Industrial Organisation 2022
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Industrial Organisation 2022 - Leaderboard
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| What does the S-C-P Diagram stand for? | Structure-Conduct-Performance (SCP) paradigm |
| What is the SCP diagram used for, and what is it specially useful for? | SCP is widely used to study the conduct and performance of firms and industries. SCP breaks down complex industry-level data into structure-conduct-performance. Neoclassical theory of the firm which assumes direct links between market structure, firm conduct (i.e., behavior) and performance is main theory behind the SCP diagram. It is especially useful for policy analysis. |
| What does the "Structure" part cover in the S-C-P diagram? | Structure: Here we look for the structure in the market (Number of firms + size of firms, size of the market, barriers of entry, competition, economies of scale etc.) Most important to define industry properly. |
| What does the "Conduct" part cover in the S-C-P diagram? | Conduct: Here we look for how the market behave, price settings, aggregate quantity, collusion, strategic positions not relating to quantity (for instance market mergers) |
| What does the "performance" part cover in the S-C-P diagram? | Performance: Here we look for what kind of performance the market makes. Profits, production efficiency (technology available) growth of firms over time. |
| What does S-C-P Diagram assume about the market? | SCP assumes structural characteristics of markets change slowly, and can be considered as fixed in the short-run |
| How is Structure, conduct and performance connected? | The structure of a market influences the conduct of the firms operating in the market, which in turn influences the performance of these firms. The performance of the firm, in turn, potentially influences market structure |
| What role does SCP diagram have in government policy? | Government policy can shape structure, conduct and performance variables. There is a role for government or regulatory intervention to promote competition and prevent abuse of market power, if there is high seller concentration in the market • Promote competition by preventing horizontal mergers or breaking up larger firms – structure • Impose price controls, legal restrictions on unlawful or acceptable forms of collusions – conduct • Adjust economic, environmental and social policies – performance |
| According to SCP diagram, is government intervention in a market a good idea? | There are two schools of thought: 1. Neoclassical theory and SCP paradigm --> Intervene, to create as much economic welfare as possible. 2. Chicago school: markets have natural tendency to revert to competition do not intervene |
| What are some limitations of the S-C-P diagram? | • Does not precisely specify the relationship between structure, conduct, and performance variables • In practice, often difficult to decide which variables belong to structure, conduct or performance • In practice, often difficult to define the relevant market or industry for analysis • Most variables are difficult to measure empirically – entry barriers, product differentiation, collusion • In practice, hard to tell collusion and economies of scale apart: a positive association between concentration and profitability could arise - through collusion OR - through cost savings achieved large firms (economies of scale) |
| What is the collusion hypothesis? | Collusion hypothesis argues that profits arise from corporation with competitors. For instance, high tech firms agree not to hire each other’s employees, keeping labor costs down. |
| What is the efficiency hypothesis | The efficiency hypothesis argues that profits arise from efficiency. |
| Is it possible in practice to tell if profits arose from either collusion or efficiency? | When analyzing at industry level, it is not possible to tell the two apart as the overall result is higher profits. Difficult to prove causality. |
| What 3 types of economies of scale are there? | 1. Economies of scale: LRAC decrease as q increase 2. Dis-economies of scale: LRAC increase as q increase 3. Constant returns to scale: LRAC increase equally as q increase |
| What 3 types of economies of scale are there? | 1. Economies of scale: LRAC decrease as q increase 2. Dis-economies of scale: LRAC increase as q increase 3. Constant returns to scale: LRAC increase equally as q increase |
| What does the long run production function look like, and what is the description of each variable? | Long run production function: q=f(L,K) q = quantity, L = labor & K = kapital. Both are variable in the long run, and the function of L and K creates quantity of products produced. |
| What does the short run production function look like, and what is the description of each variable? | Short run production function: q=f(L,K ̅ )=g(L) In the short run, 1 or more production factors are fixed. Here, there is a bar over K so capital is fixed. Hence, q is a function of L. Both L and K can be fixed. |
| What is MPL | Marginal product of labor: Additional quantity of output produced from employing each additional unit of labor. |
| What is APL | Average product of labor: Ratio of total output to quantity of labor employed. |
