Final Exam Flashcards
What are the two types of economic systems?
Examples?
(1) Centralized Economic System is where the government and related agencies COORDINATE different economic activities
(e.g., estimating demand of products, producing them).
- Gov’t owns means of production (private ownership of enterprises was generally not allowed)
- E.g., Soviet Union, East European Communist Countries
- Led to no product variety, queues to get uncommon products, shortages
(eventually disappeared)….
(2) Market-based Economic System is where most of the decision making and coordination of economic activities is left to the MARKET (voluntary transactions according to the laws of supply and demand)
- Private enterprises are allowed, which provided strong incentives for owners to create new, innovative products
- E.g., Canada, US, most Western countries
Why is the market-based economic system more successful than the centralized economic system?
(1) BETTER COORDINATION of economic activities and USE OF RESOURCES
- It is impossible for gov’t to predict demand and supply (leads to shortages)
- In a market-based system, SCARCITY is reflected in market prices
(2) STRONGER INCENTIVES for BUSINESS ACTIVITIES and innovation (due to the CHANCE of making a PROFIT)
What is the First Welfare Theorem? What does it imply?
According to the First Welfare Theorem, perfectly competitive markets are ideal because they MAXIMIZE TOTAL WELFARE (sum of consumer surplus and producer surplus).
As such, perfectly competitive markets are PARETO EFFICIENT - one cannot be made better off without making someone else worse off (aka maximum level of efficiency)
Implications:
- Government should NOT intervene in competitive markets that are functioning (unless there is market failure).
What are the characteristics of perfectly competitive markets?
(1) Price Taking – there are many buyers and sellers; no one firm can control prices.
(2) Identical/Homogenous Products
(3) Symmetric Information – perfect information between buyers and sellers.
(4) Free Entry and Exit – no barriers to entry.
When should the government intervene?
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
Even with market failure, the government should conduct a cost-benefit analysis to determine if the benefits outweigh the costs/inefficiencies of government intervention.
Examples of market failure:
- Externalities (under or overprovision)
- Concentration of market power (unregulated markets drive competition out, lead to coordinated acts, or abuse of market power)
- Under-provision of public goods (including innovation), important development projects (NIMBY problem), positive externalities
- Asymmetric Information and adverse selection
- Failed gov’t intervention
- Excessive risk taking
- Use of insider information
- Self-dealing
- Exploitation of labour
- Free-rider problem
How do government interventions create inefficiencies?
Every form of government intervention is (1) COSTLY and (2) DISTORTS economic incentives (which leads to UNINTENDED CONSEQUENCES).
Example of costly regulation:
- The cost to regulate Hydro One (a natural monopoly) by the Ontario Energy Board is $46M per year.
- Cost to enforce a competitive rental rate in a small market like Kingston can outweigh the benefits of regulation.
Example of distortion of economic incentives: (another reason for gov’t intervention to correct it!)
- In the US, following heavy subsidization of corn (which decreased the price of corn), there was an increase in the use of corn syrup (higher energy content than regular sugar). This government intervention contributed to America’s growing obesity problem.
- Cost plus pricing regulation creates incentives to increase costs!
What are the economic reasons for government intervention?
x 8
(1) Concentration of market power
(2) Asymmetric Information between buyers and sellers
(3) Provision of public goods
(4) Externalities
(5) Correction of failed government intervention
(6) OTHER REASONS:
- Macroeconomic Stabilization and ECONOMIC GROWTH
> intervention to MODERATE business cycles and CURB UNEMPLOYMENT during recessions
e.g., Bank of Canada adjusts interest rates, Gov’t imposes taxes to support gov’t spending.
- Fairness
e. g., imposing a minimum wage and providing social programs. - Protection of critical industries for NATIONAL SECURITY (defense, agriculture)
Economic Argument 1: Concentration of Market Power
What are some natural ways (market solutions) to address these issues without gov’t intervention?
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Firms with SUBSTANTIAL market power (monopolies and cartels) can ABUSE their market power by LOWERING OUTPUT and charging PRICES well above their marginal cost of production.
- Therefore, highly concentrated markets CREATE deadweight loss that hurt consumers.
- Government intervention is needed to eliminate or reduce the deadweight loss and limit the abuse of market power at the expense of consumers.
e.g., Prevent the concentration of market power (Merger Control); Regulate Monopolies (Price Regulation); Break up Monopolies.
