Instruments For Competition Policy 2020 New

Lectures
- I, II and III -
LM-90 European Studies a.a. 2020/21

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Introduction to Law and Economics II

&
What is competition? From theory to reality
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Prof. Angelo Castaldo
Scienza delle finanze
Sapienza Università di Roma
Facoltà di Giurisprudenza
Dipartimento di studi giuridici ed economici (DSGE)
Main Info on the module
-----------------------------------------------------------------------------------
- Office hours: Monday from 12 to 14
- Email: angelo.castaldo@uniroma1.it
- First intermediate exam: 4th of November 2020
- Second intermediate exam: 7th of December 2020
- Antitrust group-works and seminars: half of November
• Textbooks:
o Baldwin, Lodge, Cave (2012). Understanding regulation, Oxford University Press (Part I and II)
o Decker C. (2015). Modern Economic Regulation, Cambridge University Press (Ch. 1, 2, 3, 4)
o Motta (2003). Competition policy. Theory and Practice, Cambridge University Press (chap. 1, 2, 4 and 7).
• Internet resources:
o https://elearning.uniroma1.it/course/view.php?id=5230
o https://web.uniroma1.it/istecofin/
2
Structure of the module
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§ Main goals:
- To understand the policy aims when dealing with competition;;
- To figure out main figures of regulation;;
- To be aware that regulation is incredibly sectoral specific;;
- To learn the main figures of antitrust discipline;;
- To interpret and analyse antitrust cases.
§ Methodology:
- Microeconomics;;
- Public economics;;
- Law and Economics.

3
Economic Analysis of Law
-----------------------------------------------------------------------------------
The interest of economists for applied research on the relationship

between law and economic development is present since the
“Classics”: Adam Smith in The Wealth of Nations (1776) investigates
on the impact of some laws (English Poor Laws) over economic
development
Under this perspective – that had a great success especially in the

anglo-saxon nations – law is not or not only an unitary, complete and
coherent system of rules with or without sanctions…
… but first of all it is a system of behavioural incentives or

disincentives for each member (or legal entity) of a community
4
Economic Analysis of Law (Calabresi e Melamed, 1972)
“… economic analysis of law is a

perspective (often necessary) that helps,
together with other perspectives, the
comprehension of the problems tackled
by the rule creator”
Calabresi G. e Melamed A.D. (1972), “Property Rules, Liability Rules and

Inalienability: One View of the Cathedral”, Harvard Law Review.
5
An example of EAL: questions to start with…
-----------------------------------------------------------------------------------
ü Cicero refers of the tragedy of Rhodian citizens that experienced a long

period of famine. Egyptians merchants sailed full of wheat towards the isle
of Rhodi and one of them, thanks to a positive whiff, arrived on the island
before the other merchants.
üDid the merchant arrived first on the island had to reveal to Rhodians, in
the phase of price bargaining for wheat, the information that other
merchants (with ships full of wheat) were arriving on the island?
ü If a party makes investment such as a master in geology, and during the

bargaining of a land, takes advantage, with respect to her counterpart, of
of a precious characteristic of the soil, that is unknown to the owner, does
she have to inform her counterpart?
6
Precontractual liability:
which is the social function of the rule?
--------------------------------------------------------------------------------------
During negotiations, parties plan an exchange that will occur in the future, and
that can imply a high level of uncertainty regarding both contract conditions and
final outcome. During this phase, parties are requested, in a different way
according to the country-specific normative framework, to act in good faith
In Italy negotiations before contract closure (“trattative”) are ruled by a form of
precontractual liability stated by article 1337 c.c.:
“During negotiations and in the formation of a contract the parties must behave
according to good faith”
Why does the civil code provide such a rule and

