Presentation on theme: "DRAFT Economics and Competition Law David Stallibrass UIBE – November 2011 Personal views of author. Does not represent opinion or position of any institutions."— Presentation transcript:
DRAFT Economics and Competition Law David Stallibrass UIBE – November 2011 Personal views of author. Does not represent opinion or position of any institutions to which he is affiliated.
DRAFT Who am I?
DRAFT Objective of lecture To introduce the role of economics in competition law, discuss some key concepts, and have fun. 3
DRAFT 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 4
DRAFT Objective of competition law To reduce the negative effects of market power Three concepts: Markets Market power Its negative effects 5
DRAFT 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 6
DRAFT Markets Standard model of how a market works 7 Price Quantity 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. demand supply
DRAFT Markets Standard model of how a market works 8 Price Quantity 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 demand supply Magic price Magic quantity
DRAFT Competitive markets In a competitive markets, firms price at cost 9 Price Quantity The supply curve consists of the minimum average costs of a sequence of firms, arranged in ascending order demand supply Magic price Magic quantity
DRAFT Competitive markets If all firms are identical, then… 10 Price Quantity …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 demand supply Magic price = Marginal cost Magic quantity
DRAFT 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 11
DRAFT Market power If there is only one firm in the market… 12 Price Quantity …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 demand
DRAFT Market power The firm maximises the profit by… 13 Price Quantity …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 demand Marginal Cost Marginal Revenue New price > Marginal cost New quantity
DRAFT Society is worse off with market power The makes some profit, but… 14 Price Quantity …the consumers who buy the good pay more for it… …and some consumers no longer buy the good at all! Monopoly price New quantity 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
DRAFT And innovation can be harmed Compare the rents to innovation in a monopoly to a duopoly. 15 Quantity Price In a monopoly, innovation will let you sell a bit more, at a slightly higher price If you dont innovate, youll still do ok!
DRAFT And innovation can be harmed Compare the rents to innovation in a monopoly to a duopoly. 16 Quantity Price In a duopoly, innovation may let you capture the whole market If you dont innovate, youll exit the market
DRAFT 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 17
DRAFT 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 18
DRAFT 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 19
DRAFT 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 20
DRAFT 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 21
DRAFT Play Compete! Lets say the market consists of six identical firms Each firm decides how many dongxi they 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! 22
DRAFT 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 dongxi they will make, and then sell We compute the results, and play again! 23
DRAFT Example 1 24 Market price is less than market cost, so no one makes a profit! The firm who makes the largest amount, makes the largest loss
DRAFT Example 2 25 All firms make relatively few, keep the market price high, and all make a profit
DRAFT Example 3 26 One firm makes twice as many as the others, and makes twice as much profit
DRAFT Example 4 27 All firms make 20 units, and the market price becomes 0! The firms have to give their dongxi away!
DRAFT 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 29
DRAFT 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? 30
DRAFT Question: whats in the same market? 31 iPad iPhone Android phone Android tablet Nokia phone MP3 players Netbook Laptop Desktop Kindle
DRAFT 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 32
DRAFT Market power Standard way to define a market is with reference to why were 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 33
DRAFT SSNIP test in practice 34 Imagine monopolist imposes 5-10% price rise eg 7-11 in Guomao Convenience stores in Chaoyang district Stop: Market Defined Start narrow 1) Customers go to other shops, and/or 2) Other shops enter the market Widen Not Profitable add in other shops
DRAFT 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? 35
DRAFT The cellophane fallacy Dupont successfully argued that Cellophane and other wrapping material were in the same market It wasnt profitable for them to raise their price BUT as weve 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 36
DRAFT The cellophane fallacy 37 DuPont argueBut if DuPont dominant Current price¥100 Current profit¥1 (low)¥51 (high) Competitive price¥100¥50 Competitive profit¥1 (low) 10% increase in price¥110¥55 Impact on profit if monopolist -¥10+¥5 ConclusionMarket is wider than cellophane Market is cellophane How to work out competitive price? How to work out impact on profit?
DRAFT 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 38
DRAFT Working out impact on profit 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 %) 39 Price Quantity PSPS QSQS C PNPN QNQN π S =Q S x (P S – C) π N =Q N x (P N – C) π S > π N if (Q N – Q S ) / Q S < (P S – C) / (P N – C) - 1
DRAFT Estimating actual loss Still not there yet (though weve estimated C, P S, and π S ) 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 40
DRAFT 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 41
DRAFT 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 42
DRAFT 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 43
DRAFT 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] 44 Almost impossible to measure!
DRAFT 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 45
DRAFT Options for an efficient law A range of options for legal test Further nuanced by: Block exemptions based on market share Prioritisation of competition authourities 46 Per se illegal Rebuttable presumption of illegality Legal Rule of reason Economics used to determine rule of reason or rebut presumption of illegality
DRAFT Example use of economics in UK competition law Area of lawFilterUse of economics MergersTurnover criteria etc.Does the merger harm competition? Market definition, unilateral, co-ordinated, vertical, efficiencies, etc. Horizontal agreements If protected by a block exemption No economics (except if block exemption applies If regard price, quantity, or market Setting of fines If not hard-coreEvaluating the effect of the agreement Vertical agreements If protected by a block exemption No economics (except if block exemption applies If hard-coreSetting of fines If not hard-coreEvaluating the effect of the agreement DominanceDetermination of dominance Determination of abuse 47
DRAFT 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 48