Price - Economics

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Economics
Elective 1 Chapter 1
Monopoly Pricing
1
Perfectly competitive market

Firms are price takers



Price is determined by the price mechanism
If a firm raises its selling price, it will lose all of its
customers.
E.g. Market price = $6, Quantity demanded = 80 units
Price ($)
Price ($)
Market
6
Market supply
(S = MC)
Total
social
surplus
6

Quantity (units)
80
Demand faced by an
individual firm
An individual firm can sell all its
quantity supplied at the market price.
(Horizontal demand curve)
Market demand
(D = MB)
0
A single firm in perfectly
competitive market
0
Quantity (units)
If a firm sells at $7, customers will buy from other firms.
2
Perfectly competitive market

A firm can sell all its goods at market price.




In perfectly competitive market


P = $6
Each additional unit sold, revenue = $6
Marginal Revenue (MR) = $6
P = MR
Marginal cost rises when output rises

MC curve is upward sloping
Perfectly competitive market

Condition of profit maximization

Total revenue > Total cost



i.e. P > AC
Price (Marginal revenue) = Marginal cost

i.e. P = MC

If P > MC, firm can earn more profit by raising output

If P < MC, firm can earn by cutting output

Suppose no fixed cost:
If there’s no externality, when
MB = MC, TSS is max.
i.e. Market efficiency
Monopoly

A single supplier in the market

No close substitution

Will not lose all the customers when it raises the price

Price searcher with monopoly powers on price and
determine its output

E.g. MTR in HK, CLP in Kowloon and N.T.
5
The demand curve faced by monopolists

Suppose Firm A is a monopolist

Market demand is the demand faced by Firm A
Demand schedule faced by Firm A
Price ($)
Combination
Price ($)
Qd (units)
A
10
0
9
B
9
1
8
2
7
3
6
C
D
8
7
E
6
4
F
5
5
G
4
6
Demand curve faced
by the monopolist
A
10
B
C
D
E
F
5
G
4
Demand
Quantity (units)
0
1
2
3
4
5
6
6
Monopoly pricing

Simple monopoly pricing

A firm set a uniform price for each unit of its output at this price, consumers
can buy as much as they want.


Market demand restricts the market power of a monopolist.

From the demand schedule: When P = $9, Qd = 1 unit

If Firm A set the price at $9, 1 unit will be sold only.

If Firm A want to sell 4 units, it has to lower the price to $6.
One price-output combination based on consumers’ demand.
7
Monopoly pricing
Demand schedule faced by Firm A
Max. price a firm can charge
Combination
Price ($)
Qd (units)
Combination
Output (units)
Price ($)
A
10
0
A
0
10
B
9
1
B
1
9
C
8
2
C
2
8
D
7
3
D
3
7
E
6
4
E
4
6
F
5
5
F
5
5
G
4
6
G
6
4

Under simple monopoly pricing

The price a firm can charge = the consumers’ willingness to pay

i.e. P = MB
8
Revenue of a firm under simple monopoly pricing

Price = Average Revenue (AR)

Under simple monopoly pricing:

Total revenue (TR) = P x Q

Since AR = TR  Q, then P = AR
Output (Qd) (units)
Price ($)
Total revenue ($)
TR = P x Qd
Average Revenue ($)
AR = TR  Qd
1
9
9x1=9
91=9
2
8
8 x 2 = 16
16  2 = 8
3
7
7 x 3 = 21
21  3 = 7
4
6
6 x 4 = 24
24  4 = 6
5
5
5 x 5 = 25
25  5 = 5
9
Revenue of a firm under simple monopoly pricing

Demand curve = AR curve
Price ($)
9
8
7
6
5
D = AR
Quantity (units)
0
1
2
3
4
5
10
Revenue of a firm under simple monopoly pricing

Marginal Revenue (MR)



The change in total revenue as a
result of selling an additional unit
of output.
MRn = TRn – TR(n-1)
At Q = 1 unit,

MR = P = $9

At Q = 2 units

MR = $7, P = $8
 MR < P
When output increases, MR falls
Hence, MR curve is downward sloping
below the AR (demand) curve



Remarks:

TR = Sum of MR
Qd (units)
Price =
AR($)
TR ($)
MR ($)
0
10
0
-
1
9
9
9
2
8
16
7
3
7
21
5
4
6
24
3
5
5
25
1
6
4
24
-1
7
3
21
-3
8
2
16
-5
9
1
9
-7
10
0
0
-9
11
Revenue of a firm under simple monopoly pricing
Under monopoly pricing:
Price ($)
9
8
7
6
5
4
3
2
1
0
-1

MR curve is below D curve

MR < P

MR keeps falling
D = AR
1
2
3
4
5
6
7
8
Quantity (units)
9
-2
-3
-4
-5
-6
-7
MR
12
Revenue of a firm under simple monopoly pricing

Why MR < P ?

