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Personal views of author. Does not represent opinion or position of any institutions to which he is affiliated. Economics and Competition Law. David Stallibrass. UIBE – November 2011. Who am I?. 2001. 1998. 2004. 2005. 2011. Objective of lecture.
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Personal views of author. Does not represent opinion or position of any institutions to which he is affiliated. Economics and Competition Law David Stallibrass UIBE – November 2011
Who am I? 2001 1998 2004 2005 2011
Objective of lecture • To introduce the role of economics in competition law, discuss some key concepts, and have fun.
Topics covered • Overview of economics of competition law • Markets • Market power • Problems with market power • Play Compete! • Basic tools of economic analysis • Market definition • Interaction between economics and law
Objective of competition law • To reduce the negative effects of market power • Three concepts: • Markets • Market power • Its negative effects
Topics covered • Overview of economics of competition law • Markets • Market power • Problems with market power • Play Compete! • Basic tools of economic analysis • Market definition • Interaction between economics and law
Markets • Standard model of how a “market” works • The more expensive something is, the less people will buy it. This creates a demand curve. • The more a firm can sell something for, the more of it will be made. This creates a supply curve. Price supply demand Quantity
Markets • Standard model of how a “market” works • Where the two curve intersect, the market clears • Supply = demand, and everyone is happy • This “market price” is an almost magic creation of millions of views and decisions Price supply Magic price demand Magic quantity Quantity
Competitive markets • In a competitive markets, firms price at cost • The supply curve consists of the minimum average costs of a sequence of firms, arranged in ascending order Price supply Magic price demand Magic quantity Quantity
Competitive markets • If all firms are identical, then… • …becomes flat • This is the standard model for a “competitive market” • The market price is the same as the marginal cost of each of the firms in the market Price Magic price = Marginal cost supply demand Magic quantity Quantity
Topics covered • Overview of economics of competition law • Markets • Market power • Problems with market power • Play Compete! • Basic tools of economic analysis • Market definition • Interaction between economics and law
Market power • If there is only one firm in the market… • …it can choose the price it wishes to sell at… • …and consumers will decide how much they want to buy. • The firm will set the price that maximises the firms profit Price demand Quantity
Market power • The firm maximises the profit by… • …setting the Marginal Revenue it would gain from selling an extra item to be equal to… • …the Marginal Cost it would cost to produce an extra item Price New price > Marginal cost Marginal Cost Marginal Revenue demand New quantity Quantity
Society is worse off with market power • The makes some profit, but… • …the consumers who buy the good pay more for it… • …and some consumers no longer buy the good at all! Price Firm makes profit, and consumers pay more – just a transfer of wealth But the benefit lost to consumers that no longer buy is a “deadweight loss” Monopoly price New quantity Quantity
And innovation can be harmed • Compare the rents to innovation in a monopoly to a duopoly. • In a monopoly, innovation will let you sell a bit more, at a slightly higher price • If you don’t innovate, you’ll still do ok! Price Quantity
And innovation can be harmed • Compare the rents to innovation in a monopoly to a duopoly. • In a duopoly, innovation may let you capture the whole market • If you don’t innovate, you’ll exit the market Price Quantity
Causes of market power • OFT definition: • “Market power can be thought of as the ability profitably to sustain prices above competitive levels or to restrict output or quality below competitive levels.” • Causes of market power • Agreements • Mergers • Abuse of a dominant position • Success
Agreements • Some agreements between firms are positive • Many contractual agreements setting out how firms interact help reduce risk • But agreements involving price, quantity, maker sharing are harmful • Directly decrease competitiony • Minimal (or no) benefits to society
Mergers • Positive effects of a merger • Efficiencies • Speedy market transitions • Etc. • Negative effects of a merger • Unilateral price rises • Co-ordinated price rises • Possible foreclosure
Abuse of a dominant position • Firms that are “dominant” in a market can use that market power to extend that market power • Foreclosure • Predation • But a complex area – often dominant because successful
Topics covered • Overview of economics of competition law • Markets • Market power • Problems with market power • Play Compete! • Basic tools of economic analysis • Market definition • Interaction between economics and law
Play Compete! • Lets say the market consists of six identical firms • Each firm decides how many dongxithey will make, and then sell • The market then decides the price according to the following formula: • Price = 100 – Total Number of Dongxi Made • Each firm faces a constant marginal cost of ¥10. So it is possible to lose money!
Rules • First: get into 6 groups • Then: • In your groups, decide how many dongxi to make • Write it on a piece of paper • Hold up the paper when I ask (all at the same time) • Each firm decides how many dongxithey will make, and then sell • We compute the results, and play again!
Example 1 Market price is less than market cost, so no one makes a profit! The firm who makes the largest amount, makes the largest loss
Example 2 All firms make relatively few, keep the market price high, and all make a profit
Example 3 One firm makes twice as many as the others, and makes twice as much profit
Example 4 All firms make 20 units, and the market price becomes 0! The firms have to give their dongxi away!