what does goodfaith really mean?
7
Precontractual liability:
which is the social function of the rule?
------------------------------------------------------------------------------------------------------------------
Taking the Italian legislator of the Civil Code of 1942 as a benchmark, in his intention,
and with regard to contract law, good faith is something dealing with ethics and morality.
In other words, it is a general rule of behavior that imposes parties to act in accordance
with honesty, fairness, probity and loyalty during contract formation and performance
Aim of the rule is, in last instance, to induce parties to cooperate
In the report of the Ministro Guardasigilli (Attorney General) on the project of the Code of
1942, it’s clearly written that good faith principle “recalls in the sphere of the creditor
the consideration of the interest of the debtor and in the sphere of the debtor the
correct respect to the interest of the creditor”, operating, therefore, as a principle of
reciprocity and cooperation
This conception of good faith is perfectly in accordance with one of the establishing
principles of the Italian Constitution, the one of social and economic solidarity (Art. 2
Cost.). Therefore, in the mind of the legislator, the importance of good faith lays in the
imposition, to every party of a contractual relationship, of a duty to act in order to
preserve the interest of the counterpart, irrespective of the existence of a specific
contractual obligation or of a precise normative prescription
8
Precontractual liability and Goodfaith /1
------------------------------------------------------------------------------------------------------------------
In order to give a proper answer to the questions aforementioned, the

analysis, using a law and economics approach, focuses on the definition of
the principle of good faith during negotiations, and is aimed to point out the
social function of the provision of a pre-contractual liability regime in a
context of ex ante asymmetric information among parties (e.g.
sophisticated and naïve)
Taken note of the open-endness of good faith, the analysis aims to state that
the compatibility of a certain conduct (action) with this principle must be judged
through the understanding of the variables that influence the rational
economic process that drives parties behavior
Considering that good faith, as a general clause, is uncertain, recalling to

principles like loyalty, fairness and protection in pre-contractual liability
does not succeed in catching the essence and the operational boundaries
of good faith
9
Precontractual liability and Goodfaith /2
------------------------------------------------------------------------------------------------------------------
In order to provide a more clear methodological framework, it is necessary to

understand economic patterns that agents (parties) take into account in
their decisional processes
Given that norms act as a constraint to rational economic maximizing

behavior, it is necessary to understand if the positional and informational
advantage enjoyed by a party, could be or couldn’t be exploited from both an
efficiency and juridical perspective
In other words, the aim is to understand the reasons and circumstances in

which precontractual liability bind should or shouldn’t restrict the possible
actions of the agents in order to maximize aggregate welfare
How the presence of asymmetric information between parties can or cannot

justify the provision of a pre-contractual liability regime, in order to enhance the
aggregate efficiency of the exchange
10
Introduction to the course
-----------------------------------------------------------------------------------
Over the past decades, regulation has been a topic that has stimulated discussions in a wide set
of disciplines
law, economics, political science, technology and public policy, etc.
i.e. Regulation is a field of study that requires

a multi-disciplinary approach
Debate: Supporters (State intervention) vs. Skeptics (Market clearance)
-Technocratic device that has the potential to exert rational controls over important economic and
social activities (State intervention);;
- a potential burden on economic activity (Market clearance).
Economic crisis (recent trigger events):

11
Deregulation/Light handed regulation versus Rigorous regulation of the financial markets
Aim of Regulation = competition
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Regulation vs. Antitrust

Ex ante Ex post
- -
Set of rules that defines the Remedies to
boundaries of markets anticompetitive conducts
“Regulation seeks to hold the Promotes market

fort until competition arrives” efficiency from both a
Littlechild (1983) production and consumer
perspective
12
What is Regulation? /1
-----------------------------------------------------------------------------------
As a specific set of commands: binding set of rules to be applied

by a body devoted to this purpose
As deliberate state influence: actions that are designed to

influence business or social behavior
As all forms of social or economic influence: regulation can be

not deliberate but play an incidental role in pursuing other
objectives
More generally it is considered as a red or a green light:
a deterrence or enabling factor
13
What is Regulation? /2
-----------------------------------------------------------------------------------
Social regulation: public interest in health, safety, environmental

protection and consumer protection linked to market failures
(mainly asymmetric information or market transaction spillovers)
Economic regulation: deals with all forms of market failures, let’s

say it better, seeks to deal with the inefficiencies of private
markets by promoting competition
First signs of modern forms of regulation can be found since

