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Practice Test Monopoly and Other Forms of Imperfect Competition

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									                    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

								
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