Firms: Lower P  Increase sales


Unit price $9  $8, where 1 more unit can be sold

MR from the 1st unit = -$1

MR from the 2nd unit = $8
Price ($)
MR = $8 - $1 = $7
9
(-)
8
7
6
(+)
5
D = AR
Quantity (units)
0
1
2
13
Revenue of a firm
under simple monopoly
pricing

Why does MR keep falling?

In order to increase sales

Lower P

MR < P
Determination of price and output

Objective: Profit maximization

Conditions:
1.
Total revenue > Total cost , i.e. TR > TC
or
2.
Average revenue > Average cost , AR > AC
Marginal revenue = Marginal cost
i.e. MR = MC
15
Determination of price and output

Finding the price-output combination under profit maximization
Demand
Qd
P ($)
(units)
Revenue of firm
Cost of firm
Profit of firm
TR ($)
MR($)
TC ($)
MC ($)
Total
profit
TR-TC ($)
Marginal
profit ($)
A
1
9
9
9
3
3
6
6
B
2
8
16
7
7
4
9
3
C
3
7
21
5
12
5
9
0
D
4
6
24
3
18
6
6
-3
E
5
5
25
1
25
7
0
-6
F
6
4
24
-1
33
8
-9
-9
AtQ=3,
Q=2,
Q=1,MR=MC,
MR>MC,profit
con’tmaximized..
to produce.
At
16
Determination of price and output
Price ($)
1. Price ($7) = MB ($7)
2. Price = AR ($7) > AC ($4)
7
MC
Total profit
5
MR ($5) = MC ($5)
Total cost
MR
D = AR
Quantity
3
Profit-maximizing price and output
The output at which MR equals MC, and P > AC.
17
A monopolist does not have a supply curve

Supply curve: Qs at different prices

In a price-taker market:




Market demand and supply determines the market price
At market price, each firm determines its Qs
In a perfectly competitive market, there is a supply curve.
In a price-searcher market:

Price is determined by



A monopolist faces a downward sloping demand curve


1. demand curve faced by the firm
2. marginal cost curve
Price is determined at which MR = MC
No supply curve
18
Price range and elasticity
Price ($)
10
9
8
7
6
5
4
3
2
Qd (units)
1
2
3
4
5
6
7
8
9
TR ($)
10
18
24
28
30
30
28
24
18
MR ($)
10
8
6
4
2
0
-2
-4
-6
Ed > 1
Ed = 1
Ed < 1

Demand is elastic: P   TR  and MR is positive

Demand is unitary elastic: P   TR no unchanged and MR is 0

Demand is elastic: P   TR  and MR is negative


Price not set at or below $4, because MR is negative.
To maximize profit if MC = $6

MR = $6, where then Q = 3 units and Price = $8

Within the range where Ed > 1 *
Efficiency implications of monopoly

Efficiency in price-taking market



Market price = Equilibrium price
At Qt (where Qd = Qs ), MB = MC
Total social surplus is maximized.
Producer
Surplus
Consumer
surplus
20
Efficiency implications of monopoly

Efficiency in price-searching market






Profit-maximizing output = 3 units where MR=MC
At Qt = 3, P = MB = $7 and MC = $5
Since MB > MC, total social surplus is not maximized
Deadweight loss
Price ($)
Monopoly is inefficient.
Comparison



Consumer
surplus
Output in a perfectly
7
competitive market,
Q = 4 units
Output in a monopoly
5
market,
Q = 3 units
Deadweight loss appears
under monopoly
Deadweight
loss
Produce
surplus
Total cost
MR
MC
D = MB
Quantity
21
0
3
4
Price discrimination

Definition

A situation where seller sells identical goods produced at
the same cost to different customers at different prices.

Examples

MTR: Lower prices for children and elderly

Fast-food shop: Special offer for students

University scholarship
Reason for practising price discrimination

In simple monopoly pricing, buyers have consumer surplus.

