This article is written by Palak Dwivedi.
Economics and law
Economic analysis of law seeks to answer two basic questions about legal rules. Firstly, what, in other words, are the consequences of the legal rules on the actions of the related actors? Is it socially desirable for legal laws to have these effects? The methodology used in economic analysis of law to address these positive and normative questions is the same as that used in economic analysis in general: the conduct of individuals and firms is defined assuming that they are forward-looking and rational, and the context of welfare economics is used to determine social desirability.
Bentham, who systematically analyzed how actors will behave in the face of legal incentives and measured results with respect to an explicitly defined measure of social welfare, can be said to have started the field of economic analysis of law (utilitarianism). The writings of Bentham include a substantial and expanded study of criminal law and law enforcement, some property law analysis, and a substantial treatment of the legal process. Economic principles are used to describe the consequences of legislation, to decide which legal rules are the most economically effective, and to forecast which legal rules will be enforced.
Economics and Competition
The importance of economics to the analysis and enforcement of competition policy and law has increased tremendously in the developed market economies in the past forty years. In younger and developing market economies, competition law itself has a history of twenty to twenty-five years at most – sometimes much less – and economic tools that have proven useful to competition law enforcement in developed market economies in focusing investigations and in assisting decision-makers in distinguishing central from secondary issues are inevitably less well understood. Probably the most general tendency concerning the meaning of competition in economic theory is to regard it as the opposite of monopoly.
An unfortunate result of this way of thinking has been no little confusion concerning the relationship between economic efficiency and business behavior. Whether it was seen as price undercutting by sellers, the bidding up of prices by buyers, or the entry of new firms into profitable industries, the fact is that competition entered economics as a concept which had empirical relevance and operational meaning in terms of contemporary business behavior. The traditional distinction between competition and monopoly was, in a fundamental sense, in appropriate to begin with, and that the merging of the concepts in a theory of monopolistic competition, which suggests that Monopolistic competition is a type of imperfect competition such that many producers sell products that are differentiated from one another (e.g. by branding or quality) and hence are not perfect substitutes.
In monopolistic competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices on the prices of other firms. Clearly, the failure to distinguish between the idea of competition and the idea of market structure is at the root of much of the ambiguity concerning the meaning of competition. As far as market structure, conceived of in terms of the paucity or plethora of sellers (buyers), is the appropriate focus of analysis, consistency would suggest relying on terms such as monopoly (sony), duopoly, triopoly, oligopoly, polypoly, and, perhaps, a newly-coined term ending in “poly,” the prefix of which means an indefinitely large number. Quantitative approaches to defining markets & identifying competitors:
- Demand elasticities.
- Residual demand curves.
- Price correlations.
- Trade flows.
If a firm raises its price, and as a result, • loses most of its custom to other firms, then it has many competitors. • keeps most or all of its custom, then it faces little competition.
The size of consumer reaction to changes in price is measured by the own-price elasticity of demand the negative sign gives a positive measure of elasticity.
Identify substitutes by using the cross-price elasticity of demand: the % change in quantity of product Y in response to a 1% change in the price P x of product X
When elasticity is positive, X and Y are substitutes. When negative, X and Y are complements.
Residual demand analysis
If pricing within is constrained, then the market definition is too narrow, and should include the “outsiders”: the basis of residual demand analysis. If the group have raised their prices alone in the past because of such localised cost or tax effects and their Total Revenue rose, then can conclude that the group faces few substitutes and so constitutes a well-defined market.
If two sellers are in the same market, then they should be subject to the same demand forces. So a higher demand for one should also increase for the other, and both should increase their prices. If two sellers are close substitutes, then their change in prices should be highly correlated. But the opposite may not hold: may be difficult to determine whether products with high price correlations are competitors in markets for inputs (so they respond to common cost changes) or outputs or both. Limited use in antitrust cases.
If the cost of transporting the product (or the buyer) from one area to another is prohibitively high, then identical products sold in different geographical markets will not be good substitutes, and not in the same market.
These were the approaches under economic analysis to determine a market.
Now coming back to the economic theory, it is one of the great paradoxes of economic science that every act of competition on the part of a businessman is evidence, of some degree of monopoly power, the ability to act in an unconstrained way. While the concepts of monopoly and perfect competition have this important common feature: both are situations in which the possibility of any competitive behavior has been ruled out by definition. The “perfection” of the concept of competition, that is, the emergence of the idea of competition as itself a market structure, was a distinguishing contribution of neoclassical economics.
In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In theoretical models where conditions of perfect competition hold, it has been theoretically demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium would be a Pareto optimum. An economy is said to be in a Pareto optimum state when no economic changes can make one individual better off without making at least one other individual worse off. Perfect competition provides both allocative efficiency and productive efficiency.
Monopoly is a market situation in which intra-industry competition has been defined away by identifying the firm as the industry. Perfect competition, on the other hand, is a market situation which, although itself the result of the free entry of a large number of formerly competing firms, has evolved or progressed to the point (of equilibrium) where no further competition within the industry is possible, or, in the words of A. A. Cournot, its intellectual parent, to the point where “the effects of competition have reached their limit”. One fundamental deficiency of competition as the concept has been employed in economic theory is that it has never been related in a systematic way to costs of production.