| Is the law of diminishing returns a short run or long run concept? Elaborate your answer. | Holding capital (labor) fixed, the extra output produced from each successive unit of labor (capital) eventually declines. It is short run because either K or L is fixed. |
| What is the difference between law of diminishing returns and returns to scale? | Law of diminishing returns says, holding either K or L fixed, that increasing the non fixed production variable with 1 will lead to a decreasing output. Returns to scale is a contribution of all input factors to firm’s output when all input factors are variable. RTS govern the relationship between output and all inputs. LODR is a short run concept as one production factor is held fixed. RTS is a long run concept as both capital and labor is variable. |
| What are the 3 types of return according to returns to scale? | 1. Increasing returns (economies of scale): output increases more than proportionately to the increase in all inputs 2. Constant returns: output increases proportionately with an increase in all inputs 3. Decreasing returns (diseconomies of scale): output increases less than proportionately to the increase in all inputs |
| What is total costs and how is it calculated? | Total cost (TC) = Variable costs + fixed costs |
| What is variable costs and how is it calculated? | Variable cost (VC) = Costs associated with inputs that can be variable depending on level of output. Should be traceable directly to the cost object (product produced). |
| What is an average variable cost and how is it calculated? | Average variable cost (AVC) = VC/Q |
| What is a fixed cost? | Fixed cost (FC) = Costs associated with fixed inputs used in production and do not vary with output. |
| What is average fixed cost and how is it calculated? | Average fixed cost (AFC) = FC/Q |
| What is short run average cost and how is it calculated? | Short run average cost (SRAC) = TC/Q = AFC + AVC |
| What is short run marginal cost and how is it calculated? | Short run marginal cost (SRMC) = ΔTC/ΔQ=ΔVC/ΔQ |
| What is long run average cost? | Long-run average cost (LRAC): lowest cost of producing one unit of output by varying all inputs (here: both labor and capital) |
| What is long-run marginal cost? | Long-run marginal cost (LRMC): marginal cost of producing an additional unit of output by varying all inputs (here: both labor and capital) |
| What is economies of scale? | Economies of scale are cost advantages reaped by companies when production becomes efficient. Companies can achieve economies of scale by increasing production and lowering costs. This happens because costs are spread over a larger number of goods. Costs can be both fixed and variable. |
| How can we use LRAC and LRMC to judge the economies of scale for a firm? | LRMC < LRAC: LRAC decreasing, hence economies of scale LRMC > LRAC: LRAC increasing, hence dis-economies of scale LRMC = LRAC: LRAC at its minimum, constant returns to scale |
| What 3 types of economies of scale are there? | 1. Economies of scale: LRAC decrease as q increase 2. Dis-economies of scale: LRAC increase as q increase 3. Constant returns to scale: LRAC increase equally as q increase |
| What is economies of scope | Economies of scope: cost savings that arise when a firm produces two or more outputs using the same set of inputs. |
| What is minimum efficient scale (MES) | Minimum efficient scale (MES): all economies of scale are exhausted and the firm experiences constant returns to scale. A firm is most efficient working at this level as they use all savings of economies of scale. |
| Please describe the barometric price model oligopoly | • A firm announces a price change and the market reacts • Leader serves as a barometer for the industry and is not necessarily the dominant one • There are two types of barometric price leadership: 1. Competitive type o Frequent changes in the identity of the leader o No immediate, uniform price response to price changes o Variations in market share 2. Monopolistic type o A small number of large firms o Large entry barriers o Limited product differentiation o Low price elasticity of demand, deterring price-cutting o Similar cost functions |
| Please describe the barometric price model oligopoly | • A firm announces a price change and the market reacts • Leader serves as a barometer for the industry and is not necessarily the dominant one • There are two types of barometric price leadership: 1. Competitive type o Frequent changes in the identity of the leader o No immediate, uniform price response to price changes o Variations in market share 2. Monopolistic type o A small number of large firms o Large entry barriers o Limited product differentiation o Low price elasticity of demand, deterring price-cutting o Similar cost functions |
| What are the 3 types of market structures we have worked with in this course? | 1. Perfect competition 2. Monopoly 3. Oligopoly |
| What characterizes Perfect competition? | Firms are price takers and demand are perfectly elastic at market price: • MR does not vary with the firm’s output • Firms are price takers, P = MC. • There is allocative efficiency, the price consumers is willing to pay = marginal utility they receive. • Free entry ensures all firms achieve full efficiency, otherwise they incur losses as their MC is higher than P. Then, the firm goes out of business. |