Sellers may try to capture the consumer surplus to increase profits.


i.e. From consumer surplus to producer surplus
Price discrimination is a pricing arrangement a firm uses to
increase profit.

Price setting based on the different consumers’ demand curves.
How does price discrimination increase profit?

Given MB of a flower:

Suppose cost = $0

Customer
Marginal Benefit ($)
A
80
B
50
C
20
If the selling price of the flower is:
Price ($)
Quantity sold (units)
Total revenue ($)
20
3
60
50
2
100
80
1
80

Then the profit-maximizing price is $50 and quantity is 2 units

Consumer surplus: A: $80 - $50 = $30 and B: $50 - $50 = $0

Producer surplus: $50 x 2 = $100

Total social surplus: $100 + $30 = $130
How does price discrimination increase profit?

Given MB of a flower:
Customer
Marginal Benefit ($)
A
80
B
50
C
20

Suppose cost = $0

Suppose the seller bargains with the customer separately:






Price to A = $80, Price to B = $50 and Price to C = $20
Total revenue = Producer surplus = $80 + $50 + $20 = $150
Consumer surplus: A: $80 - $80 = $0, B: $50 - $50 = $0 and C: $20 - $20 = $0
Total social surplus = $150 + $0 = $150
Total sales = 3 units
Price discrimination:




Qt 
Producer surplus (profits) 
Total social surplus
But, consumer surplus 
How to identify price discrimination?

Key 1: Whether the goods and their costs are the same?

Price discrimination is found if


No price discrimination if



Same product sold in different price to different customers
Quality is different
Costs are different
However, Price discrimination is found if


Difference in price is disproportionate to the different in quality or cost
E.g.
Normal Set Lunch: Soup + Curry Chicken + Tea ( $30 )
Student Set Lunch: Curry Chicken + Tea ( $16 )
[The bowl of soup is disproportionately expensive.]
How to identify price discrimination?

Key 2: Whether the unit prices are the same?

Example: Telecommunication Plan

Plan A: $51 – 1100 minutes [i.e. $0.0464 per minute]



Plan B: $73 – 1600 minutes [i.e. $0.0456 per minute]
Plan C: $88 – 2100 minutes [i.e. $0.0419 per minute]


More preferable to common users, like students, for leisure usage
More preferable to businessman for occupational needs
Who has higher price elasticity in buying
telecommunication services, student or businessman?
Different in price is not necessarily price discrimination

Peak hour surcharge



E.g. Minibus fare
 Higher cost in running on the road
 Higher demand
E.g. Salon before CNY
 Higher cost in hiring additional workers
 Higher demand
Special offer to privileged customers

E.g. Loan with lower interest rate
 Loyal customers: lower chance of bad debt (cost)
 With stable occupation: stable income, less possibility of late
repayment
Types of goods can price discrimination be more
easily practised

Easy to separate the consumers

Low cost of preventing resale


If consumers can resell the goods, they can buy at a
lower price and resell at a higher price, so sellers can’t
capture the consumer surplus
In general, price discrimination is more common in
services than commodities.



Immediate consumption
Hard to resell
For commodities, it’s hard for the sellers to prevent resale.
3 Types and examples of price discrimination

First degree price discrimination

Second degree price discrimination

Third degree price discrimination
Third degree price discrimination

A situation where the seller separates customers with different
price elasticity of demand into two or more groups and charges
them different prices.

Also known as market segmentation

Different elasticity suggest that

Different willingness to pay

More elastic demand, lower willingness to pay.

Less elastic demand, high willingness to pay.
Third degree price discrimination

Suppose MC of the good is constant.

When MC = MR,

PB (inelastic demand) > PA (elastic demand)
Third degree price discrimination
Examples
 Discount for students and the elderly




E.g. MTR, restaurants, etc.
Less income
 Lower willingness to pay
 Higher elasticity of demand
Easy to be identified
Local and overseas market



E.g. Kindle sold in amazon.com (US$109) and amazon.co.uk (£89)
Easy to separate the market according to the price elasticity of demand
Geographical separations can effectively prevent resale
Third degree price discrimination
Does prohibiting price discrimination benefit consumers?
Local market
Overseas market
Price ($)
50
15
Sales (copies)
3,000
2,000
Marginal cost ($)
10 per copy
10 per copy
Fixed cost ($)
50,000
Profit = ($50 - $10) x 3000 + ($15 - $10) x 2000 - $50,000 = $80,000
 If the law requires a uniform price, books will be sold locally only.
Total revenue = ($50 - $10) x 3000 - $50,000 ) = $70,000
 Publisher will lose. Less profit.
 Overseas consumers will lose. They can’t buy the books.
 Hence, less consumer surplus.
Conclusion
 Prohibition of price discrimination will reduce the choices that producers and
consumers have. This may lead to Overall loss to society.

