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Competition Policy

Competition and the Government
Governments have introduced competition policy in order to deal with issues arising from imperfect competition. The policies are designed to encourage competition in markets as well as to protect consumers. There is also a belief that competition induces firms to eliminate X-inefficiency and encourages better resource allocation. However competition may lead to the break-up of the production process and if there are lots of firms in a market then economies of scale may not be possible. 
The graph below compares an industry which can either operate under perfect competition or as a multi-plant monopolist. It is assumed that there are no cost differences between the forms of market structure, hence the LRS curve under perfect competition is the monopolists LRMC curve. If the market were operating under perfect competition then output would be QPC and the price would be PPC. Under a monopolist the output would be lower at QM. Therefore consumer surplus which is initially ABC is reduced to ADE with the blue rectangle being the consumer surplus redirected to the monopoly as profits and the red triangle being a deadweight loss to society. Competition policy intends to mitigate this deadweight loss.
This analysis is known as the structure-conduct-performance paradigm. This is the theory that the structure of a market (based on the number of firms) determines how the firms operate in the market which determines how well the market achieves allocative and productive efficiency. 
Under perfect competition firms are price takers and all firms maximise profits thus producing allocative efficiency. Conversely, a monopoly would extract consumer surplus by using its market power (price making ability) and in turn the market wouldn’t perform as well.
This leads the government to believe that monopolies or other types of market structure which firms conduct themselves in an anti-competitive demeanour to be negative. Mergers which can result in a higher concentration in a market (as there are less firms competing) will cause allocative inefficiency. Legislation may therefore be set to assume that a monopoly will have negative affects to society. It is also believed that it is the structure of the market which leads to this anti-competitive behaviour by firms.
Cost Conditions
We assumed that costs will be the same under perfect competition as under a monopoly. This is a simplified assumption as we would usually expect there to be economies of scale in a monopoly market. Therefore monopoly firms will likely face lower costs than a firm under perfect competition would.
We can see from the graph above what this might look like, with the long run marginal cost curve for the monopolist being lower than the long run supply curve. The monopoly profit maximises at MR=MC and the perfectly competitive firm chooses to produce where the demand curve intersects the supply curve (LRS intersects AR).
In this example a lower price has been achieved with more output sold under a monopoly market than under perfect competition. Although allocative efficiency isn’t achieved this is offset by the improvements to productive efficiency (gained because a monopolist has lower costs and may have economies of scale) and actually a higher quantity is being produced than if the firm were operating under perfect competition, price is also lower. But for allocative efficiency to occur in the monopoly market, prices would have to be set where P=LMC.
If a monopolist were regulated and was forced to produce allocatively efficiently it would make no supernormal profits. Therefore it won’t have an incentive to operate efficiently, which may lead to X-inefficiency and hence the firm wouldn’t be productively efficient. Schumpeter argued that monopoly profits led to more innovative products and would benefit society through higher investment in research and development. Small firms operating in a perfectly competitive market don’t have an incentive to invest in research and development and hence regulation can be seen as negative if it prohibits monopolies from spending on R&D.
The above example shows enormous cost differences, the graph to the right shows more modest cost differences. As we can see the monopoly situation still results in a deadweight loss to society (as shown by the red triangle) as the firm isn’t operating at P=MC and so isn’t allocatively efficient. However the highlighted rectangle shows productive efficiency which occurs under a monopoly firm but not a perfectly competitive market. This rectangle may reflect monopoly profits but is still an improvement and benefits society (as firms are considered a part of society). Therefore when deciding whether it would be better for society if the market was either a monopoly or productively efficient it is important to contrast the size of the gains from productive efficiency under a monopoly to the gains in allocative efficiency under a perfectly competitive firm. It is also important to remember income distribution by examining the effects of consumer surplus under either market.
If the market is contestable (barriers to entry into the market are low and the sunk costs of entry and exit are low and entry and exit can be achieved rapidly) then monopoly firms may need to lower the price in order to prevent potential hit-and-run entries. Therefore if the market s considered contestable the monopoly firm wont set a price above average costs and therefore there is no need for intervention by a regulator. Even if contestability isn’t perfect the monopoly firm may still have to set prices low to prevent entry.
The structure-conduct-performance paradigm indicates that any firm which has an influence over the price should be regulated by competition policy. This therefore means that oligopolies should also be watched over in order to ensure they don’t collude and effectively create a monopoly. Government authorities therefore should be cautious of markets with high concentration ratios even if they aren’t 100%. It is also important to consider whether structure determines conduct. 
A high concentration ratio could mean that there are a few firms of roughly equal sizes or that there is one large, predictably dominant in which case it should have sufficient power to set the price, firm with a number of smaller competitors. 
If there are a few firms with equal concentration then they may not necessarily collude if they decide to act competitively to defend or increase their respected market shares. This may be accentuated if the market is stagnant and so any growth comes only from taking a competitors share and customers.  This may result in a very competitive market. 
A firm that dominates a domestic market may have high competition in the global market and in other countries.  Some economists believe that governments should promote large firms to dominate the domestic market in order for them to take a large share in the global market and hence promote its national origins. It could conversely be argued that large firms should face heavy competition in the domestic market so that it can be more productively efficient which will enable it to deal with international competition.