| What are the assumptions behind Perfect competition? | 1. Large number of buyers and sellers – agents with negligible share 2. Free entry and exit – no barriers and extra costs due to entry and exit 3. Firms produce homogeneous products – no product differentiation 4. Firms and consumers have perfect information 5. No transportation cost – no effect of geographic location of markets 6. Firms behave independently to maximize profit |
| What is the short run equilibrium in Perfect Competition? | For the industry SRMC = P |
| What is the long run equilibrium in Perfect Competition | P = MC for the industry |
| How does perfect competition move from short run equilibrium to long run equilibrium | Firms are price takers, hence they compete on price. If there are profits available in the market, new firms will enter until MC = P (No more profits in the market) |
| What characterises a monopoly market, and what is the consequence of monopoly for economic welfare? | There is only one firm on the market. Under monopoly, equilibrium market price is higher and output lower than perfect competition, leading to dead weight loss (reduced economic welfare). |
| Why is monopoly worse for the economy than perfect competition? | A monopolist earns abnormal profit in the long run. Total welfare is higher under perfect competition. Perfect competition and monopoly CS, PS, TS and DWL (welfare) can be seen in picture below. As can be seen, TS is higher under perfect competition as there is no dead weight loss. Meaning, total welfare is higher under perfect competition. The opposite is true for monopoly. |
| What characterises an Oligopoly, and how does it differ from perfect competition/monopoly? | Perfect competition and monopoly models cannot explain market activities such as price wars, parallel pricing, product differentiation, and advertising. Oligopoly theory recognizes the number of firms in the industry and degree of product differentiation: • A small number of firms account for substantial share of industry sales • Closely substitute product imply rivalry between competitors |
| What are the 4 important concepts of oligopoly? | 1. Conjectural variation: each firm makes assumptions on the actions rival firms take in response to the firm’s own actions 2. Interdependence: each firm’s action depends on what it thinks about what actions the other firms will take 3. Collusion: can arise when two or more rival firms recognize the interdependence of their actions might lead to formulation of joint action 4. Independent action: firm acknowledges that actions are interdependent but reaches conclusion that taking a unilateral decision is better for her (not contacting rivals) |
| Please characterise the non-collusive oligopoly model Bertrand competition (Which in fact is a duopoly) | Bertrand model (Competing on price only) (Duopoly): - There are two firms A and B - Market barriers to entry exist - Firms produce identical product – consumers buy only from the firm with the lowest price - There are no transaction or search costs – consumers are indifferent - between firms given same price - Both firms face a constant marginal cost: MCA = MCB - Firms have no capacity constraint Strategy assumptions: - Zero conjectural variation – each firm takes the rival’s price as fixed and does not expect any reaction by the rival - Firms act independently after assessing the rival firm’s strategy - Firms set their price sequentially - Equilibrium is P_C=MC_A=MC_B - Bertrand equilibrium corresponds to perfectly competitive equilibrium. |
| Please characterise the non-collusive oligopoly model Bertrand-Edgeworth (Competing on price with capacity constraint) (Duopoly): | • Same assumption as in Bertrand model but with capacity constraint • Capacity constraint implies firms cannot serve the entire market individually • At Bertrand equilibrium, firms are producing at their maximum capacity • Firms have incentive to increase price and earn more profits without fear of losing all their customers • Equilibrium: not stable |
| Please describe the non collusive dominant price model oligopoly | - The market is characterized by one large firm (dominant) and a large number of small firms (competitive fringe) - Leader firm has complete information about its demand and cost conditions and that of the competitive fringe. And it sets the price and others follow - The competitive fringe are price takers and face perfectly elastic demand at the price set by the dominant firm Equilibrium: - Dominant firm: MR_Leader=MC_Leader - Competitive fringe: dominant firm price equals their marginal costs |
| Please describe the non collusive barometric price model oligopoly | • A firm announces a price change and the market reacts • Leader serves as a barometer for the industry and is not necessarily the dominant one • There are two types of barometric price leadership: 1. Competitive type o Frequent changes in the identity of the leader o No immediate, uniform price response to price changes o Variations in market share 2. Monopolistic type o A small number of large firms o Large entry barriers o Limited product differentiation o Low price elasticity of demand, deterring price-cutting o Similar cost functions |