Tudor and Stuart regimes
Regulatory controls were explicitly recalled in the Preamble to an

Act of Parliament by reference to the “common profit of the
Realm” (Ongus, 1992)
14
Aim of Regulation = competition
-----------------------------------------------------------------------------------
Ok, different perspectives and
different roles but …
What does competition really
mean?
i.e. what do public authorities seek
to pursue?
Perfect competition or what else … 15

Competition theoretical concept at the base of the I°TWE
-----------------------------------------------------------------------------------
- I°Fundamental Theorem of Welfare Economics
- Determinants of Public intervention
- Market failures
16
Competition theoretical concept at the base of the I°TWE
-----------------------------------------------------------------------------------
On the debate on public intervention, after 2007/2008 economic crisis

and 2011 sovereign debt crisis, several economists called for a more
laissez faire approach to markets
This argumentation can rely on
I° Theorem of Welfare economics
17
Competition theoretical concept: main assumptions
-----------------------------------------------------------------------------------
A. Fragmentation: many buyers and sellers out there so firms and
consumers are price takers (“perfect competition”)
B. Homogenous product or undifferentiated
C. Perfect information: symmetry in the info set-up
D. Equal Access to Resources or Free entry and exit of firm
E. Consumers maximize their utility
F. Firms maximize profits
G. There are no significant externalities
With respect to real markets these assumptions are really naive!!!
18
Competition concept at the base of the I°TWE
-----------------------------------------------------------------------------------
Any equilibrium that arises in a perfect competion market regime is a pareto optimal
state of the world (three conditions of allocative efficiency):
1) Production Efficiency Condition MRTS KMedicine

,L = MRTS Food
K ,L
2) Exchange Efficiency Condition A

MRS M ,F = MRS B
M ,F
3) Substitution (Allocation) Efficiency
MRT M ,F = MRS M
Amber , Brent
,F
19
So … Competition: Stigler (1965)
-----------------------------------------------------------------------------------
Stigler (1965) discerns five preconditions for competition in

Adam Smith’s The Wealth of Nations:
1. The rivals must act independently, not collusively
2. The number of rivals, potential as well as present, must be sufficient to eliminate

extraordinary gain
3. The economic units must possess tolerable knowledge of the market opportunities
4. There must be freedom (from social restraints) to act on this knowledge.
5. Sufficient time must elapse for resources to flow in the directions and quantities
desired by their owners.
So … Competition: other perspectives
-----------------------------------------------------------------------------------
Competition as absence of barriers to entry and exit
“It seems preferable, therefore, to adapt the concept of competition to

changing conditions by another method: to insist only upon the absence of
barriers to entry and exit from an industry in the long-run normal period;; that
is, in the period long enough to allow substantial changes in the quantities of
even the most durable and specialized resources” (Stigler, 1957) .
Competition as a selection system
Competition is the chief selective process in modern economic society, and

through it we have the survival of the fit (Ely, 1901).
Competition as price-taking behaviour
Monopoly ordinarily means control over the supply, and therefore over the
price. A sole prerequisite to pure competition is indicated – that no one have
any degree of such control (Chamberlain, 1933).
But in reality … level of Competition depends on the LRAc
-----------------------------------------------------------------------------------
Ab origine, looking at the interaction between the Long Run Average cost function
and the Demand curve is the best way to figure out what kind of market regime
will be in place. More naturally concentrated or more competitive.
The MES with respect to total demand can give us the best hint in order to
understand the future market structure.
J. M. Clark (1940) defines the concept of Workable competition.
Price
Price
Demand Demand
LRAc
LRAc
P* P*
Output Output
MES MES
Fig. 1-A Fig. 1-B
22
So … Competition = Contestable markets
-----------------------------------------------------------------------------------
Baumol et al. (1992)
The presence of Scale economies offsets

the linkage between number of firms and efficiency
For having market efficiency we must look up to other characteristics and
depart from the static view of market regimes
Contestable markets
Access to incumbent’s Entry and Exit

