Post on 21-Jan-2023
How competition works Economists tend to begin with the assumption that firms seek to maximise profits (a reasonable assumption)
How much profit a firm makes is heavily influenced by the amount of competition it faces
A consideration of market structures enables the nature and degree of competition within a particular market to be studied
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Competition among firms
How competition works We consider two extreme cases:
Extensive competition A single firm
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Competition among firms
Case 1: extensive competition
Competition among firms
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Imagine a market in which the firms are making HUGE profits
What happens next? Two things happen simultaneously:
Profits act as signals to existing producers to increase output
Profits act as signals to alert entrepreneurs attracting more resources from new firms
Case 1: extensive competition The result leads to an increase in the quantity of the product produced
This results in the price falling if demand stays the same
Priceper Sunit
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D
Quantity per period
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Competition among firms
Case 1: extensive competition
Competition among firms
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If demand does not change, the influx of resources erodes the profits of producers of the product
This is the essence of competitive forces
The firms are competing for market share and a share of the profits available
The fewer the firms in the market, the greater the share of profits each firm will receive
Case 1: extensive competition
Competition among firms
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Suppose that so many firms are attracted into a particular market that the price falls so much as to remove the profitability of producing the product
What happens next? Firms with the highest costs will no longer find it profitable to produce the product and will leave the market
This shifts the supply curve to the left and raises price and hence the profitability of the remaining firms is increased
Case 2: a single firm
Competition among firms
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When a market is dominated by a single firm the forces of competition are absent
The main reason for the absence of competing firms is that the dominant firm has the power to prevent new firms entering the market e.g. A monopoly over an important component or specialist knowledge over processes
A statutory license to operate In the absence of competition, the huge profits will continue to accrue to the single firm
How competition works
Competition among firms
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From an economist’s perspective, the benefits of competition are clear Prices will more closely reflect the marginal cost of production delivering allocative efficiency
Allocative efficiency means that what consumers want gets produced
Goods that consumers don’t want don’t get produced
How competition works
Competition among firms
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If price exceeds the marginal cost of production (too little produced) resources will be misallocated With extensive competition this will be temporary
With less competition it can continue Competition forces firms to cut costs and to be as efficient as possible, operating at their least cost quantity of output this delivers productive efficiency
Productive efficiency means that economic resources are used in their best way
How competition works
Competition among firms
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There are significant benefits from competition: Low prices: firms compete with each other for customers
High quality: firms compete with each other for customer loyalty
Choice: competition generates a whole aisle of breakfast cereal, washing powders, toothpaste etc.
Responsive producers: firms who don’t deliver what consumers want fail, those that do grow
Innovation: firms compete to deliver new products
How competition works
Competition among firms
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From a producer’s point of view, competition make their life difficult
The more extensive the competition, the harder it is to survive unless you are efficient
The early days . . . Herbert Morrison announced July 1946 that the government intended to introduce legislation to inquire into the effect of monopolies and restrictive practices and to take appropriate action
The original Commission’s role: to assess whether monopolies or agreements were “in the public interest”
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Competition among firms
The Commission was left to interpret what “the public interest” meant
Harold Wilson said “We have tried our best to work out such a definition and failed”
The Board of Trade “The Government does not … adopt an attitude of sweeping hostility to all monopolies and restrictive agreements, which may possess good as well as bad features … it considers it better to judge each particular case on its merits…”
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Competition among firms
Economics and competition policy Economics provides the necessary underpinning for competition policy
Provides a proper theoretical basis for why given situations give rise to particular effects
Provides a way of accessing appropriate evidence to examine the effects
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Competition among firms
Economics and competition policy It is appropriate to limit the exercise of market power in the interests of economic efficiency and welfare
The general prohibition of price-fixing or market-sharing agreements between competitors is derived from economic reasoning that tells us such agreements harm the public good
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Competition among firms
Economics and competition policy In merger control, economic reasoning explains: how a market can be identified what are the barriers to an possibilities of entry
what other countervailing pressures might limit any market power enjoyed
Increasingly sophisticated quantitative analytical techniques – econometrics – have made a big difference to the way competition cases are handled
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Competition among firms
The legalities Origins of UK competition policy 1948
