Competition Policy & Collusion (Competition Policy - PC to Monopoly focus) Flashcards
Key factors for growing US economy overtime
Larger markets
Reduction in unit costs
New investments
As US got larger markets, what is issue?
Businesses want to expand, creates fierce battle for market share. Translates to price wars
How to solve price wars (2)
M&A
Informal agreements to keep prices up to recover costs of investment (COLLUSION!)
Competition authority vs industry regulators
CA checks lawfulness of firms activities (one off)
Industry regulators have more continuous extensive role e.g firms prices, investment and product
Which acts ex-post vs ex-ante
Competition authority ex-post
Industry regulators ex-ante
Competition policy definition
Set of policies and laws to ensure competition is not restricted and reduces economic welfare
3 examples of detrimental actions of firms
Collusion
Anti-competitive mergers
Exclusionary behaviour
1st: Collusion
Firms agree in some aspects of their behaviour in order to increase profits
2nd: mergers
Horizontal vs vertical merger
Horizontal is mergers with competitors
Vertical is merge with different stages of production process
2 reasons for mergers
Exercise market power and increase prices (if merger creates monopoly)
Create conditions and scope for collusion (to affect prices again)
3rd: Exclusionary behaviour
Practices that prevent entry or drive competition out
(as we prevent entry by limit pricing, entry deterrence (capacity), fudenberg investment k1
and drive competition out by predatory pricing)
Why is exclusionary behaviour challenging for competition authorities to assess
As a firms practice can benefit consumers but also give monopolistic advantage to the firm e.g predatory pricing lowers prices (good for consumers) but anti-competitive, bad for other firms.
Main aim of competition policy
Maximise Welfare (CS+PS)
So since all CA cares about is total surplus (WELFARE, both CS and PS), why do they care if an increase in price increases PS but reduces CS?
b) when is total surplus largest
As the gain in PS doesn’t fully compensate the fall in CS. (allocative inefficiency!)
b) under perfect competition P-MC
So competition policy for welfare main purpose
Other reasons for competition policy (5)
SMEs
Market integration (price discrimination)
Fairness/equity or other social reasons (small v large)
Political and environmental
Trade
Market power
The ability of a firm to charge over MC
What inefficiency is caused by market power
Allocative inefficiency - Welfare loss as firms engage in unproductive activities to gain market power
(i.e lower output but higher prices means suboptimal distribution)
How does market power reduce static welfare
As P>MC, so PS gain, and as mentioned, increase in PS does not fully compensate loss in CS
Draw welfare loss (DWL) from operating a monopoly in comparison to perfect comp
(pg8)
I worked out how to find DWL (on pg 8), using inverse demand fucntion P = a -bQ, we get
DWL = 1/2 [(a-c)/4b]²
How does deadweight loss vary with elasticity?
B) how to show it mathmatically
More elastic = larger DWL (so when price rise to monopoly price, lose more demand.
And recall, the simultaneous rise in PS, doesnt fully compensate the loss in CS! So DWL
b) differentiate DWL with respect to b
When can welfare loss be underestimated, what is this known as?
b) draw additional DWL be on the diagram pg9
If firms rent seek! i.e use productive resources to gain market power rather than using them in production.
i.e producers gains rent and extracted surplus, and use their profits in order to maintain their monopoly position. (RENT SEEKING COSTLY)
however since remain a monopoly, they lose incentive to improve (no threat of comp), so become inefficient (X inefficiency) so true cost of monopoly is higher. (drawn on diagram).
b) draw a higher true cost c, which corresponds to a higher price.
So firm rent seek and spend to maintain market power opposed to production process.
Costs rise for them as become X-inefficient as no incentive to improve. What does Posner argue additional cost is equal to
Additional cost is equal to monopoly profits, since it is what they have and willing and able to spend
What inefficiency does rent-seeking create
Productive inefficiency - they operate less efficiency compared to perfect competition (less incentive to improve since remain monopolist)
Why are monopolies by nature productively inefficient (2)
Managers have less incentive to exert effort (no real competition creates X-inefficency)
No selection process (no survival of fittest so allows inefficient monoplies to continue to operate)
So what do we need for a collusive outcome
To be able to detect deviation from collusive price (since without detection, firms could cheat and undercut and steal market share)
Punishment - trigger price wars to reduce profit (deter cheating by making cost of collusion>gains)