Absence of sunk-costs
technology without high costs
HIT AND RUN COMPETITION

Lectures
- IV, V and VI -

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&
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Public Intervention
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Equity concern Market inefficiency
Social aims Market failures
Public intervention
(regulation is everywhere)
- Public goods (Direct or indirect
production, Regulation)
Redistribution/Social regulation
- Monopoly and Natural Monopoly
(health, education, social security, etc.) (Competition law – Liberalization -
Regulation)
- Externalities/Spillovers (Regulation
Efficiency/equity Trade-off and taxation)
25
- Asymmetric information (Regulation)
Public Intervention: Second best
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I. Say we have more than one departure from competitive

market
II. Now there is a policy that tries to correct these distortions
III. Theory of the Second Best says: that such a correction
may or not improve welfare
IV. i.e. we can’t assume welfare will be improved or that we
get any closer to a competitive market
Optimal policy solutions: that’s why I suppose you are

doing this Master!!!
Both from a public or a private interest point of view
26
Public Intervention: Second best
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Market Failure Definition

Markets are NOT always efficient. There are several
circumstances under which resources will be mis-allocated by
the free market. In other words, either too much of a good will
be produced or not enough will be produced by the free
market. Examples of market failures include:
• Abuse of Monopoly Power

• Negative Externalities of Production and Consumption
• Positive Externalities of Production and Consumption
• Lack of Public Goods
• Common Access Resources and the Tragedy of the
Commons
• Asymmetric Information
27
Measurement of markets efficiency
-----------------------------------------------------------------------------------
• Consumer surplus is the value of a good (reserve price) minus the

market price paid for it, summed over the quantity bought: It is
measured by the area under the demand curve and above the market
price, up to the quantity bought.
• Producer surplus is the price of a good minus the marginal cost of

producing it, summed over the quantity sold: Producer surplus is
measured by the area below the price and above the supply curve, up to
the quantity sold.
28
Measurement of markets efficiency
-----------------------------------------------------------------------------------
Price
Consumer S
25 surplus
20
Equilibrium Equilibrium
15
price
10
5 Producer
surplus Equilibrium D
quantity
0 5 10 15 20 Quantity
29
The “whys” of public intervention in the case of Monopoly
-----------------------------------------------------------------------------------
Price/Cost
MC = S
DEADWEIGHT LOSS
A Em
Pm
B C Ec
Pc
E
D
Demand=AR=P
Qm Qc Q
MR
-----------------------------------------------------------------------------------
STATIC INEFFICIENCY
COSTS LINKED TO

LESS EFFORT
“RENT-SEEKING”
IN ACTIVITIES
COST MINIMIZATION
HICKS (1935) POSNER (1975)

“The best of all monopoly VS
profits is quiet life” TIROLE (1988)
MANAGERIAL
INEFFICIECY BURN OF RESOURCES
-----------------------------------------------------------------------------------
DYNAMIC INEFFICIENCY:
TWO DIFFERENT POINT OF VIEW
SCHUMPETER (1967):
MONOPOLIES DETERMINE
LESS DYNAMIC INEFFICIENCY
ARROW (1962):
WITH RESPECT TO COMPETITIVE
MARKETS
FIRMS’ SIZE AND INNOVATION
FIRMS THAT OPERATE IN COMPETITIVE

