CHAPTER 3 - COMPETITION POLICY

Sunday, 18 August, 2019 3:39 PM

Learning Objectives:
1) To investigate the costs of imperfect competition
2) To provide an overview of the issues in regulating market structure
3) To describe the types of market conduct that are prohibited

Imperfect competition: Different market structures

-Monopoly: Single seller
-Oligopoly: Strategic interaction between a small number of firms
-Monopolistic Competition: Firms sell differentiated products, but free entry and exit.

Sources of imperfect competition/ Market Power:

-Economies of scale and scope (natural monopoly) eg: telcom, utilities, water processing
-Differentiated products (including location)
-Competitive advantage due to technology and innovation
-Collusion among suppliers
-Government regulation

Costs of imperfect competition

1. Deadweight losses from reduced output. This DWL rises with the size of price mark-up and the fall in consumption. Can be calculated as:

2. Excessive production costs. Monopolists exploit freedom from competition by being x-inefficient where it fails to produce its output with the
minimum use of inputs. DWL caused by increase in MC and the original monopoly DWL.

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3. Innovation costs: Some argued that monopoly is required to obtain innovation and some contend that investment rises with certainty of profit,
which increases in more concentrated industries.
4. Rent-seeking costs: Competition over rights of monopolists, transfer from consumers to producers is now economic rent, wasteful real resources
used.
Rent seeking: Trying to persuade government to change the rules in such a way as to create economic rent.
Economic rents: Payments to factors of production in excess of
Rent seeking costs: Resources used in rent seeking

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Other costs of monopoly:
1. Equity: Government may view transfers from consumers to shareholders as inequitable and undesirable and regard this also as a significant social
cost.
2. The role of potential competition: Contestable market may constrains monopoly behaviour.

Arguments against competition:

1. Natural monopoly due to economies of scale or scope where efficient production requires a single firm.
2. Competition in the short run may destroy competition in the long run. Predatory pricing - set low prices and sacrificing short-term profits in order
to reduce competition in the long run. ( P < AVC )
3. Need to encourage innovation. Patents reward innovation by allowing a firm or individual control over new technology for a limited period.
4. Protect quality of service. Doctors, pharmacists, lawyers, accountants and surveyors or tradespersons like electrician and plumbers.
5. Protect infant industries: restricted entry / import tariffs and quotas

Regulating Industry Structure:

Main aim of industry structure policies (anti-trust policies) --> aim to create and maintain competitive industry structure.

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General approach to dealing with mergers and acquisitions is to determine what constitutes a market and the existing level of competition in it (using a
concentration metric) and to estimate the effects of proposed merger or acquisition on market concentration or competition and hence output and
prices.

1- Defining a market
- A market consists of similar products that can be readily substituted one for another.
- Large cross price elasticity of demand and/or supply
- Two dimensions: product dimension and geographic dimension.
- Depends on likely switching behaviour in response to an increase in the price, or decrease in the service or quality of that product.
- A larger/ broader market: dominance is less likely.

2- Measuring competition

Competition is usually thought of as a market share. But this depends on how markets are defined and this can be arbitrary. Eg: ferrari vs market for all
cars? High end cars? Key economic issue is substitution. There is little competition when there is little product substitution (or low cross price elasticity).
Substantial lessening also is not well defined and somewhat arbitrary. Eg: coke price decrease, demand for pepsi decrease, suggest coke and pepsi are in
same market, but coke price decrease, demand for milk is not really affected, so both are drinks but in different market.

3- Estimate the effect of increased concentration

Ideally the regulator would assess the effect of increased concentration on output, prices and x-inefficiency costs and innovation as appropriate. This
implies assessing economic performance with and without the acquisition or merger. (This is not easy) Regulations based on estimates of the cost and
benefits of acquisitions and mergers can be expected to produce a more efficient outcome than determinations based on arbitrary concentration ratios.

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Regulating competitive conduct

Cartels: Biggest example: OPEC (oil cartel)

- Price fixing: an agreement between firms to set certain prices
- Output restrictions
- Allocating customers, suppliers or territories
- Bid-rigging

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Predatory Pricing

Exclusive Dealing: when one party imposes restrictions/contract on another party's freedom to choose with whom it deals.

*Prohibits suppliers from specifying a minimum price below which goods or services may not be resold or advertised for sale.
*It also prohibits inducements to resellers not to discount for example by giving special deals to resellers who agree not to discount.

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