5002busbs lecture 4 1
5002BUSBS
ECONOMIC REGULATIONS AND
LAW
Lecture 4: Competition among firms
How competition works
2
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
Competition among firms
How competition works
3
We consider two extreme cases:
Extensive competition
A single firm
Competition among firms
Case 1: extensive competition
4
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
Competition among firms
5
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
Price
per
S
unit
S1
D
Quantity
per
period
Competition among firms
Case 1: extensive competition
6
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
Competition among firms
7
Case 1: extensive
competition
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
Competition among firms
Case 2: a single firm
8
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
Competition among firms
How competition works
9
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
Competition among firms
How competition works
10
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
Competition among firms
Productive efficiency
means that
How competition works
11
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
Competition among firms
that do grow
How competition works
12
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 among firms
COMPETITION POLICY
The early days . . .
14
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”
Competition among firms
15
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…”
Competition among firms
16
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
Competition among firms
17
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
Competition among firms
18
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
Competition among firms
The legalities
19
Origins of UK competition policy 1948
Fair Trading Act 1973
Has remained fundamentally unchanged
until Competition Act (1998) and
Enterprise Act (2002)
Competition among firms
20
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)
Competition among firms
1998 Competition Act
21
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
Competition among firms
1998 Competition Act
22
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
Competition among firms
1998 Competition Act
23
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
Competition among firms
1998 Competition Act
24
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
Competition among firms
2002 Enterprise Act
25
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 Competition
the regulator
among firms
2002 Enterprise Act
26
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
Competition among firms
2002 Enterprise Act
27
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”
Competition among firms
2002 Enterprise Act
28
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”
Competition among firms
2002 Enterprise Act
29
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
Competition among firms
2002 Enterprise Act
30
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
Competition among firms
Factors relevant in assessing markets
31
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
Competition among firms
Market investigations
32
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
Competition among firms
33
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
Competition among firms
Assessing the decisions
34
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
Competition among firms
Assessing the decisions
35
2005 Price Waterhouse Coopers study
2008 In-house evaluation
2009 Deloitte study
UEA Centre for Competition Policy
Website www.ccp.uea.ac.uk
Newsletter
Competition among firms
Further information
36
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
Competition among firms
ECONOMIC REGULATIONS AND
LAW
Lecture 4: Competition among firms
How competition works
2
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
Competition among firms
How competition works
3
We consider two extreme cases:
Extensive competition
A single firm
Competition among firms
Case 1: extensive competition
4
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
Competition among firms
5
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
Price
per
S
unit
S1
D
Quantity
per
period
Competition among firms
Case 1: extensive competition
6
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
Competition among firms
7
Case 1: extensive
competition
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
Competition among firms
Case 2: a single firm
8
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
Competition among firms
How competition works
9
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
Competition among firms
How competition works
10
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
Competition among firms
Productive efficiency
means that
How competition works
11
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
Competition among firms
that do grow
How competition works
12
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 among firms
COMPETITION POLICY
The early days . . .
14
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”
Competition among firms
15
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…”
Competition among firms
16
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
Competition among firms
17
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
Competition among firms
18
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
Competition among firms
The legalities
19
Origins of UK competition policy 1948
Fair Trading Act 1973
Has remained fundamentally unchanged
until Competition Act (1998) and
Enterprise Act (2002)
Competition among firms
20
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)
Competition among firms
1998 Competition Act
21
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
Competition among firms
1998 Competition Act
22
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
Competition among firms
1998 Competition Act
23
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
Competition among firms
1998 Competition Act
24
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
Competition among firms
2002 Enterprise Act
25
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 Competition
the regulator
among firms
2002 Enterprise Act
26
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
Competition among firms
2002 Enterprise Act
27
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”
Competition among firms
2002 Enterprise Act
28
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”
Competition among firms
2002 Enterprise Act
29
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
Competition among firms
2002 Enterprise Act
30
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
Competition among firms
Factors relevant in assessing markets
31
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
Competition among firms
Market investigations
32
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
Competition among firms
33
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
Competition among firms
Assessing the decisions
34
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
Competition among firms
Assessing the decisions
35
2005 Price Waterhouse Coopers study
2008 In-house evaluation
2009 Deloitte study
UEA Centre for Competition Policy
Website www.ccp.uea.ac.uk
Newsletter
Competition among firms
Further information
36
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
Competition among firms