MARKETS DESIRE TO REALIZE EXTRA-PROFITS,
THUS HAVE A GREATER PROPENSITY
TO INNOVATE
MARKET POWER AND INNOVATION

The “whys” in the case of Natural Monopoly
-----------------------------------------------------------------------------------
LRAc D
Ca
Cb
Cc
LRAc
Qa Qb Qc Output
A SINGLE FIRM THAT PRODUCES THE VECTOR OF OUTPUT Qc ( = Qa + Qb) BEARS A LOWER
TOTAL COST IN SATISFYING THE ENTIRE MARKET DEMAND:
C(Qa) + C(Qb) > C(Qc)
SO WE CAN STATE THAT A NATURAL MONOPOLY IS ANY INDUSTRIAL

CONFIGURATION (I.E. MARKET) THAT IS CHARACTERIZED BY A SUB-ADDITITIVITY COST FUNCTION.
-----------------------------------------------------------------------------------
IN ORDER DO UNDERSTAND IF A INDUSTRIAL CONFIGURATION IS

SUSTAINABLE WE HAVE TO FIRST CHECK FOR ITS’ FEASIBILITY
THUS, FOR THE SATISFACTION OF TWO CONDITIONS:
► DEMAND AND SUPPLY MKT EQUILIBRIUM

m
∑ qi = Q(p)
i=1
Where m stands for all the firms, i for the single firm and Q(p) is the vector of output
demanded by the market
► FIRMS ARE NOT BEARING LOSSES

n
∑ p k qi k – C(qi) ≥ 0
k=1
-----------------------------------------------------------------------------------
A FEASIBILE INDUSTRIAL CONFIGURATION IS

SUSTAINABLE IF
FOR ANY PRICING VECTOR p AS p £ p

AND A VECTOR OF OUTPUT q THAT IS q £ q THERE IS:
n
å pk q k – C(q) £ 0
K=1
Lectures
- VII, VIII and IX -

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&
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IS THE EFFICIENT
INDUSTRIAL
CONFIGURATION
IS THE NATURAL MONOPOLISTIC?
MONOPOLY FEASIBLE YES NO
AND SUSTAINABLE?
YES ANTITRUST POLICIES

AND REGULATION
IN ORDER TO PROMOTE
IS THERE A REASON FOR CROSS CONTESTABLE MARKETS
SUBSIDIES?
NO
NO
REGULATION IN ORDER TO PROTECT

YES
THE NATURAL MONOPOLIST
SUSTAINABLE PRICING DOES
NOT CALL FOR A PROTECTION
OF THE MONOPOLIST
POLICY AIMS IN NON COMPETITIVE MARKETS
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COMPETITION
POLICIES
WHERE POSSIBILE THE AIM IS

TO PURSUE
CONTESTABLE MARKETS
LIBERALIZATION, PRIVATIZATION,
DEREGULATION, RE-REGULATION
INDEPENDENT AUTHORITIES
EX ANTE & EX POST
The “whys” of public intervention in the case of Spillovers
-----------------------------------------------------------------------------------
Market dynamics can lead to inefficient outcomes also by the mean

of other failures….
Spillovers
An externality arises whenever an individual’s production or

consumption decisions affects the production or consumption of
other individuals, other than through market prices
Spillovers that are not internalized by economic agents …..

sub-optimality or over-production/consumption
Structural inefficiency
39
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Externality Definition: An externality exists any time the production or

consumption of a good creates spillover benefits or costs on a third party not
involved in the market. In such cases, resources will either be under-allocated
(positive externalities) or over-allocated (negative externalities) towards the
production of certain goods.
Examples of Positive Externalities Examples of Negative Externalities