Market solution - increased competition (e.g., removal of entry barriers or deregulation)
Economic Argument 2: Asymmetric Information
Examples
What are some natural ways to address these issues without gov’t intervention?
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- information asymmetry can lead to ADVERSE SELECTION, a form of market failure whereby private information is EXPLOITED. In the long-run, only LOW QUALITY products are traded in the market.
e. g., 2007/2008 Subprime Mortgage CRISIS - Information asymmetry between Wall Street banks and Institutional Investors about the QUALITY of mortgage bundles - led to a huge economic downturn.
e. g., Used car dealership - Sellers know more about the QUALITY of products than buyers. In the long run, only LOW QUALITY products are traded (Good quality cars are not sold because of lower prices due to risk of bad quality cars).
e. g., asymmetric information between depositors and banks; between inventors and investors (patents).
e. g., asymmetric information between investors and inventors
e. g., asymmetric information between buyers and sellers about CSR initiatives
Market Solution - build reputation for producing high quality products, standardize products, investing in credible signals.
Economic Argument 3: Provision of Public Goods
Examples
The government should only INTERVENE when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Public goods are both NON-EXCLUSIVE and NON-RIVAL IN CONSUMPTION
- Non-exclusive means individuals cannot be excluded from consuming the good (i.e., by not paying)
- Non-rival means that consumption by one person does not PREVENT consumption of others (e.g., no reduction fo the amount of good available to others).
- Public goods lead to the FREE-RIDER PROBLEM because individuals CANNOT be EXCLUDED from consuming the good, so they have an incentive to consume the good WITHOUT PAYING for it.
(The free-rider problem is when individuals are not willing to pay for public goods because they cannot be excluded from consumption )
- Therefore, the free market solution leads to the UNDER-PROVISION of public goods
- Gov’t intervention is needed to correct the market failure and PROVIDE public goods
e.g., Street lighting, Fireworks, Innovation, Roads, the CBC radio station
Economic Argument 4: Externalities
Examples
What are some natural ways to address these issues without gov’t intervention?
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Externalities are ECONOMIC activities that AFFECT third parties.
- Negative externalities are activities that impose COSTS on others (e.g., Pollution, congestion, smoking)
- Positive externalities are activities that CREATE BENEFITS on others (e.g., R&D, education, immunization, electric vehicles, CSR).
- Negative externalities and positive externalities lead to MARKET FAILURE and CREATE DEADWEIGHT LOSS
- Negative externalities lead to a market output that is TOO HIGH compared to the socially optimal outcome (marginal private cost DOES NOT reflect the cost on society).
- Positive externalities lead to a market output that is TOO LOW compared to the socially optimal outcome (producer is not sufficiently compensated for the benefit created for others - positive externality is NOT INTERNALIZED).
*Note: Socially optimal level (MSC = MSB) is not equal to 0 (i.e., do not need to stop most human activities).
Gov’t Intervention (to REDUCE loss in total surplus/DWL from externality): Quantity controls and standards, emission fees and taxes, cap and trade systems, subsidies.
Market Solution:
- Internalize the externality (one firm creates and is affected by the neg. externality)
- Coase Theorem - eliminate inefficiencies through private bargaining.
Economic Argument 5: Correction of failed government interventions
What are the effects of RENT CONTROLS?
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Government interventions in otherwise functioning markets creates DISTORTIONS, such as excess demand or supply.
- Government intervention is needed to ADDRESS MARKET DISTORTIONS
e.g., Rent Control is a form of government intervention whereby the government imposes a PRICE CEILING on rent increases with the intention of making RENT MORE AFFORDABLE for low income families.
However, rent control creates unintended consequences:
(1) SHORTAGES
> Binding price ceiling reduces the equilibrium supply of rental units, which creates a deadweight loss
> Such shortages make it HARDER for low income families to obtain rental units
(2) Additional inefficiencies include: lower quality rental units (due to lower incentive to invest in rundown units), landlords choosing the most solvent applicants.
Gov’t ultimately needed to intervene again with PUBLIC/SOCIAL HOUSING, which is expensive and has created social problems (housing offered in undesirable neighbourhoods).
What is the Coase Theorem?
