Monopoly, Competition, and Public Policy - Unit 2

Stackelberg first-mover advantager

if F1 can commit to producing an arbitrary q1, thereby making its threat to produce that much credible, then F2 will cede much of the market

ED: capacity commitment

Incur a large sunk cost today to build a factory that you can credibly threaten to switch on → thereby ramping up production and flooding the market → driving down price and capturing demand

learning by doing

overproduce now to slide down the “learning curve”

i.e. gain expertise via trial & error → cost advantage over future entrants

• note that, if entrant can catch up quickly, advantage might be short

raising rivals’ costs (RRC)

non-price predation

increases the residual demand for the predator’s product, allowing it to charge a higher price and/or sell a larger quantity

variants of RRC

• make technologies incompatible

• raise minimum wage

• exploit judicial process

• raise switching costs

• rase advert. costs

• sign LR contracts

• direct sabotage

aggressive reputation

convince potential entrants that you are tenacious by making a statement

respond forcefully to minor provocations

predation theory

an incumbent oligopolist induces exit by rivals to arrive at monopoly––but this process is costly

predation strategies are designed to deter rival firms

predatory pricing

set low prices to kill of firms that are already in the market

i.e. undercut rivals’ prices, forcing rivals to incur losses and eventually exit

predatory pricing vs limit pricing

predatory pricing is to eliminate existing competitors, whereas limit pricing is setting low prices to deter entry

explicit collusion

coordination that occurs using express communication

tacit (implicit) collusion

collusion that appears as the equilibrium of a noncooperative, repeated game

(e.g. an infinitely repeated Cournot game)

cartel stability inequality

(1-k)(n-k)² + (6-4k)(n-k)+(9-4k) >= 0

cartel formation

if there are at least 3 firms in the industry, a cartel will not form

a duopoly will form a cartel, but anything bigger will not

conditions for collusion

• high industry concentration

• entry barriers

• stable mkt conditions

• rapid mkt growth

• tech/cost symmetry

• product homogeneity

merger paradox

if the merger doesn’t reduce costs, firms would prefer to stay separate and earn greater profit

anti-trust analysis

• substitutes exercise

• cross-price elasticity: could a seller impose a “small but significant non-transitory increase in price”

• market shares

• concentration ratios: indication of mkt concentration

• Herfindahl Index (HHI): ranges from 0-10000, perfect comp. to monopoly

  • is sum of squared mkt shares of firms

• merger analysis & merger evaluation

policy responses to M&A

• divestiture: merger is allowed after certain assets are divested by one of the merging parties

• conduct rules/restrictions: allows merger to proceed, but imposes operating rules to control conduct

• initial conditions: merger subject to changes in initial conditions

predatory pricing rationale

• how much firm loses during predatory phase & length of phase

• discount rate, r

• gain of firm as a monopolist (recoupment profits) & length of recoupment phase before re-entry

• expected anti-trust penalties

entry/exit decisions

• enter if P > min ATC; exit if P < min ATC

• shut down when P < min ANSC

• change volume when P =/= MC

What does ‘turnover’ refer to?

The entry and exit of firms from industries due to various business reasons:

• financing

• insufficient revenue

• structural barriers

leader F1’s strategies to change tomorrow’s interactions

• merge w/ another firm

• enter a new market (or leave a current mkt)

• invest in R&D or patent licensing

• change location or product characteristics

• deter entry by potential rivals

• advertise to influence tomorrow’s demand

• collude with a rival

• vertically integrate to change relationships w/ supply chain

capacity expansion in the titanium dioxide industry

in the 1970s, DuPont was a major supplier of TiO₂

environmental laws threatened to shut down DuPont’s rivals, so DuPont announced plans to expand its current facilities and build a new one to deter entry/expansion by rivals

product proliferation

Incumbents launch new products until additional entry would not be profitable

product proliferation in the cereal industry

in the 1970s, the RTE cereal industry was highly concentrated w/ 85% of market served by Big 4

in the antitrust case, FTC found that incumbent firms had filled up the cereal aisle w a variety of brands, blocking new entrants

Rockefeller’s Standard Oil Empire

owned dozens of separate corporations, each operating in one state, and created a trust; nine trustees ran the 41 companies

Rockefeller would buy competition, improve efficiency, and undercut competition; “The Cleveland Conquest” when they absorbed 22 of 26 Cleveland competitors; Rockefeller showed comp his books and made a decent offer

Ida Tarbell exposed Standard Oil, writing 19 articles between 1902 and 1904, by revealing questionable practices and agitating the public

Standard Oil comprised 90% of mkt share, but participated in illegal monopoly activities:

• secret rebates & drawbacks

• predatory pricing

was eventually broken up into 34 smaller firms

indications of predatory pricing

conduct: F1 set price “too low” (based on some proxy)

intent: there is evidence that F1 attempted to kill of F2

probability of success: there must be substantial entry barriers

recoupment: F1 must be able to raise its price later to recover its short-run losses

The Phases of the Moon Bid-Rigging Scheme

a bid-rigging scheme that called for the automatic rotation of low bidders every four weeks

how the DOJ measures its antitrust effectiveness

level of fines collected, total jail time imposed, & pending grand jury investigations

provides insight into the objectives a bureaucracy might pursue in the absence of profit

The Clayton Act

outlaws mergers whose effect is to lessen competition or create a monopoly

Porter’s five problems revealing collusion

1. Detection by Authorities or Victims: collusion revealed by defecting members or complaints

2. Secret price cutting: cartel members undercut prices secretly

3. Entry: outsiders’ bids differ from cartel patterns

4. Reconciling disparate interests: cartels must manage internal conflict

5. Responding to changing circumstances: changing demand or costs require coordination w/o explicit communication

“killer acquisitions”

acquisitions that occur for the sole purpose of shutting down the acquired company to limit competition—leads to reduced innovation, limited consumer choice, and less long-run competition

case study: pharma

• without killer acquisitions, drug development in US could be 4% higher each year—these acquisitions are just smaller than the threshold for regulatory agencies

types of collusion

• price-fixing

• bid-rigging

• market allocation

• tacit cooperation

• joint ventures

• information exchanges