Introduction to Competition Economics Lecture_1_2016_For Publication
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Transcript of Introduction to Competition Economics Lecture_1_2016_For Publication
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HoustonKemp.comHoustonKemp.com
Introduction to Competition
Economics
University of Sydney Law School
Competition Law 2016
Dr Luke Wainscoat
Senior Economist, HoustonKemp
© 2016
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Economics provides insights into competition law
• Competition and Consumer Act is based largely on
what economics tells us harms consumers
• Economics will help you understand cases and
judgments (to an extent…)
• You will not be examined directly on your
understanding of economics
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Economics is a language and set of analytical tools
• No single answer to each economic problem
› “economics is the only field in which two people can get a
Nobel Prize for saying exactly the opposite thing” Anon
› “Give me a one handed economist” Harry S Truman
• Different economic approaches
› Classical economics/price theory (Smith, 1766)
› Structure/conduct/performance (Chamberlain & Robinson,
1930’s)
› Game theory (von Neumann & Nash, 1930’s and 1940’s)
› Behavioural economics (1980’s but mostly 2000’s)
• You will learn methods for analysing problems and
language
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Outline
• Lecture 1:
› Demand and supply model
› Perfect competition vs. monopoly
› Economic welfare and market power
• Lecture 2:
› Game theory
› Price and quantity setting competition
› Other applied topics such as collusion and predatory pricing
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Demand and SupplyThe key to understanding firm conduct
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Demand - How much is one customer willing to
purchase?
6
Price
Quantity
Demand
10 12
5
6 X
Y
7
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Price elasticity of demand• Percentage increase in demand from one per cent
increase in price (ie, a negative number)
7
Price
Quantity
Demand
98 100
100
X
Y
101
Elasticity=-2
Elasticity=-0.5
(less elastic)
99.5
• Elasticities of demand and supply are usually higher in the
long run than in the short run
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Cross-price elasticity of demand
• The percentage increase in quantity demanded
from a one per cent increase in some other price
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Negative for complements
Positive for substitutes
Weetbix Milk
Weetbix Cornflakes
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Supply - How much is one firm willing to supply?
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Price
Quantity
Supply
10
5
12
6
15
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Equilibrium is where demand is equal to supply
10
Price
Quantity
Supply
10
5
12
Demand
Excess supply
Excess demand
7
6
11
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Increase in supply leads to lower prices and
greater sales
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Price
Quantity
Supply
10
5
12
Demand
X
Y
11
4
Excess supply
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Increase in demand leads to higher prices and
greater sales
12
Price
Quantity
Supply
10
5
12
Demand
X
Y
11
4
Excess demand
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Market demand is the sum of individual demands
13
Price
Quantity5 11
Market
demand
6
4
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What affects market demand for cereal?
• Price of product (move along demand curve)
• Price of substitutes (shift demand curve)
• Price of complements (shift)
• Income (shift)
• Tastes/technology (shift)
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Increase in price of substitute will lead to rise in
market demand
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Price
Quantity
Market
demand for
cereal
Price of
toast goes
up
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Market supply is the sum of individual supplies
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Price
Quantity
6
Market
supply for
cereal
Supply of
Cornflakes
Supply of
Weetbix
2 3 5
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Most significant recent change in the world economy
• Short run demand (and supply) for crude oil are inelastic
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Price
Quantity
Supply
Jan-2014 =
$110/barrel
Demand
Dec-2014 =
$50/barrel
~2% ↑ in 2014
~55% ↓ in 2014
Source: http://www.vox.com/2014/12/16/7401705/oil-prices-falling
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Most significant recent change in the world economy
• What expect to happen in long run?
