5002busbs lecture 4 1

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5002BUSBS

ECONOMIC REGULATIONS AND

LAW

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How competition works

 Economists tend to begin with the

assumption that firms seek to maximise profits (a reasonable assumption)

 How much profit a firm makes is heavily

influenced by the amount of competition it faces

 A consideration of market structures

enables the nature and degree of

competition within a particular market to be studied

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How competition works

 We consider two extreme cases:

 Extensive competition

 A single firm

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Case 1: extensive competition

Competition among firms

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 Imagine a market in which the firms are

making HUGE profits

 What happens next?

 Two things happen simultaneously:

 Profits act as signals to existing producers

to increase output

 Profits act as signals to alert entrepreneurs

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Case 1: extensive

competition

 The result

leads to an increase in the quantity of the

product produced

 This results

in the price falling if

demand

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Case 1: extensive competition

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 If demand does not change, the influx of

resources erodes the profits of producers of the product

 This is the essence of competitive forces  The firms are competing for market

share and a share of the profits available

 The fewer the firms in the market, the

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Case 1: extensive

competition

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 Suppose that so many firms are attracted into a

particular market that the price falls so much as to remove the profitability of producing the

product

 What happens next?

 Firms with the highest costs will no longer find it

profitable to produce the product and will leave the market

 This shifts the supply curve to the left and raises

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Case 2: a single firm

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 When a market is dominated by a single firm the

forces of competition are absent

 The main reason for the absence of competing

firms is that the dominant firm has the power to prevent new firms entering the market e.g.

 A monopoly over an important component or

specialist knowledge over processes

 A statutory license to operate

 In the absence of competition, the huge profits

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How competition works

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 From an economist’s perspective, the

benefits of competition are clear

 Prices will more closely reflect the marginal

cost of production delivering allocative efficiency

 Allocative efficiency means that what

consumers want gets produced

 Goods that consumers don’t want don’t

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How competition works

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 If price exceeds the marginal cost of

production (too little produced) resources will be misallocated

 With extensive competition this will be

temporary

 With less competition it can continue

 Competition forces firms to cut costs and

to be as efficient as possible, operating at their least cost quantity of output this delivers productive efficiency

 Productive efficiency means that

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How competition works

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 There are significant benefits from

competition:

 Low prices: firms compete with each other

for customers

 High quality: firms compete with each other

for customer loyalty

 Choice: competition generates a whole

aisle of breakfast cereal, washing powders, toothpaste etc.

 Responsive producers: firms who don’t

deliver what consumers want fail, those that do grow

 Innovation: firms compete to deliver new

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How competition works

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 From a producer’s point of view,

competition make their life difficult

 The more extensive the competition, the

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The early days . . .

 Herbert Morrison announced July 1946

that the government intended to

introduce legislation to inquire into the effect of monopolies and restrictive

practices and to take appropriate action

 The original Commission’s role: to assess

whether monopolies or agreements were “in the public interest”

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 The Commission was left to interpret what

“the public interest” meant

 Harold Wilson said “We have tried our best to

work out such a definition and failed”

 The Board of Trade “The Government does

not … adopt an attitude of sweeping hostility to all monopolies and restrictive agreements, which may possess good as well as bad

features … it considers it better to judge each particular case on its merits…”

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Economics and competition

policy

 Economics provides the necessary

underpinning for competition policy

 Provides a proper theoretical basis for

why given situations give rise to particular effects

 Provides a way of accessing appropriate

evidence to examine the effects

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Economics and competition

policy

 It is appropriate to limit the exercise of

market power in the interests of economic efficiency and welfare

 The general prohibition of price-fixing or

market-sharing agreements between competitors is derived from economic reasoning that tells us such agreements harm the public good

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Economics and competition

policy

 In merger control, economic reasoning

explains:

 how a market can be identified

 what are the barriers to an possibilities of entry  what other countervailing pressures might limit

any market power enjoyed

 Increasingly sophisticated quantitative

analytical techniques – econometrics – have made a big difference to the way

competition cases are handled

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The legalities

 Origins of UK competition policy 1948  Fair Trading Act 1973

 Has remained fundamentally unchanged

until Competition Act (1998) and Enterprise Act (2002)

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The Competition

Commission

 Required to investigate mergers and

markets

 References made to it by OFT

 Required to obtain, assess relevant

evidence, hear the parties, come to a reasoned decision and decide on and apply remedial measures within

statutory time limits

 Work is subject to review by the

Competition Appeal Tribunal (CAT)