Competition Policy in Britain

In the US there is particular distrust of monopolies where as the UK is less rigid with its competition policy towards monopoly firms. In the UK cases against monopolies or highly concentrated markets are judged on a case-by-case basis. Legislation in the UK is based on the 1948 Monopolies and Restrictive Practices Act. This formed a Commission which investigated markets in which a firm, or suspected cartel, supplied more than a third of the market. The Commission then had to decide whether the market was operating in the public interest.

Other legislation include the Competition Act of 1998 and the Enterprise Act of 2002. Cartels are covered by Chapter 1 of the Competitions Act which include price fixing and agreements to restrict output in a market. The Enterprise Act made forming a cartel a criminal offense rather than a civil offense (so a jail term may be sentenced).

The Commissions which deal with these two Acts are the OFT (Office of Fair Trading) and the Competition Commission. The OFT investigates a proposed merger and can either refer it to the CC or can impose sanctions. A merger will be scrutinised by the OFT if the firms involved in the merge have a combined share in the UK of more than 25% or if the combined assets of the firm are greater than £70 million globally. The OFT can then refer the merger to the CC, recommend changes in laws and regulations and campaign to promote consumer awareness (so they know their legal rights).

The OFT is more focused on the consumer side of affairs and acts as a standard tracings office. Any hint of ant competitiveness would be passed on for the Competition Commission to deal with.

The Competition Commission can only investigate a firm or merge if it has been referred to it by the OFT. The CC has the ability to issue fines and prison sentences and implements the law regarding anti-competitive behaviour. It also liaises with the European Union and corresponding competition authorities abroad. The CC won’t necessarily prohibit a merger even if the combined market share of the firms involved are over 25% so long as the merger won’t be against the public interest.

Relevant Markets

When conducting an investigation it is important to identify the relevant market, unless the regulator knows how much of the market to include in its investigation it cannot calculate market shares or concentration ratios. For example if undertaking a review of the newspaper market, does it include things like magazines, or is it just tabloids, what about broadsheets? Until it defines what firms it will include in the market it isn’t possible to accurately calculate the market share of the investigated firm.

To resolve this question regulators’ could use the hypothetical monopoly test. Using this method the product market is defined as the least amount of products in which a monopolist controlling all such products could raise profits by a small increase in price above the competitive level. This works because if not enough products are included in the test then hypothetical consumers would substitute the good and hence an increase in price would lead to a fall in consumption and so hypothetically the test has revealed that the set of products don’t lead to a monopoly and hence more products are needed to be added. The cross-price elasticity of demand could also be used here to see whether another firm or product should be included in the market analysis.

 It may also be necessary to consider whether there are substitutes in the supply side, whether a rise in prices may cause suppliers to enter the market.

The EU

Due to integrate within the European Union possible monopoly situations that may arise on a euro-wide basis are also investigated. The EU’s stance is similar to that of its member states (including the UK) and with globalisation occurring it may soon be necessary to co-ordinate policy on a worldwide basis.