ANTITRUST ECONOMICS 2013
David S. Evans
University of Chicago, Global Economics Group
TOPIC 10:
Date
Elisa Mariscal
CIDE, Global Economics Group
COMPETITIVE CONSTRAINT AND MARKET
POWER
Topic 10| Part 2
24 September 2013
Overview
2
Part 1
Part 2
Market Power
Background
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
The Role and Definition of Market
Power
Dominance and Market Power According to the
Commission and the Courts
4
“Dominance has been defined under EC law as a position of economic
strength enjoyed by an undertaking, which enables it to prevent effective
competition from being maintained on a relevant market, by affording it the
power to behave to an appreciable extent independently of its competitors,
its customers and ultimately of consumers.”
“Guidance on the Commission’s Enforcement Priorities in Applying Article 82 EC Treaty” relying on ECJ
in United Brands and Hoffman La Roche
“… undertaking’s decisions are largely insensitive to the actions and reactions
of competitors, customers and ultimately, consumers” Id.
In modern practice before the Commission, dominance and market power
are used interchangeably.
Monopoly and Market Power in the US
5
“Market power is the ability of a firm or group of firms within a market to
profitably charge prices above the competitive level for a sustained period of
time.”
US DOJ Merger guidelines and various US court decisions.
The antitrust authorities and courts require that the excess over the competitive
level be “substantial” or “significant” for there to be market power in the
antitrust sense of the phrase.
The antitrust authorities and courts also require that the ability to sustain price
over the competitive level be more than temporary.
In the US the terms “market power” and “monopoly power” are often used
interchangeably.
Economic Definitions of Market Power
6
Antitrust economists also typically view market power as the ability to
raise price significantly above the competitive level for a sustained
period of time.
The competitive level is the price that would enable firms to earn a
long-run risk adjusted competitive return on the capital invested in the
business.
Whether price is above the competitive level could be inferred from
whether the risk-adjusted return is greater than the competitive level;
there many are difficulties in calculating this.
The competitive level is often approximated in practice by marginal
(or incremental) cost because economic theory says that price equals
marginal cost in perfectly competitive equilibrium. However, we know
in theory and in fact that p=MC is often not the competitive
equilibrium and p>MC is common in theory and fact.
7
Market Power Measurement
Market Share for the Market Power Thermometer
8
Market power for a firm is often based on its share
of sales in the relevant market
Various numbers have been tossed out for what
share demonstrates market power—from as low as
40% in the EC to 60% or more in the US roughly
speaking.
But as a matter of economics there is no
“thermometer” or “benchmark” for market power
in practice that can be used across all industries.
No 98.6o rule!
Market Shares as Measures of Market Power
9
Cournot model with homogenous goods finds positive relationship
between concentration and markup.
Price-cost markup for industry equals HHI divided by demand elasticity
and is therefore higher in more concentrated industries
• (P – MCavg)/P = HHI/, where P is the market price, MCavg is the weighted
average marginal cost, and  is the market demand elasticity.
Markup is higher for firms with larger shares
• (P – MCi)/P = Si/ for firm i with share of total market of Si
That result is not general though, since is requires homogenous
products that are uncommon in practice and Cournot competition.
There is no systematic economic theory or evidence showing a close
relationship between market share and market power.
P>MC May Not Imply Significant Market Power
10
A firm with fixed costs has to earn a large enough profit to offset its
fixed cost (see examples from previous lecture).
In a simple model where C=F+cQ the price-cost margin must be
greater than the ratio of fixed cost to sales (F/pQ) for the firm to make
a profit.
Suppose fixed costs are 20% of revenue. Then the price-cost margin
must be at least 20% and the firm must face a demand curve with an
elasticity of less than 5 to operate profitably.
Suppose fixed costs are 50% of revenue which could be the case for
IP-related products like music and software. Then the price-cost
margin must be at least 50% and the firm must face a demand curve
with an elasticity of less than 2 to operate profitably.
The Impact of Investment and Risk
11
Suppose firms in an industry must make significant investments and
incur risk.
They must expect a profit in excess of what they would get with
marginal cost pricing to compensate for those risky investments.
Entry into the industry will take place only up to the point where the
price-cost margin for the firm is high enough to compensate for risks
and capital investment.
The analysis is similar to that of fixed cost. The larger the necessary risk
premium the larger the price-cost margin and the smaller the
elasticity of demand in a “competitive equilibrium”.
Difficulties in Using Profits to Assess Market Power
12
Operating margin (price-cost markup)
• Requires accurate measurement of incremental cost
which may be hard to obtain from company data
• Need to assess which costs are fixed or variable and
over what time period
Risk-adjusted rate of return can be a measure of
economic profits
• Well-known biases in accounting profits resulting from
R&D, advertising, and accounting conventions
• Difficult to measure risk ex post—everything looks
easy after the fact!
Multiple Sources of Evidence are Best for Market
Power assessment
13
General assessment of competitive constraints
• Demand substitution
• Supply substitution
• Entry barriers, and other factors
Direct measures of market power
• Price-cost margins
• Risk-adjusted rate of return
• But use with considerable care
Market shares
• Best using alternative, plausible market definitions
• More useful for helping to understand competitive structure of industry,
not useful for making firm statements on market power.
Should have more confidence in a finding of market power—or lack
of market power—when multiple sources of imperfect evidence
point in the same direction.
