Competition Policy
Definition of the Relevant Market
Mihail Busu, PhD
Romanian Competition Council
[email protected]
Supply and Demand
Demand and Supply:
Price as a function of quantity
Assume linearity
P
p2
p1
D
q2
q1
Q
Simple elasticity of demand depending on
price: a measure of the degree to which
quantity demanded of a good responds to
changes in the price of that good.
Elastic demand: quantity demanded responds
strongly to changes in price
Inelastic demand: quantity demanded varies
little to changes in price
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Simple elasticity of demand depending on
price
P
IEI>1  elastic demand
IEI =1  unitary demand
IEI<1  inelastic demand
p2
p1
q2
5
q1
In general,
D
elasticity is related
to the slope of the
Q
demand curve
If the price of an ice cream cone increases from
$2.00 to $2.20 and the amount you buy falls from 10
to 8 cones, then your elasticity of demand would be
calculated as (Excel)
Answer: E =2 > 1 –> elastic demand
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Assume that the price of a cola can increases from
$0.40 to $0.50. That will make Tom to buy cans of
cola instead of 10. What is the price elasticity of
demand?
Answer: E =0.4 < 1 –> inelastic demand
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Elasticity of demand
Elasticity of demand as a function of price
E=0→perfectly inelastic demand E→∞ perfectly elastic demand
Examples?
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Cross Price Elasticity
Cross price Elasticity: a measure of the degree
to which quantity demanded of a good
responds to changes in the price of another
good.
Ex>0  substitutable goods
Ex<0  complementary goods
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Example 1
In a supermarket, the price of apples are increasing from
0.40 to 0.50 per kilogram. That makes the quantity of
oranges sold increase from 30 to 40 per day. Are the goods
substitutable? (assume that the prices of oranges do not
change)
Ex>0  substitutable goods
Excel
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Example 2
In a Super Store, the prices of shirts is increasing from $10
to $12. That makes a decrease in sales of bow ties from 20
per week to 15. Are the goods complementary? (assume
that the price of a bow tie does not change)
Excel
Ex<0  complementary goods
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Market definition
Market Definition
 Market definition is done with the aim of assessing
market power
 The RELEVANT market is the set of products (&
geographical areas ) that exercise some competitive
constraints on each other
 The test that guides the analysis of market definition is
the SSNIP Test (or “Hypotethical monopolist test)
 SSNIP: Small but Significant Non-transitory Increase in
Prices (originally introduced by the US Dept. of Justice)
SSNIP
 Ex.:merger between two sellers of bananasfocus on the definition
of the product market
 Suppose an hypothetical monopolist: Would he find it profitable to
raise the price of bananas above the current level by 5-10%?
 Answer:YES, then no significant competitive constraints from other
(substitute) products  bananas are a separate market
 Answer: NO, because part of the demand will be redirected to kiwi, and
to other exotic fruits then bananas could not be considered a separate
market
 The test continue by considering a wider market: banana and kiwi
 Would the H. Monopolist find it profitable to raise the price of
babanans and kiwi by 5-10% ANSWER Yesbananas and kiwi are
a separate market
 Answer: No the test continue until we have identified a separate market
(exotic fruits?)
Demand & Supply substituability
 Do not consider just substitutes from the point of
view of demand
 There could be supply substitution if producers
can switch to a new product if its price increases
 Switching must be easy-rapid and feasible
 No considerable sunk costs and entry barriers (it
should be easy and cheap to overcome entrybarriers)
 Example of civil aviation: no supply
substituability because of airport congestion.
Problem in non merger cases: abuse of
dominant positions
 Using SSNIP test in non merger investigations may raise
problems
 Ex.: abuse of dominant position: the question is: did the firm
increase prices above the competitive level?
 Applying SSNIP to current prices may distort results: the
firm, if dominant, has already increased prices it won’t find
it profitable to further raise prices according to the SSNIP
test we must reply the test for a wider market
 A too wide market could be identified and the calculation of
small market shares follows  No dominance is found
 Caution in applying SSNIP in non merger cases
Implementing the SSNIP test
 Own price elasticity: not sufficient
 Cross price elasticity useful to rank substitutes (some
closer some not): % change in the demand for B with a
1% increase of product A
 When own price elasticity of A is high ( a monopolist is
not likely to charge higher prices) look at cross
elasticities
 If estimates of cross elasticities are low, products are not
close substitutes and suggest a separate market
Geographic market definition
 The same considerations hold
 EX: merger between mineral water producers in
Italy SSNIP test: would a h. monopolist
increase the price by 5-10%? YESthe
geographic market is Italy
 NoImports from France are expected and
rising prices is unprofitabletest to be repeated
on a H. Monopolist in Italy & France
Step 2: assessment of market power
 Perfect competition is an “ideal” modelin
reality we expect each firm to enjoy some market
power (some fixed cost and some substitutes in
most cases do exist)
 1.Which measure of market power?
 2.Which treshold to call the attention of
competition agencies?
Which measure
 A theoretical measure: the Lerner Index: L = (P – MC)/
P it increases with the mark up charged by the firm
 The direct application can create problems: 1)
Estimating MC is not easy 2) High cost can be due to the
productive inefficiency caused by market power
paradox: one obtains high costs and lower margins
lower market power
 Alternative approach: L = 1 /εP  εP easier to assess
with modern econometrics
 Traditional approach look at market shares
 Other variables: potential entrants/ countervailing
power of buyers
Traditional approach: market shares
 To assess market power let us measure market shares
 A firm with a tiny market share would be unable to
excercise much market power restraints on the ability
to increase prices come from competitors
 BUT a firm with high market share is not necessarily
dominant If entry was easy the firm would not be able
to increase price OR if the buyer has countervailing
power
Market shares as screening devices
 Market shares could be used as a screening device: a
market share below a treshold (40%..) leads to presume
low market power (it cannot be considered dominant..)
– above the treshold dominance is presumed and the
burden of proof may fall on the defendant
 In practice the EC and the European Court of justice
follow this approach (useful to increase legal certainty
and reduce the cost of investigations)
Market shares and beyond
 Market shares both in units and in values might be available
 In certain industries reserves might be more informative
 If one firm is supposed to be not a crucial player in the future
(cause it uses an old inefficient technology) current market
shares may overestimate competitive constraints
 Excess capacity by rival firms may be important: if it is just
enough to satisfy current demand their supply elasticity is
low – If they have huge excess capacity the market power of
the investigated firm is low
 It is also the persistence of market shares over time that
informs on market power if the distribution varies over a
short time we presume no dominance and greater
competition
Thank you for your attention!