Understanding Competition Policy and Its Impact
Competition Policy
Challenges to Competition
Several factors can challenge market competition:
- Cartels: These are formal agreements among firms to fix prices, outputs, or market shares. They are common in industries with homogenous products, similar cost structures, and stable demand.
- Horizontal Mergers: These mergers can lead to a dominant market position, raising concerns about reduced competition.
- Non-Competitive Market Conduct: This includes informal coordination on prices, predatory pricing, and exploiting consumer lock-in.
- Vertical Restraints: These are distributional and pricing contracts along the value chain that can restrict competition.
- Public Subsidies: Government subsidies can distort competition by favoring certain firms or industries.
Why is Competition Necessary?
Competition is crucial due to the inefficiency of monopolistic pricing. Monopolists set prices above marginal cost, whereas, in a competitive setting, prices equal marginal cost. Monopoly is inefficient because some consumers pay too much, while others are excluded. This leads to a welfare loss, measured by the deadweight loss. Monopolies cause consumers and producers to lose surplus compared to a competitive market, although the monopolist gains additional surplus from consumers.
Competition forces firms to:
- Innovate
- Differentiate
- Value customers
- Produce efficiently
- Improve products
Cartelization allows firms to:
- Earn high profits
- Reduce risks
- Ignore customers
- Produce inefficiently
- Engage in “rent-seeking”
Competition Policy
Function: Competition policy protects consumers and firms from the negative effects of cartelization. It prevents rent-seeking, encourages competition, and respects property rights.
Economic Aims: It maximizes welfare (consumer + producer surplus). The aim is to ensure a fair fight, not to punish winners or protect losers.
The Rules
EU
- Horizontal and Vertical Agreements: Agreements that prevent, restrict, or distort competition (e.g., price-fixing, market control, market sharing) are prohibited.
- Abuse of Dominant Position: Exploitative behavior by dominant firms is prohibited.
- Mergers: Mergers among very large firms in Europe are investigated by the European Commission; smaller mergers are handled nationally.
US
- Sherman Act: Contracts, combinations, or conspiracies intended to restrict output or raise prices are illegal.
- Clayton Act: Prevents mergers that substantially lessen competition.
- Antitrust Act: Mergers exceeding a certain threshold must be notified.
Issues in the Assessment of Product Markets
Basic Mechanism: The product market is defined, and the joint market share of the firms is assessed. The broader the market definition, the less likely a merger will be questioned. A key criterion is whether consumers would substitute the different products in the market.
Desired Impact of Competition Policy
- Protects consumers and firms from the negative effects of cartelization and increases allocative efficiency.
- Prevents firms from engaging in rent-seeking and forces them to focus on competition parameters.
- Forces firms to replace inefficient plants with more efficient ones and inefficient competitors to exit, increasing productivity and technical efficiency.
Impact on Firm Strategy
Companies must be aware of their regulatory environment. A sustainable strategy should consider antitrust challenges. Points potentially sensitive to regulatory authorities include:
- Mergers: Those that substantially lessen competition.
- Talks to Rivals: Meetings and negotiations should be carefully documented.
- Lock-in Situations: A lack of monopoly power or competitive conduct must be proven.