| What does Schumpeter's dynamic view of competition say about entrepeneurs? | Schumpeter’s dynamic view of competition: • Innovation creates disequilibrium in the market – market power and abnormal profit for the innovator • Other competitors forced to exit or whole industry disappears (creative destruction) • Imitation follows, abnormal profit and market share of innovator declines normal profit and equilibrium will be restored |
| How does the austrian school view competition and entrepreneurs? | Austrian school view of competition put entrepreneur at the center: • Entrepreneurs respond more quickly, discover new information to adjust plans and improve outcomes • With new information and trading opportunities, other entrepreneurs appear and resources are reallocated to them |
| How has ownership and control changed over the years according to Kay? | Kay argues that today control matters more than ownership. In the mid 19th century, ownership meant control. In the mid 1930s the ownership and control were split. Today, rarely the owner controls the means of production in large firms. However, there can be tension between manager’s objectives and shareholders’ (i.e., owners). This creates the need of managerial theories of the firm, as managers now hold the control of the firm. |
| What is Baumol’s sale revenue maximization model? | Maximizing organizations sales revenue subject to a minimum profit constraint. |
| What is Marri’s growth maximization model | Managers tend to strive for growth rather than profit maximization. For a given product range, growth is constrained: • Managerial constraint: rapid growth through diversification may lead to declining profitability. • Financial constraint: growth of capital requires financing, and it is limited: - Borrowing: increase debt-equity ratio and risk - Issue new share capital: acceptable present and future profitability - Retained profit: trade-off with dividends • Growth of demand: firm’s chosen growth rate of demand and its profitability • Maximum growth of capital: firm’s rate of profit and the maximum rate at which capital grows • Point A and B profit and growth maximization respectively |
| What is Williamson’s theory of managerial utility maximization? | The managerial utility function: U=f(S,M,π_D). Meaning, managers derive personal utility from things other than profits or sales: - Staff (S). Likes to have power over many employees (empire building) - Perks (M). Large office, company car, dinners, etc. - Discretionary profit (π_D): the higher this profit, the higher the payout to owners, the more secure the manager’s job is. The manager faces a constraint: π_D=π(S)-(M+T)-π_0 where T = tax and π_0= owners’ minimum acceptable profit. We can see the model below, characterized by: - Diminishing returns: π(S) is first increasing but eventually declines. - Profit maximization: staff expenditure S1 and discretionary profit π_(D_1 ) - Utility maximization: staff expenditure S2 and discretionary profit π_(D_2 ) |
| What is a cartel? | A cartel is a voluntary, written or oral agreement between independent private agents (companies) that determine jointly the value of their action parameters (eg prices or quantity), or divide the product market and customers (geographically) between themselves. Oligopolies are very prone to cartel formations, where the few large companies in the market collude and create a monopolly like situation. |
| What is the purpose of a cartel? | The overall objective of cartels is typically to ease the competitive pressures that normally exist in market situations through collective agreements that enable members to increase prices and profits above the competitive level. |
| What two forms can collusion take form of? | Collusion eliminates uncertainties of independent action and reduces complexities of interdependence – firms no longer need to speculate about likely reactions of rival firms. Collusion can take two forms: 1. Tacit: no formal agreement and direct communication. 2. Explicit: verbal and written agreements |
| How much more does consumers generally pay more as a consequence of a cartel, and how can counter factural pricing be used in the explanation? | On average, consumers pay 50% more when there is a cartel as opposed to normal market structure. Counterfactual price: Estimate of price that would have emerged if there was no cartel. |
| What type of game theory can be used to explain a cartel? | Cartels can at times be explained by a cooperative game (as opposed to the usual game theory we have learned of a non-cooperative game) |
| What are the effects of cartels on economic welfare | The buyers pay a higher price consumer surplus goes to producer surplus Dead weight loss is created also as the price is higher than marginal cost. Hence, cartels reduce overall welfare and creates inefficient allocation of resources as we produce at lower MC than price (same issue as with monopoly). |
| What are the socio-economic effects of cartels? | • The speed of innovation in the industry may decrease as firms collaborate on price, market sharing and not competing with each other through innovations • A recent good example of this is ’Dieselgate’ in Germany involving all big German car producers. Instead of investing in new (risky) technology they formed cartel and invested in (safe) ’old’ Diesel technology - and in software that deceived emission tests • Firms’ productivity can go down, the ’quiet and comfortable life’ of the administration - and maybe in the production halls • Lower innovation and enjoying ’business as usual’ imply higher costs (ATC and MC move upwards), even higher prices, losses in both consumer and producer surplus |