Fair Trading Act 1973 Has remained fundamentally unchanged until Competition Act (1998) and Enterprise Act (2002)
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Competition among firms
The Competition Commission Required to investigate mergers and markets
References made to it by OFT Required to obtain, assess relevant evidence, hear the parties, come to a reasoned decision and decide on and apply remedial measures within statutory time limits
Work is subject to review by the Competition Appeal Tribunal (CAT)
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Competition among firms
1998 Competition Act MMC becomes the Competition Commission
Came into force 1 March 2000 Chapter I prohibition: anti-competitive agreements and secret cartel activities
Chapter II prohibition: abuse of a dominant position
Explicitly modelled on Articles 85 and 86 of Treaty of Rome
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Competition among firms
1998 Competition Act Director General of Fair Trading (DGFT) investigates alleged breaches, has powers to fine the company or companies up to 10 per cent of their annual revenue for up to 3 years
2 important safeguards: Companies can notify the OFT of agreements and seek an exemption
Companies can appeal against decisions to the Appeals Tribunal
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Competition among firms
1998 Competition Act Merger reform
Merger decisions are referred to the CC by the DGFT and the CC’s decision is not open to rejection by the Secretary of State [this makes competition decisions explicitly independent from politicians]
New criterion for judging mergers: a substantial lessening of competition Secretary of State can intervene in the case of national defence
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Competition among firms
1998 Competition Act Appointments to CC are made by the Secretary of State All members initially appointed for 4 years and are automatically reappointed for a further 4 years
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Competition among firms
2002 Enterprise Act The CC is a Phase II authority deciding on mergers, markets and regulatory issues
Cases are referred to CC Mergers: OFT Markets: OFT and principal economic regulators
Regulatory issues: rule on licence modifications and price control reviews where there is disagreement between licensees and the regulator
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Competition among firms
2002 Enterprise Act Gives CC power on reference from OFT or a regulator to investigate markets, to assess restrictions of competition and impose remedies
Purpose of market investigations To enable CC to take an in-depth look at markets where competition is thought to be not working well but when it does not appear to be from the dominant position of a single firm or the existence of hard core cartels
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Competition among firms
2002 Enterprise Act OFT and sectoral regulators each tasked to study and observe markets to assess whether a market investigation is appropriate
Adverse effect on competition (AEC) Where “any feature, or combination of features, of each relevant market prevents, restricts or distorts competition in connection with the supply or acquisition of goods or services in the UK or a part of the UK”
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Competition among firms
2002 Enterprise Act AEC test arises from one or more of the following features of the market: The market structure The conduct of suppliers or acquirers of goods or services
The conduct of customers Making a reference if discretionary, there needs to be a “reasonable ground to suspect”
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Competition among firms
2002 Enterprise Act If the CC finds an AEC, it has a duty to remedy it in as comprehensive a way as possible
CC has a statutory maximum of 2 years within which to complete a market investigation
A CC decision is final and effective subject only to review by the CAT
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Competition among firms
2002 Enterprise Act OFT & regulators can accept undertakings to avoid the need for a CC reference
The threat of a reference can be a powerful inducement for parties to offer undertakings in lieu
Settlement under the threat of a CC investigation is an important tool for enforcement Avoids unnecessary delay Avoids unnecessary expenditure
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Competition among firms
Factors relevant in assessing markets
Traditional indicators of rivalry Price competition Non-price competition Choice Quality Innovation
How open a market is to entry, expansion and exit
The countervailing powers of buyers and suppliers
The effect of any vertical integration
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Competition among firms
Market investigations Since 2003 9 market investigations
Store credit cards Home credit Personal banking in Northern Ireland Payment protection insurance Leasing of railway rolling stock BAA Airports Bulk supply of domestic LPG Classified directories Grocery retailing
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Competition among firms
Groceries market investigation Completed 2008
Over 700 submissions Held over 80 hearings Visited facilities and sites Compiled a database of over 14,000 stores
Took 2 years to complete
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Competition among firms
Assessing the decisions The cases need to be sufficiently far in the past to see how the market has evolved after a particular decision was taken, but recent enough to remain relevant to the present
Maximising the gains of evaluation is probably about achieving a good balance of both internal and external evaluation, and finding effective ways of feeding the lessons learned into future investigations
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Competition among firms
Assessing the decisions 2005 Price Waterhouse Coopers study
2008 In-house evaluation 2009 Deloitte study
UEA Centre for Competition Policy Website www.ccp.uea.ac.uk Newsletter
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Competition among firms
Further information www.competition-commission.gov.uk
Provides a mountain of information All past reports Current position of ongoing investigations
Speeches and lectures presented by competition authorities
www.oft.gov.uk Similarly a wealth of information
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Competition among firms