Download Economics of Competition - Jamaica Fair Trading Commission

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:
1. Introduce economic theories that underlie
competition law
2. Examine how competition authorities
define markets, measure market
concentration and market power
Economics and Competition
Law
• Definitions
– Competition Law
• Set of rules of conduct  market outcome
– Economics
• Importance of Economics to Competition Law
– Structure-Conduct-Performance
4
Economics and Competition
Law
• Competition
– 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
5
Market Structures
• Other Market Structures include:
– Monopoly
– Oligopoly
– Monopolistic competition
6
7
Market Structures
• Entry and Exit
• Number of Buyers and Sellers
• Information
• Product Homogeneity
Perfect Competition
• Structural Characteristics
– Many buyers and sellers
– Perfect Information
– Homogenous Goods
– No barriers to entry or exit
• Behavioral Characteristic
– Firms are price takers
8
Perfect Competition
• Existence of Perfectly Competitive
Markets?
– Agricultural Markets
9
Monopoly
• Structural Characteristic
– One Seller
– No close substitutes
– No entry possible
• Behavioural Characteristic
– Price makers
10
Monopolies
• Barriers to Entry and Monopolies
– Economies of scale
– Exclusive Access to technology or resource
– License
11
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:
– 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
Summary
15
Market Structures
Monopoly
C
H
A
R
A
C
T
E
R
I
S
T
I
C
S
Number of
One
Firms
Freedom of
Restricted/
Entry and Exit Blocked
Few
Monopolistic
Perfect
Competition
Competition
Few or Many
Many
Restricted
Unrestricted
Unrestricted
Information
Not Perfect
Not Perfect
Not Perfect
Perfect
Product
Homogeneity
Example
Differentiated
Differentiated /
Differentiated Undifferentiated
Undifferentiated
Computers, Cars, Bottled Water, Agricultural
Milk, detergents Shoes, Clothing Products
Electricity,
Water
Price Maker or Maker
Price Taker
Oligopoly
Maker
Maker
Taker
Market Power and Price
Elasticity of Demand
• Market Power
– Definition
• Price above competitive price
• Price Elasticity of Demand
– Definition
• sensitivity of demand to a price change
16
Market Power and Price
Elasticity of Demand
17
• 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.
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
18
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
19
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:
(402 + 252 + 202 + 102 + 52 = 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
Dupont (1956) Packaging
Material
Philadelphia
National Bank U.S.A
(1963)
Xerox (1975)
Market Smaller Market Market
Share
Share
20%
Cellophane
>75%
4%
Copy Machines 65%
Philadelphia
36%
Plain Paper
>90%
Copy Machines
Hypothetical Monopolist Test
25
• 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
28
Summary
Table 2. Summary of Presentation
Market
Structure
Market
Market Power Market Share Concentration
Perfect
Competition
None
Minute
Low concentration
Monopoly
Significant
All
Fully concentrated
Oligopoly
Some
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