BSc Economics and related programmes

BSc Economics and related programmes

Economics of Competition and Regulation EC 3015

Week 3: Market definition

Overview

• Why we need market definition• Key ideas:– substitutes– constraints on pricing

• Hypothetical monopolist /SSNIP approach• Practical methods and examples

2

Market definition...

is a preliminary stage in the assessment of competition, such as:

the existing state of competition in a market, or the effect of a merger on competition.

Reasons for market definition

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Reasons for specifying a market definition

• The market is the context in which competition is assessed, e.g.:– Significant lessening of competition (mergers)– Significant market power (ex ante regulation)

• Practical: impossible to consider every possible way of specifying the market

• Choice may be contentious: => must be – clear– based on evidence

Reasons for market definition Key ideas

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Example: Vue/Ster cinema merger

• OFT referred a merger between 2 cinema chains. Concern about SLCs in:– Romford/Upminster/Thurrock area– Leeds– Edinburgh– Basingstoke

• Questions:– what is the product market?– how to define the geographic market?

Reasons for market definition Key ideas

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The product market

• Candidates– cinema exhibition of films/movies– films including DVD– the leisure market including restaurants

Reasons for market definition Key ideas

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Which market definition makes most sense to you for assessing competition?

Cinema exhibition of ma...

Cinema and DVD m

ovies

Leisu

re acti

vities i

ncludi..

Someth

ing else

or don’t.

..

0% 0%0%0%

1. Cinema exhibition of mainstream movies

2. Cinema and DVD movies3. Leisure activities

including dining out4. Something else or don’t

know7

Key ideas

• Substitution:– if two goods are good substitutes they are

effectively in the same market

• Constraining pricing power– if the presence of another product “B” limits the

ability of “A” to raise prices above competitive levels then B is in the same market as A

These ideas are obviously related

Key ideasReasons for market definition

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Hypothetical monopolist test -a framework for considering market definition.

XY

Z

X = e.g. Cinema exhibition of films(the main activities of the merging firms)

Y= e.g. Films and DVD(A broader selection of activities)

Z= e.g. films + DVD +leisure activities(A broader still selection of activities)

“It is an alternative to ad hoc determination of the relevant market by arguments about product similarity.”Link

Reasons for market definition Key ideas Hypothetical monopolist test

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Hypothetical monopolist test (2)

1. Start with the narrowest definition (X)

2. Could a hypothetical monopolist of X raise price above the competitive level?

Or does the presence of the extra products in Y (DVDs) make this impossible?

X

YZ

If yes, keep this as the definition and stop

If so, new definition is Y. Repeat the procedure with Y and Z

Reasons for market definition Key ideas Hypothetical monopolist test

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Hypothetical monopolist test (3)

What do we mean by “raise price above the competitive level” ?A S mall but S ignificant Non-transitory I ncrease in P rice

X

YZ

Hence, a SSNIP test

Usually 5-10%

CC mergers 5%

Typically around a year

Reasons for market definition Key ideas Hypothetical monopolist test

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Attempt Workshop Activity 3 around now

Reasons for market definition Key ideas Hypothetical monopolist test Practical methods

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Workshop Activity 3 feedback

Reasons for market definition Key ideas Hypothetical monopolist test Practical methods

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Question 1

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Case Elasticity - definition X

Elasticity - definition Y

Elasticity - definition Z

A -1.8 -1.0 -0.5

B -0.4 -1.5 -5.6

C -7.4 -6.1 -2.0

D -12 -2.1 -0.5

X

Y

Z

What is the relevant market for case A?

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X Y Z

Contradict

ory/uncle

ar

0% 0%0%0%

1. X2. Y3. Z4. Contradictory/unclear

X

YZ

A X: -1.8 Y: -1.0 Z: -0.5

What is the relevant market for case B?

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X Y Z

Contradict

ory/uncle

ar

0% 0%0%0%

B X: -0.4 Y: -1.5 Z: -5.6

XY

Z

1. X2. Y3. Z4. Contradictory/unclear

What is the relevant market for case C?

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X Y Z

Uncle

ar/ co

ntradict

ory

0% 0%0%0%

C X : -7.4 Y: -6.1 Z: -2.0

X

YZ

1. X2. Y3. Z4. Unclear/

contradictory

Case D?

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X Y Z

contra

dictory/

unclear

0% 0%0%0%

D X: -12 Y: -2.1 Z: -0.5

1. X2. Y3. Z4. contradictory/unclear

What is the nearest to competitive price?

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1 2 3 4 6 7 >7

0% 0% 0% 0%0%0%0%

1. 12. 23. 34. 45. 66. 77. >7

Elasticity?

