Correct: B. A natural monopoly (declining long-run average costs throughout the market — e.g. water networks, rail track) has no competitive pressure to price at MC. A profit-maximising natural monopoly sets MR = MC but prices at P > MC — the standard monopoly welfare loss diagram. Regulation (RPI-X, rate of return) attempts to push price toward MC. Note: regulation does not prevent investment — RPI-X specifically allows firms to earn returns on efficient investment. Externalities and distribution are separate policy concerns.

Correct: B. To set an appropriate X factor, the regulator must estimate how much cost efficiency improvement the firm can realistically achieve. But only the firm has detailed knowledge of its own cost structure, technology, and efficiency opportunities. The firm has a clear incentive to overstate its costs (claim efficiency is harder than it is) so the regulator sets a low X — allowing prices to rise more. This is the classic principal-agent problem in regulation: the regulated firm is the agent, the regulator is the principal, and the agent has private information the principal cannot verify without costly scrutiny.