Why does it often fail in practice?
Coase Theorem explains how INEFFICIENCIES from externalities can be ELIMINATED through PRIVATE BARGAINING if two conditions are satisfied:
(1) Bargaining is COSTLESS (no transaction costs)
(2) Property rights are SPECIFICIED (someone owns legal control rights over the property).
If these two conditions are satisfied, then parties can achieve an EFFICIENT OUTCOME WITHOUT government intervention through private bargaining, REGARDLESS of which party is awarded property rights.
(private bargaining = negotiation of terms relating to the purchase/sale of the RIGHT to perform activities that CAUSE externalities)
e.g., Student Party imposes a negative externality on neighbours –> engage in private bargaining (students will pay a price to play loud music)
WHY IT FAILS?
- The Coase Theorem often fails in practice because at least one of the two conditions is not met.
- Bargaining in practice is NOT costless (it is both EXPENSIVE and TIME CONSUMING to negotiate with affected third parties).
- Property rights are not always specified (e.g., right to clean air, oceans and rivers).
Positive analysis of the role of government
Deficiencies?
Changes in government spending can be used as a proxy to measure the DEGREE of government intervention.
Deficiencies in this approach (why it is an imperfect measure):
A) Government spending IGNORES other types of government intervention (e.g., quota system restricts outputs and does not require spending).
B) Government spending DOES NOT ALWAYS PROMOTE ECONOMIC EFFICIENCY (may be motivated by political reasons). –> Politicians are ELECTED and public policies are influenced by SPECIAL INTEREST GROUPS
Stats:
- Since 1960s, government spending in Canada has increased steadily (making up ~44% of GDP in 2019).
What is transfer seeking? (Rent Seeking)
Examples of Transfer Seeking?
Transfer seeking is when individuals/groups INVEST ECONOMIC RESOURCES to RETAIN or OBTAIN ECONOMIC BENEFITS without creating any benefits or wealth to society.
Transfer seeking is optimal from an individual perspective, but is wasteful and INEFFICIENT from an ECONOMIC perspective if nothing is produced. The social cost of transfer seeking (investment in transfer seeking activities) is added to any deadweight loss. Often times, the cost of transfer seeking can EXCEED the net gains in surplus.
Examples:
- Lobbying - firms/associations lobby government officials to INFLUENCE PUBLIC POLICY that benefits their own economic self-interest without contributing benefits to society. For example, the Canadian Dairy Commission (CDC) engages in lobbying to restrict import quotas for cheese from the EU, which leads to INEFFICIENT OUTCOMES (such as lower competition, higher prices for consumers).
- Unions that engage in strikes to enforce HIGHER wages instead of producing valuable output.
- Insider trading/stealing - transfer of wealth without useful contribution to society
- Legal services - firms spend economic resources on legal services (litigation or settling of disputes) that do not produce benefits for society (such as investments in R&D).
What is the social cost of transfer seeking?
Social cost of transfer seeking is the AMOUNT INVESTED in transfer seeking activities.
For example, a competitive firm is WILLING to invest up to the NET (PRODUCER) SURPLUS created from obtaining a monopoly franchise.
The social cost of transfer seeking is an ADDITIONAL COST to deadweight loss.
Often times, the cost of transfer seeking can EXCEED the net gains in producer surplus.
Why is lobbying often not opposed by consumers?
Lobbying is often unopposed by consumers due to the CONCENTRATED BENEFITS AND DISPERSED COSTS problem.
The benefits OF LOBBYING EFFORTS (e.g., monopoly power or quota) are highly concentrated on a few firms, while the costs are highly dispersed across a large number of consumers. The COST for a SINGLE consumer is very small (e.g., small price increase), so consumers have a LOW INCENTIVE to lobby the government.
Example: Quotas on sugar in the US
- $3B cost in the form of higher prices is dispersed across consumers, such that each consumer pays $10 more per year.
- The benefits to each farmer are $3M more per year.
Why are quota systems often hard to eliminate?
relates to Private Regulation of Agriculature - Supply Management Boards
Due to the “Transitional Gains Trap” whereby only the FIRST entrants/beneficiaries that receive the quota free of charge benefit from the quota system (earn abnormal returns from higher prices).
