Market Power and Dom Firms

Question 1

What is the concentration ratio?

Answer 1

It’s just the sum of the size of K firms in the market in relation to the market as a whole

Question 2

What is the advantage of the concentration ratio? (1)

Answer 2

Only require information on the first K < n firms

Question 3

What are the disadvantages of the concentration ratio? (2)

Answer 3

The concentration ratio applies to the market it is tested in - a firm may be dominant in a local market but less so when the scope of the market is expanded

Just because a firm is dominant within its market doesn’t mean competition is lacking - competitors may just be less efficient

Question 4

How much of a market ratio is needed for oligopoly?

Answer 4

An oligopoly occurs when the top 5 firms account for 60% or more of the market ratio

Question 5

What is the Herfindahl-Hirschman Index?

Answer 5

A similar method to CR which squares the percentage share of each firm and sums them (can be decimals or whole numbers)

Question 6

What Herfindahl-Hirschman Index does a pure monopoly have?

Answer 6

1 or 100^2 = 10,000

Question 7

What share do firms have in a symmetric oligopoly?

Answer 7

n(1/n)^2 = 1/n

Question 8

What is a market?

Answer 8

A market includes all products in a given geographical area that exert competitive pressure on one another

Question 9

What is the SSNIP test?

Answer 9

A test to see whether a hypothetical monopolist a sustain a small but significant non-transitory increase in prices (SSNIP) (usually defined as 5% increase for 12 months)

• If yes then the product/stores owned by the monopolist define the market
• If no then the market definition is wider

The process repeats until a 5% change in price doesn’t affect profits

Question 10

How do we implement the SSNIP?

Answer 10

Through the use of own-price elasticity of demand and cross-price elasticity of demand

Question 11

What is own-price elasticity of demand?

Answer 11

The responsiveness of demand with respect to own price

Remember it’s negative!

-(dqi/dpi)(pi/qj)

Question 12

What is cross-price elasticity of demand?

Answer 12

The measure of Demand in response to one Good to Change Price of another Good.

(dqi/dpj)(pj/qi)

Question 13

What is the cellophane fallacy?

Answer 13

The risk that a market will be defined too widely (i.e. if studying a remote town where there are only multiple co-ops) when using the SSNIP on a dominant firm

Question 14

When was the SSNIP test created and who by?

Answer 14

First set out in 1982 US Department of Justice Merger Guidelines

EU commission adopted this method in 1997 Notice on Market Definition after using it for Nestle/Perrier and concluding an increase in price wouldn’t affect sales of soft drinks

Question 15

What did NERA, 2001 say about the SSNIP?

Answer 15

“Any statement to the effect that SSNIP is just one example of how to define a relevant market without clearly specifying what the alternative to SSNIP might be, clearly runs the risk of a return to a process of market definition by ad hoc reference to product characteristics.”

Question 16

What is the Lerner Index?

Answer 16

(P-MC)/P

Question 17

What are the properties of the Lerner Index? (3)

Answer 17

• Estimation of price elasticity of demand provides measure of market power
• it is decreasing in ε
• L = 0 for perfectly elastic demand

Question 18

What are the assumptions of a market where there is a dominant firm with a competitive fringe?

Answer 18

• Market Demand is downward sloping (dQm/dp < 0)
• Supply of the fringe is upward sloping (dQf/dp > 0)
• The profits of the dominant firm are π = pQ(p) - C(Q(p))

Question 19

If prices increase, what happpens to the dominant firm’s demand?

Answer 19

It falls for 2 reasons:

• Market Demand falls as price increases
• The fringe’s supply increases as prices increase

Question 20

What are the issues for a monopolist of a durable good? (2)

Answer 20

• The monopolist is in competition with itself
• The price consumers are willing to pay depends on the price tomorrow

Coase (1972) conjectured: project durability might eliminate market power

Question 21

What is a consumer’s surplus if they buy in period 1 vs period 2?

Answer 21

• CS in period1 is (WTP - p1) = 0
• CS in period2 is δ(WTP-p2) = δ(p1 - p2)

The consumer should delay purchase if p1>p2 for any δ

Question 22

What is the conclusion if there are an infinite number of periods for the consumer to buy in?

Answer 22

The monopolist cannot sell its product for any price p>c

Question 23

How to avoid the Coase conjecture? (5)

Answer 23

1. Leasing - if the product is returned, monopolist can supply consumers with high WTP again. Problem of moral hazard
2. Invest in reputation e.g. Disney, Star Wars
3. Most-favoured customer clause (if firms price lowers tomorrow, we’ll refund the difference!) Means firms don’t want to lower price and consumers may as well buy
4. New Customers - increasing demand in period 2 will increase price in period 2
5. Reduce the goods durability