SECTION (2) Chapter 5 Competition policy By DAVID YOUNG & STAN METCALFE 1997

The rationale for competition policy Competition policy: is concerned with maintaining a desirable level of competition between firms in a market economy to promote efficient working of the market

Advantages of competition 1.Efficient allocation of resources. 2.Looking after consumer choice. 3.Promotion of technological innovations. 4.Autonomy of industrial enterprises.

The nature of the competitive process In order to develop effective competition policy it is necessary to have a clear view of the meaning of competition. Competition policy is often seen as being necessary or helpful in aiding the competitive process and to correct any inadequacies or distortions existing in product markets. Neoclassical theory demonstrates notion of perfect competition that under certain specified conditions, which include the existence of a given technology and the absence of increasing returns to scale, perfect competition leads to all firms earning normal profits that are just enough to compensate them for their activity and to output and prices that maximize economic welfare. It defines a position of equilibrium which represents an optimal allocation of resources.

The nature of the competitive process cont…… Critic to neo-classical theory point out that the assumptions under which the neo-classical result are quite unrealistic. For example technology cannot be treated as exogenously given to firms it is determined by the activities of firms themselves (recall the strategy module). A firm must have adequate( enough) financial resources as well as an incentive to experiment with technological innovative activity. Given that the innovation process is subject to great uncertainly it may be difficult to finance such activity through reliance on external funds and the firm may need to draw on its own resources

The nature of the competitive process cont…… Also, innovation may require very considerable investment and the firm may need to earn super-normal profits for some time to secure such investment thus a ‘temporary monopoly’ may be required to induce firms to undertake innovative activity and perfect competition would be opposing with this requirements, because economies of scale, which are important in many industries are prohibited by perfect competition. If a firm can achieve scale economies (increasing return to scale) by producing a sufficiently large volume of output, it can reduce average costs, and the savings can be passed on to the consumers.

Does this mean that monopolies are not bad, and we should have no competitions policy? No Even though monopolies or oligopolies can in principle undertake innovation, they may not do so because of lack of competition pressure, and they may be under no pressure to pass on a share of these cost reductions to consumers in the form of lower prices. Thus, competition authorities need to be a balanced act. They need to consider the benefits of competition against the benefits of temporary monopolies and large size.

The theoretical basis of competition policy: impediment to competition The most noticeable barrier to competitive behavior in a market is the presence of Monopoly. Monopoly: is defined as a single seller of a given product, where there is no close substitute for this product, and where entry into market is blocked. The social cost of monopoly is considered very high, some estimates that it as high as (9%) of gross output in UK and in FRANCE. But some economists consider the profit that gained by monopolist a reward for risking-taking and as such it is considered a necessity for encouraging innovation. effort to solve this situation (situation of the loss in gross output) may arise out of developments in oligopoly which is about dominant positions, were a firm or a group of firms by virtue of its relativity high share of industry market output is in a position to extent a degree of dominance over the market. By virtue of this dominance, oligopolies acts as the price leader by setting price for the market in accordance with maximizing its own profit subject to demand constraint

Criticism of oligopoly 1.Oligopolies can restrict other firms’ choices via strategic behavior. 2. The degree of collusion of dominant firm e.g. cartel behavior; which involve a common price structure and some agreement over the output of the firms within the cartel.. 3.Merger activity, which has welfare implications arising from a variety of effects on the degree of competition. Merger activity mergers are of three types: –Horizontal. –Vertical. –Conglomerate. (for more details see p 50). The problems arising from monopoly power are influenced by political ideas more than the economic theory. The economic theory is critical in determining actual competition policy.

Competition policy in different EU countries UK: Main legislations for competition policy in UK are: Established the office of fair-trading (OFT) to refer any case of anticompetitive behavior to the monopolies and merger commission (MMC). Resale prices act and Restrictive trade practices act These two acts are given to prohibit collusion and Price-fixing agreements on the basis of operation against the public interest. Membership in Eu has created pressure on all member countries for further revision of legislative framework based on article 85 of the treaty of the European union (TEU). That Prohibited any anticompetitive practices.

Competition policy in different EU countries GERMANY: Competition policy is based on the 1957 act against restraints on competition. This act prohibits actions/ agreement to restrain competition, production with regard to trade in goods and commercial services. The act has been amended several times. The 1973 amended established mergers control and extended definition of market dominance. The 1980 amendments were particularly significant in extending the abuse of dominant positions. The 1989 amendments extended the dominance issue to powerful buyers (in addition to sellers).

Competition policy in different EU countries FRANCE: Anti-trust policies of FRANCE are significantly older than that of UK and GERMANY. Anti-monopoly legislations of FRANCE are the oldest in the world. Current legislations and policies are based on the post- war systems, which was substantially revised in 1977 to include tougher measures on mergers. Amendments in 1985 and 1986 strengthened merger policy and extended anti-trust norms. The interpretation of the law is the responsibility of the judiciary (in contradiction to the UK, where interpretation and implementation rests with the secretary of state)

Competition policy in different EU countries EU competition policy. The first concern of the founders of European economic commission (EEC) was the free mobility of goods, particularly goal and steel (1953). An essential element of (EU) (single European market (SEM) in 1992). Mobility of goods, services and factors of production so as to ensure the greatest efficiency in resource allocation. Competition policy of (EU) is based on the treaty of ROME. Traditionally, agreement not to compete has been part of European business mentality. Accordingly the imposing a competition policy on the member states. Articles 85 and 86 and the European commission merger regulation. The main concern of three pieces of regulations is adjustment of monopoly merger and anti-competitive practices. Policy to limit entry barriers, deregulate markets and stimulate innovation through technology policy is considered pro-competitive policy.