However, subsequent farmers have to pay high UPFRONT COSTS to buy quotas (reflect future abnormal returns) and face high OPPORTUNITY COSTS of using the quotas. As a result, current farmers only earn NORMAL profits despite higher prices.
Despite inefficiencies with the quota system (higher prices for consumers that decrease consumer surplus and normal profits for farmers), dairy farmers engage in intense lobbying to maintain the quota system. Otherwise, the farmers would LOSE their SIGNIFICANT INVESTMENTS (quotas would be worthless).
(only viable solution - Politicians have to buy the farmers out…).
Lobbying in more detail:
- What are the main lobbying areas?
- How do you become a lobbyist (Federal, Provincial, Municipal)?
- Can lobbying be useful?
What are the main lobbying areas:
- International trade - tariffs, import quotas (increase import barriers, reduce export barriers)
- Government Procurement (military equipment)
- Regional Economic Development (e.g., Zoning by-laws).
How do you become a lobbyist?
- Federal lobbyists must be REGISTERED (with the Office of the Commissioner of Lobbying Canada) to lobby federal government legally.
- Municipal and Provincial lobbyists are not always required to be registered.
Can lobbying be useful?
- Yes, if lobbying IMPROVES economic outcomes by providing IMPORTANT INFORMATION to ensure better decision making of policymakers.
Economic versus Social Interest Groups
Both are types of SPECIAL interest groups (influence public policies).
Economic Interest Groups are concerned about their own economic self-interest, whereas Social Interest Groups promote social or moral values.
Examples of Economic Interest Groups:
- Professional Associations (E.g., Canadian Association of Petroleum Products)
- Industry Lobbies
- Unions
Examples of Social Interest Groups:
- Animal rights groups (PETA)
- Environmentalists
What are some reasons for inefficient government policies?
1) Inefficient voting
2) Transfer seeking (economic interest groups investing economic resources to obtain benefits that are inefficient from an economics perspective)
3) Self-interest of policy makers (motivated to maximize their own economic welfare, which is an example of corruption).
4) Bureaucracy - non-elective government officials also are self-interested and spend more on certain government programs over others, leading to “bloated” public sector/government programs.
Market Solution: Internalization of externality
What is it?
Example?
Why is this not practical?
Refers to having ONE FIRM create AND be affected by the externality (common management or ownership).
E.g., A PAPER mill in BC pollutes the local river and affects downstream SALMON farm. Internalization of the externality would involve having the paper mill ACQUIRE the salmon farm, or vice versa.
The result - owner can then choose the EFFICIENT level of pollution or abatement to MAXIMIZE total profit and surplus.
Why is internalization not practical?
- Often not possible to INCLUDE ALL affected parties under one common ownership (e.g., numerous cottage owners and recreational fisheries, in addition to the salmon farm).
What are the three economic tools used by governments to reduce pollution (eliminate negative externalities)?
- Explain what they are
- Provide 1-2 examples for each
(1) Quantity controls and standards
- refer to government-imposed LIMITS on the total QUANTITY of emissions/pollution emitted (enforced by monetary and criminal penalties)
- Ideally, limit equals the socially optimal level of CO2 emissions/pollution (E*) where MSC of emissions equals MCA of emissions.
- e.g., Gov’t can impose DISCHARGE limits for paper mills to reduce pollution in rivers.
- e.g., Gov’t imposes pollution limits (emission standards) on the amount of sulphur dioxide (SO2) emitted by coal-burning power plants.
- e.g., “Emission standards” on GHG emissions from automobiles.
(2) Emission fees and taxes
- refer to government-imposed fees and taxes FOR EACH UNIT of CO2 or pollution emitted.
- The OPTIMAL emission fee (F) to address the neg. externality (get to E) is called a “Pigovian tax” —–> firms choose to continue abating until their marginal cost of abatement = emission tax.
- Emission fees/taxes also generate REVENUE
- e.g., BC government imposed a carbon tax on GHG emissions ($40/ton emitted), which caused both firms and consumers to reduce carbon emissions totalling 3M tons in 2020. (e,g, firms switched to less carbon-intense fuels; consumers DROVE LESS, purchased more fuel efficient cars and invested in home insulation).
- E.g., ON’s gas tax to address negative externalities (air and noise pollution, congestion, accidents)
(3) Cap and Trade system
- Combines quantity controls and emission fees
- Gov’t issues TRADABLE PERMITS to firms that allow firms to emit a certain level of pollution.
