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Practice Test Monopoly and Other Forms of Imperfect Competition document sample
Price abuses 1. Predation 2. Rebates 3. Price discrimination 4. Excessive prices 5. Price squeeze 1 Predatory pricing A firm (“predator”) sets low prices for a certain period in order for a rival (“prey”) to incur losses and exit the industry. Two main elements of predatory behaviour: 1. short-term loss for the predator (sacrifice of current profits) 2. expectation of recoupment: higher prices and profits when rival exits (existence of market power a necessary condition to raise prices) Practical problems in identifying predation: are low prices predation (bad) or strong competition (good)? 2 A phenomenon in search of a theory McGee (1958): we should not expect predation to occur: 1. Criticism to “deep pocket” arguments: why should the prey not be able to obtain further funds? 2. Predation inefficient (destroys industry profits): merging with rivals would be more profitable Yamey (1972)'s counter-objections: 1. Predation discourages entry (merging with an entrant would invite further entry) 2. Predation allows to buy rivals at lower prices But: no rigorous foundation to predation until the 80s. 3 Recent models of predation The predator exploits imperfect information of the entrant (or its investors) to deter entry or force exit. Three types of models: 1. Reputation: if an incumbent faces a stream of (successive) entrants, a price war with early entrants creates a reputation for being “strong”, and discourages entry from later entrants 2. Signaling: entrant does not know if incumbent is weak (high cost) or strong (low cost), and observes incumbent‟s price before entering. I chooses low price (limit pricing) to discourage entry. 4 Recent models of predation, II 3. Predation in imperfect financial markets: it formalises the “deep pocket” argument. Idea: (i) Asymmetric information (lenders have little knowledge of the industry; moral hazard) makes capital markets imperfect (ii) If capital markets are imperfect, a firm's assets (e.g., cash and retained earnings) determine its ability to raise external funds (iii) By behaving aggressively, the incumbent reduces the prey's assets, limits its ability to raise capital, and obliges it to exit 5 Predation: practice Problem: how to distinguish predatory pricing (bad) from fierce price competition (good) ? Two main ingredients for predation: 1. Sacrifice of profits in the short-run 2. Ability to recoup in the long-run Proposed rule: two-tier approach 6 Practice, II: Two-tier test for predation 1. Is there enough market power for recoupment? If predator is dominant, go to 2. Else, dismiss case 2. Is there sacrifice of profits? P>AverageTotalCost (ATC): always lawful P<AverageVariableCost (AVC): presumed unlawful (burden of proof on defendant) AVC<P<ATC: presumed lawful (burden of proof on plaintiff) 7 Practice, III: remarks Low predation standards decrease incentives to compete for non-dominant firms Many possible reasons for P<AVC (introductory price offers, switching costs, learning, network effects): a prohibition of below-cost pricing (laws in many EU countries) makes no sense; but not applicable defence for dominant firms Intent relevant if confirms existence of predatory scheme No need to prove ex-post damage to consumers Meeting rivals‟ prices: not acceptable defence if P<AVC 8 Rebates Discounts applicable where a customer exceeds a specified target for sales in a defined period Differences, according to „target‟: Conditional on purchase growth; on buying only (or in a certain %) from supplier; on buying over a given threshold (quantity discounts) And if individualised (3rd degree PD) or not 9 Rebates in antitrust law EU case law: bad because exclusionary 1. and 2. are per se illegal if used by a dominant firm (“amount to exclusive dealing”) 3. illegal if individualised Michelin II case (2003): also standardised quantity rebates are illegal US case law: usually lawful competition on the merits; burden to prove they are anticompetitive on plaintiff (high standard) But: LePage (and Dentsply) signal a change? 