| What types of cartels (or collusive institutions) do we have? | 1. Cartels – associations of independent firms that restrain competition and exploit market power. - Sales conditions; costs, prices and profit margins; allocation of territories or customers; productive capacity allocation. Pooling of such information make it easier for firms to co-ordinate pricing policies. 2. Trade associations – provide members with information on industry sales, productive capacity, creditworthiness of customers, etc 3. Joint ventures – association between two or more otherwise competing firms. Firms enter into joint ventures to: - combine firm resource to increase efficiency - overcome entry barriers and enter new markets - develop joint research and development undertakings 4. Agreements on information exchange, e.g. info on Retail sales and market shares of each member at national, regional, county, dealer territory and postcode sector level for each model. 5. Semi-collusion – firms collude in some activities and compete in others 6. State-sponsored collusion – government imposes cartel conditions on firms |
| What are the motives of collusion? | 1. Profit maximization - Higher profit by exercising (near monopoly) market power 2. Risk management and enhancement of security - Risk arises from changes in consumer tastes and competition between producers - Firms can choose to take independent actions (product differentiation, advertising and marketing) or collude and act jointly 3. Exchange of information - It lowers firms’ vulnerability, encourages cooperative behavior and increases industry stability 4. Unsatisfactory performance - Low profitability due to industry conditions such as intense competition and demand decline can encourage firms to collude |
| How is profits maximized in a cartel situation? | Assumptions: • All firms in the industry are members of the cartel • Each firm produces identical product • Firms produce under a different cost structure • No threat of entry Profit is optimized much like in a monopoly situation. Output level at which marginal revenue (derived from industry average revenue function) equals industry’s marginal cost (sum of each firm’s marginal cost) function. |
| Why are cartels inherently unstable? | 1. In a game theory scenario, the firms often has an incentive to deviate. Hence, most cartels are not in a nash equilibirum! It is a prisoners dilemma, where if both act in their own self interest both lose. 2. Leniency reductions in fines from financial authorities. If one member of the cartel whistleblows, they get no fine. Hence, it is incentivised to inform authorities of the cartel. 3. Free rider problem. Free riders earn more than what cartel members do. |
| What is the free rider problem of oligopolies with a cartel? | The cartel will set a certain price by limiting the amount of products they produce to the market. However, freeriders (firms outside the cartel) are price takers, competing on price. Hence, they will produce more than the cartel members allow participating members to produce, earning a higher profit as freeriders captures the not serviced market who does not pay the cartel price. |
| What factors decide cartel stability? | • Seller concentration and number of firms – high concentration and small number of firms contributes to cartel stability • Different goals of firms – conflicting objectives of members makes cartels unstable • Process of cartel formation and assignment of quotas • Non-price competition – significant opportunities for non-price competition makes cartels unstable • Monitoring and detection of cheating – cartels are stable if there is effective mechanism of monitoring and detection of non-compliance • Sanctions – ability of the cartel to impose punishment on non-compliance behavior increases chance of cartel stability • Buyer concentration – lower buyer concentration facilitates cartel stability • Fluctuations in demand • Entry – profitability and stability of cartels depends on effective deterrence of entry by new firms • Competition law – Leniency program. There is no fine for a firm if they blow the whistle on a cartel. |
| What factors play a role in cartel formation? | • Seller concentration and number of firms Small number of firms or high concentration facilitates collusion • Cost functions Firms with similar cost structures enhances collusive behavior • Size and product differentiation It is easier to collude when most firms are similar in their market share, size, product ranges, production technology and capacity • Vertical integration It renders effective monitoring of cartel members difficult and thus may imped collusion. • Transactions costs of collusion: costs of ensuring compliance and punishing non-compliant members: - Ability to specify contractual relations correctly - Extent to which agreement can be reached over joint gains - Uncertainty associated with change in the economic environment - Monitoring especially when there are non-price forms of competition - Penalties particularly important in the absence of legal protection |