Second degree price discrimination

A situation where the seller charges buyers higher prices for
quantities with greater marginal benefits and lower prices for
quantities with small marginal benefits.

Not to charge according to different customers,
but different quantities.

Also known as multipart pricing.

Customers have the power to do ‘self-selection’.
Second degree price discrimination

Mutlipart pricing: sellers charges different prices for different
amounts (or blocks) of a good, with higher prices for the first few
units and lower prices for subsequent one.

Sellers do not need to separate their customers into different groups
A quantity-based pricing arrangement to the customers.
Customers will do the self-selection.


Second degree price discrimination
Examples
1. Provide discount for specified quantity


$100 per piece  First two average $100 per piece
Buy 3  10% discount, i.e. $100 x 3 x 90% = $270
Average price = $90 per piece
2. Provide discount package





First 2 units: $100 each  Average $100 per piece
Third unit: $$70
Total: $100 + $100 + $70 = $270 Average $90 per price
Both methods have the same effect of multipart pricing.
They are second degree price discrimination.
Second degree price discrimination
Examples
Admission Fee
3. Two-part tariffs
Admission fee at $200,
inclusive of 50 tokens
Amusement Park
After entering the park, 10
 Tokens before entrance at higher price
tokens for every $20
 Tokens after entrance at lower price
 The more tokens customers buy, the lower the average price.
Token$100 per piece  First two average $100 per piece
Video rental clubs
 Membership fee (fixed) + Coupons (variable)
 The more coupons customers buy, the lower the average price
First degree price discrimination

A situation where the seller charges each consumer the maximum
price who prepared to pay for each unit, which is along the
demand curve of different consumers.

Extract the consumer surplus.

i.e. Consumer surplus becomes producer surplus

Producer surplus = Total social surplus

Also known as perfect price discrimination.
First degree price discrimination

According to the buyers’ marginal benefit, the seller charges



$9 for the 1st unit, $8 for the 2nd unit, $7 for the 3rd unit, $6 for the 4th unit
$5 for the 5th unit, where profit-maximization achieved (MC = MB)
No consumer surplus. All surplus becomes producer surplus.


Seller has to know the willingness to pay of all consumers.
Quite impossible to practise the first degree price discrimination in the reality.
First degree price discrimination
Pam’s marginal benefits schedule for apples
Ada’s marginal benefits schedule for apples
Q
1
2
3
4
5
6
Q
1
2
3
4
5
6
MB($)
5
4
3
2
1
0
MB($)
4
3
2
1
0
0
If sells at uniform price = $3

Pam: 3 units, TR=$3x3=$9, consumer surplus = ($5-$3) + ($4-$3) = $3

Ada: 2 units, TR=$3x2=$6, consumer surplus = $4-$3 = $1
If practices first degree price discrimination until $3

Pam: 3 units, TR=$5+$4+$3=$12, average price=$123=$4, consumer surplus = $0
(Therefore, Pam will accept a package of 3 apples at $12.)

Ada: 2 units, TR=$4+$3=$7, average price=$72=$3.5, consumer surplus =$0
(Therefore, Ada will accept a package of 2 apples at $7.)
First degree price discrimination
Examples

First degree discrimination takes place when bartering exists
between buyers and sellers.

The bid and offer system in the housing market where potential
home buyers put in an offer on an individual property

Negotiating prices with dealers for second hand cars

Haggling for the price of a hotel room (mostly foreign countries)

Dutch auctions

The sellers begins with a high asking price for an item. If nobody responds to it, he lower the price, until
the item to be sold to the first person who accept the price.
Differences among 3 types of price discrimination
1. First degree vs. Second degree price discrimination

Whether the firm can extract the consumer surplus from each consumer
complete.

First degree: Complete extraction. Different price for each unit.

Second degree: Multipart pricing, consumer surplus still found.
2. Second degree vs. Third degree price discrimination

Whether market segmentation exists.

Third degree: Different groups face different price arrangement.