10 Rebates At first sight, some types of rebates may appear similar to exclusive dealing However, contrary to ED, rebates are not an ex-ante commitment: I offers a price schedule, but E can match it. More difficult to formalise why rebates can exclude efficient entrants [Note: like ED, rebates may also have efficiency effects: they can give incentives to retailers to sell more; they avoid double marginalisation… see discussion of Michelin, II] 11 Anticompetitive rebates (Karlinger-Motta, 2006) Network industry: consumers buy only if network size above a threshold (reached by I, but not by E yet) Networks E and I identical (but E is more efficient); E has no fixed costs. One large buyer and many small ones; to reach minimum size, E needs at least 1 large and 1 small buyer. The game First: I and E simultaneously announce price schedules Then: Each of the buyers decides supplier Prices: linear, two-part tariffs, or with quantity discounts 12 Results (1) If linear pricing, both exclusionary and entry equilibria exist Intuition: Buyers‟ miscoordination. (Shows that network industries are prone to competitive problems) (2) If rebates are possible, under certain conditions only the exclusionary equilibrium exists Intuition: I gives some rents to the large buyer and compensates losses with small buyers. Getting the large buyer suffices to keep off E. Note: E does not have the same scope because I would enjoy monopoly if excludes, E will not. Comments: 1) Purely quantitative discounts manage to exclude entrants; 2) Exclusion is achieved despite I and E making simultaneous offers! 13 Price discrimination Types of price discrimination The (ambiguous) welfare effects of price discrimination Parallel imports: not justified the EU per se prohibition of clauses which prevent parallel imports. Price discrimination as monopolisation device 14 Price discrimination It is a pervasive phenomenon: examples Three types of price discrimination (PD): 1st degree (perfect) PD 2nd degree PD: self-selection of consumers 3rd degree PD: when different observable characteristics Two main ingredients of price discrimination - ability to “sort out” different consumers and charge them different prices - no arbitrage opportunities 15 Welfare effects of PD PD is not always bad: the extreme case of 1st degree PD, under which the first-best is attained (but: unrealistic example) Quantity discounts (2nd degree PD). If consumers are charged according to T+pq, the unit price (p+T/q) decreases with the number of units bought. Welfare increases because the fixed fee is used to extract surplus, allowing for a lower variable component than under linear pricing 16 3rd degree PD and parallel imports Suppose h and l are two EU countries (h=rich; l=poor) with different demands. Transport costs set to zero for simplicity. (Possible re-interpretation: consumer groups rather than countries.) If price discrimination across countries is allowed, the firm chooses prices so as to max profits in each market: it will set ph>pl. 17 Parallel imports, II If PD was prohibited (i.e., the firm cannot prevent parallel imports), then two cases may arise: 1) Under uniform pricing, sales in both markets. In this case: Pd > Pu , but Wd<Wu. 2) Under uniform pricing, one market is not served: the firm may prefer to set ph even if this implies no sales in country l. (This happens when country l is relatively unimportant, for instance.) In this case: Ph >Pu and Wh >Wu. General result: PD welfare detrimental if qPD does not increase. 18 Parallel imports, III EU policy: per se prohibition of clauses that prevent parallel imports Ratio: EU integration (one of the fundamental objectives of EU competition law) means equal prices across member states Objections: • this policy may decrease welfare • it may lead firms not to serve some countries (in example above, one market only is served under uniform pricing) • equity not an issue: under PD, „poorer‟ citizens pay less 19 Further remarks PD and investments. Since PD increases the firms‟ profits, the uniform pricing policy may have long-run negative effects (on investments, innovations etc.) PD and market power. Both small and large firms will have incentives to discriminate prices across countries. But in the former case welfare effects are less relevant. To the extent that PD will induce firms to invest more, allowing „small‟ firms to engage in PD may foster competition. Sensible to use a safe harbour: PD allowed for firms below a certain market share (not the current policy!). 20 PD as monopolisation device PD may also affect market structure, i.e. be used by an incumbent to exclude rivals. For instance, we have seen that discriminatory offers help exclude entrants Rebates and selective discounts are other possible forms of PD which may lead to exclusion (Karlinger-Motta, 2006). But an obligation to dominant firms not to discriminate (transparent pricing) may have adverse effects (helps a dominant firm to solve the commitment problem). Also, PD may increase welfare if exclusion not an issue. 