14
Multi-Sided Platforms and Market
Power
Special Issues for Multi-Sided Platforms
15
Market power reflects the ability of a platform to elevate overall prices
for various sides
• Competition forces overall prices down
• Competitive equilibrium will ordinarily result in price exceeding marginal
cost on one side
Demand substitution takes place on both sides
• Substitution on one side has effect on the other side through demand
interdependencies
• Possibility of both platform and non-platform substitutes
Supply side must address special issues
• Critical mass and entry
• Platform competition
Market power on one side might be of interest in special case
• Maybe price is held constant on one side and issue is whether price could
be elevated to the other side
• Ordinarily with strong demand interdependencies there are still cross
effects that need to be considered
A One-Sided Perspective on Market Power
16
Firm has 50% price-cost markup and it increases price by 13%.
• Is this an exercise of market power?
• Have consumers been harmed?
Price
Marginal Cost
Margin
Output
Revenue
Operating Cost
Markup
Side A
Before price
increase
$8
$4
$4
500
$4,000
$2,000
Side A
After price
increase
$9
$4
$5
500
$4,500
$2,000
50%
56%
Significant increase in price by a firm with a high mark up. Looks like a
firm with significant market power has exercised it and gotten more.
A Two-Sided Perspective on Market Power-Ex.1
17
Firm increases price by 13% to Side A and decreases price by 50% to
Side B with no change in total price or profits.
Before Price Increase
Price
Marginal Cost
Margin
Output
Revenue
Cost
Operating Margin
Markup
Fixed Cost
Total Profit
Side A
$8
$4
$4
500
$4,000
$2,000
Side B
$2
$4
($2)
500
$1,000
$2,000
50%
-100%
Total
$10
$8
$2
500
$5,000
$4,000
$1,000
20%
$1,000
$0
After Price Increase
Side A
Price
$9
Marginal Cost
$4
Margin
$5
Output
500
Revenue
$4,500
Cost
$2,000
Operating Margin
Markup
56%
Fixed Cost
Total Profit
Side B
$1
$4
($3)
500
$500
$2,000
-300%
Total
$10
$8
$2
500
$5,000
$4,000
$1,000
20%
$1,000
$0
Platform has an markup of 20% which is common and although Side A consumers
paid more, Side B consumers paid less and overall price didn’t change nor did
profits increase.
• Example assumes change in pricing structure doesn’t alter output. This example could arise if some
exogenous event like the appearance of a competitor changes the relative demand elasticities of
the two sides. How output, welfare, etc. change in actual practice would depend on what caused
the change in the pricing structure and the precise demand interdependencies.
A Two-Sided Perspective on Market Power-Ex.2
18
Firm increases price by 13% to Side A and decreases price by 50% to
Side B but with higher output and profit.
Before Price Increase
Price
Marginal Cost
Margin
Output
Revenue
Cost
Operating
Margin
Markup
Fixed Cost
Total Profit
After Price Increase
Side A
$8
Side B
$2
Total
$10
$4
$4
$8
$4
500
$4,000
$2,000
($2)
500
$1,000
$2,000
$2
500
$5,000
$4,000
Price
Marginal
Cost
Margin
Output
Revenue
Cost
$1,000
Operating Margin
20%
$1,000
$0
Markup
Fixed Cost
Total Profit
50%
-100%
Side A
$9
Side B
$1
Total
$10
$4
$4
$8
$5
550
$4,950
$2,200
($3)
550
$550
$2,200
$2
550
$5,500
$4,400
$1,100
56%
-300%
20%
$1,000
$100
In this case the change in the pricing structure increases output on both sides
and therefore increases welfare. Even though consumers on Side A are paying
more they buy more because of value of interacting with more members on
Side B. Platform also earns more profit.
•Example assumes change in pricing structure increases output. This example could arise if
the firm realized its pricing structure was not optimizing the value of the network.
Price-Cost Comparisons for Two-Sided Platforms
19
Straightforward when “units” are the same for both sides. Consider a
platform that provides “transactions” of some sort such as payments.
• The service received by both sides is a transaction
• Each side is paying a price for the same “transaction”
Price-cost margin is total price minus total incremental cost
• Total price is price paid by each side for the transaction
• Total incremental cost is cost of providing that transaction to both sides
More complicated when
• Unit is different (e.g. advertising and content use)
• Prices therefore can’t be added up (apples and oranges)
• Costs refer to the provision of different services
• Could still do revenue-weighted averages
1-Sided Price-Cost Markup Formula Wrong for 2Sided Platforms
20
Analyzing Market Power for Platforms
21
Market power is the ability to raise “total price”—reflecting a
combination of the prices to the separate sides-- significantly above
competitive level.
Question is whether competitive constraints by other platforms or in
some cases single-sided firms are sufficient to limit supracompetitive
prices.
Prices on either side by themselves can’t say anything about market
power. Looking at subsidy side leads to false negatives of no market
power while looking at money side leads to false positives of market
power.
End of Part 2, Next Class Topic 11: Market Definition
22
Part 1
Part 2
Overview of
Market
Definition
Overview of
Issues in
multisided
platforms
General
Principles of
Market
Definition
The Case of
Additive
Prices
Hypothetical
Monopolist Test
Newspaper
Markets
Critical Loss
Analysis
One-Sided
Biases