Final Exam Flashcards
(123 cards)
1
Q
What are the two types of economic systems?
Examples?
A
(1) Centralized Economic System is where the government and related agencies COORDINATE different economic activities
(e.g., estimating demand of products, producing them).
- Gov’t owns means of production (private ownership of enterprises was generally not allowed)
- E.g., Soviet Union, East European Communist Countries
- Led to no product variety, queues to get uncommon products, shortages
(eventually disappeared)….
(2) Market-based Economic System is where most of the decision making and coordination of economic activities is left to the MARKET (voluntary transactions according to the laws of supply and demand)
- Private enterprises are allowed, which provided strong incentives for owners to create new, innovative products
- E.g., Canada, US, most Western countries
2
Q
Why is the market-based economic system more successful than the centralized economic system?
A
(1) BETTER COORDINATION of economic activities and USE OF RESOURCES
- It is impossible for gov’t to predict demand and supply (leads to shortages)
- In a market-based system, SCARCITY is reflected in market prices
(2) STRONGER INCENTIVES for BUSINESS ACTIVITIES and innovation (due to the CHANCE of making a PROFIT)
3
Q
What is the First Welfare Theorem? What does it imply?
A
According to the First Welfare Theorem, perfectly competitive markets are ideal because they MAXIMIZE TOTAL WELFARE (sum of consumer surplus and producer surplus).
As such, perfectly competitive markets are PARETO EFFICIENT - one cannot be made better off without making someone else worse off (aka maximum level of efficiency)
Implications:
- Government should NOT intervene in competitive markets that are functioning (unless there is market failure).
4
Q
What are the characteristics of perfectly competitive markets?
A
(1) Price Taking – there are many buyers and sellers; no one firm can control prices.
(2) Identical/Homogenous Products
(3) Symmetric Information – perfect information between buyers and sellers.
(4) Free Entry and Exit – no barriers to entry.
5
Q
When should the government intervene?
A
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
Even with market failure, the government should conduct a cost-benefit analysis to determine if the benefits outweigh the costs/inefficiencies of government intervention.
Examples of market failure:
- Externalities (under or overprovision)
- Concentration of market power (unregulated markets drive competition out, lead to coordinated acts, or abuse of market power)
- Under-provision of public goods (including innovation), important development projects (NIMBY problem), positive externalities
- Asymmetric Information and adverse selection
- Failed gov’t intervention
- Excessive risk taking
- Use of insider information
- Self-dealing
- Exploitation of labour
- Free-rider problem
6
Q
How do government interventions create inefficiencies?
A
Every form of government intervention is (1) COSTLY and (2) DISTORTS economic incentives (which leads to UNINTENDED CONSEQUENCES).
Example of costly regulation:
- The cost to regulate Hydro One (a natural monopoly) by the Ontario Energy Board is $46M per year.
- Cost to enforce a competitive rental rate in a small market like Kingston can outweigh the benefits of regulation.
Example of distortion of economic incentives: (another reason for gov’t intervention to correct it!)
- In the US, following heavy subsidization of corn (which decreased the price of corn), there was an increase in the use of corn syrup (higher energy content than regular sugar). This government intervention contributed to America’s growing obesity problem.
- Cost plus pricing regulation creates incentives to increase costs!
7
Q
What are the economic reasons for government intervention?
x 8
A
(1) Concentration of market power
(2) Asymmetric Information between buyers and sellers
(3) Provision of public goods
(4) Externalities
(5) Correction of failed government intervention
(6) OTHER REASONS:
- Macroeconomic Stabilization and ECONOMIC GROWTH
> intervention to MODERATE business cycles and CURB UNEMPLOYMENT during recessions
e.g., Bank of Canada adjusts interest rates, Gov’t imposes taxes to support gov’t spending.
- Fairness
e. g., imposing a minimum wage and providing social programs. - Protection of critical industries for NATIONAL SECURITY (defense, agriculture)
8
Q
Economic Argument 1: Concentration of Market Power
What are some natural ways (market solutions) to address these issues without gov’t intervention?
A
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Firms with SUBSTANTIAL market power (monopolies and cartels) can ABUSE their market power by LOWERING OUTPUT and charging PRICES well above their marginal cost of production.
- Therefore, highly concentrated markets CREATE deadweight loss that hurt consumers.
- Government intervention is needed to eliminate or reduce the deadweight loss and limit the abuse of market power at the expense of consumers.
e.g., Prevent the concentration of market power (Merger Control); Regulate Monopolies (Price Regulation); Break up Monopolies.
Market solution - increased competition (e.g., removal of entry barriers or deregulation)
9
Q
Economic Argument 2: Asymmetric Information
Examples
What are some natural ways to address these issues without gov’t intervention?
A
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- information asymmetry can lead to ADVERSE SELECTION, a form of market failure whereby private information is EXPLOITED. In the long-run, only LOW QUALITY products are traded in the market.
e. g., 2007/2008 Subprime Mortgage CRISIS - Information asymmetry between Wall Street banks and Institutional Investors about the QUALITY of mortgage bundles - led to a huge economic downturn.
e. g., Used car dealership - Sellers know more about the QUALITY of products than buyers. In the long run, only LOW QUALITY products are traded (Good quality cars are not sold because of lower prices due to risk of bad quality cars).
e. g., asymmetric information between depositors and banks; between inventors and investors (patents).
e. g., asymmetric information between investors and inventors
e. g., asymmetric information between buyers and sellers about CSR initiatives
Market Solution - build reputation for producing high quality products, standardize products, investing in credible signals.
10
Q
Economic Argument 3: Provision of Public Goods
Examples
A
The government should only INTERVENE when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Public goods are both NON-EXCLUSIVE and NON-RIVAL IN CONSUMPTION
- Non-exclusive means individuals cannot be excluded from consuming the good (i.e., by not paying)
- Non-rival means that consumption by one person does not PREVENT consumption of others (e.g., no reduction fo the amount of good available to others).
- Public goods lead to the FREE-RIDER PROBLEM because individuals CANNOT be EXCLUDED from consuming the good, so they have an incentive to consume the good WITHOUT PAYING for it.
(The free-rider problem is when individuals are not willing to pay for public goods because they cannot be excluded from consumption )
- Therefore, the free market solution leads to the UNDER-PROVISION of public goods
- Gov’t intervention is needed to correct the market failure and PROVIDE public goods
e.g., Street lighting, Fireworks, Innovation, Roads, the CBC radio station
11
Q
Economic Argument 4: Externalities
Examples
What are some natural ways to address these issues without gov’t intervention?
A
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Externalities are ECONOMIC activities that AFFECT third parties.
- Negative externalities are activities that impose COSTS on others (e.g., Pollution, congestion, smoking)
- Positive externalities are activities that CREATE BENEFITS on others (e.g., R&D, education, immunization, electric vehicles, CSR).
- Negative externalities and positive externalities lead to MARKET FAILURE and CREATE DEADWEIGHT LOSS
- Negative externalities lead to a market output that is TOO HIGH compared to the socially optimal outcome (marginal private cost DOES NOT reflect the cost on society).
- Positive externalities lead to a market output that is TOO LOW compared to the socially optimal outcome (producer is not sufficiently compensated for the benefit created for others - positive externality is NOT INTERNALIZED).
*Note: Socially optimal level (MSC = MSB) is not equal to 0 (i.e., do not need to stop most human activities).
Gov’t Intervention (to REDUCE loss in total surplus/DWL from externality): Quantity controls and standards, emission fees and taxes, cap and trade systems, subsidies.
Market Solution:
- Internalize the externality (one firm creates and is affected by the neg. externality)
- Coase Theorem - eliminate inefficiencies through private bargaining.
12
Q
Economic Argument 5: Correction of failed government interventions
What are the effects of RENT CONTROLS?
A
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
- Government interventions in otherwise functioning markets creates DISTORTIONS, such as excess demand or supply.
- Government intervention is needed to ADDRESS MARKET DISTORTIONS
e.g., Rent Control is a form of government intervention whereby the government imposes a PRICE CEILING on rent increases with the intention of making RENT MORE AFFORDABLE for low income families.
However, rent control creates unintended consequences:
(1) SHORTAGES
> Binding price ceiling reduces the equilibrium supply of rental units, which creates a deadweight loss
> Such shortages make it HARDER for low income families to obtain rental units
(2) Additional inefficiencies include: lower quality rental units (due to lower incentive to invest in rundown units), landlords choosing the most solvent applicants.
Gov’t ultimately needed to intervene again with PUBLIC/SOCIAL HOUSING, which is expensive and has created social problems (housing offered in undesirable neighbourhoods).
13
Q
What is the Coase Theorem?
Why does it often fail in practice?
A
Coase Theorem explains how INEFFICIENCIES from externalities can be ELIMINATED through PRIVATE BARGAINING if two conditions are satisfied:
(1) Bargaining is COSTLESS (no transaction costs)
(2) Property rights are SPECIFICIED (someone owns legal control rights over the property).
If these two conditions are satisfied, then parties can achieve an EFFICIENT OUTCOME WITHOUT government intervention through private bargaining, REGARDLESS of which party is awarded property rights.
(private bargaining = negotiation of terms relating to the purchase/sale of the RIGHT to perform activities that CAUSE externalities)
e.g., Student Party imposes a negative externality on neighbours –> engage in private bargaining (students will pay a price to play loud music)
WHY IT FAILS?
- The Coase Theorem often fails in practice because at least one of the two conditions is not met.
- Bargaining in practice is NOT costless (it is both EXPENSIVE and TIME CONSUMING to negotiate with affected third parties).
- Property rights are not always specified (e.g., right to clean air, oceans and rivers).
14
Q
Positive analysis of the role of government
Deficiencies?
A
Changes in government spending can be used as a proxy to measure the DEGREE of government intervention.
Deficiencies in this approach (why it is an imperfect measure):
A) Government spending IGNORES other types of government intervention (e.g., quota system restricts outputs and does not require spending).
B) Government spending DOES NOT ALWAYS PROMOTE ECONOMIC EFFICIENCY (may be motivated by political reasons). –> Politicians are ELECTED and public policies are influenced by SPECIAL INTEREST GROUPS
Stats:
- Since 1960s, government spending in Canada has increased steadily (making up ~44% of GDP in 2019).
15
Q
What is transfer seeking? (Rent Seeking)
Examples of Transfer Seeking?
A
Transfer seeking is when individuals/groups INVEST ECONOMIC RESOURCES to RETAIN or OBTAIN ECONOMIC BENEFITS without creating any benefits or wealth to society.
Transfer seeking is optimal from an individual perspective, but is wasteful and INEFFICIENT from an ECONOMIC perspective if nothing is produced. The social cost of transfer seeking (investment in transfer seeking activities) is added to any deadweight loss. Often times, the cost of transfer seeking can EXCEED the net gains in surplus.
Examples:
- Lobbying - firms/associations lobby government officials to INFLUENCE PUBLIC POLICY that benefits their own economic self-interest without contributing benefits to society. For example, the Canadian Dairy Commission (CDC) engages in lobbying to restrict import quotas for cheese from the EU, which leads to INEFFICIENT OUTCOMES (such as lower competition, higher prices for consumers).
- Unions that engage in strikes to enforce HIGHER wages instead of producing valuable output.
