Market Power and Dom Firms Flashcards
What is the concentration ratio?
It’s just the sum of the size of K firms in the market in relation to the market as a whole
What is the advantage of the concentration ratio? (1)
Only require information on the first K < n firms
What are the disadvantages of the concentration ratio? (2)
The concentration ratio applies to the market it is tested in - a firm may be dominant in a local market but less so when the scope of the market is expanded
Just because a firm is dominant within its market doesn’t mean competition is lacking - competitors may just be less efficient
How much of a market ratio is needed for oligopoly?
An oligopoly occurs when the top 5 firms account for 60% or more of the market ratio
What is the Herfindahl-Hirschman Index?
A similar method to CR which squares the percentage share of each firm and sums them (can be decimals or whole numbers)
What Herfindahl-Hirschman Index does a pure monopoly have?
1 or 100^2 = 10,000
What share do firms have in a symmetric oligopoly?
n(1/n)^2 = 1/n
What is a market?
A market includes all products in a given geographical area that exert competitive pressure on one another
What is the SSNIP test?
A test to see whether a hypothetical monopolist a sustain a small but significant non-transitory increase in prices (SSNIP) (usually defined as 5% increase for 12 months)
- If yes then the product/stores owned by the monopolist define the market
- If no then the market definition is wider
The process repeats until a 5% change in price doesn’t affect profits
How do we implement the SSNIP?
Through the use of own-price elasticity of demand and cross-price elasticity of demand
What is own-price elasticity of demand?
The responsiveness of demand with respect to own price
Remember it’s negative!
-(dqi/dpi)(pi/qj)
What is cross-price elasticity of demand?
The measure of Demand in response to one Good to Change Price of another Good.
(dqi/dpj)(pj/qi)
What is the cellophane fallacy?
The risk that a market will be defined too widely (i.e. if studying a remote town where there are only multiple co-ops) when using the SSNIP on a dominant firm
When was the SSNIP test created and who by?
First set out in 1982 US Department of Justice Merger Guidelines
EU commission adopted this method in 1997 Notice on Market Definition after using it for Nestle/Perrier and concluding an increase in price wouldn’t affect sales of soft drinks
What did NERA, 2001 say about the SSNIP?
“Any statement to the effect that SSNIP is just one example of how to define a relevant market without clearly specifying what the alternative to SSNIP might be, clearly runs the risk of a return to a process of market definition by ad hoc reference to product characteristics.”
What is the Lerner Index?
(P-MC)/P
What are the properties of the Lerner Index? (3)
- Estimation of price elasticity of demand provides measure of market power
- it is decreasing in ε
- L = 0 for perfectly elastic demand
What are the assumptions of a market where there is a dominant firm with a competitive fringe?
- Market Demand is downward sloping (dQm/dp < 0)
- Supply of the fringe is upward sloping (dQf/dp > 0)
- The profits of the dominant firm are π = pQ(p) - C(Q(p))
If prices increase, what happpens to the dominant firm’s demand?
It falls for 2 reasons:
- Market Demand falls as price increases
- The fringe’s supply increases as prices increase
What are the issues for a monopolist of a durable good? (2)
- The monopolist is in competition with itself
- The price consumers are willing to pay depends on the price tomorrow
Coase (1972) conjectured: project durability might eliminate market power
What is a consumer’s surplus if they buy in period 1 vs period 2?
- CS in period1 is (WTP - p1) = 0
- CS in period2 is δ(WTP-p2) = δ(p1 - p2)
The consumer should delay purchase if p1>p2 for any δ
What is the conclusion if there are an infinite number of periods for the consumer to buy in?
The monopolist cannot sell its product for any price p>c
How to avoid the Coase conjecture? (5)
- Leasing - if the product is returned, monopolist can supply consumers with high WTP again. Problem of moral hazard
- Invest in reputation e.g. Disney, Star Wars
- Most-favoured customer clause (if firms price lowers tomorrow, we’ll refund the difference!) Means firms don’t want to lower price and consumers may as well buy
- New Customers - increasing demand in period 2 will increase price in period 2
- Reduce the goods durability