Second degree: Consumers can choose different price arrangement according
to their willingness to pay, but the firm may not know which groups do they
belong to and how much they are willing to pay.
Other examples of price discrimination
1. Coupon clipping


Customers can have lower price by using coupon.
The firm does not cut the price because


Customers with higher elasticity of demand and lower willingness to pay will
try hard to use the coupon.
The customers separate themselves into different groups.
2. Medical fees



Cost of providing the treatment of same illness to the rich and the poor is
the same.
Rich people: higher income, higher willingness to pay
Poor people: lower willingness to pay
Other examples of price discrimination
3. Air ticket


Different prices for tickets
Passengers for business trip



Passengers for leisure



lower elasticity, higher price
don’t want to stay over the weekend
Higher price elasticity, lower price
Don’t‘ mind staying over the weekend, so lower price for ticket for travellers to
stay for the weekend.
However, different prices of first class, business class and economy class
may not be price discrimination because of different costs for providing
services
Conditions for price discrimination
General conditions
1.
Monopoly or market power


2.
Can effectively prevent resale

3.
If consumers can resell the products easily, buy low sell high. Take away the firm’s
customers who are willing to pay higher prices.
Consumers’ willingness to pay is different

4.
The firm can influence the market price by changing its output.
Price search, facing a downward sloping demand curve.
If no difference, products will be sold in the same price.
Low cost is practising price discrimination


Price discrimination involves complicated pricing arrangement.
If cost is too higher, simple monopoly pricing will be better than price
discrimination
Conditions for price discrimination
Specific conditions
For first degree price discrimination
 Aim at extracting all consumer surplus
 Seller must have perfect information on each customer’s willingness to pay.
For third degree price discrimination
 Aim at put different consumers into different group according to their elasticity
of demand.
 Consumers’ price elasticity of demand must be different.
For second degree price discrimination
 No need to have perfect information on consumers’ willingness to pay. (1st)
 No need to group consumers according to their price elasticity of demand. (3rd)
 Need to have a general idea about consumers’ preferences or consumption
patterns before making different price arrangement
Conditions for price discrimination
Consumers’ market information and price discrimination
In tradition economics, for third degree price discrimination
 Different price elasticity of demand of consumer is necessary.
Argument from Steven N.S.Cheung
 Not necessarily have different price elasticity of demand
 Different information cost can help price discrimination to be practised


Consumers have different information about the market
E.g.
 Tourists and local residents might have the same elasticity of demand on camera.
 However, tourists have less information, i.e. higher information cost, and would
likely to pay higher than local residents.
Monopoly and anti-competition
In traditional economics, ‘Monopoly’ is often labelled as

anti-competitive

harmful to the interest of consumers and society
However, economists argue that

monopoly may be anti-competitive,

but might not be harmful to the society.
Monopoly and anti-competition
Ask yourself:
1. Is monopoly necessarily anti-competitive?


No, the reasons are:

Monopoly because of economies of scale

Elimination of weak competitors under normal market competition.
Not necessarily anti-competitive, but beneficial to the society

Natural monopoly  lower average cost, so lower price

Dominate the market because of high quality, e.g. MS Windows XP in 2001
Monopoly and anti-competition
Ask yourself:
2. Why is monopoly often seen as being anti-competitive and harmful?


Monopolists, who’s dominate the market, aimed at more profit

have the ability and

have the incentive to engage anti-competitive practices

great temptation to control the price and output

So, monopoly is always suspected of being anti-competitive.
Large enterprises may abuse their dominance and hinder competition

sell products below cost

ask suppliers to stop supplying goods to competitor
Definition of anti-competition
Enterprises use unfair or inappropriate ways to reduce or restrict market
competition.
In USA, Australia, the UK and Singapore

Define “anti-competition” according to the behaviours of the
enterprises instead of their scales and market shares;