(known as merit goods) (known as demerit goods)
Electronic communication network externalities:
each owner of a telephone benefits when the size Driving sports-utility vehicles contributes to
of the network increases and they can contact traffic and contributes more to global warming
greater number of telephone users
Riding bicycles to work reduces congestion on the Producing electricity using coal creates
roads and makes for less traffic for everyone else greenhouse gas emissions and air pollution
Smoking cigarettes contributes to lung disease
Getting vaccines against communicable diseases
among not just the smokers, but those who
reduces the chance you will get others sick
suffer from second-hand smoke
40
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EC
41
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EB
42
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a) Public production: the State or a publicly-owned company
provides goods or services by setting the optimal level of
production
b) Regulation: price or quantity regulation
c) Pigouvian taxes or subsidies: tax = EC or subsidy = EB
d) Coase theorem: private market negotiation
e) Trading permits: regulamented market
43
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Evaluation of Corrective Taxes
Corrective taxes are a popular response to negative externalities among
economist, but among policy-makers, they are rarely popular. Some
arguments against corrective taxes include:
• Higher costs for producers: Producers face higher costs, and therefore
will reduce their output of the goods being taxed. This is bad for business.
• Higher prices for consumers: Consumers of the goods being taxed face
higher prices, reducing consumer surplus and the real incomes of
households. For some goods (such as electricity) this could place a major
financial burden on households.
• Less employment: As the taxed industries reduce their output, they may
be forced to lay off workers, increasing unemployment in the economy.
• Loss of competitiveness in global market: This is a major one. Policy-

makers fear that if they impose taxes on their nation’s producers, but other
nations’ governments do not impose taxes on their producers, then the
44
domestic industries will suffer while foreign producers thrive.
-----------------------------------------------------------------------------------
Coase Theorem (Part I):

When there are well-defined property rights and costless
bargaining, then negotiations between the party creating the
externality and the party affected by the externality can bring about
the socially optimal market quantity.
Coase Theorem (Part II):

The efficient solution to an externality does not depend on which
party is assigned the property rights, as long as someone is
assigned those rights.
That is to say: Law can be a beautiful landscape!
45
-----------------------------------------------------------------------------------
COASE THEOREM EXAMPLE

Firms pollute a river enjoyed by individuals. If firms ignore individuals,
there is too much pollution.
1) Individuals owners: If river is owned by individuals then individuals

can charge firms for polluting the river. They will charge firms the
marginal damage (MD) per unit of pollution. Why price pollution at MD?
Because this is the equilibrium efficient price in the newly created pollution market.
2) Firms owners: If river is owned by firms then firm can charge

individuals for polluting less. They will also charge individuals the
MD per unit of pollution.
Final level of pollution is the same
46
-----------------------------------------------------------------------------------
In practice, the Coase theorem is unlikely to solve many of the types of

externalities that cause market failures.
1) The assignment problem: In cases where externalities affect many

agents (e.g. global warming), assigning property rights is difficult
⇒ Coasian solutions are likely to be more effective for small,
localized externalities than for larger, more global externalities
involving large number of people and firms.
2) The holdout problem: Shared ownership of property rights gives

each owner power over all the others (because joint owners have
to all agree to the Coasian solution)
As with the assignment problem, the holdout problem would be

amplified with an externality involving many parties.
47
-----------------------------------------------------------------------------------
3) Free Rider Problem: When an investment has a personal cost but a
common benefit, individuals will underinvest (example: a single
country is better off walking out of Kyoto protocol for carbon emission
controls);;
4) Transaction Costs and Negotiating Problems: The Coasian

approach ignores the fundamental problem that it is hard to negotiate
when there are large numbers of individuals on one or both sides of
the negotiation.
This problem is amplified for an externality such as global warming,

where the potentially divergent interests of billions of parties on one
side must be somehow aggregated for a negotiation.
It won’t help with large-scale, global externalities, where only a

