Competition Law Notes – Markets and Market Power
Competition Law Notes – Markets and Market Power
Read our FREE competition law notes covering markets and market power. Ideal for general reference and exam revision.
- Efficient market
Whereby no rearrangements of production or distribution will improve the position of any consumer or seller (without making someone else worse off) – Pareto optimal.
- Perfect Competition
The conditions for perfect competition are:
- There are many buyers and sellers
- The quantity of the market’s products bought by any buyer or sold by any seller is so small relative to the total quantity traded that changes in these quantities leave market prices unaffected.
- The product is homogeneous; no buyer has a reason to prefer a particular seller and vice versa.
- All buyers and sellers have perfect information about market prices and the nature of goods sold.
- There is complete freedom of entry into and exit out of the market
- Allocative efficiency
The allocation of available productive forces and materials among the various lines of industry – making what consumers want as shown by their willingness to pay
- Productive efficiency
The effective co-ordination of the various means of production in each industry into such groupings as will produce the greatest result – producing goods or services at the lowest cost thus using the fewest resources.
A profit-maximising firm will increase production when the additional revenue exceeds the additional costs. It will expand output whenever marginal revenue (MR) exceeds marginal cost (MC) and keep expanding output until marginal revenue equals marginal cost.
Other extreme to perfect competition.
- One seller occupies the entire market
- The seller’s product is unique (no close substitutes – high differentiation)
- Substantial barriers to entry by other firms into the industry, and exit is difficult
- The monopolist will maximise profits by restricting output and setting price above marginal cost.
- Deadweight loss – loss of value to consumers who at the competitive price would buy the product but who at the monopoly price are forced to buy inferior substitutes – allocative inefficiency.
- Market Power
- The ability to profitably raise prices above the competitive level for a significant period of time without rivals taking away customers in the short run
- Measures of direct market power e.g. Learner index and indirect market power – “market definition”
- Can only really exercise market power if barriers to entry exist
- Economies of scale – may be less costly for one firm to produce any level of output rather than subdivide production among two or more firms
- Economies of scope – possible for one firm to produce two products more cheaply than two or more firms could
- Barriers to Entry
Constraints in a market which prevent or hinder other firms from entering a specific market and thereby taking away sales from the incumbents.
- Two Views
- Bain – Any legal or economic factor which hinders entry to a market by a new entrant
“the extent to which, in the long run, established firms can elevate their selling prices above the minimal average costs of production and distribution.. without inducing potential entrants to enter the industry”
These can include minimum efficient scale, scale economies, access to raw materials or distribution channels
- Stigler/ Chicago School
Chicago School argue that barriers to entry are few and relate only to legal regulatory constraints: tariffs, environmental restrictions, licences, patents.
Barriers to entry are only those constraints which are faced by the entrant but not the incumbent.
Stigler: “a cost of producing (at same or every rate of output) which must be borne by a firm which seeks to enter the industry but is not borne by firms already in the industry”
- Sunk costs
Costs which cannot be recovered when a firm exits a market and hence serve to commit a firm or firms to stay in the market. They include advertising costs, brand proliferation, long term contracts, investments in R & D
Incumbent firms can use sunk costs strategically to limit entrants
- investments to alter demand conditions
- influence expectations about post-entry prices
- Market definition
All competition analysis begins with the market definition
- important for defining:
- market power, dominance
- substantial lessening competition for merger analysis
- area of close competition between firms
- field of rivalry between them
- field of actual and potential transactions between buyers and sellers amongst whom there can be strong substitution, if given sufficient price incentive.
Regulatory authorities issues Guidelines on Market definition
EC Guidelines (1997) Notice on the definition of the relevant market for the purposes of Community competition law.
- Product or Service
- cross elasticity of demand
- The % change in the quantity of B demanded that results from a 1% change in the price of A. If cross elasticity is positive the goods are substitutes if negative (pen and pencils) then complements (left and right shoes; shoes and socks ); Operating systems and application software)
- SSNIP Test
- Small but Significant Non-transitory Increase in Price
- Market definition can be viewed as establishing the smallest area of product, functional and geographic space within which a hypothetical monopolist (or cartel) could impose a small but significant and non-transitory increase in price (SSNIP)
- EC Notice on the relevant market
- Par 17: “starting from the type of products that the undertakings involved sell and the area in which they sell them, additional products and areas will be included in, or excluded from, the market definition depending on whether competition from these other products and areas affect or restrain sufficiently the pricing of the parties’ products in the short term”
- Product or Service
- Demand or supply side substitution
- Single brand markets
- One market or two? i.e tying Windows and media player
- Conglomerate markets (avionics and jet engines)
- Geographic market
- look at sources of supply consumers would turn and firms which supply or would supply the relevant product in the event of a significant price rise.
- Local, EU or global
- depends on cost of transport (price differential)
- nature of product – perishable
- local or national preferences are important
- impediments foreign or non-local firms may have in supplying – i.e. no ready distribution network
- regulatory barriers
- quotas, tariffs, taxes, exchange rates
- technical standards – foreign DVDs will not run in certain countries if not local standard.
- (EC contacts customers, traders looks at past evidence of deliveries to different regions, trade flows).
- Cellophane fallacy
For SSNIP test usually use the prevailing market price but may not if the price has been determined in the absence of sufficient competition
- firm may already be charging monopoly prices and focus on substitution does not help because increase now on the monopoly price will exaggerate the competition it faces.
- US case US v E.I. Du Pont De Nemours & Co (1956) 351 US 377
- Market definition is used to determine the level of market power or dominance
- Dominance: Hoffmann-La Roche
- “position of economic strength enjoyed by an undertaking which enables it to prevent effective competition being maintained on the relevant market by giving it the power to behave to an appreciable extent independently of its competitors, customers and ultimately of consumers”