ANTITRUST ECONOMICS 2013
Alexis G. Pirchio
Elisa Mariscal
CIDE, Global Economics Group
REVIEW:
Date
CPI
LECTURES 9.1, 9.2 AND 10.1, CARTELS AND
COMPETITIVE CONSTRAINTS
Review
19 September 2013
Overview
2
Review
Cartels: The
Economics of
Price Fixing
Cheating and
Detection
Competitive
Constraints and
Market Power
3
Cartels: The Economics of Price
Fixing
Replicating the Monopoly Outcome with a
Cartel: Agreements on Price and Output
The Economics of Price Fixing
4
Price fixing is per se illegal in the U.S., E.U. and many other jurisdictions.
• Illegal by virtue of the behavior regardless of its intent or effect, the
“inherent nature” of the practice is injuriously restraining trade.
• There is no allowable defense (though some industries are exempted)
• Focus in on the existence of an agreement (see Kaplow, Competition
Policy and Price Fixing for critique).
Per se prohibitions should be reserved for practices for which:
• There is an extremely high likelihood that the practice can have only an
anti-competitive effect.
• It is very difficult and costly to investigate claims of pro-competitive vs.
anti-competitive effects, making a per se approach economical
• The practice can be defined specifically enough so that companies can
identify what they are, and are not, allowed to do
Cartel Price Paths
5
Railroads
Citric Acid
Lysine
Fact About Cartel Data
6
Biased sample because we only observe discovered cartels.
Suppose only the less effective cartels are caught.
• Cartel duration has been underestimated.
• Welfare losses have been underestimated.
Suppose only the more effective cartels are caught because the less
effective ones collapse before being discovered.
• Cartel duration has been overestimated.
• Welfare losses have been overestimated
Policy challenge: How can we measure the efficacy of cartel
enforcement policies, when we cannot measure the number of
cartels in an economy?
Harrington, CRESSE Lectures, 2011
Price Agreements
7
P
Monopoly
Profit margin of $15 a unit and total profit
of $15 million.
PM = $20
Perfect
competition
PC = $5
MC
D
1,000,000
MR
2,000,000
Q
Suppose there are 20 competing firms, all identical. With competition they each
charge a competitive price of $5 dollars, and each sell 100,000 units (for a total 2
million units) and just earn a competitive return.
If they each agree to charge $20, they each sell 50,000 on average (for a total 1
million units) and make $750,000 of monopoly profit each ($15 * 50,000) for a total of
$15 million. [How does output get allocated?]
Output Agreements
8
Competing firms in the example could achieve monopoly price if
they each agreed to offer only 50,000 units to the market:
• Divided up by geographic regions so that each sold 50,000 units
• Divided up by customers so that each had customers to whom they
could sell 50,000 units only
We have assumed firms are all the same size and have the same
bargaining power. They could also divide things so that some got a
larger share of profits by getting a larger region or more (or better)
customers.
Which is better: price agreement or output agreement?
Cartels with Two-Sided Platforms
9
Replicating the monopoly outcome requires
fixing prices (or allocating output) on both sides
•If competing newspapers could fix subscription and
advertising prices they could exactly replicate the
monopoly outcome
•Note that this issue is different than “customers” on one
side colluding
If one side is constrained to zero then fixing price
on the other side replicates monopoly outcome
•If competing shopping malls fixed rental prices but
shoppers continued to get in for free they could replicate
the monopoly outcome
If a cartel can’t fix price on one side then:
•Monopoly profits get competed away if competition is
intense on other side
•Profits might increase relative to the competition level, but
this is still suboptimal—they don’t realize the full cartel
potential—if there is imperfect competition on other side
Fixed priced to buyers,
not clear to sellers
10
Cheating and Detection
The incentives to cheat and methods
aimed at detecting and punishing
cheaters
Incentives to Cheat on a Cartel Agreement
11
Could an individual firm do better than with the cartel?
The answer is always “yes” when it is certain that the other firms stick
with their cartel agreement (this case is unrealistic of course).
The answer may be “yes” whenever the gains from cheating exceed
the losses from either punishment or from de-stabilizing the cartel. The
“cheater” just needs to make enough extra profit long enough in
order to outweigh the losses of the cartel breaking down or possible
“retribution”.