| How are cartels regulated? | Cartels in Denmark is regulated by The Danish Competition Act (DCA) which is harmonized with the treaty on the functioning of the European Union (TFEU). We will look at DCA: §6 - It is not legal to create a cartel. i. Fix purchase or selling prices or other trading conditions ii. Share markets or sources of supply iii. Undergo contracts that are accepted by agreeing to supplementary obligations with no relation to the contract. iv. To determine binding resale prices or ensure partners do not deviate from a recommended resale price. Overall, agreements that restrict competition are violations of §6. |
| What are the exemptions to regulation of cartel formation? | Exemptions to §6: §7 - §6 does not apply if the firms involved have aggregate annual turnover of less than DKK 1 billion and an aggregate share of less than 10% of the market or an aggregate annual turnover of less than DKK 150 million Important note re §7: price/quantity cartels are regarded as a hardcore violation of §6! §8 - If the cartel provide better efficiency and provide consumers a fair share of the resulting benefits then §6 do not apply. Further, no unnecessary obligations or elimination of competition must happen. |
| What can competition authorities do about cartels? | 1. Prohibit the cartel 2. Competition authorities can hand over the cartel case to Special Economic and International Crime (SØIK) and creating a lawsuit. - Penalties may be fines and/or prison up to 6 years. Note: The Danish competition council is not the judicial authority in Denmark but may conclude voluntary settlement and fines for violation of DCA. 3. Competition authorities can receive a court order to raid a firm for information relating to the case (§18) 4. Granting leniency reductions for cartel members who whistle blow. |
| What is the theory behind fines and leniency rules? | With fines, the likelihood of cartel formation becomes smaller due to greater risk and less expected returns. Effect of leniency rules: 1. In theory, a firm might participate in a cartel to gain some benefit and then report it to the authorities. However, that is very risky and hence unlikely in practice. 2. The likelihood of the cartel being stable decreases as there is an incentive to report the rest of the cartel to the authorities. (See prisoners dilemma). 3. On the other hand, cartels might be stronger as other cartel members can sanction a cartel member. 4. Argument 2 is the most important in practice (The cartels becoming unstable) |
| What are the effects of increased transparancy on cartel stability? | Increased market transparency creates the following effects: • Cartel members will find it easier to detect deviators • At the same time, expected gain from deviation and loss after break-up becomes larger • Deviations from cartels become less attractive as the gains from deviation decreases. Hence, increases market transparency can lead to more cartel formation. However, there is a dilemma regarding this. Market transparency can increase on both the producer side (PT) and consumer side (CT). |
| What are the effects of transparancy on the producer side (PT)? | 1. Information of competitors’ prices, discounts, and capacity increases, making it easier to align interests and actions. 2. PT is a prerequisite for effective cartel agreements. It is easy to detect when a firm deviates from the cartel. 3. PT gives new entrants better market information and perhaps better competition, but increased PT makes it easier for the other firms to deter entry of new businesses limiting competition and creating DWL. |
| What are the effects of transparancy on the consumer side (CT)? | 1. The prerequisite for competition is that consumers respond to price and quality signals. The faster and stronger the consumer responds, the greater the incentive for the companies to compete on price and quality. Increase in CT implies that consumers are better informed and can respond faster and stronger to price and quality signals. 2. Implication for cartel formation: Increase in CT increases incentives for companies to break cartel agreements, for example - a big potential gain by lowering the price. With higher CT the market demand is more elastic, so consumers switch faster to the cheaper company. |
| Consumer side or producer side transparancy. What is better to combat cartel formations? and what is the dilemma of market transparency for competition authorities? | Overall, PT increases likelihood for cartel formations but CT decreases likelihood for cartel formations. However, there is an argument for CT leading to more cartels: CT could cause the counter-response by loyal cartel firms to create price war and use predatory pricing . Consumers would switch to the loyal cartel firms running smaller firms out of business, decreasing competition. This creates the dilemma of market transparency for competition authorities: Can you increase consumer transparency (which in general has positive effects on competition) without increasing producer transparency (which in general has negative effects on competition through facilitating cartel formation)? Rule of thumb: The more unfavorable market structure is for competition, the greater the risk that information sharing may harm competition. Ie focus on the ’usual suspects’ for cartel-promoting factors: • High market concentration • High entry barriers • Homogeneous products • Similar companies (same size, costs, etc.) • Stable market development • Regular demand • Small, frequent orders |