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-9. -4.-2.33

-1.5 -1.-.6

7-.4

3-.2

5-.1

1

0% 0% 0% 0% 0%0%0%0%0%

1. -9.00 2. -4.00 3. -2.33 4. -1.50 5. -1.00 6. -0.67 7. -0.43 8. -0.25 9. -0.11

Monopoly price?

219 8 7 6 5 4 3 2

0% 0% 0% 0%0%0%0%0%

1. 92. 83. 74. 65. 56. 47. 38. 2

Elasticity at monopoly price?

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-9. -4.-2.33

-1.5 -1.-.6

7-.4

3-.2

5-.1

1

0% 0% 0% 0% 0%0%0%0%0%

1. -9.00 2. -4.00 3. -2.33 4. -1.50 5. -1.00 6. -0.67 7. -0.43 8. -0.25 9. -0.11

Some practical methods

• Price level comparisons• Price correlations• Demand elasticities• Critical loss analysis• Diversion ratio analysis• Price-concentration studies• Transport costs• Journey time analysis (“isochrones”)

Reasons for market definition Key ideas Hypothetical monopolist test Practical methods

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Price level comparisons

Law of one price:Homogeneous products in same market will

have the same price because of arbitrage.

Large price differentials (if unexplained by quality differences) tend to indicate separate markets

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Price correlations

Similarly, if prices move closely together (for differentiated products)

suggests in same marketIssues:

How closely is “closely?” Can we get a benchmark

Deflate by RPI or CPI first?

Some other cause of correlation?

Use stationarity & other analyses to correct for possible biases?

See conference paper by MnCube et.al .

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Price correlations

Examples mentioned in MnCube et al:1. “Stigler and Sherwin (1985) used correlation analysis to test

whether the cities of Chicago, Detroit and New Orleans are in the same market for wholesale petrol. They correlate monthly fuel prices in the three cities during the period 1980-82 inclusive. Their results indicate that the correlation coefficients are very high: the coefficient between New Orleans and Chicago is 0.792; that between New Orleans and Detroit is 0.967; and that between Chicago and Detroit is 0.77, hence the three cities are in the same market.”

2. Nestlé/Perrier (EU) (1992) 3. Rexam/AN (2001)

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Demand elasticities

• See examples in workshop 3

• Own elasticities: “low” elasticity => we have found relevant market.

• How low is low?• Cross elasticities: High cross elasticitiy

suggests we should add another product/location

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Critical loss analysis• When we do not have econometric

estimates, but have a knowledge ofcosts:

• “Critical Loss Analysis calculates the hypothetical monopolist’s Critical Loss, meaning the magnitude of lost sales that would (just) make it unprofitable for the hypothetical monopolist to impose a SSNIP, and compares it against the so-called Actual Loss of sales that would result from the SSNIP. If the Actual Loss would be less than the Critical Loss, the SSNIP would be profitable, so PNOS would form a relevant market.”

Farrell and Shapiro “Improving Critical loss analysis” linkSee Workshop 3 for an example

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Diversion ratio analysis

Response to question:If you could not buy A , what would you buy

instead? B? C?

It is a hot summer’s day and you fancy a Coke. But the Coke is all gone...

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

What will you have instead?

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Pepsi

Dr Pep

per

Lemonad

e

Other s

oft drink

Hot drin

k Beer

Other

I do not d

rink C

oke

0% 0% 0% 0%0%0%0%0%

1. Pepsi2. Dr Pepper3. Lemonade4. Other soft drink5. Hot drink6. Beer 7. Other8. I do not drink Coke

Diversion ratio analysis

• Does not require actual behaviour (revealed preference) to be observed.

• But Stated Preferences tend to be mistrusted by economists

• In combination with other techniques can provide corroboration (or otherwise)

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Price-concentration studies

• Based on structure-conduct -performanceparadigm

• Do prices depend on concentration in this candidate market?

• If so, suggests it is a relevant market• Example: Staples/Office World• As always, econometric studies are contested!

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Transport costs

Useful for geographic definitionIf transport cost are low between P & Q suggests P & Q are in same geographic

market(can be checked by comparing prices and

price trends)

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Isochrones

Useful for geographic definition:

Used in CC inquiries:Supermarkets, SE airports, Vue/Ster

merger, Stericycle (hospital waste)

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Practical methods

Isochrones

Simplified case:

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Store

max distance travelled by most consumers

Isochrones

Simplified case:

Price level comparisonsPrice correlationsDemand elasticitiesCritical loss analysisDiversion ratio analysisPrice-concentration studiesTransport costsIsochrones

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Store A

max distance travelled by most consumers

Store B

Overlap area

Are there enough consumers in the overlap area to constrain the pricing of the other store? If so they are in the same market

Summary

• Some basic theory to learn• Understand the SSNIP test• Many practical methods• Widely used because competition agencies

require objective, auditable evidence• Different parties submit competing analyses• Interesting field for an applied economist• More next week, including “Cellophane fallacy”

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