- Insider trading/stealing - transfer of wealth without useful contribution to society
- Legal services - firms spend economic resources on legal services (litigation or settling of disputes) that do not produce benefits for society (such as investments in R&D).
16
Q
What is the social cost of transfer seeking?
A
Social cost of transfer seeking is the AMOUNT INVESTED in transfer seeking activities.
For example, a competitive firm is WILLING to invest up to the NET (PRODUCER) SURPLUS created from obtaining a monopoly franchise.
The social cost of transfer seeking is an ADDITIONAL COST to deadweight loss.
Often times, the cost of transfer seeking can EXCEED the net gains in producer surplus.
17
Q
Why is lobbying often not opposed by consumers?
A
Lobbying is often unopposed by consumers due to the CONCENTRATED BENEFITS AND DISPERSED COSTS problem.
The benefits OF LOBBYING EFFORTS (e.g., monopoly power or quota) are highly concentrated on a few firms, while the costs are highly dispersed across a large number of consumers. The COST for a SINGLE consumer is very small (e.g., small price increase), so consumers have a LOW INCENTIVE to lobby the government.
Example: Quotas on sugar in the US
- $3B cost in the form of higher prices is dispersed across consumers, such that each consumer pays $10 more per year.
- The benefits to each farmer are $3M more per year.
18
Q
Why are quota systems often hard to eliminate?
relates to Private Regulation of Agriculature - Supply Management Boards
A
Due to the “Transitional Gains Trap” whereby only the FIRST entrants/beneficiaries that receive the quota free of charge benefit from the quota system (earn abnormal returns from higher prices).
However, subsequent farmers have to pay high UPFRONT COSTS to buy quotas (reflect future abnormal returns) and face high OPPORTUNITY COSTS of using the quotas. As a result, current farmers only earn NORMAL profits despite higher prices.
Despite inefficiencies with the quota system (higher prices for consumers that decrease consumer surplus and normal profits for farmers), dairy farmers engage in intense lobbying to maintain the quota system. Otherwise, the farmers would LOSE their SIGNIFICANT INVESTMENTS (quotas would be worthless).
(only viable solution - Politicians have to buy the farmers out…).
19
Q
Lobbying in more detail:
- What are the main lobbying areas?
- How do you become a lobbyist (Federal, Provincial, Municipal)?
- Can lobbying be useful?
A
What are the main lobbying areas:
- International trade - tariffs, import quotas (increase import barriers, reduce export barriers)
- Government Procurement (military equipment)
- Regional Economic Development (e.g., Zoning by-laws).
How do you become a lobbyist?
- Federal lobbyists must be REGISTERED (with the Office of the Commissioner of Lobbying Canada) to lobby federal government legally.
- Municipal and Provincial lobbyists are not always required to be registered.
Can lobbying be useful?
- Yes, if lobbying IMPROVES economic outcomes by providing IMPORTANT INFORMATION to ensure better decision making of policymakers.
20
Q
Economic versus Social Interest Groups
A
Both are types of SPECIAL interest groups (influence public policies).
Economic Interest Groups are concerned about their own economic self-interest, whereas Social Interest Groups promote social or moral values.
Examples of Economic Interest Groups:
- Professional Associations (E.g., Canadian Association of Petroleum Products)
- Industry Lobbies
- Unions
Examples of Social Interest Groups:
- Animal rights groups (PETA)
- Environmentalists
21
Q
What are some reasons for inefficient government policies?
A
1) Inefficient voting
2) Transfer seeking (economic interest groups investing economic resources to obtain benefits that are inefficient from an economics perspective)
3) Self-interest of policy makers (motivated to maximize their own economic welfare, which is an example of corruption).
4) Bureaucracy - non-elective government officials also are self-interested and spend more on certain government programs over others, leading to “bloated” public sector/government programs.
22
Q
Market Solution: Internalization of externality
What is it?
Example?
Why is this not practical?
A
Refers to having ONE FIRM create AND be affected by the externality (common management or ownership).
E.g., A PAPER mill in BC pollutes the local river and affects downstream SALMON farm. Internalization of the externality would involve having the paper mill ACQUIRE the salmon farm, or vice versa.
The result - owner can then choose the EFFICIENT level of pollution or abatement to MAXIMIZE total profit and surplus.
Why is internalization not practical?
- Often not possible to INCLUDE ALL affected parties under one common ownership (e.g., numerous cottage owners and recreational fisheries, in addition to the salmon farm).
23
Q
What are the three economic tools used by governments to reduce pollution (eliminate negative externalities)?
- Explain what they are
- Provide 1-2 examples for each
A
(1) Quantity controls and standards
- refer to government-imposed LIMITS on the total QUANTITY of emissions/pollution emitted (enforced by monetary and criminal penalties)
- Ideally, limit equals the socially optimal level of CO2 emissions/pollution (E*) where MSC of emissions equals MCA of emissions.
- e.g., Gov’t can impose DISCHARGE limits for paper mills to reduce pollution in rivers.
- e.g., Gov’t imposes pollution limits (emission standards) on the amount of sulphur dioxide (SO2) emitted by coal-burning power plants.
- e.g., “Emission standards” on GHG emissions from automobiles.
(2) Emission fees and taxes
- refer to government-imposed fees and taxes FOR EACH UNIT of CO2 or pollution emitted.
- The OPTIMAL emission fee (F) to address the neg. externality (get to E) is called a “Pigovian tax” —–> firms choose to continue abating until their marginal cost of abatement = emission tax.
- Emission fees/taxes also generate REVENUE
- e.g., BC government imposed a carbon tax on GHG emissions ($40/ton emitted), which caused both firms and consumers to reduce carbon emissions totalling 3M tons in 2020. (e,g, firms switched to less carbon-intense fuels; consumers DROVE LESS, purchased more fuel efficient cars and invested in home insulation).
- E.g., ON’s gas tax to address negative externalities (air and noise pollution, congestion, accidents)
(3) Cap and Trade system
- Combines quantity controls and emission fees
- Gov’t issues TRADABLE PERMITS to firms that allow firms to emit a certain level of pollution.
- Allow externalities to have a market equilibrium price (between MCA of efficient and inefficient firm).
- Gov’t typically reduces the number of permits every year to lower pollution.
- Gov’t also raises money from sale of permits
- e.g., ON’s cap and trade system (abolished in 2018) involved “pollution permits” that were tradable at auctions.
Result - Direct cost in the form of higher heating costs, indirect cost through higher cost of goods and services.
24
Q
Pollution negative externality graph (abatement, social cost)
A
Downward sloping marginal cost of abating CO2 emissions(MCA):
- Cost to “abate” (REDUCE) ONE MORE unit of pollution increases as the level of emissions reduces
- At high levels of CO2 emission, MCA is low.
- At lower levels of CO2 emission, MCA is very high (need very efficient technology to achieve low levels of CO2 emissions).
Upward sloping marginal social cost of CO2 emissions (as emissions increase, the cost to society increases).
Total cost of abatement = MCA * amount abated.
25
Why are emission fees/taxes generally more efficient than quantity controls and standards to restrict pollution?
(Recall: both achieve E* = socially optimal level)
(1) Taxes MINIMIZE total abatement costs when firms have DIFFERENT COSTS.
- Taxes allow the more efficient firms (low abatement costs) to reduce emissions MORE than firms with higher abatement costs.
- Therefore, taxes may PREVENT less efficient firms from relocating/exiting the market (e.g., pay fee versus large investment to decrease CO2).
(2) Taxes PROVIDE CONTINUING INCENTIVES to reduce pollution
- By investing in efficient production technology, firms can lower their tax burden.
(3) Taxes GENERATE REVENUES which can be used to fund other environmental projects.
26
What are the general concerns about emission fees that make the general public oppose them?
In other words, why does the government often implement quantity controls and standards instead of emission fees/taxes?
(1) Impression that firms "can BUY right to pollute" (as opposed to being forced to reduce emissions through emission standards).
- -> emission standards AVOID impression...
(2) (Consumers have) No trust in MARKETS- the general public believes that firms simply PAY taxes and PASS them on to consumers, WITHOUT reducing pollution (or changing behaviour)
* flawed thinking though because firms/consumers tend to change behaviour!
(3) Negative EFFECT on INTERNATIONAL COMPETITIVENESS of firms by making domestic production most costly. Therefore, taxes could lead to reduced employment and relocation to LESS STRICT JURISDICTIONS
- -> emission standards can SOFTEN effect on local firms.
Another benefit of Quantity Controls and Standards: ??
- Allows to set voluntary emission limits without imposing taxes on firms.
27
What are the advantages of the cap and trade system?
One limitation of the cap and trade system?
(1) Allows government/agency to LIMIT total emissions each year by controlling the number of permits (similar to quantity controls and standards)
(2) PROVIDES STRONG INCENTIVES to ABATE emissions
- High emission firms face high COSTS to buy permits; low emission firms face high OPPORTUNITY cost of using permits
(Better than tax system - paying tax might be more efficient than abating emissions)
(3) ALLOWS EMISSIONS TO BE abated at MINIMUM COST
- because cap and trade system COMBINES emissions fees/taxes and quantity controls and standards, so it is very efficient from an economics POV.
Limitation:
- High bureaucracy because a government agency issues permits and oversees auction for permits.
28
What is the NIMBY problem?
Provide 2 examples.
NIMBY stands for "Not In My Backyard". The NIMBY problem characterizes the OPPOSITION BY local residents to proposed developments that generate NEGATIVE EXTERNALITIES.
The opposition stems from the CONCENTRATION of negative externalities on few, local residents (as opposed to evenly spreading the costs across the province).
Outcome - UNDER-PROVISION of these important goods and services LOCALLY, so toxic waste must be exported to DEVELOPING countries (which leads to disastrous effects on local communities).
For example, Oakville and Mississauga residents opposed the proposed GAS-FIRED POWER PLANT because of potential harmful effects on nearby homes and schools. Similar opposition is seen with nuclear and coal-burning power plants.
Another example - Opposition to hazardous waste treatment facilities (by the town of Erin - opposed proposed wastewater treatment plant), safe injection sites (helps with addiction), and social housing.
29
Negative Externality of Congestion - cause?
Efficient solutions?
Traffic Congestion is an example of a negative externality caused by the OVERCONSUMPTION/OVERCROWDING of roads
Efficient solutions:
- Road charges (tolls), with peak-load pricing (vary the optimal "tax" depending on the time of day or location)
(however, this will be faced by public resistance)
Congestion in the form of long lines:
Efficient solutions
- Peak-load pricing (charge more at peak times)
- Fast-track line (fast-track customers pay premium)
30
Canadian Competition Policy:
How does it relate to government regulation?
Why do we need it?
What is the OBJECTIVE of Canadian Competition Policy?
Competition laws are an INDIRECT way for governments to intervene in the market by ensuring that markets are somewhat competitive.
Entire unregulated markets might lead to LOWER COMPETITION (firms drive competitors out, coordinate acts, and abuse market power at the expense of consumers).
Objective of Canadian competition laws is to ENSURE markets are "REASONABLY" competitive in an attempt to maximize total welfare (the government recognizes that markets cannot be perfectly competitive).
31
Canadian Competition Policy:
| How is Industry Canada structured?
