Market Power and Entry

Question 1

What is market power?

Accepted Answer

Definition: (1) the extent to which a firm has control over its supplies or demand or both (2) the ability to charge a price above marginal costs in the SR, above average costs in the LR

Question 2

Implications of Static Competition

Accepted Answer

Price Competition Firms try to win market share by charging a low price Competition drives prices down so Price just covers cost and offers a competitive return on capital More consumers can afford to buy at lower prices competition tends to increase output

Question 3

Lerner index of a dominant firm facing a competitive fringe

Accepted Answer

|εf | = |εD |+(1−si )εR si / si L = si/ |εD|+(1−si)εR = 1/|εf | X(P) = Z(P) - Y(P) Y(P) is rival supply function Z(P) is the market demand The firm-specific elasticity of demand is larger (and hence its market power lower), the larger the market elasticity of demand and the elasticity of supply of rivals and the smaller its market share

Question 4

Lerner index in Cournot model with homogeneous products l different MC

Accepted Answer

Li = si / |εD| Lower cost firms have higher market shares and enjoy more market power With constant marginal cost, productive efficiency calls for the firm with the lowest marginal cost to serve the entire market. Nash equilibrium in a one-shot game in quantity The Cournot model understates the firm demand elasticity and overstates its market power

Question 5

Lerner index and HHI in Cournot model with homogeneous products

Accepted Answer

L= 1/|εD| ∑si2 = H /|εD| H = ∑ si2 = 1/N H < 1000 is a non-concentrated market structure 1000 < H < 1500 is a bit concentrated 1500 < H < 2500 is moderately concentrated H > 2500 is highly concentrated

Question 6

Harvard School

Accepted Answer

SCP Paradigm = Focus on market structures generating performances Empirical approach Competition policy is an insturment for generating optimal outcomes by directly influencing market structures => Merger guidelines based on HHI values and changes High concentration is bad if not the outcome of scale economies Vertical restraints are illegal per se

Question 7

Chicago school

Accepted Answer

Theoretical approach Concentration reflects efficiency and/or the role of sunk costs Vertical restraints can increase welfare by reducing transaction costs and/or providing the right incentives for dealers Competition policy has a limited role to play

Question 8

Vorteile: Game theory and transaction approach

Accepted Answer

Rigorous (gründlich) analytical framework to analyse competition between firms. Requires being explicit on the set of players (firms), on their strategies and on the advantages these strategies can bring to them (payoffs) allows antitrust authorities to operate along a decision tree approach Takes into account imperfect information and transaction costs - Amount of models does not make easy to pick a model and be sure it is appropriate for the sector under investigation Main contributors: Nash

Question 9

Assumptions: static competition

Accepted Answer

Each firm sets price to attract customers from other firms in the market that produce interchangeable (substitute) products Product characteristics are set so firms cannot change the quality or characteristics of their products Firms’ cost structures are set so firms cannot expand capacity or lower costs through improved technology or management Constant State of technology ( no effects of innovation on market power) Constant number of firms

Question 10

Dynamic competition for leadership

Accepted Answer

Firms race to secure leading position First to market Finding a niche Creating a brand Innovation (new products/cheaper products) Firms try to foreclose (vorwegnehmen)the market to recover their investments and risk taking First-mover advantages IPR - Intellectual Property Rewards Switching costs Entry barriers such as economies of scale + network effects

Question 11

Antitrust authorities try to Minimize errors

Accepted Answer

Type I error : False positive - convicting an innocent- declaring a behaviour as illegal that is not restricting competition Type II error : False negative - absolving a guilty- not condemning a behaviour that is restricting competition

Question 12

Classical economics

Accepted Answer

Competition is a process of rivalry taking place between large and small competitors in open and accessible markets Widespread belief in « laissez-faire » principle Focus on price competition Limited role of competition policy

Question 13

Neo-classical economics

Accepted Answer

Shift to competition as a situation Focus on market structure Main contributors: Edgeworth, Cournot, Bertrand, Hotelling, Chamberlin, Robinson

Question 14

Constable markets

Accepted Answer

When entry is free, high profits attracts entry, ↗ Q and ↘ p Contestable markets: potential entry forces a monopolist to decrease p A contestable market is a market structure where there is freedom of entry and exit. It is a market structure which must have low sunk costs (non recoverable costs e.g. advertising).

Question 15

Firms anticipating entry

Accepted Answer

try to deter it by influencing the perceived profit by potential entrants, hence creating endogenous barriers to entry. Market size, demand, technology and the nature of competitive interaction will determine expected profitability This, in turn, will determine the observed number of firms SCP paradigm

Question 16

Strategic barriers to entry

Accepted Answer

Excess capacity R&D/Advertising Reputation Brand proliferation Bundling Patents Generally: those barriers affect your entry cost or/and your (gross) expected profits

Question 17

Sunk costs = barriers to enry

Accepted Answer

costs which are uncoverable Difference in “committment” In the short-run, investing in a new machine is a fixed cost only because you may sell it back. Depreciation = a part of the fixed cost has to be sunk. If you “commit” to keep the machine forever, this cost is “sunk”

Question 18

Fixed cost

Accepted Answer

a cost that is independent of the number of units produced. They are incurred in each period. C(0) = 0

Question 19

Strategic barriers: influencing the perceived profit by potential entrants

Accepted Answer

Taxonomy of entry-related strategies Strategies affecting cost variables Strategies affecting demand variables Entry deterrence and multiple incumbents

