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 (:math:`DWL`) - under consumer welfare standard: loss equals :math:`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 - :math:`p=mc` with monopoly - contestable market: firm may be only seller but :math:`p0` - new product 2 with :math:`v_2 > v_1` but nobody uses it yet - even with :math:`p_2 = c_2 < p_1` can be that :math:`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 :math:`=` 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 :math:`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 :math:`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 :math:`X` but cartridges are sold by :math:`X` at a high price - do cartridges of :math:`X` form a relevant market - probably not: although you will be stuck if :math:`X` increases price, buyers of new printers substitute away from :math:`X` because its cartridges are so expensive - buyers of new printers are the marginal consumers - if enough marginal consumers switch away from :math:`X`, rise in cartridge prices is not profitable - if so, market for :math:`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 :math:`u(x,y)=(a x^\theta + b y^\theta)^{1/\theta}` - whether goods are substitutes is determined by :math:`\theta` - if :math:`a >> b` then price of :math:`X` will be higher than price of :math:`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 ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ .. _concentration: market share ------------ - tendency among lawyers to interpret high market share as a signal of market power - not necessarily correct: - two firms :math:`1,2` producing a homogenous good - :math:`p = 1- (q_1+q_2)` - firm's marginal costs: :math:`c_1=0,c_2=c< 0.5` - Cournot competition implies (*check*) :math:`q_1^C = \frac{1+c}{3},q_2^C = \frac{1-2c}{3},p^C=\frac{1+c}{3}` - Bertrand competition: :math:`q_1^B=1-c,q_2^B=0,p^B=c` - Bertrand outcome is more competitive than Cournot - Bertrand market is more concentrated than Cournot market - lack of competition under Cournot allows less efficient firm 2 to enter - high concentration can be sign of intense competition 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 .. ..