Canadian Competition Bureau is the part of Industry Canada responsible for enforcing the Competition Act (Head: Commissioner of Competition)
Different branches of the Competition Bureau handle different complaints:
- Criminal Matters Branch - cartels
- Merger Branch - Merger Reviews
- Fair Business Practices Branch - Deceptive Marketing Practices
- Civil Matters Branch - Abuse of market power
32
Competition Policy regulating CARTELS (A)
```
What are cartels?
Types of collusion
What is illegal?
Civil or criminal?
Penalty?
```
S. 45 of the Competition Act prevents and breaks up CARTELS, which are groups of firms or countries that COLLUDE (e.g., to fix prices, restrict quantities, allocate markets).
Types of Collusion:
- Explicit Collusion - there is an explicit agreement or communication with competitors to collude.
- Tacit Collusion - there is an implicit agreement to collude (e.g., maintain high prices). While there is NO communication between cartel members, there is an UNDERSTANDING in the industry to avoid price competition (e.g., Price Leadership - one firm acts as the price leader that announces a high price in which all firms then match).
Law: S. 45(1) "every person commits an offence who, with a competitor [...], conspires, agrees or arranges" ...
According to the Competition Act, it is ILLEGAL (CRIMINAL offence) to CONSPIRE with competitors to MAKE...
(1) Price-fixing agreements, (S. 45(1)(a))
- -> e.g., maintain high prices for the supply of products (Chocalate cartel, bread cartel, gas cartels)
(2) Market allocation agreements, (S. 45(1)(b))
- -> Dividing the market (in Kingston)
- -> e.g., West vs East Kingston.
(3) Output restriction agreements (S. S. 45(1)(c))
- -> e.g., Lessen production of a product (in order to raise the market price).
*Requires proof of conspiracy on the criminal standard of "beyond a reasonable doubt" --> strong economic incentives to collude in concentrated industries because the risk of getting caught is low.
Penalty imposed on MANAGERS/EXECUTIVES and companies: ("The managers of Firm A and B are agreeing to...")
- Imprisonment not exceeding 15 years, or
- Fine not exceeding $25M
- or both.
Convicted individuals ad their companies are LISTED publicly on the Competition Bureau's website
Note that it is the explicit agreement by the two competitors that is illegal; choosing not to
serve some customers by itself is not illegal, as long as each company makes this decision
unilaterally (i.e., as long as there is no coordination among competitors)
33
Explain the Competition Bureau's Immunity Program and Leniency Program.
How do both programs help break up cartels?
The "Immunity Program" ALLOWS cartel members to SHARE EVIDENCE of the cartel to the Competition Bureau in exchange for FULL IMMUNITY from prosecution. The program is ONLY available BEFORE official investigations into the cartel have started.
The "Leniency Program" GIVES cartel members REDUCED PENALTIES for COOPERATING after official investigations have started. For example, the applicant/cartel member
(i) Terminates participation in the cartel;
(ii) Cooperates during official investigation; and
(iii) Pleads guilty
Both programs help the Competition Bureau obtain EVIDENCE about cartels to break up cartels. CONVICTIONS are only possible IF the prosecutor can prove collusion "beyond a reasonable doubt".
34
Competition policy preventing the concentration of market power (B)
What are the problems with mergers (specifically, horizontal mergers - mergers between competing firms)?
What does Canadian Competition Law do to address these problems?
Problem:
- Horizontal mergers typically lead to the LESSENING of competition (more concentrated markets).
- Firms in concentrated markets have high MARKET POWER, allowing them to CHARGE HIGHER PRICES AT THE EXPENSE of consumers (reduce consumer surplus).
Therefore, the Competition TRIBUNAL can DENY ANTI-COMPETITIVE mergers (mergers that prevent or lessen competition SUBSTANTIALLY), SUBJECT TO the "efficiency criterion".
35
Competition policy preventing the concentration of market power (B)
When must the Canadian Competition Bureau be notified of a proposed merger (require CB's permission)?
Notifiable transactions:
- Firms require PERMISSION from the Competition Bureau to merge when the following THRESHOLDS are met:
(1) The value of the merger exceeds $96 million, and/or
- -> target assets or revenue in Canada
(2) In the case of share acquisitions, SHARE THRESHOLDS are exceeded (35% for private corporations and 20% for public corporations).
- -> not market share! (purchaser's post-merger share ownership)
(Competition Bureau will then conduct merger review to determine if they are likely to substantially lessen/prevent competition) *
36
Competition policy preventing the concentration of market power (B)
Describe the merger review process.
Remember: Competition Bureau can review mergers of all sizes and sectors (but certain proposed mergers require permission).
Merger Review Process:
1. FIRMS submit official NOTIFICATION to the Competition Bureau, triggering a 30-day waiting period (aka firms cannot proceed with the transaction).
2. CB REVIEWS the proposed merger and its impact on competition. CB may issue a "Supplementary Information Request", which triggers a second 30-day waiting period.
3. Decision made by CB (either approved or denied). Firms part of denied mergers can APPEAL the decision to the Competition Tribunal.
37
Competition policy preventing the concentration of market power (B)
What are the TWO GROUNDS that the Commissioner of Competition can challenge the merger on?
What are their rule of thumbs?
E.g., Post-merger market share equal to 40%
(Either during the Merger Review process or after the merger)
(1) Unilateral Exercise of Market Power
- Rule of Thumb - Post-merger market share of the firm is greater than 35%
(2) Coordinated Exercise of Market Power - possibility of collusion
- First Rule of Thumb - Post-merger market share of the 4 largest firms in the market exceeds 65%
- Second Rule of Thumb - Post-merger market share of the firm is greater than 10%
*If the merger does not exceed these thresholds, they are generally APPROVED.
Example: CB can challenge the merger on both grounds - unilateral exercise of market power (because post-merger market share exceeds 35%) and coordinated exercise of market power (because post-merger market share exceeds 10%).
38
Competition policy preventing the concentration of market power (B)
What is the efficiency criterion?
Anti-competitive mergers are ALLOWED IF the COST SAVINGS of the merger OFFSET the loss in TOTAL SURPLUS.
Therefore, Canadian Competition Law maximizes total welfare.
Competition Bureau conducts economic analysis to decide whether to allow the merger:
1. Estimate the demand and economic costs of the involved firms. (e.g., sales data, cost data to get PRE-MERGER quantity and price).
2. Use demand elasticity and marginal cost of merged firm to PREDICT POST-MERGER PRICE and Quantity.
3. Calculate the LOSS in Total Surplus due to the merger.
4. Compare loss in total surplus and COST SAVINGS (e.g., from lower MC)
5. Make a final decision
*Economic analysis is SENSITIVE to small errors
39
Competition Policy preventing deceptive marketing practices (C)
What are the three main TYPES of deceptive marketing practices?
(1) False and misleading representations (criminal and civil provisions)
- misleading claims about the PROPERTIES of a product.
(2) Price-related representations - (2 civil, 1 criminal)
(3) Pyramid Selling - multi-level marketing plans
40
Competition Policy preventing deceptive marketing practices (C)
What are the two provisions for false OR misleading REPRESENTATIONS?
When does each apply?
An example for each
When does criminal or civil provision apply?
- Depends on whether there was CRIMINAL INTENT to make the false or misleading representation (Y = Criminal provision, N = Civil provision)
(1) Criminal Provision (S. 52) - states it is ILLEGAL to make "KNOWINGLY or RECKLESSLY" false or misleading representations about products and services.
- Include claims about product characteristics (e.g., PLACE OF ORIGIN), warranties, servicing, testimonials, product tests.
- As a criminal provision, there needs to be CRIMINAL INTENT
Potential Penalties upon indictment:
- Fine (in the discretion of court), and/or
- Imprisonment up to 15 years
- Example - scams and frauds (like the Yellow-Pages Scam - companies and individuals knowingly mislead businesses into believing they were related to the popular Yellow Pages and signed them up for costly 2-year contracts)
(2) Civil Provision (S. 74) - prohibits the making of false or misleading representations about products and services
- No criminal intent.
- Individuals can file a complaint to the Competition Bureau about false or misleading representations
Competition Tribunal can ORDER to:
- STOP the false or misleading representation
- Publish a corrective notice
- Pay restitution to the purchaser
- Pay administrative monetary penalties
- ---Individuals: up to $750k for the first violation; $1M for repeat violations.
- ---Corporations: up to $10M for the first violation; $15M for repeat violations.
- Example - Brick promotion ("Buy Now, Pay Later") was found to be misleading because customers had to pay substantial UPFRONT FEES
> type of misrepresentation about hidden or additional charges.
41
What is the name of this type of misrepresentation?
"Best SELLING ice cream in Kingston!"
Market Position
42
What is the name of this type of misrepresentation?
"Brake check for $29.99 plus tax" - excludes an additional charge of $69.99 for labour
Hidden OR additional charges
43
What is the name of this type of misrepresentation?
"Authorized Apple dealer" - when they are not authorized by Apple
Attributes of SUPPLIER
44
What is the name of this type of misrepresentation?
"We donate 20% of our profits" - when they donate less than 10%
Image advertising
45
What is the name of this type of misrepresentation?
"Blowout sale - everything must go before we close our doors. Forever"
Reason for sale
46
Competition Policy preventing deceptive marketing practices (C)
What is this type of price-related representation called? Is it a criminal or civil provision?
> A car dealer advertises a new model at a VERY LOW PRICE, but only had one of the new models on its lot.
Bait and Switch Selling
- Civil provision (s. 74.04)
- Illegal tactic whereby sellers ADVERTISE a product at a BARGAIN PRICE (very low price) but the product is NOT AVAILABLE in REASONABLE QUANTITIES.
- The intent is to lure customers into their stores in the hopes that customers switch to more expensive/profitable products.
47
Competition Policy preventing deceptive marketing practices (C)
What is this type of price-related representation called?
Is it a criminal or civil provision?
> Box of Coke cans are advertised at $2.99, but Metro will only sell the beverages if customers pay $5.99.
Sale above advertised price
- Civil provision (s. 74.05)
- It is illegal for retailers to SELL or RENT products at a price HIGHER THAN the advertised price.
48
Competition Policy preventing deceptive marketing practices (C)
What is this type of price-related representation called?
Is it a criminal or civil provision?
> A bag of apples has two price tags. Metro will only sell the apples at the higher price.
Double ticketing
- Criminal provision (S. 54)
- If a PRODUCT is MARKED by the seller WITH TWO PRICE TAGS, then it is ILLEGAL to sell the product at the higher price.
- In other words, the retailer must sell the product at the LOWER price.
49
Competition Policy preventing deceptive marketing practices (C)
When is pyramid selling legal and illegal?
Is it a criminal or civil provision?
Are Pyramid schemes the same as Ponzi schemes?
Pyramid selling is a form of MULTI-LEVEL MARKETING plan.
Multi-level marketing plans are LEGAL if the main compensation/income for participants comes from SELLING THE PRODUCT, as opposed to recruiting new members.
- Legal multi-level marketing plans require CLEAR COMMUNICATION to members about the COMPENSATION that an AVERAGE member is actually or likely to receive.
Multi-level marketing plans (pyramid selling) are ILLEGAL if the main compensation/income for participants comes from RECRUITING new participants instead of selling the product. > Criminal offence (S. 55.1)
e.g., Herbalife was accused of being a pyramid scheme.
Penalties:
- Fine (discretion of court), and/or
- Imprisonment up to 5 years
Pyramid schemes are not the same as Ponzi schemes (which refer to the practice of paying old investors with money from new investors and taking a fee off the amount).