Question 20

Taxonomy of entry-related strategies

Accepted Answer

Blockaded entry: firm 2 does not enter whatever the incumbent does (including the case when it does nothing), firm 1 payoff is π1(K,x1,x2 ) Deterred entry: if firm 2 anticipates that its profit in the third stage is π2 (K,x1,x2) < 0 Accomodated entry: Choice of K is such that π2 (K,x1,x2) > 0 The choice of entry depends upon the investment K sunk by the incumbent in the first stage

Question 21

Fudenberg and Tirole’s taxonomy

Accepted Answer

4 strategies are possbile: Top dog: Be big or strong to look tough or agressive Puppy dog: Be small of weak to look soft or inoffensive Lean and hungry look: be small or weak to look tough or agressive Fat cat: be big or strong to look soft or inoffensive

Question 22

Strategies affecting cost variables

Accepted Answer

Investment in R&D as an entry deterrent (abschreckung) Investment to increase my rival’s costs (as well as my own) e.g. lobby to increase minimum wage... (

Question 23

Strategies affect demand variables

Accepted Answer

• Brand proliferation • Bundling • Switching costs Predatory pricing

Question 24

Conclusion on Entry theory vs empirical facts

Accepted Answer

Discrepancies between theory and empirical facts Entry and exit are correlated (and hence not driven by profitability) Inter-industry variation in profit rates stable over time (between industries) BUT intra-industry variation in entry rates varies over time (within industry) Survival rather than entry impacts on profitability. Barriers to expansion seem to matter more than barriers to entry.

Question 25

Entry barriers in competition cases

Accepted Answer

1. Likelihood l Under stable environment frequency of entry incumbents’ responses to previous entrants Regulatory or technological developments can make historic events not relevant to understand current situation 2. Timeliness Usually: two years as the longest acceptable payback considered by AA No logical connection between timing of payback and timing of entry based on overall profitability Consumer welfare justification 3. Sufficiency Few barriers to small-scale entry (see Geroski) but significant barriers to expansion Short-run effects of entry are likely to be less significant than the long-run effects.

Question 26

Reasons not to deter entry

Accepted Answer

- Competition leads to low cost and low prices - Incomplete market = lack of supply l still profits for new entrants - State ownership = post legalized monopoly l we do not consider who the owners are - Learning curve = strategic entry deterrence l they use as entrants the strategy and price very aggressively in order to quickly go down the learning curve l systematically prevent entrance - Advertising = informative advertising and persuasive advertising l in some case - Strategies in perfect information framework and imperfect information framework

Question 27

Entry deterrence

Accepted Answer

any action that is taken by any business existing in a particular market that discourage potential entrants from entering into competition in that market - sequential models (not on simultaneous models)

Question 28

Why is entry bad? Strategies to prevent entry

Accepted Answer

more market power = more firm earn a smaller share of the pie-> it is hart to sustain profits Drivers of entry: expected profits in one market l Are post-entry expects on profit negative? Strategies of firms to prevent from entry: Learning curve Building Excess capacities Advertising R&D patent Reputation Limit pricing Fill all niches Masking data on profitability Hide profits

Question 29

Do you intend to enter in competition low cases?

Accepted Answer

- Yes - Conlusion: No barriers to entry - No - (High barriers to entry) - No expected profit in market - post-entry profit opportunities are to low l no replication by entrants that are less efficient than incumbent firm - to efficient firm l Microsoft (others are not able to be as efficient and innovation which allow to build the firm significant barriers to entry l

Question 30

Dynamic competition: innovation

Accepted Answer

Incremental innovation: win market share by introducing new features that differentiate them from rivals Drastic innovation: to create new products and dominate new categories - Consumer Welfare: Society benefits enormously 1. from new products and services 2. cheaper products

Question 31

SSNIP TEST

Accepted Answer

Market definition and market performance Tast: Identify the closest substitutes to the product/service => strongest competitive constrains on behavior of the firmSSNIP-Test: framework to establish which products are close enough substitutes to be in the relevant market relevant market = smallest product group such that a hypothetical monopolist/ artel in that area could profitably sustain a SMALL AND SIGNIFICANT NON-TRANSITORY INCREASE of 5-10 % above competitive levels for 1 year. => meaning: no body switches to a substitute and price increase is unprofitable => if people switch to the substitute product, the market should be expanded to include that alternative product => repeated until the SSNIP becomes sustainable

Question 32

Lerner Index

Accepted Answer

Lerner-Index= Snapshop of intensity of competition Limitations= COST / MC are not directly observable ignores dynamic considerations chicken-and-egg problem: low price does not mean that the market is competitive

Question 33

LIMITS of the SSNIP

Accepted Answer

focus on demand-side sustainability: consumers switching possibilities may be prevented from sustaining a SSNIP by new entrants if new entrants/new threat: widening of the market

Question 34

Herfidahl Index

Accepted Answer

better measure of concentrationcaptures both the number of firms and the dispersion of the market shareshigher concentration: number of firms decrease, market shares become less dispersed The European Commission prefers to focus on the level of the change of the index (that would result, e.g.,from a proposed merger). indices vary across industry groups (from as low as 8.5, up to 797.6, on a scale going from 0 to 10 000) market = unconcentrated if the index is below 1000 market = highly concentrated if the index is above 1800 IH = 1 if one firm serves the whole market. IH = 1/n if there are n firms with identical market shares IH = 0 => perfectly competitive market with many small firms (i.e., n → ∞), the index has a value close to 0

IO and Competition Policy (Fach) / Market Power and Entry (Lektion)