1. Economics of Competition St. John’s, Antigua March 2016
Desroy Reid
Competition Analyst, Fair Trading Commission (Jamaica)

2. Outline Objectives Economics and Competition Law
Market Structures and Firm Conduct
Market Power and Price Elasticity of Demand
Market Share and Market Concentration
Market Definition

3. Objectives The Objectives of this presentation are to:
Introduce economic theories that underlie competition law
Examine how competition authorities define markets, measure market concentration and market power

4. Economics and Competition Law
Definitions
Competition Law
Set of rules of conduct  market outcome
Economics
Importance of Economics to Competition Law
Structure-Conduct-Performance
Opportunity cost

5. Economics and Competition Law
Ideal for governments looking to maximize its society’s welfare
Benefits of Competition
Total Surplus Maximum
Consumer: Increase in choices & reduction in prices
Producer: Access to cheaper to inputs

6. Market Structures Other Market Structures include: Monopoly Oligopoly
Monopolistic competition

7. Market Structures Entry and Exit Number of Buyers and Sellers
Information
Product Homogeneity

8. Perfect Competition Structural Characteristics
Many buyers and sellers
Perfect Information
Homogenous Goods
No barriers to entry or exit
Behavioral Characteristic
Firms are price takers
Structural Conduct Performance – Economists focus on conduct and not on the price

9. Perfect Competition Existence of Perfectly Competitive Markets?
Agricultural Markets

10. Monopoly Structural Characteristic Behavioural Characteristic
One Seller
No close substitutes
No entry possible
Behavioural Characteristic
Price makers

11. Monopolies Barriers to Entry and Monopolies Economies of scale
Exclusive Access to technology or resource
License

12. Monopoly Natural Monopolies
Only one supplier can exist profitably in the market
High capital cost;
Largest volume, lowest production cost firm
APUA (Water)

13. Oligopoly Structural Characteristics: Behavioural Characteristic
Few firms
High Barriers to entry
Differentiated/Undifferentiated Products
Behavioural Characteristic
Interdependence of Firms
Strategic Interaction

14. Monopolistic Competition
Structural Characteristics
Many Firms
Differentiated Products
Low Barriers to Entry and Exit
Behavioural Characteristics
Price Maker

15. Monopolistic Competition
Summary
Market Structures C H A R T E I S
T I
Monopoly
Oligopoly
Monopolistic Competition
Perfect Competition
Number of Firms
One
Few
Few or Many
Many
Freedom of Entry and Exit
Restricted/
Blocked
Restricted
Unrestricted
Information
Not Perfect
Perfect
Product Homogeneity
Differentiated
Differentiated / Undifferentiated
Undifferentiated
Example
Electricity, Water
Computers, Cars, Milk, detergents
Bottled Water, Shoes, Clothing
Agricultural Products
Price Maker or Price Taker
Maker
Taker
Government Intervention – eliminate; use old one

16. Market Power and Price Elasticity of Demand
Definition
Price above competitive price
Price Elasticity of Demand
sensitivity of demand to a price change
Introduce cross price elasticity of demand

17. Market Power and Price Elasticity of Demand
Measuring Market Power
Lerner Index
Relates market power and price elasticity of demand
Formula:
P = market price; MC = marginal cost; E = price elasticity of demand.

18. Market Power and Price Elasticity of Demand
In summary
Lerner Index and Price Elasticity of Demand
Competition Authorities’ Market Power Interest
Abuse of market power
Price Manipulation

19. Market Share and Market Concentration
Measuring market share
Sales
Market Concentration
Definition
Small number of firms = Large % of Market
Proximity of competition to market structures
Max. monopoly; Min. perfect competition

20. Market Concentration Method 1: Herfindahl Hirschman Index (HHI)
Example:
In a market consisting of five firms with shares of 40%, 25%, 20%, 10% and 5% the HHI would be equal to:
( = 2750)

21. Market Concentration Method 2: Concentration Ratio
Total Output produced by firms
Using the HHI example information calculate the four firm concentration ratio:
40% + 25% + 20% + 10% = 95%
Four-Firm concentration ratio
40% competitive

22. Market Definition
Identify and define the boundaries of competition between firms
Who is competing with whom
Market Power

23. Market Definition Are Pepsi, Coca-Cola and Water in the same market?
Too Narrow (overstate) or Too Broad (understate)

24. Market Definition Firm Large Market Market Share Smaller Market
Dupont (1956)
Packaging Material
20%
Cellophane
>75%
Philadelphia National Bank (1963)
U.S.A 4%
Philadelphia
36%
Xerox (1975)
Copy Machines
65%
Plain Paper Copy Machines
>90%
Change quota to share; market share proxy of market power

25. Hypothetical Monopolist Test
Aka Small but Significant Non-transitory Increase in Price (SSNIP)
HMT/SSNIP Test:
Logic: Is a “market” worth monopolizing?
Start with smallest possible market and ask if a 5% price increase is profitable
If yes, then the market is defined as the substitutes outside the “market” must be weak
If not, then firm does not have sufficient market power to profitably raise price.

26. Hypothetical Monopolist Test
So, next closest substitute is added to the relevant market and test repeated.
Process continues until the point is reached where a hypothetical monopolist could profitably impose a 5% price increase.
Thus the group worth monopolizing pulls in all of the relevant substitutes
Market then define

27. SSNIP Example
Are Coca-Cola, Pepsi, and Bottled Water in the same market?
Step 1: Smallest Possible Market – Coca Cola
Step 2: Is a 5% increase in PRICE profitable
If yes, Market defined.
If no, Move on to step 3
Step 3: Include substitute (Pepsi) and go back to Step 2
Flow diagram

28. Summary Table 2. Summary of Presentation Market Structure Market Power
Market Share
Market Concentration
Perfect Competition
None
Minute
Low concentration
Monopoly
Significant
All
Fully concentrated
Oligopoly
Some
Highly Concentrated

29. Hypothetical Exercise
SunSea is a small country in the Caribbean with a population of 10 people. On the island only three beverages are consumed: K-Kola, Phlepsi and bottled water.
K-Kola and Phlepsi are sold for $100 while bottled water is sold for $70. Things have been this way for some time. The recession has however seen an increase in the cost of K-Kola and its suppliers now have to pay $80 for each unit of K-Kola.

30. Hypothetical Exercise
Last month Mr. Badum, the chief executive officer of Koca Planet (the sole distributor of K-Kola in SunSea), noted that his companies accounts shows that that five SunSeanians drank K-Kola on average per week. Based on his calculations, his weekly revenue is $500 (5 people who drank K-Kola X $100 price of K-Kola). With the increase in the cost of K-Kola he now spends a total of $400 (5 bottles X $80 unit cost) to supply the five K-Kolas demanded weekly, which gives him a weekly profit of $100 ($500-$400).
Mr. Badum is contemplating increasing the price of K-Kola by 10%. He seeks your advice in determining if that 10% increase is profitable.

31. Hypothetical Exercise
All members of your group are citizens of SunSea and drink K-Kola.
Conduct a survey among your group to determine if this increase is profitable by asking each member of the group
what they would do if the price of K-Kola were to increase by 10%? Would they switch to phlepsi or bottled water (given these are the only substitutes) or would they continue buying K-Kola?
Based on your calculations and the responses from your group members, what is the market for K-Kola?
If Phlepsi had 3 customers and bottled water had 2 customers, what would be the market share of all three market participants? Calculate the Herfindahl Hirschman Index.

32. END