50
Competition Policy preventing the abuse of market power (D)
What are the main TYPES of abuse of market power?
When are these practices ILLEGAL?
(1) Restrictive Trade Practices
- Refusal to deal
- Price maintenance
(2) Exclusionary Agreements
- Exclusive dealing
- Market restriction
- Tied selling
(3) Abuse of dominant position
- Predatory pricing
- Pre-emption
- Market price stabilization
- Product specification
*These practices are ONLY illegal when they have a SIGNIFICANT ANTI-COMPETITIVE EFFECT (e.g., lessening of competition, charging high prices well above MC, disciplining competitors). In other words, firms must have SUBSTANTIAL MARKET POWER.
51
Competition Policy preventing the abuse of market power (D)
Restrictive Trade Practices: Explain and give one example of Refusal to Deal
Refusal to deal refers to the OUTRIGHT refusal to SUPPLY to or BUY products from another firm.
(no conditions attached like selling a minimum price = price maintenance)
Generally, there is no obligation on any business to deal with another firm.
However, s. 75 states that there is an OBLIGATION to deal when the following elements are all met:
(1) Refusal to deal would SIGNIFICANTLY AFFECT the the business of the WOULD-BE CUSTOMER in a negative way
(e. g., Insufficient supply due to lack of competing sellers)
(2) Would-be customer is WILLING and ABLE to meet the supplier's USUAL trade terms (e.g., normal price)
(3) Product is in AMPLE SUPPLY (e.g., no shortage or capacity limit)
(4) Refusal to deal has ADVERSE EFFECT on COMPETITION
Competition Tribunal may issue an ORDER to force the supplier to supply and sell the product to the customer when ALL 4 elements are met.
Example: Intel refuses to supply its microprocessors to computer manufacturers.
52
Competition Policy preventing the abuse of market power (D)
Restrictive Trade Practices: Explain and give one example of Price Maintenance
When is price maintenance illegal?
Price maintenance refers to the PRACTICE of PREVENTING customers (e.g., retailers) from selling a product BELOW a minimum price.
- Manufacturers enforce a minimum price (not a bargain price) by using threats (e.g., refusal to sell) or promises.
E.g., Nike refuses to sell shoes to a retailer, UNLESS the retailer agrees to a minimum price.
Price maintenance is ONLY ILLEGAL when it has a SIGNIFICANT anti-competitive effect (such as the lessening of competition, disciplining of competitors, or higher prices well above marginal cost of production). In other words, the firm engaging in price maintenance must have substantial market power.
53
Competition Policy preventing the abuse of market power (D)
Restrictive Trade Practices: Price Maintenance
What are the main economic concerns about price maintenance?
What is an argument FOR price maintenance?
AGAINST PRICE MAINTENANCE:
(1) Price maintenance RESTRICTS PRICE COMPETITION between retailers, thereby keeping prices high and reducing consumer surplus.
(2) Price maintenance FACILITATES COLLUSION (specifically, price-fixing) - because price maintenance sends a SIGNAL to competitors that the firm won't go below a price for a product.
FOR PRICE MAINTENANCE:
(1) Price maintenance allows RETAILERS to COVER THE COST of providing PRODUCT-RELATED SERVICES so that they can remain competitive
e.g., A customer could go to Best Buy and learn more about the different TV options from a sales representative. Since Amazon does not have to pay for product-related services or overhead, Amazon can charge a LOWER PRICE for the same TV. Price maintenance ensures prices of TVs are COMPARABLE at Best Buy and Amazon so that Best Buy can cover its product-related services.
54
Competition Policy preventing the abuse of market power (D)
Exclusionary Agreements: What is the following an example of?
> if any entity wanted to use NutraSweet (sweetener company), all related contracts have to enter into contracts with NutraSweet too.
Exclusive Dealing
- Occurs when a customer (or supplier) is REQUIRED to NOT buy (or sell) SPECIFIC products from (to) other firms and competitors.
- The firm becomes the exclusive supplier or customer.
- E.g., D&B Canada signed exclusive contracts with major grocery chains, mandating that only D&B can get access to Canadian data (exclusive customer).
* Exclusive dealing is only illegal if it has significant anti-competitive effects and the firm has substantial market power.
55
Competition Policy preventing the abuse of market power (D)
Exclusionary Agreements: What is the following an example of?
> Authorized dealers of furnaces can only sell furnaces in specific geographic regions
Market Restriction
- Occurs when a SUPPLIER allows a customer to sell their product ONLY in a SPECIFIC MARKET (with geographic restrictions).
* Market restriction is DIFFERENT than market allocation agreements
- Market restriction - one firm has power
- Market allocation agreements - 2+ firms AGREE on which markets to serve.
*Market restriction is only illegal if it has significant anti-competitive effects and the firm has substantial market power.
56
Competition Policy preventing the abuse of market power (D)
Exclusionary Agreements: What is the following an example of?
> Printer company requires you to buy their toner cartridges
Tied Selling
- Occurs when a supplier REQUIRES a customer to buy ANOTHER PRODUCT as a CONDITION of supplying the first product.
* Tied selling is only illegal if it has significant anti-competitive effects and the firm has substantial market power.
57
Competition Policy preventing the abuse of market power (D)
Abuse of Dominant Position: Explain what is Predatory Pricing
How likely are convictions of predatory pricing?
What is the main economic concern with predatory pricing?
Is there an argument for why predatory pricing cannot be profitable?
**S. 78. (1i) Predatory pricing refers to the ILLEGAL practice of charging a PRICE BELOW COST of production to ELIMINATE or DISCIPLINE current or potential competitors.
The effect of predatory pricing is to drive competitors out of the market, which allows the firm to gain market power (and in extreme cases, become a monopolist).
The challenge for the Competition Bureau is to DISTINGUISH predatory pricing from NORMAL PRICE COMPETITION => (CB cannot observe MC of production) => leads to very few convictions
Main economic concern:
- Predatory pricing INITIALLY benefits consumers due to price competition (increases consumer surplus)
* *- However, once competition is reduced or eliminated, THE MARKET becomes CONCENTRATED, leading to price increases and the creation of deadweight loss.
Why predatory cannot be profitable?
- Cost of predatory pricing (e.g., selling products at a lower price or loss) can EXCEED the EXTRA PROFIT made as a monopoly or in a concentrated market.
- This is because profit ATTRACTS NEW ENTRANTS, hence why we don't expect many firms to engage in predatory pricing.
*CB only intervenes when the firm has a DOMINANT POSITION and the practice has significant anti-competitive effects (see below for thresholds to intervene)
58
Competition Policy preventing the abuse of market power (D)
Abuse of Dominant Position: Explain what is Pre-emption
S. 78. (1e): Pre-emption is the practice of BUYING SCARCE facilities or resources with the intention of WITHHOLDING them from competitors
*CB only intervenes when the firm has a DOMINANT POSITION and the practice has significant anti-competitive effects (see below for thresholds to intervene)
59
Competition Policy preventing the abuse of market power (D)
Abuse of Dominant Position: Explain what is Market Price Stabilization
S. 78. (1f): Market price stabilization is the practice of BUYING up PRODUCTS to PREVENT EROSION of their market price.
E.g., Manufacturer sold LARGE quantities of their product to retailers. Then, retailers start MARKING down their products. Manufacturer starts buying their products.
*CB only intervenes when the firm has a DOMINANT POSITION and the practice has significant anti-competitive effects (see below for thresholds to intervene)
60
Competition Policy preventing the abuse of market power (D)
Abuse of Dominant Position: Explain what is Product Specification
S. 78. (1g): Product specification is the practice of ADOPTING INCOMPATIBLE product specifications TO PREVENT ENTRY or ELIMINATE competitors.
e. g., your product is incompatible with others (Apple designs its AirPods to be incompatible with non-Apple devices).
* CB only intervenes when the firm has a DOMINANT POSITION and the practice has significant anti-competitive effects (see below for thresholds to intervene)
61
Competition Policy preventing the abuse of market power (D)
What are the guidelines for when the Competition Bureau INTERVENES for abuses of dominant position?
What are the consequences that the Competition Tribunal can order?
If the firm's market share is less than 35%, CB does NOT investigate (market share is too small to constitute market power)
If the firm's market share is between 35 and 50%, CB ONLY investigates if CB believes the practice will LIKELY INCREASE the firm's MARKET SHARE.
If the firm's market is greater than 50%, CB will launch an investigation
If the GROUP of FIRMS' combined market share is greater than 65%, CB will launch an investigation.
Consequences - CB Tribunal can order to:
- STOP the anti-competitive practice
- Impose ADMINISTRATIVE monetary penalties up to $10 million for the first violation, and then $15 million for subsequent orders
62
What is price regulation?
List all the types of price regulations and their main problems
Price regulation is a form of direct government intervention
- when the government ENFORCES a price (Pr) charged for products/services to PREVENT the abuse of monopoly/market power.
Different types of (uniform) price regulation schemes include:
(1) Marginal cost pricing (Pr = MC)
- Problem: Loss (bankruptcy)
(2) Average cost pricing (Pr = AC)
- Problem: Destroys incentives to reduce costs
- E.g., Hydro One uses average cost pricing
(3) Rate-of-return pricing (Pr to make a reasonable rate of return)
- Problem: Incentives to make inefficient capital investments (Averch-Johnson effect)
(4) Cost-plus pricing (Pr = (1 + n)*ATC), n = profit margin
- Problem: Incentives to increases costs
(5) Price-caps (Pr bar > ATC)
- Problem - still has DWL
63
What are natural monopolies?
List a few examples of natural monopolies
Can natural monopolies still abuse market power?
What are natural monopolies?
- Natural monopolies exist when it is MORE EFFICIENT to have a SINGLE FIRM produce the entire industry output (than multiple firms) because the firm can produce at a LOWER COST of production.
- Natural monopolies usually arise when there are both
(1) Economies of Scale (average cost to produce a unit of product DECREASES as output increases, for the relevant output range)
(2) Economies of Scope (average cost ACROSS different products decreases when firm produces TWO OR MORE PRODUCTS)
- Put simply, natural monopolies have HIGH FIXED COSTS and LOW MARGINAL COSTS, producing in the output range where average cost exceeds marginal cost (AC > MC)
Examples of natural monopolies: High FC and LOW MC
- Hydro One, BC Hydro (electric power transmission systems, utility companies)
- FIXED-line telecommunication companies (in their regions)
- Canada Post
- oil pipeline companies
- Railroads
Can natural monopolies still abuse market power?
- Yes, because natural monopolists can charge prices ABOVE competitive levels, leading to deadweight loss.
64
What are the three objectives of any price regulations scheme?
What is another problem faced by governments when regulating prices?
(1) Maximize welfare (sum of consumer surplus and producer surplus)
(2) Ensure the SURVIVAL of the firm (charge a PRICE that can cover its costs). Bankruptcy would lead to ZERO surplus.
(3) Maintain incentives to REDUCE costs (e.g., POSSIBILITY to earn a profit).
In practice, compromises are inevitable; there exists NO PERFECT price regulation scheme that satisfies all three objectives.
Another problem faced by governments when regulating prices:
- Government has IMPERFECT information of firm's cost structure
65
What is marginal cost pricing?
What is the main problem with marginal cost pricing?