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1998 Competition Act

 MMC becomes the Competition

Commission

 Came into force 1 March 2000

 Chapter I prohibition: anti-competitive

agreements and secret cartel activities

 Chapter II prohibition: abuse of a

dominant position

 Explicitly modelled on Articles 85 and 86

of Treaty of Rome

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1998 Competition Act

 Director General of Fair Trading (DGFT)

investigates alleged breaches, has powers to fine the company or

companies up to 10 per cent of their annual revenue for up to 3 years

 2 important safeguards:

 Companies can notify the OFT of

agreements and seek an exemption

 Companies can appeal against decisions to

the Appeals Tribunal

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1998 Competition Act

 Merger reform

 Merger decisions are referred to the CC by

the DGFT and the CC’s decision is not open to rejection by the Secretary of State

[this makes competition decisions explicitly independent from politicians]

 New criterion for judging mergers: a

substantial lessening of competition

 Secretary of State can intervene in the case of national defence

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1998 Competition Act

 Appointments to CC are made by the

Secretary of State

 All members initially appointed for 4 years

and are automatically reappointed for a further 4 years

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2002 Enterprise Act

 The CC is a Phase II authority deciding

on mergers, markets and regulatory issues

 Cases are referred to CC

 Mergers: OFT

 Markets: OFT and principal economic

regulators

 Regulatory issues: rule on licence

modifications and price control reviews where there is disagreement between licensees and the regulator

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2002 Enterprise Act

 Gives CC power on reference from OFT or

a regulator to investigate markets, to assess restrictions of competition and impose remedies

 Purpose of market investigations

 To enable CC to take an in-depth look at

markets where competition is thought to be not working well but when it does not appear to be from the dominant position of a single firm or the existence of hard core cartels

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2002 Enterprise Act

 OFT and sectoral regulators each tasked

to study and observe markets to assess whether a market investigation is

appropriate

 Adverse effect on competition (AEC)

 Where “any feature, or combination of

features, of each relevant market prevents, restricts or distorts competition in

connection with the supply or acquisition of goods or services in the UK or a part of the UK”

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2002 Enterprise Act

 AEC test arises from one or more of the

following features of the market:

 The market structure

 The conduct of suppliers or acquirers of

goods or services

 The conduct of customers

 Making a reference if discretionary, there

needs to be a “reasonable ground to suspect”

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2002 Enterprise Act

 If the CC finds an AEC, it has a duty to

remedy it in as comprehensive a way as possible

 CC has a statutory maximum of 2 years

within which to complete a market investigation

 A CC decision is final and effective

subject only to review by the CAT

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2002 Enterprise Act

 OFT & regulators can accept undertakings

to avoid the need for a CC reference

 The threat of a reference can be a powerful

inducement for parties to offer undertakings in lieu

 Settlement under the threat of a CC

investigation is an important tool for enforcement

 Avoids unnecessary delay

 Avoids unnecessary expenditure 30

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Factors relevant in assessing markets

 Traditional indicators of rivalry

 Price competition

 Non-price competition  Choice

 Quality

 Innovation

 How open a market is to entry, expansion and

exit

 The countervailing powers of buyers and

suppliers

 The effect of any vertical integration

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Market investigations

 Since 2003 9 market investigations

 Store credit cards  Home credit

 Personal banking in Northern Ireland  Payment protection insurance

 Leasing of railway rolling stock  BAA Airports

 Bulk supply of domestic LPG  Classified directories

 Grocery retailing 32

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Groceries market

investigation

 Completed 2008

 Over 700 submissions

 Held over 80 hearings

 Visited facilities and sites

 Compiled a database of over 14,000 stores

 Took 2 years to complete

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Assessing the decisions

 The cases need to be sufficiently far in

the past to see how the market has

evolved after a particular decision was taken, but recent enough to remain

relevant to the present

 Maximising the gains of evaluation is

probably about achieving a good balance of both internal and external evaluation, and finding effective ways of feeding the lessons learned into future investigations

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Assessing the decisions

 2005 Price Waterhouse Coopers study  2008 In-house evaluation

 2009 Deloitte study

 UEA Centre for Competition Policy

 Website www.ccp.uea.ac.uk

 Newsletter

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Further information

 www.competition-commission.gov.uk

 Provides a mountain of information

 All past reports

 Current position of ongoing investigations

 Speeches and lectures presented by

competition authorities

 www.oft.gov.uk

 Similarly a wealth of information

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