Effective cartels must be able to detect and punish cheating.
Detecting Cheating
12
Given incentives to cheat cartels and their participants must be able
to detect firms that are deviating from the agreement.
Some market situations make it easier to detect cheating:
• Goods are homogeneous
• Pricing is transparent
• Customer relationships are well known
Cartel and its members can also devise special arrangements to
make it easier to detect cheating
Incentives to Cheat on a Price Agreement
13
Suppose firms 2 …. 20 charge the cartel (monopoly) price of $20.
Suppose firm 1 drops its price to $19.95.
Then all customers will buy from firm 1 (in a frictionless world).
• Firm 1 gets monopoly profits of almost $15 million (up from 750,000)
• Firms 2 … 20 get nothing
To avoid detection it could drop price but increase sales just enough
not to be detected. A successful cheater can’t be too greedy.
If many firms cheat competition reemerges.
Output Allocation and Cheating
14
Exclusive territories: if a firm has exclusive rights to a region, the
appearance of a competitor alerts firm to cheating.
Exclusive customers: if a firm has exclusive rights to a customer then
the defection of that customer alerts firm to cheating.
Exclusive contract wins: with bidding rigging, one firm is designated
to be the winner of each contract; deviation is detected instantly.
But some of these methods can also raise suspicions and increase
likelihood of detection. Some cartels therefore incorporate some
flexibility.
Punishing Cheating: Price Wars
15
If rivals deviate from agreed on
price this period then lower price
to competitive level next period.
This strategy leads to price wars
where periods of high prices are
followed by price wars.
To end price wars firms move
back to collusive equilibrium.
Importance of Cheating for Antitrust Enforcement
16
Ability to detect and prevent cheating is key to organizing and
maintaining a cartel. Cartels are more likely to exist when detection
and prevention of cheating are possible.
Detection and punishment methods leave traces of evidence that
authorities can look for.
Certain seemingly legal practices may “facilitate” detection and
prevention of cheating and therefore authorities may want to prohibit
or monitor these.
An authority looking for evidence of a cartel
• First look at role of cheating
• Then detection/punishment methods
• Conclude by looking at “facilitating practices”
Factors that Facilitate a Cartel
17
Facilitating factors include anything that increases the gains from
operating a cartel, helps detect cheating on a cartel, and enables
punishment of cheaters.
Facilitating factors include:
• Structural features of the market (number of firms, entry conditions, etc.)
• Institutional features (information exchanges, joint facilities, etc.)
• Contractual relationships and methods of transacting between buyers
and sellers.
What Can Competition Authorities Do?
18
Head them off at the pass – Sharp prohibitions/warnings in the Law
•Forbid/limit practices that facilitate cartels (Information exchange, MFNs, RPM—
but are these practices ever efficient?)
•Prohibit mergers that will facilitate collusion (e.g. ones that eliminate a maverick
player or increase the likelihood of coordinated effects)
Hunt them down – Assign resources, prioritize, enforce
•Focus investigative efforts on industries that have features that facilitate
cartels—but are these cartels the most damaging or the easier ones to detect?
•Screening technologies
•Dawn raids when enough suspicion—requires specialized know-how and can
be legally challenging in some jurisdictions
Get them to squeal – Leniency Programs
•Encourage cartel members to report each other (leniency programs)
•Get employees to be “whistleblowers”
Carry a big stick – Deterrence
•Fines
•Jail, Debarment
•Private Damages
Head Them Off At The Pass: Facilitating Practices
19
A facilitating practice is an activity that makes collusion more likely
or more effective, either by making coordination easier or making
it easier to sustain a collusive agreement.
A facilitating practice may be prosecuted either as an anticompetitive agreement in and of itself or as circumstantial
evidence of price fixing.
Some examples include:
• Information exchange of current individual firm sales or prices
• Announcements of future price changes
• List (or posted) pricing with no discounts
• Most favored consumer clauses, meeting competition clauses
• Delivered or basing point pricing
Information Exchange Agreements Help Collusion
20
Exchanging future pricing intentions
help coordinate price
Exchanging past prices help police
price agreement
Exchanging demand and cost data so
that firms have:
• A more common set of beliefs (this
makes it more likely that, without express
communication, they can settle on the
same collusive price)
• More precise estimates of demand
Firms Often Cooperate For Pro-Competitive
Reasons
21
Joint facilities to obtain scale economies (e.g. Computer Reservation
Systems).