Is there a viable solution to address the problem?
Marginal cost pricing is when the regulated price is set equal to the firm's MARGINAL COST of production
(Pr = MC)
For a regular monopolist (do not have economies of scale), marginal cost pricing satisfies all three objectives (since the monopolist produces the COMPETITIVE output level, qr = qc).
However, marginal cost pricing is NOT an EFFECTIVE pricing strategy to regulate natural monopolies because natural monopolies PRODUCE WHERE average cost exceeds marginal cost due to large economies of scale (for the relevant output range).
Main Problem: The natural monopolist would OPERATE AT A LOSS (P < AC). The firm can only cover its VARIABLE COSTS, NOT FIXED COSTS. Therefore, the firm may become BANKRUPT, which results in ZERO SURPLUS for the economy
Possible solution: Government can provide a SUBSIDY equal to the firm's total loss, (AC - Pr)*Qr, so that the firm makes zero economic profit. However, this subsidy is POLITICALLY DIFFICULT to do.
66
What is average cost pricing?
What is the main problem with average cost pricing?
Average cost pricing is when the regulated price is set equal to the firm's average cost of production, which allows the firm to break even and cover its TOTAL COST.
(Pr = AC)
Criteria:
- Somewhat maximizes welfare (small deadweight loss)
- Ensures the survival of the firm (Price can cover firm's costs)
Main Problem: Average cost pricing DESTROYS the firm's incentive to REDUCE costs and improve production efficiency.
If the firm's production costs rise, the firm can ask the government to INCREASE the regulated price, which leads to INEFFICIENT PRODUCTION METHODS.
E.g., Hydro One is regulated with the average cost pricing and has an OUTDATED grid system. Whenever Hydro One faces higher production costs, the company ask the Ontario Energy Board to approve a higher price.
67
What is rate-of-return pricing?
Example
What is the main problem with rate-of-return pricing?
Rate-of-return pricing is when the government allows the regulated firm to CHARGE A PRICE for its products that ENSURES a REASONABLE rate of return (profit).
The allowed profit is a product of the firm's TOTAL VALUE OF ASSETS and a "reasonable" rate of return (benchmark rate of return in RELATED industries).
It should be noted that the calculation to determine the maximum price (p bar) is not trivial, as price affects the quantity produced and variable cost of production.
e.g., fixed-line telephone service providers (before 2002).
Main Problem: Pricing scheme provides INCENTIVES to make INEFFICIENT CAPITAL INVESTMENTS to increase the value of its ASSETS and PROFITS.
- Known as the Averch-Johnson Effect
- e.g., purchasing a new HQ
68
What is cost-plus pricing?
What is the main problem with cost-plus pricing?
Example
Cost-plus pricing allows the firm to CHARGE a price equal to its AVERAGE TOTAL COST PLUS a "reasonable" profit margin
(Pr = (1 + n)*ATC)
Cost-plus pricing somewhat maximizes total welfare (by limiting the price to reduce DWL) and ensures the survival of the firm (able to earn positive economic profit).
Main Problem: Provides incentives to INCREASE COST
Example: Cost-plus pricing is still used in the defense industry
*Considered the worst possible price regulation from an economic POV.
69
What are price caps?
Example
Price caps is when the regulator sets a PRICE CEILING (maximum price) ABOVE the firm's average total cost.
*- The regulated price is ADJUSTED annually based on INFLATION and expected PRODUCTIVITY IMPROVEMENTS.
(Pr bar > ATC)
Price caps somewhat maximize total welfare (still creates DWL) and ensures the survival of the firm (able to make positive economic profit).
*There are also STRONG incentives to IMPROVE COST EFFICIENCY
Problem -> still have DWL
Example: Fixed-line telephone service providers since 2002, local telephone service in the US like AT&T.
70
What is entry regulation?
Provides examples of entry regulation
Why can it be OPTIMAL from an economics perspective to restrict market entry?
Entry regulation is when the government RESTRICTS market entry to PROTECT firms (specifically, multi-product firms) from DISRUPTIVE COMPETITION (e.g., "skimming" by UNREGULATED, private sector ENTRANTS).
Examples of entry regulation:
- Marketing boards restrict total industry supply of dairy using a QUOTA system
- Patents in the pharmaceutical industry prevent entrants from exploiting patented inventions
- Licenses (e.g., Law Society of Upper Canada) restrict number of professionals.
Entry restrictions goes against the First Welfare Theorem (perfectly competitive markets require free entry and exit).
Why can it be OPTIMAL from an economics perspective to restrict market entry?
- Can be optimal when there is a MULTI-PRODUCT MONOPOLIST that engages in CROSS-SUBSIDIZATION.
- This means that PROFIT from one product/service is used to SUBSIDIZE the sale of other products/services.
- Market entry regulation PREVENTS UNREGULATED ENTRANTS from "SKIMMING the market" - focusing on profitable products, services, or markets.
- Market skimming PREVENTS the multi-product monopolist from cross-subsidizing its products/services, which leading to the under-provision of products/services to less profitable areas, more subsidies, or higher prices.
e. g., Canada Post (Crown corporation and natural monopolist)
- Canada Post offers mail delivery services in both densely populated areas (more profitable) and remote rural communities (less profitable)
- Canada Post engages in cross-subsidization to be able to offer delivery mail services to remote areas.
- If market entry were allowed, competitions would "skim the market" and focus on the GTA and Toronto.
- Canada Post may NOT BE ABLE TO COVER THE COST of mail delivery services in remote rural communities,
- This would lead to more expensive delivery, abandoned services, or requirement for more subsidies.
- However, the gov't did allow entry for COURIER SERVICES in response to slow mail service by Canada Post.
e.g., Air Canada was protected from market entry until the 1980s, which allowed the company to cross-subsidize routes.
71
Public Sector Regulation
Regulation of Crown corporations (government-owned enterprises), such as:
- VIA Rail
- Canada Post
- LCBO
- Ontario Cannabis Store
Profit maximization is NOT necessarily the main objective (e.g., could be to provide services that won't be offered by private enterprises).
72
Private Sector Regulation: Agriculture Sector
Q1) What is the REASON for regulation?
Q2) HOW is the industry regulated?
Q3) What are the IMPLICATIONS of regulation for the Canadian economy
Examples
Q1) Reason for regulation: To raise profits/income for the domestic industry.
- Why?
- Without government intervention, the agricultural sector is very COMPETITIVE and faces highly UNCERTAIN INCOMES (due to VOLATILE market prices and farm output).
- Gov't intervention can STABILIZE income for farmers.
*It should be noted that the rationale for government intervention in the agriculture sector is more political than economic.
Q2) HOW is the industry regulated?
- The government allows producers to form MARKETING BOARDS that market their products (e.g., run commercials to increase product demand).
- The government also gave some marketing boards (called Supply Management Boards) the AUTHORITY to CONTROL TOTAL INDUSTRY SUPPLY by implementing a QUOTA system.
* *- When the total quota is SMALLER than the competitive quantity, the quota system REDUCES total industry output, LEADING to HIGHER prices and POSITIVE rents for the INDUSTRY (possibly even monopoly rent is quota = qm).
- System is only effective on the market when the quota is SMALLER than the competitive quantity (binding quota).
e. g., Dairy, eggs, and poultry sector in Canada
- Canadian dairy industry generates $2.4 billion in annual industry rent from the supply quota ($175k for each dairy farmer).
Q3) What are the IMPLICATIONS?
- Inefficient quota system
- Higher prices for dairy products, eggs, poultry, which decreases consumer surplus and creates deadweight loss.
- Farmers do not necessarily benefit from higher prices either because of the HIGH UPFRONT COST to buy quotas (market price reflects future abnormal returns) and HIGH OPPORTUNITY COST of using them (instead of selling quotas). -> only earn normal profit.
- Despite these inefficiencies, the quota system is difficult to ELIMINATE because of the TRANSITIONAL GAINS TRAP.
E.g., Canadian Dairy Industry's Supply Quota System
- Total Industry rent = $2.4 billion or $175k per farmer.
- Cost to buy one quota in Ontario ~24k (for 1 cow's worth of output).
E.g., Canadian Wheat Marketing Board
- Former mandatory producer marketing board for wheat and barley in the Prairies (AB, SK, and MB).
- It was illegal for farmers in the jurisdiction to sell their wheat and barley through other channels.
- CWB was the sole buyer and seller of Prairies wheat and barley.
73
Private Sector Regulation: Canadian Airline Industry
Q1) What is the REASON for regulation?
Q2) HOW is the industry regulated? (general and Air Canada)
- Federal or not?
Q3) What are the IMPLICATIONS of regulation for the Canadian economy
Q1) Reason for regulation: To protect domestic industry from FOREIGN competition
*It should be noted that the rationale for government intervention in the Canadian airline industry is more political than economic.
Q2) HOW is the industry regulated?
- Industry is regulated FEDERALLY
General regulations limit foreign competition by creating legal barriers to entry.
- Prohibition of "cabotage", meaning ONLY Canadian airlines can offer DOMESTIC AIR SERVICES.
- Foreign ownership CAP equal to 49% (but a single airline cannot hold more than 25% of voting shares of a Canadian airline)
Beyond these restrictions on foreign airlines, the federal gov't requires airports to pay GROUND RENTS, and Canada has entered into "Open skies" agreements with the US, EU and other countries that facilitate trans-border air services.
Air Canada is regulated according to the Air Canada Public Participation Act (1985), which requires Air Canada to:
(1) Offer customer SERVICE in both English and French;
(2) Maintain operational and OVERHAUL centers in Winnipeg, Montreal and Mississauga; and
(3) KEEP its head office in Montreal (compromise to the Quebec government).
*Air Canada rules do not apply to its competitors like WestJet (results in higher operating costs for Air Canada)
Q3) Implications on Canadian Economy
- In-country air fares are higher in Canada than the US and EU due to insufficient competition in the domestic market (duopoly between Air Canada and WestJet protected by barriers to entry) and higher taxes and fees (ground rents paid to the federal government)
- Air Canada is also less competitive compared to its peers because of the additional rules imposed by the Air Canada Public Participation Act.
*US airlines are also subsidized by the gov't.
74
What is the history of the Canadian airline industry?
- Air Canada used to be a Crown corporation and natural monopolist (high FC, low MC, decreasing AC)
- Government used to regulate Air Canada's prices and routes (prevented entry to deter market skimming and ensure cross-subsidization of routes to Northern destinations)
- By 1984-89, there was a wave of deregulation in Canada and the US
- Air Canada was privatized in 1988/89.
- In 1955, Canada entered into an "open skies" agreement with the US, which allowed trans-border air services between the two countries and increased competition among Canadian and US airlines.
- By 2021, Canada has "open skies" agreements with 107 countries.
- Canada's DOMESTIC market is primarily a DUOPOLY (Air Canada and WestJet).
75
Private Sector Regulation: Canadian Financial Industry
(Chartered banks, insurance, trust and loans companies, credit unions and security dealers)
Q1) What is the REASON for regulation? (Financial Industry versus Chartered Banks)
Q2) HOW is the industry regulated? What about chartered banks?
- Federal or not?
- Legislation
Q1) Reason for regulation (of the FINANCIAL INDUSTRY): To PREVENT certain types of market failure.