Lets play! • Round 1 • Round 2 • Round 3 • Round 4 • BREAK • Round 5 • Round 6 • Round 7 • Discussion
Topics covered • Overview of economics of competition law • Markets • Market power • Problems with market power • Play Compete! • Basic tools of economic analysis • Market definition • Interaction between economics and law
Recap • Market power can be bad • Bad market power can come from mergers or agreements that lead to firms no longer competing with each other within a market • The higher proportion of the market involved, the worse the harm • …but how do we define the market?
Question: what’s in the same market? Nokia phone Desktop Android phone Android tablet Netbook iPhone iPad Laptop MP3 players Kindle
Market definition • “A market” is a concept created by economist. It implies a bright line – anything outside of the bright line is not in the market
Market power • Standard way to define a market is with reference to why we’re defining it: • Would a “hypothetical monopolist” of the proposed market be able to profitably raise price? • This is called the Small, but Significant Non-transitory Increase in Price (SSNIP) test • Traditionally a 5% - 10% price rise for a year
SSNIP test in practice eg 7-11 in Guomao Start narrow add in other shops Imaginemonopolist imposes 5-10% price rise Widen NotProfitable 1) Customers go to other shops, and/or 2) Other shops enter the market Stop: Market Defined Convenience stores in Chaoyang district
SSNIP test in practice • Two reasons why it may not be profitable to raise price: • Demand side substitution: consumers go elsewhere • Supply side substitution: other firms enter the market because it is now profitable to do so • Key conceptual difficulty: the “cellophane fallacy” • Key technical difficulty: where to get the data?
The cellophane fallacy • Dupont successfully argued that Cellophane and other wrapping material were in the same market • It wasn’t profitable for them to raise their price • BUT as we’ve seen, firms always set their price at a level where it would not be profitable to raise it! • Not such a problem with mergers, but a problem in dominance cases
The cellophane fallacy How to work out “competitive price?” How to work out “impact on profit?”
Getting the data • Working out the “competitive price” • In merger analysis, can often assume that current price is reasonably competitive • In dominance, there is a chance that current price is the monopoly price • Need to look at profitability… • …but looking at profitability is really hard • Calculating fair return on risk • Off-balance sheet investments • Separating business functions
Working out impact on profit πS=QS x (PS – C) πN=QN x (PN – C) πS> πN if (QN – QS ) / QS < (PS – C) / (PN – C) - 1 • Once we know starting price, new price, and starting profit… • …we can calculate the amount of quantity that the price rise would need to lose to make it unprofitable… • …this is the Critical Loss (in %) Price PN PS C QN QS Quantity
Estimating actual loss • Still not there yet (though we’ve estimated C, PS , and πS) • We need to know the likely loss of Q if P increases 10% • Four ways of estimating: • Asking people – consumer surveys, customer surveys, diversion rations, etc. • Looking at historical price data • Looking at internal marketing documents • Guessing
Recent developments in merger analysis • UK (at least at first phase) • Moving towards “frame of reference” rather than strict market definition • Upward Pricing Pressure • Look at “closeness of competition” of two competitors, rather than market definition and market shares
Topics covered • Overview of economics of competition law • Markets • Market power • Problems with market power • Play Compete! • Basic tools of economic analysis • Market definition • Interaction between economics and law
Economics and competition law • Two areas where economics and competition law intersect: • Economics can help design an efficient law • Economics can help determine when the law is broken
Designing an efficient law • In competition law and economics, the objective is to use economics to design a law that maximises welfare, while minimising enforcement and compliance costs: • MIN [ • Type 1 error + • Type II error + • enforcement cost + • compliance cost] Almost impossible to measure!
Objective • Requires accuracy • Close mapping of economics and empirical evidence of harm and benefit • Requires effectiveness • Self assessment by firms • Predictability of courts and administrative bodies • Proportionate punishment
Options for an efficient law • A range of options for legal test • Further nuanced by: • Blockexemptions based on market share • Prioritisation of competition authourities Rebuttable presumption of illegality Per se illegal Legal “Rule of reason” Economics used to determine “rule of reason” or rebut “presumption of illegality”
Further reading • Films • A Beautiful Mind (the man who invented Nash equilibrium) • The Informant (pretty accurate story of the inside of a cartel) • Books • Straight economics: “The Economics of EC Competition Law”, Bishop and Walker, 2010 (third edition) • Mixed with policy (slightly less well written):“Competition Policy, Theory and Practice”, Massimo Motta, 2006 • Based on cases:“Cases in European Competition Policy: The Economic Analysis”, 2009, Edited by Bruce Lyons
Contact details • economics@davidstallibrass.com • PRC Tel: (+86) 186 1155 0686 • www.davidstallibrass.com