Standard setting to obtain network economies and reduce
transactions costs for consumers (see Lecture 4) (DVD standards).
Solving various market imperfections (e.g. Portobello Road Antique
Dealers).
Exchanging information (costs, best practices, etc.) for procompetitive reasons (e.g. all trade associations). Cooperatives, joint
ventures, standard setting organizations, and other horizontal
combinations pose difficult problem for antitrust.
Engage in obvious efficiency enhancing activities.
Efficiencies from Cooperation
22
Sharing of facilities and reduction in
duplicative costs
Realization of network effects through e.g.
standardization
Cooperation may be essential to the creation
of a product (sports leagues, payment cards)
Hunt Them Down: Enforcement
23
Stages in the process: screen, verify,
prosecute
• Screening: Identifying markets where
collusion is suspected.
• Verification: Systematically distinguish
between collusion and competition.
• Prosecution: Developing economic
evidence to determine guilt.
Two empirical methods for screening:
structural, behavioral
• Structural: Identifying industry traits
conducive to collusion.
• Behavioral: Identifying collusive behavioral
patterns.
Get them to Squeal: the Economics of Leniency
Programs
24
A cartel shares common characteristics with organized
crime
•Cooperation within an illegal environment means that
there is a corporate governance problem at its core
•Repeated interaction, monitoring, threats and reactions
against cheaters, means that participants acquire
important information about all their co-conspirators
A viable cartel requires that 2 conditions be fulfilled
•Participation Constraint:
E(Profit from participating in the cartel) – E(Cost of
Punishment)>0
•Incentive Compatibility Constraint:
Under incomplete information and different types of
agents, the participant will find it in its interest to act in
accordance with the cartel rules.
A successful leniency program weakens a cartel by
maximizing conflict of interest among its members and
reducing the compatibility of interests
Carry a Big Stick: Customer Damages’ Purpose
25
Compensation to harmed consumers
Deterrence and resistance of cartels
• Additional financial penalties to fines levied by the government.
• Create added incentives for customers to monitor, report, and
investigate.
Customer damages – US
• Treble damages: Multiplier serves deterrence since the probability of
being caught and paying penalties is well below one.
• Indirect purchasers cannot sue for damages except in some states.
• Class action suits used when many customers each incur a small loss.
The Economics of Damages
26
Damages inflicted by firm i from colluding in period t are calculated
to be:
• [ Pic(t) – Pibf(t) ] * Qic(t)
Pic(t) – Pibf(t) is the overcharge
Qic(t) is the number of units sold by firm i in period t.
Pic(t) is the observed (collusive) price charged by firm i in period t.
Pibf(t) is the “but for” (or counterfactual) price for firm i in period t.
Harrington, CRESSE Lectures, 2011
27
Competitive Constraints and
Market Power
Definitions of Market Power
28
Ability of a firm to raise prices significantly above the competitive
level
• “Significant” required because almost all firms have some degree of
short-run 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
Monopoly, Perfect Competition, and Market Power
29
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
Level Versus Changes in Market Power
30
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
31
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 (e.g. market share, concentration) 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 the demand side
and from the supply side.
Competitive Constraints Can Limit Market Power
32
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
Demand-Side Substitution and the Marginal
Consumer
33
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
Pints of Beer Demanded (Millions per Year)
9
10
Entry, contestability and Supply-side Substitution
34
New Entry
• Can new firms get in quickly when prices go up? [Barriers to
entry]
Expansion
• Could current rivals expand production easily by switching
production lines from other products? [Excess capacity, time to
respond, availability of inputs, flexibility in technology and
factors of production…]
Product repositioning
• Could current rivals make their products more competitive by
adding or changing features?
Barriers to Entry Debate
35
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.
End of Review, Next Class Topic 10.2
36
Topic 10.2
Topic 11.1
Role and Definition
of Market Power
Overview of Market
Definition and
Market Power in
Competition Policy
Market Power
Measurement
General Principles
of Market Definition
Multi-Sided
Platforms and
Market Power
Hypothetical
Monopolist Test