Broadly speaking, regulations prevent against:
(1) Excessive risk-taking (increases bankruptcy risk))
(2) Use of insider information
(3) Self-dealing
- e.g., selling a product to a client that is not in the client's best interest.
- Risk averse retiree is knowingly sold high risk derivatives by the broker because it gives him a higher commission.
Reason for regulation of Chartered Banks:
(1) Failure of a chartered bank would SEVERELY disrupt economic activities
- e.g., Households and firms may not be able to get access to loans to fund their spending needs.
(2) Failure also may CAUSE other financial institutions to fail.
- e.g., The collapse of the Lehman Brothers in 2008 led to the bankruptcy of several other financial institutions.
(3) Imperfect market control due to asymmetric information
- Depositors DO NOT have all the information to ASSESS the bankruptcy risk of a bank, so they may engage in INEFFICIENT decision-making (e.g., choose a high-risk bank but receive low interest rate).
Q2) How is the industry/chartered banks regulated?
- **Canadian financial industry is regulated FEDERALLY AND PROVINCIALLY, depending on the entity.
> Insurance, trust and loan companies are regulated federally and provincially
> Credit unions and security dealers are regulated provincially.
- Chartered banks are regulated FEDERALLY by the Office of the Superintendent of Financial Institutions (OSFI) according to the Canada Bank Act.
> There are CAPITAL REGULATIONS that PREVENT over-leverage and minimize the risk that financial institutions go bankrupt.
> For example, banks are required to maintain a minimum RISK-BASED CAPITAL RATIO equal to 8% (Tier 1, 2021). --> The ratio equals Capital / Total Risk-Weighted Assets
> A higher ratio implies HIGHER FINANCIAL STABILITY of the bank (lower risk of bankruptcy).
> OFSI also has designated Canada's "Big Five" banks as "too big to fail" (BMO, BNS, CIBC, RBC, TD), meaning that the failure of which would cause significant shocks throughout the economy.
> These five banks collectively account for over 90% of banking assets in Canada.
(Gov't will intervene to prevent failure of these banks through taxpayer dollars , which could incentivize excessive risk taking...)
> Since bank failures are not unusual, CDIC provides deposit insurance up to $100k per account for CDIC members
76
Since failure of Canadian banks is not unusual, how is deposit insurance offered in Canada?
Canada Deposit Insurance Corporation (CDIC) is a crown corporation that insures up to $100k per account (so long as the bank is a CDIC member; does not insure deposits in foreign banks in Canada)
However, CDIC's deposit insurance is ONLY effective for SMALL, isolated bank failures rather than SYSTEMATIC SHOCKS (e.g., failure of one of the Big Five banks)
- Total assets available for payout is less than 1% of the total amount of insured deposits.
77
Private Sector Regulation: Canadian Telecommunications Industry
Q1) What is the REASON for regulation?
Q2) HOW is the industry regulated?
(Broadly, Fixed-line, cellular/Wireless)
Q1) Reason for Regulation: To prevent monopolist/oligopoly from abusing its market power.
Q2) How is the industry regulated?
- The telecommunications industry is regulated FEDERALLY by the Canadian Radio-television and Telecommunications Commission (CRTC) according to the Telecommunications Act.
- CRTC regulates two broad areas using price and entry regulations:
(1) Fixed-line telephone service and
(2) Cellular (wireless) telephone service
- CRTC also deals with CONSUMER complaints, such as those arising from telemarketing calls despite being registered on the "National Do Not Call List"
How CRTC Regulates the Fixed-Line Telephone Service:
- The Canadian fixed-line telephone market is dominated by REGIONAL natural MONOPOLISTS, such as Bell Canada, TELUS, and SakTel.
- The market is a natural monopoly because it is INEFFICIENT to have more than two firms offering PARALLEL transmission lines.
Since the market is composed of regional monopolists, there are several regulations imposed to prevent such firms from abusing their market power.
- Main regulations include:
(1) Providers must be majority-owned by Canadians (limits market entry);
(2) Rate-of-return regulation was in place until 2002. Since 2002, price cap regulation was imposed (maximum price for fixed-line telephone services that adjusts based on inflation).
(3) Households pay a FIXED monthly ACCESS fee to be able to make FREE LOCAL calls.
How CRTC Regulates the Cellular (wireless) Telephone Service:
- The Canadian wireless telephone market is HIGHLY CONCENTRATED and dominated by THREE firms (Rogers, TELUS, and Bell have a combined market share of 90%)
- Since the market is an oligopoly, small local companies are simply too small to influence the prices of wireless telephone services.
Since the market is highly concentrated with three main players (Rogers, Bell and Telus), there are several regulations imposed to prevent such firms from abusing their market power.
- Main regulations include:
(1) Providers must be majority-owned by Canadians;
(2) PRICE CAPS for roaming charges BETWEEN providers
- e.g., CRTC regulates the maximum price that Bell can ask Rogers to pay for a call made by a Rogers customer to a Bell customer.
(3) Default caps on data overage charges and data roaming charges ($50 and $100, respectively);
* *- ANY additional charges require CONSENT from the customer.
(4) Contract terms relating to duration, cancellation, and fees.
*There is no price regulation for the price paid by customers of wireless telephone services. CRTC does NOT regulate rates for consumers of wireless telephone services (service providers are generally free to charge their customers whatever they want).
78
How does business ethics and corporate social responsibility (CSR) relate to government regulation?
Firms engaging in CSR is an ALTERNATIVE to government regulation
79
What is meant by "ethical" behaviour?
Ethical behaviour depends on the PERSPECTIVE taken, but generally, it refers to "FAIR" practices.
Examples:
- Consumers - fair prices
- Competitors - fair business practices (no comparative advertising)
- Employees - fair compensation and working hours
- Taxpayers - fair share of taxes paid
80
What does "fairness" mean? Is it easy to define?
Fairness is difficult to define because every person's PERCEPTION of fairness is SENSITIVE to HOW a situation is DESCRIBED or HOW INFORMATIVE is given.
For example: The reason for a price increase can determine one's perception of fairness (due to cost increases or greater market power)
People's perception of fairness can be susceptible to MANIPULATION OF INFORMATION (e.g., firm lies about the reason for the price increase).
81
When is engaging in fair business practices in the ECONOMIC interest of firms?
(provide examples)
At a high level, it is in the economic interest of firms to engage in fair business practices when the firm sufficiently values long-term customer/business relationships than short-term gains. In these cases, the firm's DISCOUNT FACTOR (degree of patience for future payouts) is sufficiently high.
Specifically, there are three cases when firms have an economic incentive to engage in fair business practices:
(1) NEWS about UNFAIR practices spreads quickly and AFFECTS RELATIONS with OTHER customers and business partners (such as through social networks).
e. g., A video showing how United Airlines forcibly removed a passenger from a flight spread throughout social media, damaging the airline's reputation.
* (2) Customers/BUSINESS PARTNERS have GOOD SUBSTITUTES.
- Therefore, engaging in unfair practices can lead to lasting effects on a firm's reputation that ultimately drives them out of business.
e. g., Competing restaurants in Kingston (highest number of restaurants per capita in Canada)
(3) Business MODEL builds on trust/reputation
e. g., plastic surgeons, financial advisors, realtors.
- when trust is broken, customers were not return in the future.
From these reasons, the economic incentive to engage in UNFAIR business practices is strong when firms deal with ONE-TIME TRANSACTIONS (e.g., sale of a used car on Kijiji)
82
What is business ethics about?
Business ethics includes FAIR BUSINESS PRACTICES, but also MORAL RULES that DEFINE HOW businesses should operate.
- Moral rules are SHAPED BY SOCIAL NORMS and CHANGE OVER TIME.
- e.g., Pollution is NO LONGER ACCEPTABLE by the public
- Other areas: Work environment, social impact.
Business ethics are often CHARACTERIZED BY CONFLICTING VIEWS on what is ethical or not.
- e.g.,
> Lobbying (firms vs. consumers) - firms believe lobbying is ethical because it informs policy makers about the consequences of their policies
> Production of bioethanol (While bioethanol reduces the demand for oil, production requires land that could have been used to address starvation or hunger)
> Inappropriate TV shows (parent or entertainment company's responsibility?)
83
Corporate Social Responsibility (CSR) - What was Milton Friedman's perspective on CSR?
Milton Friedman believed that the ONLY RESPONSIBILITY of MANAGERS is to MAXIMIZE FIRM PROFITS.
Shareholders should decide what to do with their money, not managers on their behalf.
Additionally, the government should CHANGE THE RULES when SOCIETY does not like certain kinds of firm behaviour (e.g., changing the regulatory framework to curb pollution)
Therefore, Milton Friedman believed there is NO REASON for CSR.
84
What are the arguments for CSR (to refute Milton Friedman's views)?
* (1) Social preferences often change at a faster rate than GOVERNMENTS CAN adjust regulations, creating a REGULATION GAP.
- Thus, it is MORE EFFICIENT for firms to respond to changing social preferences through CSR (firms can respond faster through CSR)
(2) Government REGULATIONS can be INEFFICIENT BECAUSE of LACK OF INFORMATION and COSTLY ENFORCEMENT
- Often times, the same or more efficient outcome may be achieved by CSR (and possibly at a lower cost).
(3) FIRMS are often CONFRONTED with VARIOUS DIFFERENT LAWS and STANDARDS in different countries.
* - Cannot rely on all countries to enforce the same regulations
85
What were the two assumptions that Milton Friedman relied on for his conclusion that consumers should be "free to choose" whether to install the $13 plastic block into Ford Pintos?
(1) Providing DIFFERENT options to consumers is ECONOMICAL for firms
(2) Consumers FULLY UNDERSTAND the associated risks of their decisions.
86
What are the incentives for firms to invest in CSR?
Are their economic incentives to invest in CSR?
(1) CSR can be used as a DISTRACTION from more serious issues at the firm.
- e.g., Shell regularly ranked very high on Fortune's CSR list. However, Shell has had scandals relating to oil spills that were not cleaned.
(2) Firms often face CONSUMER PRESSURE to invest in CSR
- e.g., Shell intends to DISPOSE of an oil platform in response to public pressure from consumers.
(3) Investments in CSR can proactive AVOID LAWSUITS
- e.g., adopting higher labour standards in factories around the world can avoid lawsuits about the exploitation of labour or unsafe working conditions.
(4) Firms adhere to self-imposed standards to PRE-EMPT more EXPENSIVE industry regulations
- e.g., VISA/Mastercard KNEW of impeding industry regulations and cut merchants' fees in 2014
*Firms in COMPETITIVE industries generally do not have strong economic incentives to invest in CSR (e.g., safety standards at factories) because firms CANNOT INTERNALIZE the SOCIAL BENEFIT from CSR (positive externality).
> Specifically, consumers are MORE RESPONSIVE to PRICE-changes than to CSR, especially when CLOSE substitutes are available.
> Therefore, consumers are unwilling to pay higher prices for CSR, making the socially desired outcome where all firms invest in CSR is NOT a stable Nash Equilibrium!
* DEPENDS on the context and industry
(e. g., Food industry - segment of consumers value CSR and potentially refrain from buying products from firms that are considered unethical).
(e.g., in concentrated industries, the firm sometimes voluntarily engages in CSR initiatives to pre-empt more invasive, expensive government regulations.)
87
How can the socially desirable outcome (where all firms invest in CSR) be implemented?
What are the main problems with these options?