- Allow externalities to have a market equilibrium price (between MCA of efficient and inefficient firm).
- Gov’t typically reduces the number of permits every year to lower pollution.
- Gov’t also raises money from sale of permits
- e.g., ON’s cap and trade system (abolished in 2018) involved “pollution permits” that were tradable at auctions.
Result - Direct cost in the form of higher heating costs, indirect cost through higher cost of goods and services.
Pollution negative externality graph (abatement, social cost)
Downward sloping marginal cost of abating CO2 emissions(MCA):
- Cost to “abate” (REDUCE) ONE MORE unit of pollution increases as the level of emissions reduces
- At high levels of CO2 emission, MCA is low.
- At lower levels of CO2 emission, MCA is very high (need very efficient technology to achieve low levels of CO2 emissions).
Upward sloping marginal social cost of CO2 emissions (as emissions increase, the cost to society increases).
Total cost of abatement = MCA * amount abated.
Why are emission fees/taxes generally more efficient than quantity controls and standards to restrict pollution?
(Recall: both achieve E* = socially optimal level)
(1) Taxes MINIMIZE total abatement costs when firms have DIFFERENT COSTS.
- Taxes allow the more efficient firms (low abatement costs) to reduce emissions MORE than firms with higher abatement costs.
- Therefore, taxes may PREVENT less efficient firms from relocating/exiting the market (e.g., pay fee versus large investment to decrease CO2).
(2) Taxes PROVIDE CONTINUING INCENTIVES to reduce pollution
- By investing in efficient production technology, firms can lower their tax burden.
(3) Taxes GENERATE REVENUES which can be used to fund other environmental projects.
What are the general concerns about emission fees that make the general public oppose them?
In other words, why does the government often implement quantity controls and standards instead of emission fees/taxes?
(1) Impression that firms “can BUY right to pollute” (as opposed to being forced to reduce emissions through emission standards).
- -> emission standards AVOID impression…
(2) (Consumers have) No trust in MARKETS- the general public believes that firms simply PAY taxes and PASS them on to consumers, WITHOUT reducing pollution (or changing behaviour)
* flawed thinking though because firms/consumers tend to change behaviour!
(3) Negative EFFECT on INTERNATIONAL COMPETITIVENESS of firms by making domestic production most costly. Therefore, taxes could lead to reduced employment and relocation to LESS STRICT JURISDICTIONS
- -> emission standards can SOFTEN effect on local firms.
Another benefit of Quantity Controls and Standards: ??
- Allows to set voluntary emission limits without imposing taxes on firms.
What are the advantages of the cap and trade system?
One limitation of the cap and trade system?
(1) Allows government/agency to LIMIT total emissions each year by controlling the number of permits (similar to quantity controls and standards)
(2) PROVIDES STRONG INCENTIVES to ABATE emissions
- High emission firms face high COSTS to buy permits; low emission firms face high OPPORTUNITY cost of using permits
(Better than tax system - paying tax might be more efficient than abating emissions)
(3) ALLOWS EMISSIONS TO BE abated at MINIMUM COST
- because cap and trade system COMBINES emissions fees/taxes and quantity controls and standards, so it is very efficient from an economics POV.
Limitation:
- High bureaucracy because a government agency issues permits and oversees auction for permits.
What is the NIMBY problem?
Provide 2 examples.
NIMBY stands for “Not In My Backyard”. The NIMBY problem characterizes the OPPOSITION BY local residents to proposed developments that generate NEGATIVE EXTERNALITIES.
The opposition stems from the CONCENTRATION of negative externalities on few, local residents (as opposed to evenly spreading the costs across the province).
Outcome - UNDER-PROVISION of these important goods and services LOCALLY, so toxic waste must be exported to DEVELOPING countries (which leads to disastrous effects on local communities).
For example, Oakville and Mississauga residents opposed the proposed GAS-FIRED POWER PLANT because of potential harmful effects on nearby homes and schools. Similar opposition is seen with nuclear and coal-burning power plants.
Another example - Opposition to hazardous waste treatment facilities (by the town of Erin - opposed proposed wastewater treatment plant), safe injection sites (helps with addiction), and social housing.