Whether they use unfair and inappropriate ways to reduce or restrict
market competition.
Definition of anti-competition
Hong Kong - <<Competition Bill>> (Proposed, to be legislated in 2012)
First Conduct Rule
Prohibition of anti-competitive agreements, concerted practices and decisions
(1) An undertaking must not –
(a) make or give effect to an agreement;
(b) engage in a concerted practice; or
(c) as a member of an association of undertakings, make or give effect to a decision of the association, if the object or
effect of the agreement, concerted practice or decision is to prevent, restrict or distort competition in Hong Kong.
(2) Subsection (1) applies in particular to agreements, concerted practices and decisions that –
(a) directly or indirectly fix purchase or selling prices or any other trading conditions;
(b) limit or control production, markets, technical development or investment; or
(c) share markets or sources of supply.
(3) Unless the context otherwise requires, a provision of this Ordinance which is expressed to apply to, or in relation to, an
agreement is to be read as applying equally to, or in relation to, a concerted practice and a decision by an association of
undertakings (but with any necessary modifications).
(4) The prohibition imposed by subsection (1) is referred to in this Ordinance as the “first conduct rule”.
Definition of anti-competition
Hong Kong - <<Competition Bill>> (Proposed, to be legislated in 2012)
Second Conduct Rule
Abuse of market power
(1) An undertaking that has a substantial degree of market power in a market must not abuse that power by
engaging in conduct that has as its object or effect the prevention, restriction or distortion of
competition in Hong Kong.
(2) For the purpose of subsection (1), conduct may, in particular, constitute such an abuse if it involves –
(a) predatory behaviour towards competitors; or
(b) limiting production, markets or technical development to the prejudice of consumers.
(3) The prohibition imposed by subsection (1) is referred to in this Ordinance as the “second conduct rule”.
Definition of anti-competition
Hong Kong - 《 競 爭 條 例 草 案 》
第一行為守則
禁止反競爭的協議、經協調做法及決定
(1) 如某協議、經協調做法或業務實體組織的決定的目的或效果,是妨礙、限制或扭曲
在香港的競爭,則任何業務實體 —
(a) 不得訂立或執行該協議;
(b) 不得從事該經協調做法;或
(c) 不得作為該組織的成員,作出或執行該決定。
(2) 第 (1)款尤其適用於符合以下說明的協議、經協調做法及決定 —
(a) 直接或間接訂定買入或售出價格或其他交易條件;
(b) 限制或控制生產、市場、技術發展或投資;或
(c) 分享市場或供應來源。
(3) 除文意另有所指外,如本條例的條文明訂為適用於協議或就協議而適用,該條文須
解釋為在經必要的變通後,同樣適用於經協調做法及業務實體組織的決定,或就該
等做法及決定而適用。
(4) 第(1)款施加的禁止,在本條例中稱為“第一行為守則”。
Definition of anti-competition
Hong Kong - 《 競 爭 條 例 草 案 》
第二行為守則
濫用市場權勢
(1) 在市場中具有相當程度的市場權勢的業務實體,不得藉從事目的或效果是妨礙、限
制或扭曲在香港的競爭的行為,而濫用該權勢。
(2) 為施行第 (1)款,符合以下說明的行為,尤其可構成上述濫用 —
(a) 該行為包含對競爭對手的攻擊性表現;或
(b) 該行為包含以損害消費者的方式,限制生產、市場或技術發展。
(3) 第(1)款施加的禁止,在本條例中稱為“第二行為守則”。
Different types of anti-competitive practice
Anti-competitive practices refer to all behaviours that distort or restrict
market competition.
4 Types of anti-competitive practices

Mergers (合併)

Horizontal agreement (橫向協議) [also known as ‘Cartel’]


Vertical agreement (縱向協議)


Competitors in the same industry make agreement on price and output in order to
jointly control the market price.
Agreement on purchasing or sales conditions made between firms in different stages in
production (producers) or sales chain (distributors)
Abuse of dominance (縱向協議)

a dominant firm perform any practices to restrict market competition is regarded as
abuse of dominance.
Mergers
1. Horizontal mergers

the merging of firms producing the same type of goods.

Aim at reduce competition

Increase the power of the newly merged enterprise in controlling the price

Examples: Toyota and Lexus (motor vehicle), HP and compaq (computer)

Guideline in US case:

Large horizontal mergers are often perceived as anticompetitive.

If one company holding 20% of the market share combines with another company also holding 20% of the
market share, their combined share holding will then increase to 40%.

This large horizontal merger has now given the new company an unfair market advantage over its competitors.

The amalgamation of Daimler-Benz and Chrysler is a popular example of a horizontal merger.
Mergers
2. Potential competition mergers

the merging of a firm and another firm that plans to enter the market and
compete with it.

Former taking over the latter or vice versa

Removal of potential competitors  more power in price control
Mergers
3. Vertical mergers

the merging of firms which are in different production stages and have a
buyer-seller relationship.