“government” can successfully aggregate the interests of all
individuals suffering from externality 48
-----------------------------------------------------------------------------------
The U.S. Environmental Protection Agency (EPA) was formed in 1970 to

provide public-sector solutions to the problems of externalities in the
environment.
Public policy makers employ two types of remedies to resolve the problems
associated with negative externalities:
1) price policy: corrective tax or subsidy equal to marginal damage per

unit;;
2) quantity regulation: government forces firms to produce the socially

efficient quantity.
49
-----------------------------------------------------------------------------------
Hp: Assume MD of pollution is $1 per unit of pollution
2 firms with low (L) or high (H) cost of pollution reduction q:

cH(q) = 1.5q2 ⇒ MCH(q) = c’H(q) = 3q
cL(q) = .75q2 ⇒ MCL(q) = c’L(q) = 1.5q
With no taxes, no regulations, firms, do qL = qH = 0
But … from a Social welfare maximization point of view:
V = maxqH,qL qH + qL − cH(qH) − cL(qL)

⇒ MCH = 1, MCL = 1 ⇒ qH = 1/3, qL = 2/3
Optimum outcome is to have the low cost firm do more pollution reduction
than the high cost firm
50
-----------------------------------------------------------------------------------
TAX VERSUS REGULATION SOLUTION
Socially optimal outcome can be achieved by $1 tax per unit of pollution

(same tax across firms): cH(q) = 1.5q2 ⇒ MCH(q) = c’H(q) = 3q
2 cL(q) = .75q ⇒ MCL(q) = c’L(q) = 1.5q
Firm H chooses qH to maximize qH − cH(qH) ⇒ MCH = 1

Firm L chooses qL to maximize qL − cL(qL) ⇒ MCL = 1
qH = 1/3, qL = 2/3
Uniform quantity regulation qH = qL = 1/2 is not efficient because firm H has

higher MC of polluting than firm L
Proof: Firm H would be happy to pay firm L to reduce qL and increase qH to

keep qL + qH = 1, firm L is happier and society has same level of pollution
51
-----------------------------------------------------------------------------------
Quantity Regulation with Trading Permits
Suppose start with quantity regulation qH0 = qL0= 1/2 and allow firms to trade
pollution reductions as long as qH + qL = 1
Generates a market for pollution reduction at price p

Firm H maximizes pqH − cH(qH) ⇒ MCH = p and qH = p/3
Firm L maximizes pqL − cL(qL) ⇒ MCL = p and qL = 2p/3
⇒ qH + qL = p
As 1 = qL0+qH0 = qH +qL, in equilibrium p = 1
and hence,
qH = 1/3 and qL = 2/3
Final outcome qH, qL does not depend on initial regulation qH0 ,qL0
Quantity regulation with tradable permits is efficient as long as total quantity
qL0 + qH0 = 1 52
-----------------------------------------------------------------------------------
Externalities are the classic answer to the “when” of State intervention: when
one party’s actions affect another party, and the first party doesn’t fully
compensate (or get compensated by) the other for this effect, then the market
has failed, and government intervention is potentially justified.
This naturally leads to the “how” question of State intervention. There are
two classes of tools in the government’s arsenal for dealing with externalities:
price-based measures (price-regulation, taxes and subsidies) and
quantity-based measures (quantity-regulation).
Which of these methods will lead to the most efficient regulatory outcome
depends on factors such as the heterogeneity of the firms being regulated,
the flexibility embedded in quantity regulation, and the uncertainty over
the costs of externality reduction.
53
The “whys” of public intervention
in the case of Asymmetric information
-----------------------------------------------------------------------------------
Asymmetric information occurs when one party to a transaction has

more information than the other
We focus on two specific forms:
ü Adverse selection
ü Moral hazard
The analysis of how asymmetric information problems affect behavior

is known as agency theory
54
-----------------------------------------------------------------------------------
Adverse Selection
Occurs when one party in a transaction has better information

than the other party
• Before transaction occurs (ex ante contract)
• In the bank loan market: Potential borrowers most likely to

produce adverse outcome are ones most likely to seek loan
and be selected
55
-----------------------------------------------------------------------------------
Moral Hazard
Occurs when one party has an incentive to behave differently

once an agreement is made between parties
• After transaction occurs (ex post)
• In the bank loan market: Hazard that borrower has incentives

to engage in undesirable (immoral) activities making it more
likely that won't pay loan back
56

