Regulation and Competition Policy
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ECON 3440: Regulation and Competition Policy
Regulation and Competition Policy 1
4. Monopolisation Practices
Our Plan
1 What is Monopolisation?
2 Predatory Pricing
3 Exclusionary Contracts
4 Bundling and Tying
Regulation and Competition Policy 2
1. What is Monopolisation?
in practice few pure monopolists but many dominant firms
in particular relevant for (i) deregulated industries and (ii) industries
with network effects
monopolisation=pursuit of anticompetitive practices to either sustain
or extend market power
examples: exclusive contracts, tying/bundling, capacity preemption,
price predation, strategic incompatibility, input foreclosure, raising
rivals costs, refusal to supply
monopolisation is prohibited by law
Regulation and Competition Policy 1. What is Monopolisation? 3
US Sherman Act Section 2
Every person who shall monopolize, or attempt to monopolize, or combine
or conspire with any other person or persons, to monopolize any part of the
trade or commerce among the several States, or with foreign nations, shall be
deemed guilty of a felony, and, on conviction thereof, shall be punished by fine
not exceeding $100 million if a corporation, or, if any other person, $1 million,
or by imprisonment not exceeding ten years, or by both said punishments, in
the discretion of the court.
AUS Competition and Consumer Act 2010 Section 46
[Misuse of market power] (1) A person (the first person) who has a substantial
degree of power in a market shall not take advantage of that power in that or
any other market for the purpose of:
(a) eliminating or substantially damaging a competitor of the first person
or of a body corporate that is related to the first person in that or any
other market;
(b) preventing the entry of a person into that or any other market; or
(c) deterring or preventing a person from engaging in competitive conduct
in that or any other market.
Regulation and Competition Policy 1. What is Monopolisation? 4
EU-Article 82: Abuse of dominant position
Any abuse by one or more undertakings of a dominant position shall be pro-
hibited. Such abuse may, in particular consist in
(a) directly or indirectly imposing unfair purchase or selling or other unfair
trading conditions
(b) limiting production, markets or technical development to the prejudice of
consumers
(c) applying dissimilar conditions to equivalent transactions with other parties
(d) making the conclusion of contracts subject to acceptance of supplementary
obligation which have no connection with the subject of such contracts
- minor differences in these laws with respect to whether purpose and/or
effects test is required (in AUS currently only purpose required)
Regulation and Competition Policy 1. What is Monopolisation? 5
Prosecution of Monopolisation
- laws require following steps for prosecution of monopolisation:
1 show that firm was in a dominant position, i.e. had a substantial
degree of market power in the relevant market
2 show a motive/mechanism by which monopolisation practice could be
rational for defendant
3 show evidence that firm engaged in anticompetitive behaviour which
outweighs any procompetitive effects of this business practice
- rule of reason approach: weigh costs against benefits of practices
- no hard evidence of anticompetitive intent (like internal documents)
necessary
- creation of dominant position is not illegal but its abuse is!!!
- building market power through innovation, investment, marketing is
perfectly legal
Regulation and Competition Policy 1. What is Monopolisation? 6
Judge Kaufman in Eastman Kodak Case (1979):
One must comprehend the fundamental tension - one might almost
say the paradox - that is at the heart of Section 2...The successful
competitor, having been urged to compete, must not be turned
upon when he wins.
- law should not work against monopolies built up by superior efficiency
- two-tiers approach to companies (big versus small)
- courts make difference between dominant companies and non-dominant
companies: dominant firm not allowed to engage in some practices
- aggressive conduct allowed to competitors but not to dominant firm
which has “special responsibility”
- in practice judging dominance and abusive behavior is not an easy task
Regulation and Competition Policy 1. What is Monopolisation? 7
When is a firm in a dominant position?
supra-normal profits or market share thresholds are not sufficient for
dominance
dominant firm has unique access to instruments that makes
competition on even playing field hard, such as patents, economies of
scale, network effects or essential facilities
definition of relevant market is important for this judgment
we discuss market definition in more detail in merger analysis
market includes all firms and products that a hypothetical cartel
would need to control in order to raise price in a permanent way
disputes over market boundaries occupy much time and effort in
monopolisation cases
Regulation and Competition Policy 1. What is Monopolisation? 8
2. Predatory Pricing
Definition
Predatory pricing are practices of one or more firms that aim at
1 deterring entry of competitors or
2 driving competitors out of the market
Economic mechanism:
- predator is taking strategic actions to reduce (actual or expected) current
or future profitability of (potential) competitor (=prey)
- motivated by gaining market power in the long run
- predator deviates from his short-run (non-predatory) optimal strategy
- once target of predation has left industry, predator enjoys higher profits
through maintained market power
- price predation is very controversial competition policy issue
Regulation and Competition Policy 2. Predatory Pricing 9
CASE: Entry in Airline Market
Regulation and Competition Policy 2. Predatory Pricing 10
Regulation and Competition Policy 2. Predatory Pricing 11
- court in Matsushita vs Brooke (1986):
“that predatory pricing schemes are rarely tried, and even more
rarely successful” ...