21 Excessive Pricing Art. 82 EC Treaty v. Sect. 2 Sherman Act Very few cases in the EU General Motors, United Brands, SACEM Recent trends: more interventionist? Liberalisation (most recent cases in postal services, telecommunications, airlines…) A tool to overcome situations where competition does not work properly? Role of National CAs (might increase with decentralisation trends?), more subject to political pressure towards price controls 22 Excessive prices: a typology 1. Exploitative abuse: too high 2. Exclusionary abuse: too prices in final markets high prices in intermediate markets 23 Exploitative excessive prices (final markets) How to establish that prices are „excessive‟? ECJ: Unreasonable disproportion between price and economic value of the good (General Motors) Different methods to estimate the “economic value” (i) Price „much higher‟ (>100%?; >60%?) than cost (ii) Price „much higher‟ than some benchmark 24 (i) Price „much higher‟ than cost (i) Price „much higher‟ than cost Problems: How to establish the „highest fair‟ price p*? How to compute costs? (accounting principles) Costs may be high because firm is dominant 25 (ii) Price „much higher‟ than a benchmark (ii.a) Price „much higher‟ than in another benchmark market 26 (ii) Price „much higher‟ than a benchmark, cont‟d (ii.b) Price „much higher‟ than in a competitive benchmark market 27 Excessive price or something else? (ii) amounts to prohibiting price discrimination across markets (which may be different for demand or for market structure reasons) (i) Since a dominant firm may not charge the monopoly price, but a lower price p*, this amounts to a de facto prohibition of exercising a dominant position 28 Excessive prices in intermediate markets Concern: excluding rivals, or putting them at disadvantage. (Refusal-to-deal extreme case of excessive price) Theory: a vertically integrated dominant firm may want to foreclose (say, downstream) competitors, but: Foreclosure not necessarily welfare detrimental (!) Dis-incentive effect if firm cannot freely decide its intermediate good prices 29 Incentive effects In this setting, excessive pricing = compulsory licensing = ‘essential facilities doctrine’ ex post: they improve welfare ex ante: they discourage firms‟ incentives Governments (or CAs) face a committment problem: they should commit never to expropriate firms‟ investments, so as to give firms the right incentives to invest. 30 Policy implications Prohibition of excessive pricing reduces profitability (and increases legal uncertainty), thus discouraging investments CAs not competent enough to establish „costs‟ CAs‟ role not to set prices Problems of remedies: continuous monitoring? Structural remedies? Entry should reduce monopoly power; (and if legal barriers exist, there should be sectoral regulation) Even if it does not, intervention breaks commitment not to expropriate firms economy-wide (dis-) incentive effects Yet… 31 Conditions for „excessive pricing‟ actions The following conditions must simultaneously arise: 1. There exist legal barriers to entry (and such barriers are not justified by protection of investments, such as in IPRs) 2. There is no way to eliminate those barriers 3. No sectoral regulation Such conditions are broadly consistent with past EU practice: (SACEM, Belgacom/ITT Promedia, General Motors, British Leyland) And if sector regulator exists, but it „is sleeping‟…? CAs‟ excessive prices action might stimulate the RAs to intervene EU cases in telecom industry, initiated by DG-COMP but later picked up by NRAs. 32 Price (or margin) squeezes Price (or margin) squeeze if a dominant firm‟s own downstream operation could not trade profitably if it was charged the UI Cost c0 price offered to its competitors: p-a<cI. a Price squeeze if margin p-a is not sufficient to allow a „reasonably Cost cI DI Cost cE E efficient‟ service provider to obtain a normal profit: p-a<cr. p Predation and excessive pricing tests may not capture this practice. 33 Price squeeze: when is it likely? Chicago School: no need for price squeeze, as upstream firm can already get monopoly profit. However, if downstream imperfect competition exists, rationale for exclusion arises. More general, price squeeze more likely if: - monopoly (or near-) upstream - no alternative sources of inputs - imperfect downstream competition - downstream products are close substitutes (else, market demand for input would shrink) 34
"Practice Test Monopoly and Other Forms of Imperfect Competition"