Competition Policy

Competition Policy Market definition and the Assesment of Market Power

Step 1: Market Definition • Market definition is done with the aim of assessing market power • The RELEVANT market is the set of products (& geographical areas ) that exercise some competitive constraints on each other • The test that guides the analysis of market definition is the SSNIP Test (or “Hypotethical monopolist test) • SSNIP: Small but Significant Non-transitory Increase in Prices (originally introduced by the US Dept. of Justice)

SSNIP • Ex.:merger between two sellers of bananasfocus on the definition of the product market • Suppose an hypothetical monopolist: Would he find it profitable to raise the price of bananas above the current level by 5-10%? • Answer: YES, then no significant competitive constraints from other (substitute) products  bananas are a separate market • Answer: NO, because part of the demand will be redirected to kiwi, and to other exotic fruits then bananas could not be considered a separate market • The test continue by considering a wider market: banana and kiwi • Would the H. Monopolist find it profitable to raise the price of babanans and kiwi by 5-10% ANSWER Yesbananas and kiwi are a separate market • Answer: No the test continue until we have identified a separate market (exotic fruits?)

Demand & Supply substituability • Do not consider just substitutes from the point of view of demand • There could be supply substitution if producers can switch to a new product if its price increases • Switching must be easy-rapid and feasible • No considerable sunk costs and entry barriers (it should be easy and cheap to overcome entry-barriers) • Example of civil aviation: no supply substituability because of airport congestion.

Problem in non merger cases: abuse of dominant positions • Using SSNIP test in non merger investigations may raise problems • Ex.: abuse of dominant position: the question is: did the firm increase prices above the competitive level? • Applying SSNIP to current prices may distort results: the firm, if dominant, has already increased prices it won’t find it profitable to further raise prices according to the SSNIP test we must reply the test for a wider market • A too wide market could be identified and the calculation of small market shares follows  No dominance is found • Caution in applying SSNIP in non merger cases

Implementing the SSNIP test • Own price elasticity: not sufficient • Cross price elasticity useful to rank substitutes (some closer some not): % change in the demand for B with a 1% increase of product A • When own price elasticity of A is high ( a monopolist is not likely to charge higher prices) look at cross elasticities • If estimates of cross elasticities are low, products are not close substitutes and suggest a separate market

Geographic market definition • The same considerations hold • EX: merger between mineral water producers in Italy SSNIP test: would a h. monopolist increase the price by 5-10%? YESthe geographic market is Italy • NoImports from France are expected and rising prices is unprofitabletest to be repeated on a H. Monopolist in Italy & France

Step 2: assessment of market power • Perfect competition is an “ideal” modelin reality we expect each firm to enjoy some market power (some fixed cost and some substitutes in most cases do exist) • 1.Which measure of market power? • 2.Which treshold to call the attention of competition agencies?

Which measure • A theoretical measure: the Lerner Index: L = (P – MC)/ P it increases with the mark up charged by the firm • The direct application can create problems: 1) Estimating MC is not easy 2) High cost can be due to the productive inefficiency caused by market power paradox: one obtains high costs and lower margins lower market power • Alternative approach: L = 1 /εP  εP easier to assess with modern econometrics • Traditional approach look at market shares • Other variables: potential entrants/ countervailing power of buyers

Traditional approach: market shares • To assess market power let us measure market shares • A firm with a tiny market share would be unable to excercise much market power restraints on the ability to increase prices come from competitors • BUT a firm with high market share is not necessarily dominant If entry was easy the firm would not be able to increase price OR if the buyer has countervailing power

Market shares as screening devices • Market shares could be used as a screening device: a market share below a treshold (40%..) leads to presume low market power (it cannot be considered dominant..) – above the treshold dominance is presumed and the burden of proof may fall on the defendant • In practice the EC and the European Court of justice follow this approach (useful to increase legal certainty and reduce the cost of investigations)

Market shares and beyond • Market shares both in units and in values might be available • In certain industries reserves might be more informative • If one firm is supposed to be not a crucial player in the future (cause it uses an old inefficient technology) current market shares may overestimate competitive constraints • Excess capacity by rival firms may be important: if it is just enough to satisfy current demand their supply elasticity is low – If they have huge excess capacity the market power of the investigated firm is low • It is also the persistence of market shares over time that informs on market power if the distribution varies over a short time we presume no dominance and greater competition

Competition Policy