Cut off the raw material supply or retail outlet of competitors  unable to
compete.

Newly merged enterprise has more power to control the market price.
Horizontal agreements
1. Price-fixing

An agreement between firms to fix or raise the price to restrict price
competition and increase profits.

Distort normal operation of the market

Customers bear higher costs.

Examples

Newspapers: Fixed before the publication of Apple Daily in 1995.

Telecommunication: $12 Mobile Service Licence and Administration Fee of $12.

Gasoline: Price adjust at the same time. (Suspected only)
Horizontal agreements
2. Sales and production quotas

An agreement among producers or suppliers to fix a sales or production
quota so that their joint reduction in output can raise the product price.

Less quantity  higher price

Examples

Oil: Limit the oil export in 1973

Limited version: Ferrari Motor vehicles
Horizontal agreements
3. Bid rigging / Collusive bidding (串通投標)






Gov’t or organisation seek bids to use price competition to lower the cost of
the project or services
An agreement to submit
 common bids to eliminate price competition.
 The lowest bid to win the contract by rotation and thereby getting a certain
amount of contracts.
If bid rigging, price of project will be higher than the market price.
Disadvantageous to tendering organisation (higher cost without better quality)
Often seen in tenders for the gov’t or public organisation. Illegal.
Example

In 1993, representatives of two dairies from Cincinnati in the US, Meyer Dairy and Coors
Dairy, confessed to rigging bids in school milk auctions in the 1980s10
Horizontal agreements
4. Market division in products and location (市場分配)





An agreement among producers or suppliers on the scope of operation.
Each firm specifies in
 Selling a certain kinds of products.
 Selling in a certain locations.
Creation of monopoly in product supply or in locations.
Colluded firms can sell the products at a higher price.
Example

In January 2003, Bluefield Regional Medical Center (BRMC) and Princeton Community
Hospital Association (PCH) entered into agreements to allocate cancer services to PCH and
cardiac-surgery services to BRMC in six West Virginia counties and three Virginia counties.
5. Customer allocation (分配顧客)



An agreement among market participants on the source of customers.
Divide up the market without competition.
Distributors may monopolize the market.
Horizontal agreements
6. Joint boycotts (聯合抵制)




An agreement among competitors not to trade with certain suppliers or
customers, or the joint effort of competitors to force suppliers or customers not
to trade with another competitor.
Take away the supply or choices of the targets of the boycott.
Damage the market efficiency.
Example

In 1976, a group of Indiana dentists formed the Indiana Federation of Dentists13 to pursue a
restraining policy not to comply with dental health insurers’ requests for x-rays, resisting
insurers’ control on the costs of dental treatment. The restraining policy was found to violate
the US antitrust laws, and the Federation failed to establish a pro-competitive justification for
trade restraints.
7. Unfair or discriminatory standards (不公平或歧視性的準則)

The standards agreed upon among members of a trade union or professional
body, which deny newcomers the chance to enter or compete in the market.
Vertical agreements
1. Exclusive dealing (獨家交易安排)

An agreement made between a supplier and its distributors so that the
distributors cannot sell products of the same kind provided by other suppliers.


Illustration:

Fruit Supplier A made an agreement with its distributor with a discounted price.

The distributor can sell fruit from Fruit Supplier A only.

Channel of Fruit supplier B is blocked.
Fruit
Supplier A
Fruit
Supplier B
Restrict the sales channels of competitors

Hinder market efficiency

Less customers’ choices
Distributor
(Agreement to sell fruit from Fruit
Supplier A only.)
Vertical agreements
2. Sole distributor / Exclusive territories (獨家代理)

An arrangement that the producer only assigns one distributor for its products
in a specified sales territory.

Example:

Before 2007: Ng Fung Hong (五豐行) was the sole distributor of live cows imported from
the mainland to HK.


Dai Chong Hong (大昌行) is the official dealer to sell Honda motor vehicles in HK
Monopolize the market  Higher price
Vertical agreements
3. Tie-in sales (搭賣)

The buyer can buy the desired good or service (the tying good) only if he
agrees also to buy a different good or service (the tied good).

Example:

Printer (the tying good) and specified cartridge (the tied good)

Playstation 3 and Gamedisc

Reduce consumers’ choice

Restrict competition of the tied good.
Vertical agreements
4. Bundling (搭賣)

A commercial strategy whereby two or more products (or services) are offered
together at a bundled price lower than the sum of the individual prices.