Negative Externality of Congestion - cause?
Efficient solutions?
Traffic Congestion is an example of a negative externality caused by the OVERCONSUMPTION/OVERCROWDING of roads
Efficient solutions:
- Road charges (tolls), with peak-load pricing (vary the optimal “tax” depending on the time of day or location)
(however, this will be faced by public resistance)
Congestion in the form of long lines:
Efficient solutions
- Peak-load pricing (charge more at peak times)
- Fast-track line (fast-track customers pay premium)
Canadian Competition Policy:
How does it relate to government regulation?
Why do we need it?
What is the OBJECTIVE of Canadian Competition Policy?
Competition laws are an INDIRECT way for governments to intervene in the market by ensuring that markets are somewhat competitive.
Entire unregulated markets might lead to LOWER COMPETITION (firms drive competitors out, coordinate acts, and abuse market power at the expense of consumers).
Objective of Canadian competition laws is to ENSURE markets are “REASONABLY” competitive in an attempt to maximize total welfare (the government recognizes that markets cannot be perfectly competitive).
Canadian Competition Policy:
How is Industry Canada structured?
Canadian Competition Bureau is the part of Industry Canada responsible for enforcing the Competition Act (Head: Commissioner of Competition)
Different branches of the Competition Bureau handle different complaints:
- Criminal Matters Branch - cartels
- Merger Branch - Merger Reviews
- Fair Business Practices Branch - Deceptive Marketing Practices
- Civil Matters Branch - Abuse of market power
Competition Policy regulating CARTELS (A)
What are cartels? Types of collusion What is illegal? Civil or criminal? Penalty?
S. 45 of the Competition Act prevents and breaks up CARTELS, which are groups of firms or countries that COLLUDE (e.g., to fix prices, restrict quantities, allocate markets).
Types of Collusion:
- Explicit Collusion - there is an explicit agreement or communication with competitors to collude.
- Tacit Collusion - there is an implicit agreement to collude (e.g., maintain high prices). While there is NO communication between cartel members, there is an UNDERSTANDING in the industry to avoid price competition (e.g., Price Leadership - one firm acts as the price leader that announces a high price in which all firms then match).
Law: S. 45(1) “every person commits an offence who, with a competitor […], conspires, agrees or arranges” …
According to the Competition Act, it is ILLEGAL (CRIMINAL offence) to CONSPIRE with competitors to MAKE…
(1) Price-fixing agreements, (S. 45(1)(a))
- -> e.g., maintain high prices for the supply of products (Chocalate cartel, bread cartel, gas cartels)
(2) Market allocation agreements, (S. 45(1)(b))
- -> Dividing the market (in Kingston)
- -> e.g., West vs East Kingston.
(3) Output restriction agreements (S. S. 45(1)(c))
- -> e.g., Lessen production of a product (in order to raise the market price).
*Requires proof of conspiracy on the criminal standard of “beyond a reasonable doubt” –> strong economic incentives to collude in concentrated industries because the risk of getting caught is low.
Penalty imposed on MANAGERS/EXECUTIVES and companies: (“The managers of Firm A and B are agreeing to…”)
- Imprisonment not exceeding 15 years, or
- Fine not exceeding $25M
- or both.
Convicted individuals ad their companies are LISTED publicly on the Competition Bureau’s website
Note that it is the explicit agreement by the two competitors that is illegal; choosing not to
serve some customers by itself is not illegal, as long as each company makes this decision
unilaterally (i.e., as long as there is no coordination among competitors)
Explain the Competition Bureau’s Immunity Program and Leniency Program.
How do both programs help break up cartels?
The “Immunity Program” ALLOWS cartel members to SHARE EVIDENCE of the cartel to the Competition Bureau in exchange for FULL IMMUNITY from prosecution. The program is ONLY available BEFORE official investigations into the cartel have started.
The “Leniency Program” GIVES cartel members REDUCED PENALTIES for COOPERATING after official investigations have started. For example, the applicant/cartel member
(i) Terminates participation in the cartel;
(ii) Cooperates during official investigation; and
(iii) Pleads guilty
Both programs help the Competition Bureau obtain EVIDENCE about cartels to break up cartels. CONVICTIONS are only possible IF the prosecutor can prove collusion “beyond a reasonable doubt”.
