Introduction to course¶
This lecture¶
two parts
first, how the course is organized
then introduction to competition policy
recommended reading: Massimo Motta, 2004, Competition Policy: theory and practice, Cambridge University Press.
expectations¶
we expect you to prepare each lecture
watch video lecture beforehand
prepare exercises to be discussed in class
follow the datacamp lectures on python
for next lecture: install python
look here to see how this should be done
grade¶
your grade is the average of
2 assignments
1 exam
class and datacamp participation
each has the same weight (25%)
assignments are mandatory and involve programming in python
class participation is mandatory and involves exercises from previous exams
part of the class participation is finishing the datacamp course in time
grades for assignments and class participation can only be used this academic year
assignments¶
assignments can be done alone or in a team of 2 students
for the programming assignments, you will do simulations
next lecture will be an introduction to python
during the other lectures, we will also show you how to program in python
attend (on the web) the datacamp courses on python and finish the course in time!
we know this is new for (most of) you
with python we can bring the theory to life
as python is new, you are allowed to help each other a bit with this
however, assignments are made independently by each team
python¶
good idea to look into python in the following weeks
when you get stuck, you can google
but some basic knowledge saves you a lot of time!
with python notebooks you can program and explain what you do in the same file
learn a bit of markdown and latex
details¶
Rules of the game gives further details and an outline of the lectures
Competition law¶
EU law¶
EU law is structured as follows:
Article 101: agreements between firms
horizontal agreements: cartels, collusion, joint ventures
vertical agreements: manufacturer and wholesaler or wholesaler and retailer
Article 102: abuse of a dominant position
price discrimination, predatory behavior, tying and bundling, refusal to supply
Merger Regulation: when one firm plans to acquire another firm, the Commission has to be notified
why needed?¶
economists tend to believe that markets work well
welfare theorems: Pareto efficient allocations
why do we need a competition authority (CA)?
imperfections¶
welfare theorems assume firms are price takers
in real world firms have (market) power to set prices
first year micro: monopolist setting prices leads to deadweight loss
under total welfare standard: welfare loss equals deadweight loss (\(DWL\))
under consumer welfare standard: loss equals \(DWL+PS\)
CA tries to prevent monopolies from emerging through mergers
when firm is dominant, CA tries to prevent firm from abusing this position
objective CA¶
EU and US tend to put more emphasis on CS than on PS
firms can fight for themselves
harder to organize consumers because of free riding problems
against: consumers are also shareholders
EU every now and again states as a goal promotion of market integration
political objective; hard to formalize in economics
EU forbids price discrimination across national borders
but from economic point of view can be welfare enhancing
market power¶
efficiency¶
Nickell (JPE, 1996): firms with market power are less efficient
with market power, less reason to “worry”
moral hazard: more competitive the market, firms and managers work harder to survive
selection: with market power, inefficient firm can survive; cannot happen in a competitive market
Aghion et. al (QJE, 2005) find that more competition leads to more innovation
Michael Porter (1990): competition is necessary to stimulate firms to innovate
not always bad¶
patents give firms incentives to innovate
ex post we lose welfare but we gain ex ante through the introduction of products
Government can regulate a monopolist: ACM (formerly, OPTA) regulates KPN
Coase: durable good monopolist competes with itself
if monopolist cannot commit, reduce prices over time
\(p=mc\) with monopoly
contestable market: firm may be only seller but \(p<p^m\)
potential entrants discipline the firm
barrier to entry is formed by sunk entry cost (not fixed cost)
taxi market: entry cost is not the price of a mercedes; can be resold
Too competitive?¶
Mankiw and Whinston (RAND, 1986): two externalities market entry
business stealing effect: excess entry
appropriability effect: too few firms enter
create power¶
Outperform other firms:
\(n \geq 2\) firms compete in prices, \(i\)’s cost function: \(C(q_i) = c_i q_i\)
\(c_1 \leq c_2 \leq ... \leq c_n\)
\(c_1 < c_2\) implies 1 is monopolist, \(p_1 = c_2\)
switching costs: offer frequent flyer miles or coupons for loyal customers
if customer gathered enough miles, optimal to keep on using this airline
though consumers love loyalty schemes, they create market power and lead to higher prices
network effects: network effects keep incumbents in the market when there are superior (potential) entrants
exclude rivals:
incumbent beer brewer sells to pubs and restaurants if they only sell incumbent’s beer brands
raises entry cost for newcomers
network effects¶
consumers value both intrinsic quality of product and how many other people use it
this is different from consuming ice-cream
when you decide on your operating system (Linux, Mac, Windows); relevant how many of your friends use the same os
utility good \(i\): \(u_i = v_i + \nu(n_i) - p_i\)
\(1\) is incumbent product with \(n_1 >0\)
new product 2 with \(v_2 > v_1\) but nobody uses it yet
even with \(p_2 = c_2 < p_1\) can be that \(v_1 + \nu(n_1) - p_1 > v_2 + \nu(0) - p_2\)
network effect gives incumbent market power
small differences at the start lead to completely different outcomes
defining markets¶
relevant market¶
not much damage can be done by firms that are small players
if two firms with each a market share of 1 percent want to merge, no reason to block such a merger
but when Microsoft or Google act suspiciously, we do worry
market share is important in competition policy cases
market share \(=\) firm’s revenue divided by total market revenue
but what is the total market?
if you sell apples, is the relevant market apples or fruit?