Example:

Microsoft Windows Vista and Media Player

Goodwell Property Management Limited (under Cheung Kong Holdings) charges the
management fee of its residents with broadband service charge bundled together, no matter
they use the service or not

Reduce consumers’ choice

Unfavourable to market competition.
Vertical agreements
5. Resale price maintenance (RPM) (規定零售價)

A supplier specifying the minimum or maximum price at which a product
must be re-sold to customers by downstream firms.

Example:


Suggested price of electronic appliances and books.
Selling price must be fixed or within a price range  Lack of competition
between retailors.

Unable to lower price  Customers can’t pay less through price war.
Abuse of dominance
1. Predatory pricing

A firm with dominant market position sells below the costs of production.

Drive the competitors out and prevent new firms entry.

Raises the price finally.
2. Tie-in sales

Tied products or services without justifiable purposes, e.g. quality and safety
reassurance.
3. Price discrimination

Different prices to different consumers
4. Retail price minimum

Set a minimum price for products or services without close substitution.
Impacts of anti-competitive practices
1. Hindering the development of the industry

Reduce the number of competitors  Less development in the future

Anti-competitive practices damage free trade and fair competition
2. Unfavourable to consumers

Less choices

Higher prices
3. Harmful to economic efficiency

Monopoly has less output as compared with perfect competition

Deadweight loss
Justification and concerns for competition policy
The Hong Kong SAR Government set up Competition Policy Review
Committee (CPRC) in June 2005.

Review the policy and law overseas

Propose competition policy and law for legislation
Justification and concerns for competition policy
Major justification

To provide a legal basis for the investigation and sanctioning of anticompetitive conduct

To strengthen the competition regulatory framework in order to promote market
discipline.

To improve the business environment and provide a level playing-field for
business.

To improve transparency through delineating what constitutes anti-competitive
conduct so that firms and the public are fully aware of them and can prevent
their occurrence in society.

Without such regulation through legislation, in the long run there might be an
adverse effect on the relative competitiveness of HK, especially in those sectors
with high entry barriers.
Justification and concerns for competition policy
Concerns
1. Does HK need a competition policy?

Interference with the market structure


Increase in the cost of doing business



Harmful to the famous free and competitive market in HK?
Higher cost of production  Lower HK’s regional competitiveness
Effects on the development of small- and medium-size enterprises (SMEs)

SMEs may not fully understand their responsibilities under the new law  Easy to break the law

SMEs may have high legal fee

SMEs may under the threat of facing a lot of lawsuits. Large enterprises may make use of the law
to kick out SMEs.
Use of alternative ways to enhance market competition

Legislation should be the last option. Any other better ways to achieve the target?
Justification and concerns for competition policy
Concerns
2. Should it be a cross-sector or a sector-specific competition law?

Existing sector-specific anti-competition provision could not stop cross-sector
anti-competitive practices

The property management company bundled management fee with telecommunication service
charge

However, Telecommunication Ordinance does not regulate the practices of property management
companies.

Anti-competitive practices can be found in different sectors.

Legislation to tackle cross-sector bundling effectively and avoid discrimination
against certain business sectors and consumers.
Justification and concerns for competition policy
Concerns
3. What scope of behaviour should be covered by the competition law?

The new law should not point against market structures or natural monopolies.

Focus on stopping specific anti-competitive practices that hinder economic
efficiency or free trade and are not in the interest of consumers.

The CPRC recommended 7 types of anti-competitive practices to be covered in
the new law

Price-fixing

Bid rigging

Market division

Sales and production quotas

Joint boycotts

Unfair and discriminatory standards

Abuse of dominance
However, the CPRC added that these
practices are not illegal unless they are
found:
1. To have been carried out with the
intent to distort the market; or
2. To have the effect of distorting normal
market operation and lessening
competition
Justification and concerns for competition policy
Concerns
4. Should there be exclusions or exemptions?

The new law is aimed at avoid anti-competitive practices in business sectors.

Government should be exempted from being sued under the new law.

Since the new law may be abused to suppress lawful competitive business
activities, the CPRC also suggested that the regulatory authority should have the
discretion to ignore complaints that are inappropriate.
5. Should it be a civil or criminal offence?

Heavy fine and disqualification from holding a directorship in a company should
be enough.

Since the law is first enacted, civil penalties are more appropriate.
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