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Price
Quantity
Supply
Jan-2014 =
$110/barrel
Demand
Dec-2014 =
$50/barrel
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But the oil price continued to fall…
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Source: http://www.nasdaq.com/markets/crude-oil.aspx?timeframe=2y
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Supply exceeded demand for prolonged period
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Source: http://www.vox.com/2016/1/12/10755754/crude-oil-prices-falling
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Opportunity and sunk costs
• Opportunity cost
› Cost of doing something relative to next best alternative
• Sunk cost
› Already incurred and can never be recovered
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Total cost curve
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$
Quantity
Cost of
supplying
Weetbix
Fixed cost
Economies of
scale
Diseconomies of
scale
Variable
costs
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Average and marginal cost
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$
Quantity
Marginal cost
Average cost
Efficient scale of
production
Marginal cost less
than average
cost
Marginal cost more than average
cost
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Break
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Competition and
MonopolyAn introduction to market power
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Efficiency and welfare
• Economic welfare: consumer surplus + producer
surplus
• Consumer surplus: difference between valuation (ie,
willingness to pay) and actual price paid
• Producer surplus: difference between price received
and minimum willing to accept
• Economic welfare = ‘gains from trade’
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• Features:
› Many firms – individual firms are ‘price takers’
› Many consumers – individual consumers are ‘price takers’
› Homogeneous goods
› No barriers to entry
• Outcomes:
› Price=average cost
› Zero economic profit (revenue=opportunity cost)
› Firms operate at efficient scale
› Price=
What is perfect competition?
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Marginal revenue=Marginal costPrice=Marginal revenue =Marginal costPrice=Marginal revenue =Marginal cost
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Perfect competition illustrated
2828
Price
Quantity
Supply
Demand
PC
price
PC
output
Each firmThe market
Quantity
Average
cost
Marginal
cost
PC output
Demand
Price
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Supply curve for global iron ore
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Source: http://www.rba.gov.au/publications/smp/2015/feb/graphs/graph-a2.html
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Price of iron ore 2011-2016
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Source: http://www.indexmundi.com/commodities/?commodity=iron-ore&months=60
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Example – shifts in supply curve for iron ore
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Source: RBA Statement of Monetary Policy August 2014, Box B,
http://www.rba.gov.au/publications/smp/boxes/2014/aug/b.pdf
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Features of a monopoly
• A single firm which is a ‘price maker’
• The higher the price, the less it sells
• Barriers to entry prevent new suppliers entering
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Monopoly in practice
• Natural monopoly
› Privatised government businesses, e.g. electricity distribution
› Large sunk costs, e.g. airports
• Monopoly licensing: e.g. Tabcorp wagering
• Proprietary knowledge protected by
patent/copyright, e.g. drug companies, musicians
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Two elements to a monopolist’s marginal revenue
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Monopoly increases
output by one unit
Quantity sold increases
Price Revenue
Output
Price falls
Loss of revenue
from lower price
on existing sales
Additional revenue
from greater salesRevenue
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Output is lower and prices are higher under a monopoly
3535
$
Quantity
Marginal
cost
Output
(Monopoly)
Price
(Monopoly)
Demand
Marginal revenue
(monopoly)
Price (perfect
competition)
Output
(Perfect
competition)
Producer surplus
Consumer
surplus Dead weight loss
Richard A. Posner ‘the economic
theory of monopoly provides the only
sound basis for antitrust policy’
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Efficiency and welfare
• Allocative efficiency
• Productive efficiency
• Dynamic efficiency
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Market power
• Ability to profitably raise prices above competitive
level is called ‘market power’
› Non competitive outcomes
› Absence of competitive constraints
• The logic of the monopoly model…
› Marginal revenue < price
› Firms produce and sell less than in a competitive market
› There is deadweight loss / inefficiency
…holds for any firm with market power
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What do we do about market power?
• Some market power is good…
› Incentive to innovate
› And so it is not illegal to have or use market power
• But ‘substantial’ market power can be bad
› Regulation is sometimes used when there is significant and enduring market power (eg electricity distribution)
› If used for particular purposes (extend market power), s46
› If it is achieved through collusion or mergers (substantial
lessening of competition, s50)
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Preview of Lecture 2
• Game theory
› What do the monopoly and PC models leave out?
› A toolkit for analysing strategic interactions
› Examples of entry deterrence and collusion
• Models of price (Bertrand) and quantity (Cournot)
competition
• Other applied situations
39