| Describe a trade association | A trade association is generally a group of experts gathered to promote common interests and participate in public relations activities such as advertising, education, political donations, lobbying, and publishing, but their focus is Information exchange of trade associations means collecting, processing and retransmitting information and statistics to its members. Hence, trade associations create PT. This increases the risk of cartel-like conditions. Recommendation for prices, discounts, limits, and disclosure of future price information is prohibited. All information must be confidential, meaning it should not be possible to know which firm the information comes from. Historical data might be OK if the information is unconfidently old and aggregated. |
| What does concentration in a market refer to? | Concentration in a market refers to how many firms operate in the market. If there is low concentration there are many firms, but if there are few large operators then there is high concentration. The DCA uses it to understand if the industry has a competition problem - Among other things. |
| What does a firms competitive environment revolve around? And what has market concentration do do with it? | Firms’ competitive environment revolves around three key elements: 1. Number and size distribution of firms 2. Market entry and exit barriers 3. Degree of product differentiation The seller concentration typically refers to point 1: the number and size distribution of firms. |
| What are the two levels of measuring seller concentration | 1. Aggregate concentration - firms forming part of an economy located within a given geographical boundary • This can have implications for concentration in specific industries • Information about importance of large, diversified firms can be revealed • Indicate country’s regulatory environment 2. Industry or market concentration - reflects importance of large firms in a particular industry |
| Hannah and Kay (1977) suggest several criteria a specific concentration measure should satisfy. What are those? | 1. Concentration curve ranking criterion - industry A is more concentrated than industry B if firms’ cumulative market share for A is greater at all points in the size distribution. 2. Sales transfer criterion - transfer of sales from smaller to larger firms should increase measured concentration 3. Entry criterion - entry of a new firm (smaller than the average size of existing firms) should decrease measured concentration 4. Merger criterion - merger of firms should increase measured concentration |
| What is the concentration ratio? | Measures share of the industry’s largest n firms in total industry size measures such as sales, assets, employment. |
| What are the benefits and disadvantages of concentration ratio? | Advantages of the concentration ratio: It is easy to compute since we only need information on the largest n firms and aggregate industry It is easy to interpret - CR_n [n/N,1] Disadvantages n is arbitrarily chosen; different values of n can give completely different concentration measure Only takes information few points on the concentration curve Transfer of sales may not affect the ratio In practice n is often 4. However, it depends on how the industry is defined. |
| What is the Hirschman-Herfindahl index (HH index) | The HH index is another way of measuring concentration based of sum squared market shares of all firms in the industry. The HH index gives more weight to larger firms, where the weights are firms’ market shares. |
| What is better, HH index or CR index for measuring market concentration? | HH index is considered the most accurate as it takes all firms into account. The CR index only considers the largest firms. CR is more easy to calculate and require less data through. Hence, HH index and CR index is a trade-off of accuracy and how easy it is to calculate. |
| What are the issues with concentration measures? | 1. It is often problematic to define a market. Hence, it becomes difficult to compare market concentration calculations. 2. Firms existing in market might be multiproduct or diversified. Hence, is it fair to assume that 100% of the firm is in the defined market? This leads to a need to only use a part of the firm which is often difficult. 3. Multiple firms in an industry might be owned by the same individual (Vertical ownership structure). Market concentration can then underestimate market power. 4. Constant concentration index over time does not capture shift in market shares (Identity problem) 5. Companies’ import /export conditions often neglected - correction necessary to assess competition in the domestic market. 6. SCP vs Chicago School. Efficiency hypothesis - maybe it’s wrong at all to use concentration measures to infer problems with competition. |