(1) Firms can AGREE on INDUSTRY STANDARDS
- Problem: Difficult to enforce because of economic incentives to deviate.
(2) Firms can CHANGE CONSUMER BEHAVIOUR to PAY MORE for "ethical" products
- Problems: There is ASYMMETRIC INFORMATION between producers and consumers (about overseas conditions and what the extra premium will be used for) and FREE-RIDER PROBLEM (firms can take advantage of the other firm making the investment into "fair trade" labels)
(3) Government regulation (intervention)
- Problems: Incentives for the EXPORTING COUNTRY to impose regulations (e.g., stricter safety standards) is often weak and it is COSTLY/IMPERFECT to enforce such standards by the IMPORTING COUNTRY.
88
What is the importance of innovation to the Canadian economy?
Innovation is essential for the COMPETITIVENESS of the Canadian economy.
> Canada cannot rely on its natural resources.
> Innovations fuels Canada's "knowledge economy"
Examples of Canadian inventions:
- Peanut butter
- Insulin
89
Why would free markets lead to INSUFFICIENT innovation?
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
Free markets lead to INSUFFICIENT innovation for three reasons:
(1) Innovation as public goods (innovations are often public goods...)
- Innovation is both non-exclusive (i.e., cannot exclude others from using or IMITATING innovations) and non-rivalrous (i.e., use of the innovation by one person does not prevent the use of others)
- Therefore, innovators have LOW INCENTIVES to MAKE INVESTMENTS in innovation IF they CANNOT REAP the benefits due to the FREE-RIDER PROBLEM (people are unwilling to pay for it).
- e.g., Drugs by pharmaceutical companies
(2) Innovation EXTERNALITIES
- Innovation generates positive externalities ON society (KNOWLEDGE SPILLOVERS)
- Since innovators are not able to be sufficiently compensated for these investments (positive externality is not internalized), the free market leads to UNDER-PROVISION of innovation.
- e.g., R&D
(3) Asymmetric information between INNOVATORS and investors.
- Innovators know more about their innovations than investors, leading to INSUFFICIENT INVESTMENTS in startup companies that explore innovations.
THEREFORE, there needs to be government intervention to stimulate investments in innovation and prevent market failure.
90
What are the main policies to encourage innovation?
(1) Government TREATS SUCCESSFUL INNOVATIONS as intellectual property, which GIVES people the right to EXCLUDE others from using their property.
- Copyrights, patents, trademarks, industrial designs
(2) Government provides FUNDING FOR INNOVATION through R&D subsidies (e.g., tax credits), RESEARCH funding for universities (e.g., Tri-Council Agency), and government-sponsored venture capital.
91
What can be protected under copyright?
Any ORIGINAL WORK can receive copyright protection. Specifically, any literary, artistic, musical and dramatic work (e.g., books, paintings, software, music, live performances/lectures)
How to obtain copyright and duration of protection:
- Copyright protection arises AUTOMATICALLY upon the creation of original work (without the need for registration) and lasts for the CREATOR'S life plus 50 years thereafter.
92
What rights are given in copyrighted work?
Copyright gives the creator the EXCLUSIVE right to exploit original work (e.g., produce, publish, perform work etc.).
Copyright holders can also SELL or LICENSE their copyrights to THIRD PARTIES FOR COMPENSATION
- e.g., A musician can transfer copyright in his musical work to record labels for compensation.
--> unauthorized copying would constitute copyright infringement (violate the author's/PUBLISHER's, MUSICIAN'S/RECORD LABEL's copyright)
93
What is an exception to copyright protection?
Fair dealing is the PERMITTED USE of copyrighted material WITHOUT PERMISSION of the copyright holder UNDER CERTAIN CONDITIONS, such as for:
- Reviews or criticism of work (e.g., Book Review);
- Private study (e.g., a few pages or chapters of a book, but NOT the entire book);
- Teaching and research (e.g., images in lecture slides)
Therefore, the copyright holder CANNOT prevent others from using their original work if the use falls under fair dealing.
94
When do employees own copyrights of their work over employers?
Employees own copyright in their work when CREATING WORK is NOT part of their employment.
> e.g., An employee at a clothing store has copyright in a poem written at lunch.
EMPLOYERS own copyright in the work when CREATING WORK IS A PART of their employment.
> e.g., An employee is a writer at the Globe and Mail. The newspaper owns copyright in her work.
95
Who owns copyright in work created by independent contractors on a for-hire basis
Creators own copyright, unless specified otherwise.
e.g., Globe and Mail pays someone to write articles, but they are not an employee.
96
What are the main provisions of Canadian patent law (Canadian Patent Act, 1985)?
- According to the Canadian Patent Act, patents give the inventor EXCLUSIVE CONTROL over their patented invention in CANADA for a period of 20 years from the application FILING DATE (not patent grant date)
> Includes the legal right to prevent others from using the invention and the right to license all or part of the patent rights to third parties for compensation.
- Canada's patent law regime follows a FIRST-TO-FILE SYSTEM. In other words, the patent IS GRANTED to the inventor who FIRST FILES a patent application, not the person who invents the invention first.
- The Canadian Intellectual Property Office (CIPO) is responsible for handling patents and patent applications
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What are the criteria for an invention?
INNOVATIONS must meet three criteria to QUALIFY as inventions that can be patentable.
* (1) Invention must NOVEL, meaning it must NOT HAVE been DESCRIBED in PREVIOUS patent applications in Canada and must not have been PUBLICLY DISCLOSED BY a third party ANYWHERE in the world.
(2) Invention must be NON-OBVIOUS to the "unimaginative skilled technician" in the field. He could not have immediately SEEN THE POTENTIAL for the invention.
(3) Invention must have UTILITY or some useful function.
98
What are patentable and non-patentable inventions?
Patentable inventions include NEW:
- machines
- MATERIAL
- manufactured items
- production processes
Non-patentable inventions include BASIC RESEARCH, such as:
- SCIENTIFIC theories or principles
- Abstract ideas
- Basic laws of nature
- Mathematical facts, METHODS or algorithms
99
Main steps in the patent application process
What are the main fees/costs for the patent application
1) RESEARCH existing patents to prove novelty (such as the patent database of the CIPO)
- It is helpful to obtain the help of a patent agent.
2) Prepare and submit a patent application and pay the APPLICATION FEE
3) REQUEST examination and pay the EXAMINATION FEE
4) Decision (approval or rejection) is made. Rejections can be appealed to the Patent Appeal Board
5) Application is MADE PUBLIC within 18 months from the filing date.
Total cost for the patent application: $10k-20k (mainly for the patent agent)
Other fees: Annual maintenance fee (otherwise, the patent is invalid). The purpose is to DISCOURAGE UNUSED patents.
- Protection in other countries requires additional patents (5k-10k per country!)
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What are the rights of patent holders?
Patents give the patent holder EXCLUSIVE RIGHTS over the invention in CANADA, such as:
- the right to LEGALLY PREVENT others from using your invention
- the right to license all or part of PATENT RIGHTS to third parties. Licensing allows small, private inventors to COMMERCIALIZE their inventions.
Patent holder can also MARK their patented invention as "patented". For submitted patent applications, individuals can mark inventions with "patent applied for" or "patent pending"
- it is illegal to mark "patented" without a patent
- Purpose: to SIGNAL to other INVENTORS and competitors that there is a chance you will be granted a patent for the invention
101
What is patent infringement?
| What are the remedies available to patent holders?
Patent infringement is the UNLAWFUL use of patented inventions.
Remedy:
- There is NO automatic INTERVENTION by the government (CIPO); patent holders have the responsibility to SUE for patent infringement.
(Hence why corporations have large and costly legal departments to deal with patent litigation)
- Patent holders can choose to take the infringer to COURT or SETTLE the issue outside of court (and AVOID expensive and disruptive lawsuits).
102
What are patent trolls?
Patent trolls are FIRMS that BUY MARGINAL PATENTS TO EXTORT SETTLEMENTS (demand compensation for patent infringement).
Patent troll industry arose due to the strong incentives for firms to settle patent litigation issues outside of court (to avoid expensive and disruptive lawsuits).
Patent trolls are an example of RENT-SEEKING because the firms DO NOT USE the patents to produce innovations and simply use the patent system to advance their economic self-interests.
In the US, patent trolls are costly:
- Direct costs: $29 billion/ year for legal fees and licensing fees (10% of R&D expenses)
- Indirect costs: $83 billion/ year.
Patent troll activity is lower in Canada due to higher legal barriers.
103
What are the main problems of the patent system?
(1) Patents GRANT MONOPOLY POWER for up to 20 years, which CREATES deadweight loss.
- Therefore, patent protection can be viewed as a double-edged sword - monopoly power is the price to pay for encouraging innovation
(Patent policy tries to trade-off cost and benefits: Patent duration, patent breadth, and enforcements)
(2) There are HIGH COSTS of OBTAINING and MAINTAINING patent protection for PRIVATE INVENTORS and SMALL Firms
- Costs include application fee, examination fee, patent agent fee, annual maintenance fee, and any litigation fees.
- Patent system could DETER innovation by these smaller inventors.
(3) There is FULL DISCLOSURE of the invention after 18 months of submitting a patent application, REGARDLESS of whether the patent was eventually granted.
- The system creates a HIGH RISK for private inventors BECAUSE they might receive NO PROTECTION for their invention (allows competitors to IMITATE them).
(Hence why many firms use trade secrets instead).
104
Why must the government intervene in labour markets?
The government should only intervene when there is MARKET FAILURE (markets fail to achieve the Pareto Efficient outcome).
In the case of labour markets, perfect competition is UNDESIRABLE because it could lead to the EXPLOITATION of workers/employees (e.g., poor or unsafe working conditions, low wages etc.)
Origina: "Manchester Capitalism" in the 19th century when workers virtually had no rights. Many workers died or were injured.
Therefore, there is public pressure for government intervention.
105
What are the main types of government intervention in labour markets?
(1) Labour laws (regulate health and safety, minimum wage, and paid vacation days)
(2) GOVERNMENT PROGRAMS (e.g., employment insurance, job-related training to maximize their chance of finding another job)
(3) FREEDOM TO ORGANIZE - ALLOW workers to join UNIONS and INCREASE their bargaining power relative to employers
106
Where are labour laws found in Canada?
Labour laws exist on a FEDERAL AND PROVINCIAL LEVEL.
Federal law is the Canada Labour Code. The Canada Labour Code ONLY applies to INDUSTRIES UNDER federal jurisdiction (e.g., airports and air transportation, telecommunications, banks, RCMP).
> Canada Labour Code DEALS with health and safety standards, employment standards, and collective bargaining.
Provincial law has similar provisions to the Canada Labour Code and apply to ALL OTHER industries.
> In Ontario, the Employment Standards Act deals with health and safety standards and employment standards
> Ontario's Labour Relations Act deals with collective bargaining.
107
What are the main provisions of Canadian labour laws?
Federal and provincial laws have similar provisions as follows:
(A) Maximum working hours --> STANDARD WORKING HOURS should NOT EXCEED 8 hours/day or 40 hours/week.
> THESE LIMITS can be exceeded WITH the employee's consent up to 13 hours/day or 60 hours/week.
> Employee consent is NOT REQUIRED IN THE CASE OF emergencies, UNFORESEEN events, and seasonal operations.
