Market Power and Concentration Flashcards
In the cournot model for a case of an oligopoly with more than two firms, what does each firms profit depend on?
the total output produced by all firms, irrespective of individual firms’ outputs.
Why is perfect competition justified as a good reference point for markets where there are many firms
The Cournot model converges to perfect competition as the number of firms goes to infinity
True or false:
Under the cournot model in a duopoly, the equilibrium output per firm decreases as the number of firms increases, and total output increases with more firms, eventually converging to the level seen in perfect competition.
True
market performance under oligopoly lies ____ the extremes of perfect competition and monopoly
between
Do models like cournot describe dynamic processes that lead from one equilibrium to another?
No they are static and eventually converge to the Nash equilibrium over time
The price cost margin (P - MC) can be used to measure __________ in symmetric markets
Market power
Does it take a large number of identical firms for the performance of the cournot model to be very close to perfect competition?
No
An inverse of the number of firms can be used to measure ________ in symmetric markets
market concentration
In asymmetric firms (more generally), market power can be measured by ________
The Lerner index
“The weighted average of each firms margin, with weights given by the firms market shares” is the definition for ________
The Lerner index
What is the most common index to measure market concentration?
Coeffecient Cm, where the sum of the market shares of the largest m firms is calculated (etc C5 ratio)
What does the value of C4 vary between?
0 (minimum concentration) and 1 (maximum concentration aka monopoly)
What does SCP stand for?
Structure-conduct-performance paradigm. Where structure = how concentrated, conduct = the behaviour of its firm, performance = market power, allocative efficiency etc
Apart from the Cm index, how can market concentration be measured?
The Herfindahl index (HHI)
What does the value of HHI vary between?
0 and 1 but usually is multiplied by 10,000 so 0 and 10,000
Why is the HHI harder to compute than the C4 measure?
Knowledge of the market shares for all firms in the industry is required, not just 4
The greater the market concentration (H) the ____ the degree of market power (L)
greater
Consider two markets with identical demands. In one market, there are two firms with identical market shares. In the other market, there is one firm with a 70% market share and two small firms with 15% each. Assuming that both markets are in a Cournot equilibrium, where is market power the greatest?
whichever market has the greatest concentration, as measured by the Herfindahl index. In this case even though the second market has more firms (n is greater), the disparity in their sizes (i.e., market shares) leads to a higher concentration and thus more market power.
What does allocative efficiency mean?
resources are distributed in a way that maximises the net benefit to society.
How do structure, conduct and performance relate
structure influences conduct, both structure and conduct influence performance
Explain the relationship between conduct and performance
the more competitively firms behave the lower the degree of market power and the greater the allocative efficiency
Explain the relationship between structure and performance
A more concentrated industry, where a few firms hold significant market share, tends to exhibit greater market power due to less competitive pressure.
The relation between noncompetitive behaviour and market power (hence concentration) is a) positive or b) negative
a) Positive
What does the structure-performance hypothesis test (SPH)?
The positive relation between concentration and market power
Is measuring market power or concentration harder?
Market power (the lerner index)
To test the SPH we need data on _______ and ______
concentration and market power
What is a caveat of empirically testing the SPH?
difficult to accurately measure variables like market power and the impact of externalities
As price is increased and the number of firms adjusts, concentration ____ as market power ______
- decreases
- increases
(opposite to usual prediction)
What relationship between concentration and market power does the simultaneity problem imply?
There can be a negative relationship between concentration and market power, contrary to the positive relationship suggested by SPH
What limitation of the SPH does the simultaneity problem highlight?
The SPH fails to account for the possibility of reverse causality between structure, conduct, and performance.
The suggestion that conduct (behaviour) can influence market structure etc when aggressive pricing strategies by one firm lead to changes in the market shares or exit of competitors, aligns with the SPH or simultaneity problem?
The simultaneity problem, the SPH implies structure influences conduct and both structure and conduct influence performance
Does the reverse effect (simultaneity problem) treat market structure as endogenous (meaning affected by firm conduct and market outcomes)?
hell yeah
Why can it be difficult to draw clear conclusions about the nature of the relationship between market structure and performance?
relationships may reflect the sum of direct and reverse effects, potentially with opposite signs
What is the collusion hypothesis?
concentration implies market power through increased collusion between firms
What is another hypothesis for the positive relation between structure and performance?
