5002busbs lecture 4 (1)

5002BUSBS ECONOMIC REGULATIONS AND LAW

Lecture 4: Competition among firms

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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Case 1: extensive competition


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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

S1

D

Quantity per period

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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



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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


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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


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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



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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



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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



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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

COMPETITION POLICY

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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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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http://www.ccp.uea.ac.uk/

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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http://www.competition-commission.gov.uk/

http://www.oft.gov.uk/

5002busbs lecture 4 (1)

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