ANTITRUST ECONOMICS 2013
David S. Evans
University of Chicago, Global Economics Group
TOPIC 10:
Date
Elisa Mariscal
CIDE, Global Economics Group
COMPETITIVE CONSTRAINTS AND MARKET
POWER
Topic 10| Part 1
12 September 2013
Overview
2
Part 1
Part 2
Competitive
Constraints and
Market Power
Role and
Definition of
Market Power
Market Power
and the
Demand Side
Market Power
Measurement
Market Power
and the
Supply Side
Multi-Sided
Platforms and
Market Power
3
Competitive Constraints and
Market Power
Definitions of Market Power
4
Ability of a firm to raise prices significantly above the competitive
level
•“Significant” required because almost all firms have some degree of shortrun market power as a result of product differentiation and location.
•No consensus on what “significant” means
•Competitive level often taken as p=MC
Ability of a firm to take actions that a competitive firm couldn’t do
that significantly harm consumers such as impose contractual
restraints, prevent entry, and so forth.
•Market power not always manifested in price
•Firms compete on many dimensions besides price
Market Power and the Ability to Do Harm
5
The degree to which a firm has market power could tell us the extent to
which it is able to engage in practices that harm competition and
consumers.
Market Power Provides a Screen
6
Firms that pass the screen have enough market power that they could do
bad things. They then need a closer look.
The Quest for the Market Power Thermometer
7
Courts and authorities would like a “market power thermometer”.
If market share or mark-up is “too high” then conclude that there is significant market
power say courts.
But there is no “thermometer” or “benchmark” for market power in practice that can
be used across all industries. No 98.6o rule!
Monopoly, Perfect Competition, and Market Power
8
Monopoly price significantly above competitive levels
And significantly above marginal cost
Supply = MC
P
PM
PC
Textbook description of competitive industry
but need to be careful in using in practice.
Demand
MR
QM
QC
Q
Definition of Competitive Level
9
Price equal to marginal cost is typically used.
• But price must be greater than marginal cost if there are fixed costs
• In fact for long-run equilibrium P>ATC for firms to remain in business in
competition
Could also use “prices that would emerge in a competitive
industry” to accommodate diversity of industries.
• The “you know it when you see it” definition leads to debate
• Provides some flexibility in assessing market power
Could also use structural and behavioral proxies to assess the
degree of market power.
• This is the “if it looks like a duck, quacks like a duck it must be a duck”
definition of monopoly
• But … not everyone sees the duck …
Market Power in Antitrust and Mergers
10
Monopolization and abuse of dominance
• Does the firm have the ability to engage in anticompetitive actions
(e.g. a firm couldn’t “force” consumers to take a tied product if it has
no power).
• Has the firm’s actions increased its market power (e.g. will behavior
such as exclusive dealing increase monopoly power).
• Also there is a view that firms with market power shouldn’t be allowed
to compete “as hard” as firms without (special obligations).
Merger analysis
• Will the merger result in the combined firms having significantly more
market power than the firms had separately.
• The merger inquiry does not care much whether either firm had market
power to start with.
Level Versus Changes in Market Power
11
Why we care about market power?
Merger
Unilateral Conduct
Level
Background
information that may
affect concern over
the change
Can the firm impose
anticompetitive
constraints?
Change
Will the merger
Do the anticompetitive
increase market power constraints increase
of merged firms?
market power and
thereby harm
consumers?
Market Power and Competitive Constraints
12
Market power is a measure of the extent to which “competitive
constraints” limit the ability of a firm to dictate prices or other
competitive conditions
An inquiry should make sure that simple approaches to assessing
market power don’t obscure consideration of the full spectrum of
competitive constraints since that is what market power is
supposed to summarize
The source of competitive constraints come from demand side and
from the supply side.
Competitive Constraints Can Limit Market Power
13
Demand
Supply
Substitutes in demand based on
products and geography
Product repositioning
Consumer switching costs
Elasticity of supply
Two-sided platform constraints
resulting from loss of
complementary sales/indirect
network effects
Barriers to entry including scale
economies, network effects,
regulation
Innovation and feature
competition
Innovation and feature
competition
14
Market Power and the Demand
Side
Demand Substitution and Economic Concepts
15
Market power is limited if consumers can turn to alternative products
if price exceeds competitive levels.
Own-price elasticity of demand which measures the percent
change in sales for the company resulting from a 1% change in
price. The higher the elasticity the less the ability to raise prices.
Cross-elasticity of demand with other products measures the extent
to which an increase in price results in substitution to other products.
The higher the elasticity the more substitutable the product.
Diversion ratio is the portion of lost sales that are diverted to
competing product with small increase in price; this is a function of
cross-elasticity.
Own-price, cross-elasticity, and diversion ratios are all
mathematically related and yield same answers
“Marginal” not “Average” Consumers Matter
16
Market equilibrium result in prices set where consumers are almost
indifferent between buying the subject product over an alternative
product
If there are many of these marginal consumers then a price increase
will result in much lost sales; if there are few of these marginal
consumers then a price increase will not result in much lost sales.
The average consumer will typically value the subject product more
than the marginal consumer and therefore be less likely to switch. But
there could still be significant lost sales if there are many marginal
consumers.
In US Whole Foods acquisition of Wild Oats the question was whether
there were many marginal consumers of “premium natural organic
supermarkets” who would switch to a regular supermarket if prices
increased.