Competition policy preventing the concentration of market power (B)
What are the problems with mergers (specifically, horizontal mergers - mergers between competing firms)?
What does Canadian Competition Law do to address these problems?
Problem:
- Horizontal mergers typically lead to the LESSENING of competition (more concentrated markets).
- Firms in concentrated markets have high MARKET POWER, allowing them to CHARGE HIGHER PRICES AT THE EXPENSE of consumers (reduce consumer surplus).
Therefore, the Competition TRIBUNAL can DENY ANTI-COMPETITIVE mergers (mergers that prevent or lessen competition SUBSTANTIALLY), SUBJECT TO the “efficiency criterion”.
Competition policy preventing the concentration of market power (B)
When must the Canadian Competition Bureau be notified of a proposed merger (require CB’s permission)?
Notifiable transactions:
- Firms require PERMISSION from the Competition Bureau to merge when the following THRESHOLDS are met:
(1) The value of the merger exceeds $96 million, and/or
- -> target assets or revenue in Canada
(2) In the case of share acquisitions, SHARE THRESHOLDS are exceeded (35% for private corporations and 20% for public corporations).
- -> not market share! (purchaser’s post-merger share ownership)
(Competition Bureau will then conduct merger review to determine if they are likely to substantially lessen/prevent competition) *
Competition policy preventing the concentration of market power (B)
Describe the merger review process.
Remember: Competition Bureau can review mergers of all sizes and sectors (but certain proposed mergers require permission).
Merger Review Process:
1. FIRMS submit official NOTIFICATION to the Competition Bureau, triggering a 30-day waiting period (aka firms cannot proceed with the transaction).
- CB REVIEWS the proposed merger and its impact on competition. CB may issue a “Supplementary Information Request”, which triggers a second 30-day waiting period.
- Decision made by CB (either approved or denied). Firms part of denied mergers can APPEAL the decision to the Competition Tribunal.
Competition policy preventing the concentration of market power (B)
What are the TWO GROUNDS that the Commissioner of Competition can challenge the merger on?
What are their rule of thumbs?
E.g., Post-merger market share equal to 40%
(Either during the Merger Review process or after the merger)
(1) Unilateral Exercise of Market Power
- Rule of Thumb - Post-merger market share of the firm is greater than 35%
(2) Coordinated Exercise of Market Power - possibility of collusion
- First Rule of Thumb - Post-merger market share of the 4 largest firms in the market exceeds 65%
- Second Rule of Thumb - Post-merger market share of the firm is greater than 10%
*If the merger does not exceed these thresholds, they are generally APPROVED.
Example: CB can challenge the merger on both grounds - unilateral exercise of market power (because post-merger market share exceeds 35%) and coordinated exercise of market power (because post-merger market share exceeds 10%).
Competition policy preventing the concentration of market power (B)
What is the efficiency criterion?
Anti-competitive mergers are ALLOWED IF the COST SAVINGS of the merger OFFSET the loss in TOTAL SURPLUS.
Therefore, Canadian Competition Law maximizes total welfare.
Competition Bureau conducts economic analysis to decide whether to allow the merger:
- Estimate the demand and economic costs of the involved firms. (e.g., sales data, cost data to get PRE-MERGER quantity and price).
- Use demand elasticity and marginal cost of merged firm to PREDICT POST-MERGER PRICE and Quantity.
- Calculate the LOSS in Total Surplus due to the merger.
- Compare loss in total surplus and COST SAVINGS (e.g., from lower MC)
- Make a final decision
*Economic analysis is SENSITIVE to small errors
Competition Policy preventing deceptive marketing practices (C)
What are the three main TYPES of deceptive marketing practices?
(1) False and misleading representations (criminal and civil provisions)
- misleading claims about the PROPERTIES of a product.
(2) Price-related representations - (2 civil, 1 criminal)
(3) Pyramid Selling - multi-level marketing plans
Competition Policy preventing deceptive marketing practices (C)
What are the two provisions for false OR misleading REPRESENTATIONS?
When does each apply?
An example for each
When does criminal or civil provision apply?
- Depends on whether there was CRIMINAL INTENT to make the false or misleading representation (Y = Criminal provision, N = Civil provision)
(1) Criminal Provision (S. 52) - states it is ILLEGAL to make “KNOWINGLY or RECKLESSLY” false or misleading representations about products and services.
