Lecture 1

• Market Definition

• Product Market Definition

• Geographic Market Definition

• Concentration Measures (Ck and HHI)

• Economies of Scale and Concentration Price-Cost margin and Concentration

The cross-price elasticity of demand is a measure used in economics to show how the quantity demanded of one good (or service) changes in response to a change in the price of another good. It's a useful concept for understanding the relationship between two products, often used to classify goods as substitutes or complements.

For example, if the price of coffee increases and, as a result, more people start buying tea (a substitute), the cross-price elasticity between coffee and tea would be positive. Conversely, if the price of printers increases and fewer people buy ink cartridges (a complement), the cross-price elasticity between printers and ink cartridges will be negative.

Positive CPED: The goods are substitutes. As the price of Good B increases, the demand for Good A also increases (and vice versa).

Negative CPED: The goods are complements. As the price of Good B increases, the demand for Good A decreases (and vice versa).

CPED close to zero: The goods are independent, meaning the price of one does not significantly affect the demand for the other.

1. They have similar performance characteristics

2. They have similar occasion for use and

3. They are sold in the same geographic area

Market Structure: refers to the number and characteristics (e.g. size) of firms in a market.

Market: set of products (and geographical areas) that exercise some competitive constraints to the firm.

• high cross-priceelasticityofdemand

contains both:

• product dimension

• geographic dimension

added new:

• digital markets, in particular with respect to products or services marketed at zero monetary price and to digital ‘ecosystems';

• the assessment of geographic markets in conditions of globalization and import competition;

• non-price competition (including innovation).

Why is it so difficult to define a Market?

1. Frequently product differentiation is due to small characteristics of the product.

   Ex: Diet Coke belongs to:

   • Light cola market

   • Cola market

   • Soft drinks market

2. Relevant Geographic Market:

   • Imports

   • Transportation Costs

Product Market: Set of suppliers producing the same product or a set of products that are close substitutes.

The set of products that define a market must have very high cross-price demand elasticities among them and very low cross-price demand elasticities vis à vis other products.

The extent to which firms are able to increase their prices above normal competition levels depends on the possibility for consumers to buy substitute goods.

The fewer the substitute products the less elastic the demand curve is and the more probable is to find higher prices.

The SSNIP test, which stands for "Small but Significant and Non-transitory Increase in Price," is a tool used in competition economics to define the relevant market for antitrust and competition policy purposes. The test tries to determine the smallest market within which a hypothetical monopolist could impose a small but significant (usually 5-10%) and non-transitory (lasting for some time, typically one year) increase in price without consumers switching to other products, thus making the price increase unprofitable.

How the SSNIP Test Works:

1. Select a Product and Geographic Area: Start with the product and geographic area in question.

2. Consider a Price Increase: Hypothetically increase the price of the product by a small but significant amount (often 5-10%).

3. Analyze Consumer Reaction: Assess whether a sufficient number of consumers would switch to other products or areas to make the price increase unprofitable for the hypothetical monopolist.

4. Adjust the Market Definition: If the price increase is unprofitable because of consumer switching, the market definition is too narrow. It needs to be expanded to include substitute products or areas until the hypothetical monopolist could profitably impose the price increase.

Example:

Imagine a market for bottled water in a city. To determine the relevant market, we apply the SSNIP test:

1. Initial Market: The market is "bottled water in City X."

2. Price Increase: Assume the price of bottled water is increased by 5-10%.

3. Consumer Reaction: Observe whether consumers switch to other sources of water (like tap water, flavored water, or water from nearby towns) in significant numbers.

4. Adjustment:

   • If many consumers switch to tap water or flavored water, these alternatives are part of the same market. The market definition might be expanded to "drinking water in City X."

   • If consumers do not significantly switch, then the relevant market might remain "bottled water in City X."

