DRAFT Economics and Competition Law David Stallibrass UIBE – November 2011 Personal views of...
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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.
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Transcript of DRAFT Economics and Competition Law David Stallibrass UIBE – November 2011 Personal views of...
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.
DRAFTDRAFT
Who am I?
2
1998
2005
2011
2001
2004
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Objective of lecture
To introduce the role of economics in competition law, discuss some key concepts, and have fun.
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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
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Objective of competition law
To reduce the negative effects of market power
Three concepts: Markets Market power Its negative effects
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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
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Markets
Standard model of how a “market” works
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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
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Markets
Standard model of how a “market” works
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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
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Competitive markets
In a competitive markets, firms price at cost
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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
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Competitive markets
If all firms are identical, then…
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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
DRAFTDRAFT
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
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Market power
If there is only one firm in the market…
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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
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Market power
The firm maximises the profit by…
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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 CostM
arginal
Revenue
QxQ
RMR
QxQRQxQR
QxPPQR
2
][ 2
New price
>Marginal
cost
New quantity
DRAFTDRAFTSociety is worse off with market power
The makes some profit, but…
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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”
DRAFTDRAFT
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And innovation can be harmed
Compare the rents to innovation in a monopoly to a duopoly.
Quantity
Pric
e
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!
DRAFTDRAFT
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And innovation can be harmed
Compare the rents to innovation in a monopoly to a duopoly.
Quantity
Pric
e
In a duopoly, innovation may let you capture the whole market
If you don’t innovate, you’ll exit the market
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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
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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
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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
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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
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DRAFTDRAFT
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
DRAFTDRAFT
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!
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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
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Example 1
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DEMAND Q = 100 - PCOST MC = 10
FIRM QUANTITYPER UNIT
COST TOTAL COSTMARKET
PRICETOTAL
REVENUE PROFIT[A] [B] [C]=[A] X [B] [D] [E]=[A] X [D] [F]=[E]-[C]
1 15 10 150 5 75 -752 20 10 200 5 100 -1003 30 10 300 5 150 -1504 15 10 150 5 75 -755 10 10 100 5 50 -506 5 10 50 5 25 -25
TOTAL 95 950 475 -475
Market price is less than market cost, so no one makes a profit!The firm who makes the largest amount, makes the largest loss
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Example 2
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All firms make relatively few, keep the market price high, and all make a profit
DEMAND Q = 100 - PCOST MC = 10
FIRM QUANTITYPER UNIT
COST TOTAL COSTMARKET
PRICETOTAL
REVENUE PROFIT[A] [B] [C]=[A] X [B] [D] [E]=[A] X [D] [F]=[E]-[C]
1 10 10 100 40 400 3002 10 10 100 40 400 3003 10 10 100 40 400 3004 10 10 100 40 400 3005 10 10 100 40 400 3006 10 10 100 40 400 300
TOTAL 60 600 2,400 1,800
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Example 3
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One firm makes twice as many as the others, and makes twice as much profit
DEMAND Q = 100 - PCOST MC = 10
FIRM QUANTITYPER UNIT
COST TOTAL COSTMARKET
PRICETOTAL
REVENUE PROFIT[A] [B] [C]=[A] X [B] [D] [E]=[A] X [D] [F]=[E]-[C]
1 10 10 100 30 300 2002 10 10 100 30 300 2003 20 10 200 30 600 4004 10 10 100 30 300 2005 10 10 100 30 300 2006 10 10 100 30 300 200
TOTAL 70 700 2,100 1,400
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Example 4
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All firms make 20 units, and the market price becomes 0! The firms have to give their dongxi
away!
DEMAND Q = 100 - PCOST MC = 10
FIRM QUANTITYPER UNIT
COST TOTAL COSTMARKET
PRICETOTAL
REVENUE PROFIT[A] [B] [C]=[A] X [B] [D] [E]=[A] X [D] [F]=[E]-[C]
1 20 10 200 0 0 -2002 20 10 200 0 0 -2003 20 10 200 0 0 -2004 20 10 200 0 0 -2005 20 10 200 0 0 -2006 20 10 200 0 0 -200
TOTAL 120 1,200 0 -1,200
DRAFTDRAFT
Lets play!
Round 1 Round 2 Round 3 Round 4 BREAK Round 5 Round 6 Round 7 Discussion 28
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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
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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?
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DRAFTDRAFTQuestion: what’s in the same market?
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iPadiPhone
Android phone
Android tablet
Nokia phone
MP3 players
Netbook
Laptop
Desktop
Kindle
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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
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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 33
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SSNIP test in practice
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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
WidenNot Profitable
add in other shops
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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?
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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
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The cellophane fallacy
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DuPont argue But if DuPont dominant
Current price ¥100 ¥100
Current profit ¥1 (low) ¥51 (high)
Competitive price ¥100 ¥50
Competitive profit ¥1 (low) ¥1 (low)
10% increase in price ¥110 ¥55
Impact on profit if monopolist
-¥10 +¥5
Conclusion Market is wider than cellophane
Market is cellophane
How to work out “competitive price?”
How to work out “impact on profit?”
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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
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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 %)
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Price
Quantity
PS
QS
C
PN
QN
πS =QS x (PS – C)πN =QN x (PN – C)πS > πN if (QN – QS ) / QS < (PS – C) / (PN – C) - 1
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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
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DRAFTDRAFTRecent 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
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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
DRAFTDRAFT
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
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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!
DRAFTDRAFT
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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
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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
Per seillegal
Rebuttable presumption of
illegality
Legal“Rule of reason”
Economics used to determine “rule of reason” or rebut “presumption of illegality”
DRAFTDRAFTExample use of economics in UK competition law
Area of law Filter Use of economics
Mergers Turnover 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-core” Evaluating the effect of the agreement
Vertical agreements
If protected by a “block exemption”
No economics (except if “block exemption” applies
If “hard-core” Setting of fines
If not “hard-core” Evaluating the effect of the agreement
Dominance Determination of dominance
Determination of abuse
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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
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Contact details
PRC Tel: (+86) 186 1155 0686
www.davidstallibrass.com
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