- Include claims about product characteristics (e.g., PLACE OF ORIGIN), warranties, servicing, testimonials, product tests.
- As a criminal provision, there needs to be CRIMINAL INTENT
Potential Penalties upon indictment:
- Fine (in the discretion of court), and/or
- Imprisonment up to 15 years
- Example - scams and frauds (like the Yellow-Pages Scam - companies and individuals knowingly mislead businesses into believing they were related to the popular Yellow Pages and signed them up for costly 2-year contracts)
(2) Civil Provision (S. 74) - prohibits the making of false or misleading representations about products and services
- No criminal intent.
- Individuals can file a complaint to the Competition Bureau about false or misleading representations
Competition Tribunal can ORDER to:
- STOP the false or misleading representation
- Publish a corrective notice
- Pay restitution to the purchaser
- Pay administrative monetary penalties
- —Individuals: up to $750k for the first violation; $1M for repeat violations.
- —Corporations: up to $10M for the first violation; $15M for repeat violations.
- Example - Brick promotion (“Buy Now, Pay Later”) was found to be misleading because customers had to pay substantial UPFRONT FEES
> type of misrepresentation about hidden or additional charges.
What is the name of this type of misrepresentation?
“Best SELLING ice cream in Kingston!”
Market Position
What is the name of this type of misrepresentation?
“Brake check for $29.99 plus tax” - excludes an additional charge of $69.99 for labour
Hidden OR additional charges
What is the name of this type of misrepresentation?
“Authorized Apple dealer” - when they are not authorized by Apple
Attributes of SUPPLIER
What is the name of this type of misrepresentation?
“We donate 20% of our profits” - when they donate less than 10%
Image advertising
What is the name of this type of misrepresentation?
“Blowout sale - everything must go before we close our doors. Forever”
Reason for sale
Competition Policy preventing deceptive marketing practices (C)
What is this type of price-related representation called? Is it a criminal or civil provision?
> A car dealer advertises a new model at a VERY LOW PRICE, but only had one of the new models on its lot.
Bait and Switch Selling
- Civil provision (s. 74.04)
- Illegal tactic whereby sellers ADVERTISE a product at a BARGAIN PRICE (very low price) but the product is NOT AVAILABLE in REASONABLE QUANTITIES.
- The intent is to lure customers into their stores in the hopes that customers switch to more expensive/profitable products.
Competition Policy preventing deceptive marketing practices (C)
What is this type of price-related representation called?
Is it a criminal or civil provision?
> Box of Coke cans are advertised at $2.99, but Metro will only sell the beverages if customers pay $5.99.
Sale above advertised price
- Civil provision (s. 74.05)
- It is illegal for retailers to SELL or RENT products at a price HIGHER THAN the advertised price.
Competition Policy preventing deceptive marketing practices (C)
What is this type of price-related representation called?
Is it a criminal or civil provision?
> A bag of apples has two price tags. Metro will only sell the apples at the higher price.
Double ticketing
- Criminal provision (S. 54)
- If a PRODUCT is MARKED by the seller WITH TWO PRICE TAGS, then it is ILLEGAL to sell the product at the higher price.
- In other words, the retailer must sell the product at the LOWER price.
Competition Policy preventing deceptive marketing practices (C)
When is pyramid selling legal and illegal?
Is it a criminal or civil provision?
Are Pyramid schemes the same as Ponzi schemes?
Pyramid selling is a form of MULTI-LEVEL MARKETING plan.
Multi-level marketing plans are LEGAL if the main compensation/income for participants comes from SELLING THE PRODUCT, as opposed to recruiting new members.
- Legal multi-level marketing plans require CLEAR COMMUNICATION to members about the COMPENSATION that an AVERAGE member is actually or likely to receive.
Multi-level marketing plans (pyramid selling) are ILLEGAL if the main compensation/income for participants comes from RECRUITING new participants instead of selling the product. > Criminal offence (S. 55.1)
e.g., Herbalife was accused of being a pyramid scheme.
Penalties:
- Fine (discretion of court), and/or
- Imprisonment up to 5 years
Pyramid schemes are not the same as Ponzi schemes (which refer to the practice of paying old investors with money from new investors and taking a fee off the amount).