(B) Minimum Number of Paid Vacation Days --> Employees are ENTITLED to AT LEAST two weeks of vacation EACH YEAR (with vacation pay).
> There are different provisions in Canadian labour law for vacation pay.
> There are also AUTOMATIC increases of vacation days with TENURE (e.g., to incentivize retention)
(C) Minimum Wage --> Employees MUST BE PAID AT LEAST the MINIMUM WAGE (currently $14.25/HOUR in Ontario).
> However, there are EXCEPTIONS in the SERVICE industry.
(D) Gender-based WAGE discrimination is ILLEGAL
> Put simply, an employer is not allowed to pay someone MORE OR LESS for the same position solely because of their gender
(E) Union Representation --> Employees HAVE the RIGHT to be REPRESENTED by a union.
> Union NEGOTIATES a collective agreement with the employer ON BEHALF of employees. The collective agreement contains all the terms and conditions of employment.
- Union and employer engage in collective bargaining.
108
What are some union coverage statistics in Canada?
National unionization rate: 31.3% (declining)
Public Sector unionization rate: 75.8% (includes education, public administrative roles)
Private Sector unionization rate: 16%
109
How do employees obtain union representation?
Two ways to obtain union representation:
(1) Certification of a BARGAINING unit.
> REQUIRES SUPPORT from the MAJORITY of employees at the time of application.
(2) Voluntary Recognition
> whereby the employer AGREES THAT the union REPRESENTS its employees.
> Likely to happen went the employer believes it is more advantageous to negotiate contracts with a union than each employee.
Outcome is the same: ALL members of the bargaining unit are then automatically COVERED by the collective agreement (both union members and non-union members).
110
What is the effect of obtaining union representation?
Upon obtaining union representation, the union officially BECOMES the EXCLUSIVE REPRESENTATIVE of all employees of the bargaining unit (union and non-union members).
The union is responsible for NEGOTIATING a collective agreement with the employer on behalf of the bargaining unit. Individual employees CANNOT negotiate with the employer or settle disputes (e.g., unilaterally sue the employer for being wrongfully laid off). All communication must go through the union.
> Employee needs to go through grievance and arbitration (as usually outline in the
collective agreement)
The collective agreement also applies to ALL members of the bargaining unit (union members and non-union members). This could lead to the FREE-RIDER problem because non-union members receive the SAME BENEFITS and have LITTLE INCENTIVE to BECOME A MEMBER and pay union dues.
(Security clauses in collective agreements can prevent the free-rider problem and require non-union members to still pay - Rand formula).
111
What are examples of unfair labour practices?
LABOUR LAWS PROHIBIT unfair labour practices (ULP) BY the employer, particularly during the certification of a bargaining unit and collective bargaining (could be anytime though!).
Unfair labour practices include:
(1) ATTEMPTS by the employer to DEFEAT UNIONIZATION of a unit / INFLUENCE THE VOTING ON THE COLLECTIVE AGREEMENT
> For instance, the employer DISCHARGES, DISCIPLINES, or DISCRIMINATES against UNION-SUPPORTING employees due to anti-union motives.
> IMPORTANT***: Employers are ALLOWED to discipline or discharge employees for other non-anti-union motives (e.g., employee has stolen office supplies). --> no anti-union motive.
(2) Use of THREATS, INTIMIDATION, or PROMISES to DISCOURAGE unionization (sway the votes) or INFLUENCE THE VOTING ON THE COLLECTIVE AGREEMENT
- Evidently, Canadian labour laws constrain freedom of expression.
112
What are four types of union security clauses?
(1) Closed Shop - EMPLOYEES must be union members BEFORE being hired (otherwise, they are automatically disqualified).
- quite rare clause
(2) Union Shop - EMPLOYEES must BECOME union members WHEN they are HIRED
(Anyone can apply for the job, but they must join the union once they are hired).
(3) Rand formula - EMPLOYEES can CHOOSE whether to become union members or not, BUT EVERYONE is required to pay union dues (both union members and non-union members)
- Rand formula is DESIGNED to ELIMINATE the free-rider problem by making non-union members PAY to RECEIVE unionization benefits.
- Otherwise, non-union members lack the incentive to join the union and pay union dues.
- E.g., Queen's University Faculty Association (Veikko is not a union member but still pays union dues).
(4) Voluntary Check-off - UNION MEMBERSHIP and PAYMENT OF DUES are both VOLUNTARY
- Usually rare
- DOES NOT address the free-rider problem.
113
What are work stoppages and when are they illegal?
Work stoppages refer to the TEMPORARY CESSATION of work initiated by employees or employers as a way to increase their BARGAINING POWER relative to the other party.
For example, employees conduct a STRIKE when they COLLECTIVELY REFUSE to work or SLOW DOWN their work.
> Employees who strike are NOT paid their normal salary. Instead, they receive STRIKE PAY from their union (which is much less than their usual pay).
> Employees who want to work cannot because of picketing
> E.g., Canada Post workers strike in 2018
Employers can initiate a LOCKOUT when they DENY EMPLOYEES access to the workplace.
> e.g., Caterpillar lockout in London, ON (2012).
Work stoppages are ILLEGAL (e.g., wildcat strike) if at least one of the following conditions are not met:
(1) The collective agreement must have EXPIRED (and no new collective agreement has been reached between the union and employer).
> Prevents either party from using work stoppages to increase their bargaining power DURING negotiations
(2) A CONCILIATOR must have investigated the DISPUTE and ISSUED A REPORT.
(3) For a strike, the MAJORITY of employees must have VOTED IN FAVOUR of the strike.
114
What are back-to-work orders (legislation)? Types of back-to-work orders?
Back-to-work legislation is passed by the government to END WORK STOPPAGES, thereby making the strike or lockout ILLEGAL.
**Typically the government intervenes with back-to-work legislation when the work stoppage has a SEVERE IMPACT on the Canadian economy.
> e.g., 2018 - Canada Post worker strike (Canadian Union of Postal workers) resulted in the halt of mail delivery services across the country.
> e.g., 2012 - Air Canada pilot, ground crew and mechanic strike resulted in disruption of the airline industry (flight cancellations, stranded travellers)
There are two types of back-to-work orders:
(1) Government APPOINTS an ARBITRATOR TO make a PROPOSAL THAT both parties MUST ACCEPT (creates a binding collective agreement)
> "Both parties submit what they are willing to accept a government-appointed arbitrator and the arbitrator makes a proposal reflecting some compromise position that both parties must LEGALLY accept."
or
(2) Government IMPOSES A NEW CONTRACT ON the union and employer WITHOUT negotiation or arbitrator.
(otherwise, wildcat strike)
115
What are wildcat strikes?
Wildcat strikes are ILLEGAL strikes (e.g., when one of the three conditions is not met OR refusing to stop the work stop once the government has passed back-to-work legislation).
Examples:
> Nurses in Saskatchewan engaged in a wildcat strike after deciding to continue the work stoppage despite the government's back-to-work order.
> Result: Wages increased by 13.7%
116
In general, how does unionization affect wages and employment? (focus on private sector)
(In the unionized industries and non-unionized industries)
UNIONIZED INDUSTRY:
- In unionized industries, unions often negotiate HIGHER WAGES and MORE BENEFITS for workers compared to the competitive wage (creating a union wage premium).
- IN RESPONSE to higher labour costs, UNIONIZED firms CHOOSE to use LESS LABOUR (e.g., by replacing labour with capital/machines or relocating production to low-wage areas), so employment falls in unionized industries.
- As a result, some UNIONIZED workers are UNEMPLOYED in the industry (unused labour).
NON-UNIONIZED INDUSTRY:
- ***HIGHER WAGES in unionized industries IMPOSES a NEGATIVE EXTERNALITY on the wages in non-unionized industries.
- As unemployed workers in the unionized industry seek employment in non-unionized industries, the SUPPLY OF LABOUR in the non-unionized industry INCREASES.
- The increase in supply puts DOWNWARD PRESSURE on wages in the non-unionized industry, but also INCREASES FIRM DEMAND for labour.
- HOWEVER, some firms may VOLUNTARILY choose to INCREASE WAGES in non-unionized industries in order to PREVENT UNIONIZATION at the firm (higher wages is cheaper than unionization) or COMPETE with unionized firms for skilled employees.
Hence why wages in non-unionized industries are reduced on average by LESS THAN 3%
117
How much do wages increases in unionized industries?
The size of wage increases depends on the BARGAINING POWER OF UNIONS, which is influenced by the degree of industry competition and elasticity of labour demand.
In highly competitive industries, firms have LITTLE ROOM to increase wages compared to a monopolist (otherwise, they risk losing their competitive edge).
Elasticity of labour demand refers to how easy it is to replace labour with capital or relocate production to low wage countries. When there is LOW elasticity of labour demand, UNIONS have HIGH bargaining power relative to employers.
> e.g., Teachers are difficult to replace and thus have high bargaining power.
118
How does unionization affect firm profits?
Studies have shown that unionization have generally had a NEGATIVE EFFECT on firm profits (e.g., decrease in a firm's market value reflects the increased labour costs).
- On average, the market value of the firm falls by 4.3% after unionization
119
Why do public sector unions have substantial bargaining power?
What are the implications for the public sector?
Politicans and government officials LACK MARKET DISCIPLINE when negotiating with public sector unions. Specifically, politicians and government officials can RAISE TAXES or BORROW from future generations in order to pay for wage increases of public sector employees.
In contrast, private sector firms face immense market pressure that LIMIT the amount of wage concessions given. Wages that are too high can put the company at risk of losing its competitive edge.
Implications:
(A) Public sector wages are quite high (~30% higher than similar private sector jobs)
(B) Public sector benefits are MORE GENEROUS
- e.g., A teacher can retire earlier at 59 years old and receive a comfortable pension, in addition to higher annual benefits.
(C) There are HIGHER HURDLES for DISMISSING poor performance
- Strong public sector unions PROTECT low performers BY RESISTING DISMISSAL
- e.g., LA spent $3.5M from 2000 to 2010 to dismiss 33,000 teachers, but succeeded in only dismissing 5.
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What are the negative externalities of HIGH DRIVING ACTIVITY
1) Congestion (reduces productivity)
2) Air and noise pollution to the environment
3) Accident risk (causes injury, increases healthcare costs)
5) Health effects (from air pollution)
Other externalities:
- loss of biodiversity from land loss/deforestation
- water contamination
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Private sector unions often argue that enforcing higher wages only leads to a redistribution of
some of the firm’s profits to its workers. Do you agree? Why or why not? Briefly discuss
NO this is incorrect because:
(1) Firms respond by using less labour to produce the lower output, leading to fewer workers who benefit from the wage increase.
(2) Firms with market power respond to higher labor costs by charging higher prices, which in turn reduces consumer demand for products. Enforcing higher wages implies a shrinking "pie", so it is not just a redistribution of rents
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What are the motives for mergers?
(1) Increase market power
(2) Realize cost synergies
Both result in higher profits.
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What is the structure of the patent application?
1) Abstract - brief summary of the content of the specification.
2) Specification - complete description of the invention and its USEFULNESS. There are also REFERENCES to related patents.
3) Claims - description of characteristics of invention that are claimed for EXCLUSIVE PROPERTY. Defines BOUNDARIES of invention.
4) Drawings - must be included when the invention can be shown by one. Clear description of drawings