The SSNIP test helps in determining the boundaries of a market for antitrust analysis, highlighting which products or areas are close substitutes from the consumer's perspective.

takes into consideration the:

• number of firms

• size of firms

is used by regulatory authorities to analyse horizontal mergers

The k-firm concentration ratio is a measure used in economics and antitrust analysis to assess the degree of market concentration. It indicates the combined market share of the top "k" firms in a particular market. This measure helps in understanding the competitive landscape of an industry, with a higher concentration ratio often indicating less competitive conditions.

Definition

The k-firm concentration ratio is calculated as the sum of the market shares of the top "k" firms in a market. If CRkCRk​ denotes the k-firm concentration ratio for the top kk firms, then:

CRk=Market Share of Firm 1+Market Share of Firm 2+⋯+Market Share of Firm kCRk​=Market Share of Firm 1+Market Share of Firm 2+⋯+Market Share of Firm k

Example

Suppose we have an industry with five firms, and their market shares are as follows:

• Firm A: 30%

• Firm B: 25%

• Firm C: 20%

• Firm D: 15%

• Firm E: 10%

For different values of kk, the k-firm concentration ratios would be:

• 2-firm concentration ratio (CR2): 30%+25%=55%30%+25%=55%

• 3-firm concentration ratio (CR3): 30%+25%+20%=75%30%+25%+20%=75%

• 4-firm concentration ratio (CR4): 30%+25%+20%+15%=90%30%+25%+20%+15%=90%

This means that the top 2 firms control 55% of the market, the top 3 firms control 75%, and the top 4 firms control 90%. A high concentration ratio (like CR3 or CR4 in this example) suggests that the market is oligopolistic, with a few firms dominating the market share. In contrast, a lower concentration ratio indicates a more competitive market structure.

The Herfindahl-Hirschman Index (HHI) is a commonly used measure of market concentration, and it's often applied in antitrust cases to evaluate the potential for market power or monopoly control. The HHI is calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers.

Formula

For a market with NN firms, where sisi​ is the market share of the iith firm (expressed as a percentage), the HHI is calculated as:

Sum of the squares of each market share

Characteristics

• The HHI ranges from 0 to 10,000 (when expressed as a percentage).

• A market with only one firm (a monopoly) will have an HHI of 10,000.

• A higher HHI suggests a less competitive market, while a lower HHI indicates a more competitive market.

Example

Suppose there are four firms in a market with the following market shares:

• Firm A: 40%

• Firm B: 30%

• Firm C: 20%

• Firm D: 10%

To calculate the HHI for this market:

HHI=402+302+202+102=1600+900+400+100=3000HHI=402+302+202+102=1600+900+400+100=3000

An HHI of 3000 indicates a moderately concentrated market. In general, markets with an HHI below 1500 are considered to be competitive, those with an HHI between 1500 and 2500 are considered moderately concentrated, and those with an HHI above 2500 are considered highly concentrated.

Numbers-equivalent of firms (Adelman):

The Herfindahl index in a market with N identical firms is 10.000/N. Because of this property the reciprocal of the HHI index is referred to as the numbers–equivalent of firms.

𝑁𝐸 = 10.000/𝐻𝐻𝐼

for an HHI= 1250

the number of equivalent firms is NE=8

The current draft of the new merger guidelines (expected to be released soon) is significantly more stringent, going back to thresholds used in 1982

• High Concentration: HHI>1.800

In the new guidelines, any merger resulting in an HHI higher than 1.800 and involving an increase in HHI larger than 100 points will raise significant competitive concerns and will likely be investigated.

MarketDefinition:National,regional,orlocal?

• In general statistics are at the national level, instead of national or regional

Global Market: concentration ratios likely to overstate the concentration level

• Foreign producers (imports) are excluded from national statistics.

Static measures: donotcapturethemarket dynamics.

• Useful to present concentration ratios for different moments in time

• Industries with large minimum efficient scales compared to the size of the market tend to have high concentration

• The inter-industry pattern of concentration is replicated across countries

• When production enjoys economies of scale, entry is difficult and hence profits are high