Demand-Side Substitution and the Marginal
Consumer
17
Pub Beer
$7
O
A,B, C, D are at “the
margin” of buying or
not buying beer
Price per Pint
$6
$5
F is an “average consumer” of beer
(from O to C)
F
$4
D
A
C
B
$3
G
$2
G is not a consumer
of beer at current
prices
$1
$0
0
1
2
3
4
5
6
7
8
9
10
Pints of Beer Demanded (Millions per Year)
The “average” consumer may not switch to a substitute product in response
to a small price increase; the producer needs to worry about what consumers
“at the margin” between buying and not buying the product, will do.
Price-Cost Margin and Demand Elasticity
18
Elasticity of
demand
Markup
1.25
80.0%
1.50
66.7%
1.75
57.1%
2.00
50.0%
2.50
40.0%
3.00
33.3%
3.50
28.6%
4.00
25.0%
5.00
20.0%
Elasticity of demand for product x (for
single-sided firm):
ex = dqx/qx
dpx/px
Price – Cost mark-up (“Lerner condition”
for product x:
mx = px – cx = 1
px
ex
Notes: Elasticity of demand for a profit maximizing firm
has to be greater than 1.0 (in absolute value); so
demand is relatively more inelastic as it is closer to 1.0
and relative more elastic as it is farther than 1.0
Markups and Fixed Costs
19
Fixed costs
as a percent
of revenue
Minimum
elasticity of
demand
Minimum
Markup
80.0%
1.25
80.0%
66.7%
1.50
66.7%
57.1%
1.75
57.1%
50.0%
2.00
50.0%
40.0%
2.50
40.0%
33.3%
3.00
33.3%
28.6%
3.50
28.6%
25.0%
4.00
25.0%
20.0%
5.00
20.0%
Percent markup must be greater than or
equal to fixed costs as a proportion of
sales for a firm to cover its costs and make
a profit
mx ≥ F
pxx
Example based on constant
marginal costs and linear
demand.
Practical Assessment of Demand Substitution
20
Interchangeability
•Do customers switch between products?
Company records on competitors
•Who do company executives in internal business documents say they compete
with?
Win-loss Reports
•What do company sales reports say about who they won business from or lost
business to (many B2B companies collect records systematically)?
Customer surveys
•What do customers say in response to a survey question about which if any
product they would switch to if prices increased?
Statistical estimates
•What do econometric studies of historical prices and sales imply about crosselasticities of demand?
Natural experiments
•Is there a situation where one can compare sales before and after a price
increase or between two locations with different prices?
Special Factors on Demand-Side
21
Buyer power: Large customers can discipline market power
Two-sided platforms Price increase on one side reduces customers
available to other side which makes price increase more expensive
(more details next week).
Price discrimination: is ability to engage in price discrimination
evidence of market power? In theory yes, because p>MC; if
practice, no because price discrimination common among firms in
competitive industries.
22
Market Power and the Supply
Side
Supply Substitution
23
New Entry
• Can new firms get in quickly when prices go up?
Expansion
• Could current rivals expand production easily by switching
production lines from other products?
Product repositioning
• Could current rivals make their products more competitive by
adding or changing features?
Elasticity of Supply and Competitive Fringe
24
Market
demand
elasticity
Fringe
supply
elasticity
Share of
dominant
firm
Dominant
firm
demand
elasticity
Markup
3.00
0.25
40%
7.88
12.7%
3.00
0.50
40%
8.25
12.1%
3.00
0.75
40%
8.63
11.6%
3.00
0.25
60%
5.17
19.4%
3.00
0.50
60%
5.33
18.8%
3.00
0.75
60%
5.50
18.2%
3.00
0.25
80%
3.81
26.2%
3.00
0.50
80%
3.88
25.8%
3.00
0.75
80%
3.94
25.4%
ex = eM + (1 – sx)ef
sx
where:
Sx is the share of the
dominant firm,
ef is the elasticity of demand
of the fringe, and,
eM is the elasticity of demand
of the market
Barriers to Entry Debate
25
Bain
• Any advantage existing firms have that enable them to raise
price above short-run competitive level.
• Corresponds to what many competition authorities and courts
use
Stigler
• Costs that new firms bear that existing firms don’t
• Helps to emphasize that firms must incur investments to enter
and expand and realize a return from that.
• Not really a barrier if entrant must incur these same investments.
Bain-Type Barriers to Entry
26
Scale economies
• Can additional firms fit into the market?
Network effects
• Chicken and egg problems/critical mass; Demand-side scale
economies that may limit number of efficient firms
Sunk costs
• Discourages entrants because of high risk incumbent will lower prices
and firm will lose sunk costs
Switching costs
• Can consumers readily switch?
Advertising/brand value
• Incumbents may have significant brand assets
Intellectual property
• Patents, copyrights, trademarks, business secrets that limit entry
Special assets
• Access to unique facilities or sources of supply; locational advantages
Legal/regulatory barriers
• Licenses, regulatory approvals; regulation-induced fixed costs
Dynamic Competition
27
Threat of entry encourages firms to innovate and keep prices low
Limit pricing models have firms keeping prices just low enough to
deter entry
More sophisticated theories of dynamic competition focus on
innovation rather than pricing
End of Part 1, next week Part 2
28
Part 1
Part 2
Competitive
Constraints and
Market Power
Role and
Definition of
Market Power
Market Power
and the
Demand Side
Market Power
Measurement
Market Power
and the
Supply Side
Multi-Sided
Platforms and
Market Power