The efficiency hypothesis
What does the efficiency hypothesis suggest?
the observed correlation between market concentration and profitability is not solely due to market power, but could also be because more efficient firms tend to earn higher profits, which in turn allows them to gain a larger market share.
What does a symmetric oligopoly mean?
all firms have same MC
True or false:
According to both the collusion and efficiency hypothesis, a lower marginal cost by one of the firms implies a redistribution of market shares, whereby both concentration and market power increase
True,
Under the collusion hypothesis, if a firm has lower marginal costs, it can lead to a more dominant position, which could facilitate collusion, increasing both concentration and market power.
The efficiency hypothesis posits that more efficient firms (lower MC) can outcompete their rivals, thereby increasing their market share. As these firms grow larger, the market becomes more concentrated, and these efficient firms gain more market power, albeit through competitive means rather than anti-competitive ones.
Is it possible for society to be better off under the efficiency hypothesis where both concentration and market power are greater
Yup
Are the policy implications from the collusion and efficiency hypothesis the same?
No, the collusion hypothesis tends to support more regulatory and antitrust intervention to promote competition, while the efficiency hypothesis may lead to policies that encourage firms to pursue efficiencies and innovations to compete in the market.
According to the collusion hypothesis, why should policymakers be concerned about mergers?
because they can significantly increase industry concentration, which, under the collusion hypothesis, would lead to increased market power and potential harm to consumers
If all firms had the same marginal cost, what would be the expected relationship between market shares and profit rates?
market shares would not be an explanatory factor for profit rates, as there would be no efficiency advantage to differentiate firms.
What are some of the theoretical and conceptual problems with the traditional approach to testing the structure-performance hypothesis?
It combines several effects into one measurement: the direct effect of concentration on performance, the effect through firm conduct, and the feedback effects of conduct and performance on market structure, as well as uses profit rates as a proxy for the price-cost margin.
What is the New Empirical Industrial Organisation (NEIO) approach, and how does it differ from the traditional approach?
NEIO attempts to directly model and estimate firm behaviour using firm-level data for a specific industry. It differs from the traditional approach by not assuming profit rates as proxies for the price-cost margin and by estimating marginal costs as part of the statistical analysis.
True or false in terms of demand elasticity,
If θ = 1, firms behave according to Cournot competition. If θ = 0, it corresponds to Bertrand competition where price equals marginal cost.
True
Why might using firm-level data be more beneficial for estimating firm behaviour and market power?
Firm-level data can be more precise and relevant for modeling the behavior of individual firms, as it allows for the estimation of firm-specific variables like marginal cost, without the need to rely on profit rates as proxies for price-cost margins.
Why is the degree of market power small even with perfect collusion if demand is elastic?
With elastic demand, consumers are more sensitive to price changes. Even with perfect collusion, firms have limited ability to raise prices without losing a significant number of customers, which keeps market power in check.
True or False:
Accurate data on marginal cost are often unavailable, complicating the direct calculation of θ..
True - Instead, θ may be indirectly estimated using observable data like sales tax changes, which can serve as proxies for marginal cost changes
True or false:
Collusive behaviours may result in price stickiness, where prices do not change proportionally with changes in marginal cost due to the costs associated with price adjustments.
True
True or false:
Estimating conduct, in particular, the degree of collusion between firms, is a complicated process for which there is no hard and fast solution
True!
True or False:
It takes a large number of identical firms for the performance of the Cournot model to be close to perfect competition
False
The degree of market power depends on 3 factors, what are they?
- Demand elasticity
- market concentration
- extent of collusive behaviour
What is the first step in the assessment of market power?
Defining the market
Why is defining the market necessary?
To identify competitive constraints and provide a framework for competition policy
What is the first step in actually defining the market? Why?
Identifying the closest substitutes to the product (or service) as these substitutes exert the strongest competitive constraints on the behaviour of the firms supplying the product in question
What is the hypothetical monopolist test?
What competition authorities worldwide use to establish which products are ‘close enough’ substitutes to be in the relevant market
What is another word for the hypothetical monopolist?
A cartel
How does the hypothetical monopolist test actually define the relevant market ?