economists do not tend to worry about relevant market
find out directly whether a merger leads to higher prices; whether a practice is welfare reducing
European Courts do require a definition of the relevant market
procedure¶
guiding principle: “a relevant market is worth monopolizing”
relevant market is a collection of products and regions such that a (hypothetical) monopolist would be able to increase prices profitably (but from which benchmark?)
contains all substitute products and regions which provide competitive constraint on the products and regions under consideration
you wonder whether bananas in the Netherlands form a relevant market:
ask: if there would be a (hypothetical) monopolist on the Dutch banana market, would she be able to profitably raise prices by 5 to 10 percent (ceteris paribus: assuming all other prices remain constant)?
if so, bananas in the Netherlands is a relevant market (perhaps bananas in Brabant is already a relevant market)
if not, expand the market and see whether on this expanded market a hypothetical monopolist would be able to profitable raise prices
substitution¶
demand side substitution: if consumers would switch from bananas to kiwis after the price increase, the question becomes whether bananas and kiwis together form a relevant market
supply side substitution: if suppliers of banana liquor would start to sell bananas after the price increase, question becomes whether the combined market of bananas and banana liquor form a relevant market
geographic market: if consumers would start to buy bananas in Belgium after the price increase, the question becomes whether bananas in the Netherlands and Belgium form a relevant market
question is: is the market under consideration worth monopolizing?
relevant market is smallest set of products worth monopolizing
SSNIP test¶
this is known as SSNIP test: small but significant non-transitory increase in prices
“small but significant” is often taken to mean 5-10%
“non-transitory”: if this could be profitably done for 5 days only, the market is not worth monopolizing
in economic terms, relevant question concerns elasticities
if price of \(x\) is increased by 10%, by which percentage does demand fall? e.g. because consumers buy outside the region
if drop in demand is big, price rise is not profitable; market for \(x\) is not worth monopolizing
or by which percentage does supply increase?
fallacies¶
applying SSNIP test can lead to two “famous mistakes”:
toothless fallacy: marginal vs average consumer
cellophane fallacy: starting point for price increase
toothless fallacy¶
Commission in United Brands case: defining relevant market on the basis of the average consumer
Commission argued that very young and very old (those without teeth) did not consider other fruit a substitute for bananas
Commission concluded that bananas is a relevant market
however, when a (hypothetical) monopolist raises its price, question is not whether average consumer moves away, but whether marginal consumer substitutes away
if enough consumers at the margin substitute away, price increase is not profitable (although a number of consumer may be captive)
other examples¶
some people do not like sparkling water; for them still and sparkling water are not substitutes
yet, still and sparkling water are on same relevant market if enough consumers (at the margin) switch from still to sparkling if the price of still water is increased by 10%
aftermarkets: cheap ink-jet printer of brand \(X\) but cartridges are sold by \(X\) at a high price
do cartridges of \(X\) form a relevant market
probably not: although you will be stuck if \(X\) increases price, buyers of new printers substitute away from \(X\) because its cartridges are so expensive
buyers of new printers are the marginal consumers
if enough marginal consumers switch away from \(X\), rise in cartridge prices is not profitable
if so, market for \(X\) cartridges is not a relevant market
are Rolex and Casio watches in the same market?
some people argue they are not because they sell at completely different prices and are of completely different quality
correct question: do consumers at the margin switch from Rolex to Casio if price of Rolex watches is increased by 10%
CES utility function \(u(x,y)=(a x^\theta + b y^\theta)^{1/\theta}\)
whether goods are substitutes is determined by \(\theta\)
if \(a >> b\) then price of \(X\) will be higher than price of \(Y\)
cellophane fallacy¶
SSNIP test considers price increase of 5-10%, but from which benchmark?
depends on the question that you want to answer
benchmark price differs between merger cases and Article 101, 102 cases
definition of relevant market is different for different questions
merger case: whether the merger between two firms leads to price increase
question is whether at current prices merged firm has enough market power to raise prices
benchmark price is current price on the market
abuse of a dominant position case: current price not necessarily the right benchmark
cellophane case¶
US case: Du Pont argued that cellophane was not a separate relevant market
empirical evidence showed that it competed closely with other packaging materials such as aluminium foil and wax paper
Du Pont sole supplier of cellophane
on the wider market of packaging materials it had a smaller market share
US Supreme Court agreed that because of these other packaging materials Du Pont could not increase prices further
from this it does not follow that Du Pont did not have market power
as a monopolist Du Pont had increased the price of cellophane to such an extent that other (inferior) packaging materials now became substitutes
observation that Du Pont’s cellophane did compete with these other materials strongly suggests that Du Pont did abuse its market power by charging excessive prices for cellophane
benchmark price¶
in abuse case, current price level is not necessarily right benchmark for SSNIP test
sometimes take competitive price (or the price prevailing under effective or workable competition) as a benchmark
Du Pont as monopolist was able to raise price of cellophane profitably by 10% from the competitive price
if you try to determine whether a firm has abused her market power by raising prices, relevant market should be determined with competitive prices as benchmark (not current prices)
recall that a profit maximizing monopolist cannot profitably increase her price by 10% at current prices
concentration and market power¶
summary¶
in this lecture we have seen:
how EU competition law is structured
why we need CA and what its objectives are (can be)
what the welfare losses are due to monopoly/market power
why market power is not always bad
why high concentration does not always signal market power
ways in which firms create market power
how to define relevant market and avoid two fallacies