9. Competition Policy and State Aid Flashcards
What are the basis of competition policy in UK after Brexit?
- State aid key element in Brexit negotiations
- How much state aid can British companies receive without being considered unfair competition or fair play?
- UK and EU agreed to set up an ‘independent authority’ to monitor supply decisions
- Some elements of anti-trust policies have changed
-New merger control rules in the UK
What is the importance of large companies in competition policy decisions?
Economic integration can compensate a small size of a country:
- Market size is good for economic performance
- With fixed production costs or decreasing marginal costs, larger markets can reduce average total costs
Production activity can be concentrated within few very large firms:
- Value added of multinationals account for 25% world GDP
- 70% of world businesses R&D produced by 700 largest multinationals (MNEs)
Economic integration is also associated with mergers, acquisitions and cooperation between firms
What is the importance of mergers and acquisitions in the EU
M&A activity very high in the EU
Much M&A activity is mergers within member states:
- About 55% is domestic
- Remaining 45% split between:
One non EU firm (24%)
One firm located in another EU nation (15%)
Counterparty’s nationality not identified (6%)
Why is there need for competition policy?
Large companies can be beneficial, but sometimes limit competition.
- Need for policy in EU as collusion may rise as number of firms fall
Other extreme is ‘perfect collusion’
- Firms coordinate prices and sales perfectly
- Perfect collusion is where firms charge monopoly price and split the sales among themselves, causing average profits to rise
What are some examples of Cartels, Competitions policy and state aid?
Cartels:
- RBS and JPM fined for market manipulation
- Sausage producers fined for fixing prices for decade in Germany
- Beer breweries fixed prices of 1/2 German beer sales
- Google made to change practices due to abusing dominant position
State aid:
Governments tempted to subsidise firms in trouble after integration - unfair for competitors in other countries
Example:
- Governments under pressure to subsidise national airlines. Commission has restricted subsidies to cover only the exceptional losses after 9/11
What are the 3 pillars of the European Commission Policy?
- Antitrust policy:
- Prevents cartels and other anticompetitive agreements
- Preventing abuses of dominant position - Merge control
- Prevents anticompetitive M&As - State aid control:
- Limit distortions to competition and trade resulting from state subsidies; allowing aid when it is in the common EU interest
What are the 3 theories on explaining the effect of collusion?
- Economic integration without collusion
- Collusion
- Mergers
What is the theory of economic integration without collusion?
Assumptions:
- Two identical countries with identical firms
- Constant marginal costs and positive fixed costs -> decreasing average costs
e.g.
MC = 10
FC = 50
Total cost(x) = 10x+50
AC(x)=10x/50/x = 10 + 50/x
As x increases, average cost decreases
- Perfect competition in the long run, there is free entry and exit of firms. There are 0 profits but positive mark up (price-marginal costs) due to fixed costs
What are the curves that relate firms with mark ups? How does this show economic integration without collusion
Competition curve:
- If there are more firms in the market, competition will force each firm to charge a lower mark up. The curve is decreasing with the number of firms
(graphed on page 3)
Break even Curve:
- Given the market size - and fixed costs - more firms are able to survive if price is above the marginal cost (if the mark up is high)
Economic Integration without collusion:
A. Markte size - each firm has access to a second market of the same size. This shifts the Break Even curve to the right to point
B. Degree of competition - each firm now faces twice the number of competitors, shift along the COMP curve. Some firms lose money, mark up falls - short run price moves from p’ to p*A
In equilibrium, industrial restructuring from A to E’’
- Number of firms from 2n’ to n’’
- larger firms (more output) and more efficient (lower AC, lower prices)
Result:
- Bigger, fewer more efficient firms facing more effective competition
- Welfare gain of C
However, there are incentives from the Government to keep losing money firms via subsidies; state aid
- Incentives from remaining frims to collude to keep prices high
Examples of state aid
- Starbucks illegal tax advantage from the Netherlands
- Luxembourg selective tax benefits to Amazon illegal
- Ireland given illegal preferential tax treatment to Apple
How do we graphically demonstrate the benefits of state aid?
Consider a subsidy preventing exit of firms, making the economy stay at A
- Subsidy is equal to losses - profts are 0, not negative
Profts = p - mc - FC = 0
OR
P-MC = FC
Equilibrium with no trade: P - MC = A + B
At point A: P-MC = B + C
- At point A, to get 0 profts: b + c + subsidy = FC
We know from that FC = a+b
- If we substitute that into above, we get b+b+subsidy = a+B
- Thus subsidy is a-c
Welfare analysis:
- Change in producer surplus is 0 - profit is zero before and after
- Change in consumer surplus is a + d
- Subsidy cost is a - c
- Welfare effect is d + c
What would the effect be if both countries make subsidies to their firms after integration?
Both countries are better off with integration and subsidies than without integration:
- Prices go down. Increased consumer surplus that compensates the subsidy
- This is a SECOND BEST policy
However, subsidies are preventing firms from growing and becoming more efficient
Within the EU, state aid that provides firms with an unfair advantage and thus distorts competition is forbidden
What are the effects of collusion and mergers on the comp/break even curves
Summarised on page 4
What are the effects of mergers
Firms can merge or buy eachother out
- Creates a concentration of firms and a cartel-condition
Suppose a merger than charges high prices from P to P’
- Lower average costs by reducing redundant capacities, from AC to AC’ (price without collusion is P’’)
Profits = a + c (note revenue is a + c + e and total costs = e)
Loss in consumer surplus: - (a+b)
Overall welfare effect: c-b
Example: Pfizer walked away from $118bn Astra Zeneca takeover flight - tried to buy them
Summarise what we ahve learned about collusion and mergers
Economic integration generates increase in potential sales of firms: market effect
- Without collusion, economic integration creates fewer, bigger and more efficient firms
However, governments can provide state aid to prevent the closure of firms. This prevents potential firms’ efficiency gains
- Private firms can engage in anti competitive practices such as collusion. This increases prices and reduces consumers’ surplus