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Lectures

-­ I, II and III -­

LM-­90 European Studies a.a. 2020/21

Introduction to Law and Economics II

-­ Office hours: Monday from 12 to 14

-­ First intermediate exam: 4th of November 2020

-­ Second intermediate exam: 7th of December 2020

-­ Antitrust group-­works and seminars: half of November

-­ To understand the policy aims when dealing with competition;;

-­ To figure out main figures of regulation;;

-­ To be aware that regulation is incredibly sectoral specific;;

-­ To learn the main figures of antitrust discipline;;

-­ To interpret and analyse antitrust cases.

-­ Law and Economics.

The interest of economists for applied research on the relationship

Under this perspective – that had a great success especially in the

… but first of all it is a system of behavioural incentives or

“… economic analysis of law is a

Calabresi G. e Melamed A.D. (1972), “Property Rules, Liability Rules and

ü Cicero refers of the tragedy of Rhodian citizens that experienced a long

ü If a party makes investment such as a master in geology, and during the

Why does the civil code provide such a rule and

In order to give a proper answer to the questions aforementioned, the

Considering that good faith, as a general clause, is uncertain, recalling to

In order to provide a more clear methodological framework, it is necessary to

Given that norms act as a constraint to rational economic maximizing

In other words, the aim is to understand the reasons and circumstances in

How the presence of asymmetric information between parties can or cannot

law, economics, political science, technology and public policy, etc.

i.e. Regulation is a field of study that requires

Debate: Supporters (State intervention) vs. Skeptics (Market clearance)

-­ a potential burden on economic activity (Market clearance).

Economic crisis (recent trigger events):

Regulation vs. Antitrust

“Regulation seeks to hold the Promotes market

As a speciﬁc set of commands: binding set of rules to be applied

As deliberate state inﬂuence: actions that are designed to

As all forms of social or economic inﬂuence: regulation can be

Social regulation: public interest in health, safety, environmental

Economic regulation: deals with all forms of market failures, let’s

First signs of modern forms of regulation can be found since

Regulatory controls were explicitly recalled in the Preamble to an

Perfect competition or what else … 15

-­ I°Fundamental Theorem of Welfare Economics

-­ Determinants of Public intervention

On the debate on public intervention, after 2007/2008 economic crisis

This argumentation can rely on

I° Theorem of Welfare economics

B. Homogenous product or undifferentiated

C. Perfect information: symmetry in the info set-­up

E. Consumers maximize their utility

F. Firms maximize profits

G. There are no significant externalities

1) Production Efficiency Condition MRTS KMedicine

2) Exchange Efficiency Condition A

3) Substitution (Allocation) Efficiency

Stigler (1965) discerns five preconditions for competition in

1. The rivals must act independently, not collusively

2. The number of rivals, potential as well as present, must be sufficient to eliminate

4. There must be freedom (from social restraints) to act on this knowledge.

Competition as absence of barriers to entry and exit

“It seems preferable, therefore, to adapt the concept of competition to

- I, II and III -

LM-90 European Studies a.a. 2020/21

- Office hours: Monday from 12 to 14

- First intermediate exam: 4th of November 2020

- Second intermediate exam: 7th of December 2020

- Antitrust group-works and seminars: half of November

- To understand the policy aims when dealing with competition;;

- To figure out main figures of regulation;;

- To be aware that regulation is incredibly sectoral specific;;

- To learn the main figures of antitrust discipline;;

- To interpret and analyse antitrust cases.

- Law and Economics.

- a potential burden on economic activity (Market clearance).

- I°Fundamental Theorem of Welfare Economics

- Determinants of Public intervention

C. Perfect information: symmetry in the info set-up

Competition as price-taking behaviour

LM-90 European Studies a.a. 2020/21

LM-90 European Studies a.a. 2020/21

• Loss of competitiveness in global market: This is a major one. Policy-

It won’t help with large-scale, global externalities, where only a