| What is the Lerner index | The Lerner index is another way of measuring concentration. It is a theoretically founded index that tells us the degree of market power as it tells us how much the actual price is higher than marginal cost. The difference between P and MC is called the mark-up: P - MC. The Lerner index provide a key relationship: The higher the price elasticity of demand in a market, the lower is the mark-up in that market and therefore the lower the Lerner index. Hence, if L = 0 then we are at perfect competition P = MC (Low centration/high competition). But if L has a large value that indicates a large mark-up and hence indicates high concentration (i.e., low competition). |
| How does the DCA measure concentration? | The DCA has multiple ways of measuring competition in an industry. Each way can gain an industry points: 1. Concentration ratio CR_4 CR_44 - share of the largest four firms in the total industry sales. CR_4 > 80% is considered problematic. 2. Concentration ratio CR_4 adjusted for imports. Many firms operate internationally. To account for this, CR_4 is adjusted for imports. 3. Entry ratio - share of new entrants as a percentage of number of firms in the industry. 4. Market share mobility - absolute changes in firms’ market share between two periods. 5. Productivity dispersion. Dispersion in productivity is compared with the average productivity dispersion in the entire economy. Should not be higher than 25%. 6. Wage premium. Difference in industry wages that cannot be explained by workers’ age, work experience, skill etc. Wage premium in excess of 15% higher than the benchmark industry = problematic. 7. ROI - industry profit after tax relative to the value of the fixed assets. Return on investment in excess of 50% percent higher than the average for all industries = Problematic. 8. Price level - Price index with EU9 = 100, calculated by correcting the Eurostat PPP price figures for differences in VAT and duties. Price index in excess of 3 percent higher than EU9 price index = Problematic. 9. Public regulation of the industry. Competition is normally weaker in regulated industries . 10. Subjective evaluation. Competition authority can undertake a qualitative assessment of the industry despite the quantitative indicators. |
| How does MES affect seller concentration? Does it function as a systematic determinant of concentration? | • At MES output level, all economies of scale are exhausted. A firm cannot make any further cost savings through expansion. • If MESq = total demand (D), a single firm can serve the market, and the industry structure is monopolistic. • If MESq,1 + MESq,2 + … + MESq,N = total Demand, N firms serve the market, and the industry structure becomes perfect competition when N is large. It is a systematic determinant for concentration, as it can be applied generally to all industries. |
| How does barriers of entry affect concentration and is it a systematic determinant of concentration? | • Free entry is likely to reduce concentration, assuming the entrant is smaller than average size of incumbent firms • Free entry at a large scale is likely to decrease concentration (Increase competition) • Exit is likely to increase concentration (Decrease competition) It is a systematic determinant for concentration, as it can be applied generally to all industries. The need for heavy investments, expenditure on advertisement etc. is likely to increase concentration as there are higher entry barriers and more seller concentration. |
| How can regulation reduce concentration? | Usually, government regulated industries have a high level of concentration. However, government policy can reduce concentration by disallowing mergers or discouraging restrictive practices. On the flip side, policies can increase concentration by granting exclusive property rights to selected firms, protecting domestic firms etc. |
| How can industry life cycle influence concentration? | The industry lifecycle can also influence concentration based on where in the lifecycle the industry is: 1. Introduction - High investment required in R&D, high price/low volume, low seller concentration 2. Growth - Market expands, economies of scale (cost saving, falling prices), new entrants due to profit, seller concentration still low, low prices to increase demand. 3. Maturity - No more demand growth through price-cut, heavier advertisement required (increasing entry barriers), seller concentration increases. 4. Decline - Sales and profit decline, firms leave (voluntarily or not), collusion and mergers, for surviving firms seller concentration is high |
| How can firms themselves affect concentration? | Firms can have distinctive capabilities that lead to higher concentration, such as internal organization, relationship with suppliers and distributors and specialized industry knowledge, but also innovation and reputation. The core competences such as specialized industry knowledge, protection of specialized resources and competences from imitation and flexibility and adaptability to changing environment can also influence concentration. |
| What is the random growth hypothesis and how does it play into industry concentration? | There is randomness in a firm’s growth. Hence, past performance is rarely a good indicator for future performance. A firm’s growth is independent of its size - Law of proportionate effect (LPE) or Gibrat’s law. However, seller concentration is still not a matter of chance. There is a natural tendency for an industry to become increasingly concentrated over time such as described above in the industry lifecycle. |