“mistaken inferences in cases like this one are especially costly,
because they chill the very conduct the antitrust laws are designed
to protect”
- antitrust task: search for motives and evidence
Questions we want to address in this section:
1 What are ingredients for predation to work?
2 How to distinguish predation from “innocent” competition?
3 What should and can competition policy do?
Regulation and Competition Policy 2. Predatory Pricing 12
2.1 The Chicago School’s view on Predation
McGee (1958): Predatory pricing is unlikely to happen because
1 a large firm (=predator) suffers more from price cuts than small
(=prey)
not the case if price discrimination is possible
2 recouping predation cost impossible because assets of prey still in
industry
however, there might be sunk cost; reputational effects
3 no predation in the presence of perfect capital markets
why does the incumbent have deeper pocket?
4 predation has to be more profitable than other options like mergers
merger might not be allowed: can attract more entrants
Regulation and Competition Policy 2. Predatory Pricing 13
2.2 Economic Theories to rationalise price predation
two lines of arguments are used to explain profitable predation
(a) predation due to imperfect capital markets (“deep pockets”)
(b) predation due to incomplete information and reputation building
(a) Predation and Imperfect Capital Markets
firm with more financial resources wages price war to drive financially
weaker rival out of market
firms cannot make losses for a long time and weak firms will exit
market
but Chicago School argument: if weak firm is at least as efficient as
incumbent and capital markets are perfect, why shouldn’t it get a
loan and stay in the market?
Regulation and Competition Policy 2. Predatory Pricing 14
predation theory has to take into account relationship between firms’
finance and entrant
in following: simple version of deep pocket predation
Deep Pocket Predation
two periods and two firms (incumbent I and entrant E)
in first period incumbent can fight or accommodate, entrant then
decides to stay or exit
in second period there is either accommodation (if E stays) or a
monopoly for I (if E exits)
profits for both firms satisfy:
P < 0 < A < M
both firms discount second period profits by δ ∈ [0, 1]
Regulation and Competition Policy 2. Predatory Pricing 15
Extensive Form Game:
E
enter out
E
I
fight accommodate
E
(P+δM, P<0)
out stay
(A+δA, A+δA)
(M+δM, 0)
- predation occurs if
P + δM ≥ (1 + δ)A
Regulation and Competition Policy 2. Predatory Pricing 16
An Asset-based Model of Predation
I and E produce homogenous good, MC = 0
compete in quantities with infinite horizon, predation only in period 1
weight of future profits is δˆ = δ/(1− δ) > 0, δ discount factor
market with linear per-period demand D(p) = 1− p
E has to pay amount D = 1/36 to stay in the market after period 1;
if not, it has to exit (imperfect capital market)
two interpretations possible:
1 E has to pay back debt D; if not, bankruptcy
2 E has assets A smaller than fixed costs D = F − A
sunk costs make re-entry cost not profitable
backward induction: second period profits after exit
qm = 1/2,Πm = 1/4
Regulation and Competition Policy 2. Predatory Pricing 17
if E stays on, firms play Cournot in second period with reaction
functions
Ri (qj) =
1
2
(1− qj)
and second period quantities and profits of
qd = 1/3,Πd = 1/9
at the end of period 1, E has to exit if
(1− qI − qE )qE ≤ D
or
qI ≥ qI (qE ) =
qE (1− qE )− D
qE
two types of scenarios for period 2 as a function of qI in period 1:
competition (when E stays on) and predation (when E leaves)
Regulation and Competition Policy 2. Predatory Pricing 18
1. Competitive equilibrium
- incumbent sets qI such that E stays in market
- firms get Cournot duopoly profits in second period
- firms maximise first period profits and play Cournot quantities in period 1
- entrant E has no incentive to deviate as it would strictly lower first
period profits and weakly lower second period profits
- firm I could deviate to quantity qI (q
d) such that E leaves market