It defines the relevant market as the smallest product group (or geographical area) such as a hypothetical monopolist (or cartel) controlling the product group (in that area) could profitably sustain a “small and significant non-transitory increase in prices, SSNIP)
What does a SNNIP stand for?
Small and significant non-transitory increase in prices
What price increase is meant by the SNNIP?
a 5-10% price increase above competitive levels for at least one year (keeping the terms of sales of all other products constant)
true or false:
If there is a substitutable product that a sufficient number of consumers would switch to and make the price increase unprofitable, then the relevant market should be expanded to include that alternative product
true
What is a limit of the SSNIP?
It focuses on demand-side substitutability: it is the consumers switching possibilities that constrain the hypothetical monopolists ability to raise prices but in reality other firms supplying the product may also prevent them
What might prevent a hypothetical monopolist from sustaining a SSNIP?
If entry conditions are such that additional firms can supply the product at short notice and without incurring substantial sunk costs, this supply-side substitutability could prevent a hypothetical monopolist from sustaining a SSNIP.
True or false:
Demand-side substitutability on its own would define the relative market in a relatively narrow way
True!
What is the definition of market power?
The ability to raise prices above perfectly competitive level
What is the first way to measure market power?
Look at the difference between price and marginal cost
What is the definition of the Lerner index?
Its defined as the markup, so the difference between price and marginal costs as a percentage of price
What is the formula for the Lerner index?
L = (P - C’)/P
True or false?
The SSNIP is a snapshot of the intensity of competition
False- the Lerner index is tho
Why is the Lerner Index not a perfect measure of market power?
Since costs, particularly marginal costs, are often not directly observable. It also ignores dynamic considerations and does not account for long-term strategic behaviours of firms.
What are concentration indices?
Statistics that measure the degree of concentration of the market by adding up the market shares of a certain number of firms.
What is the m-firm concentration ratio?
The m-firm concentration ratio ( Im ) adds up the market shares of the top m-firms in the market.
etc C4 measures the top 4 firms
What does it suggest if the m-firm concentration ratio is close to 1?
The market is quite concentrated, which may warrant scrutiny by antitrust authorities.
What is an important consideration when interpreting the m-firm concentration ratio?
Interpreting the m-firm concentration ratio requires consideration of market conditions, as markets vary and those dominated by a few firms might still be competitive, while markets with many firms could be less competitive.
How do antitrust authorities use the m-firm concentration ratio?
Antitrust authorities use various (Im) rules to identify dominant firms or assess market competition. For example, in the EU, a firm with a market share of alpha1 ≥0.4, or 40% of the relevant market is considered a dominant firm.
What does the observation of low prices by active firms in the market not necessarily indicate?
The observation of low prices by active firms does not necessarily mean that the market is very competitive. Firms may forgo short-term gains to be able to raise margins in the future.
Why is the outcome from the use of concentration indices important for a firm?
The outcome from the use of concentration indices is important for a firm because it determines whether a firm is subject to certain types of regulation, such as being classified as a dominant firm.
What does the Herfindahl–Hirschman Index (HHI) consider that the m-firm concentration ratio does not?
The full distribution of market shares for all firms active in the market, not just a small number of the largest firms.
How is the Herfindahl–Hirschman Index (HHI) calculated?
As the sum of the squared market shares of all firms in the market.
Why is the HHI considered a better measure of market concentration than the m-firm concentration ratio?
The HHI is considered better because it captures both the number of firms and the dispersion of their market shares, providing a more comprehensive view of market concentration.
What does an HHI of 1 indicate?
An HHI of 1 indicates that one firm has a complete monopoly over the market.
What is the range of the HHI when market shares are expressed in percentage terms?
When expressed in percentage terms, the HHI ranges from 0 to 10,000.
What HHI value indicates an un-concentrated market according to US antitrust agencies?
An HHI below 1500 indicates an un-concentrated market.
At what HHI value do US antitrust agencies consider a market to be highly concentrated?
An HHI above 2500 is considered to indicate a highly concentrated market.
What limitation does the Herfindahl index have in terms of translating into market power?
It does not necessarily translate into market power due to factors like capacity constraints and product differentiation.
What is not directly linked to a firm’s ability to sustain price above marginal costs?
The market share of a firm is not directly linked to its ability to sustain prices above marginal costs.