There has been a curious dichotomy in economic science in the assumption that self-interest alone will insure that the businessman will work optimally in the interests of society within the business enterprise, or in his administration of owned or hired, while without the enterprise, in his buying and selling of factors or products in the market, either an “invisible hand” of competition, or a “visible hand” of public policy, is needed to insure efficiency.
The two concepts of perfect competition and monpopoly as market structure are the basis of economics theory and primary step towards its analysis.
“Antitrust” or “competition law,” a set of policies now existing in most market economies, largely consists of two or three specific rules applied in more or less the same way in most nations. It outlaws (1) multilateral agreements, (2) unilateral actions, and (3) mergers and acquisitions if either of them is deemed to hinder the smooth operation of healthy markets. Most jurisdictions are now applying or purporting to apply these laws, more or less as described in contemporary microeconomic theory, in the service of some definition of economic ‘performance.’ In the United States and Europe, the word “antitrust,” which is a little unintended, remains widespread, although those laws are more generally referred to elsewhere as “competition regulation” or “competition law.”
As in China, Japan, and Russia, they are also often referred to as “anti-monopoly laws,” and as “trade practice regulation,” as in Australia and the United Kingdom. Competition law economization entails addressing antitrust problems as established by competition law in the following ways: 1. referring to economic theories, models, and categories when resolving antitrust cases; 2. using economics-related techniques and procedures in antitrust analyses; 3. examining actual market consequences of activities under investigation.
Competition law in India and other countries
India is hailed as a green-field competition regime. However, India’s competition law jurisprudence is older than many of its developing country counterparts. The Monopoly and Restrictive Trade Practices Act, 1969 was the first competition-related legislation of India followed by the recent enactment of the Competition Act, 2002. The Competition Act has also created a new enforcement authority, the Competition Commission of India (CCI), which is solely responsible for the enforcement and administration of the Competition Act.
The CCI comprises of a chairperson and not fewer than two and not more than six other members to be appointed by the Government of India. It keeps a check on abuse of dominant position, Cartel conduct, anti-competitive agreements. European competition law today derives mostly from articles 101 to 109 of the Treaty on the Functioning of the European Union (TFEU), as well as a series of Regulations and Directives. Four main policy areas include: Cartels, Market dominance, Mergers, control of proposed mergers, acquisitions and joint ventures involving companies that have a certain, defined amount of turnover in the EU, according to the European Union merger law, State aid, control of direct and indirect aid given by Member States of the Europe.
Economic tools and measures applied in competition law
The importance of economics to the analysis and enforcement of competition policy and law has increased excessively in the developed market economies. This assignment aims at giving a non-technical introduction to three economic tools that have become widespread in competition law enforcement in general and in the analysis of proposed mergers in particular: critical loss analysis, upward pricing pressure, and vertical arithmetic.
Critical loss analysis
Critical loss analysis has gained increasing importance in competition law. A critical loss is the loss in sales or output necessary to make a given price increase unprofitable, and thus it determines the amount of substitution needed to expand a provisional relevant market definition. Critical loss analysis remedies a number of deficiencies in the current approach to market definition, which focuses excessively on product characteristics and absolute price differences, and ignores the profitability of hypothetical price increase. It is a relatively simple calculation that better reflects the market definition test and fills a gap in the way market definition is determined. This test is often referred to as either the Hypothetical Monopolist Test (HMT) or, as it is called in the United States, the SSNIP test. It was developed by Barry Harris and Joseph Simons.
The formula used to calculate the critical loss depends only on the magnitude of the price increase being considered, and the contribution (or profit) margin (CM) of the group of firms attempting to increase prices. More precisely, in its simplest form, the critical loss is equal to Y/(Y + CM) × (100 per cent), where: Y = the hypothesised price increase (e.g. 5 or 10 per cent) expressed as a proportion (e.g. 0.05 or 0.10), and CM = the contribution margin defined as the difference between the original price and average variable cost stated as a proportion of the original price. the critical loss provides important information on the magnitude of the output effects required for market definition purposes which can be compared to company, industry and general market information to see whether substitution effects greater than or less than the critical loss seem plausible and reasonable.
In the United States, the concept of critical loss first appeared in FTC v. Occidental Petroleum Corp. This method involves cost estimates. The profit maximization derivations on SSNIP tests are based on the margin between price (or sometimes marginal revenue) and marginal cost to analyze the incentives of either individual firms or the hypothetical monopolist. In general, however, business firms do not calculate “marginal cost” in the ordinary course of business; rather, they usually calculate “variable cost”.
A variable cost is one that changes based on production output and costs there is a marginal cost when there are changes in the total cost of production. Since fixed costs are constant, they do not contribute to a change in total production costs. true marginal cost as the first derivative of total cost includes at least implicitly a rental value of capital, and this term may become especially important as firm and/or industry production approaches capacity. Another method that we will discuss in details is the upward pricing pressure.
Upward pricing pressure
UPP (Upward Pricing Pressure) is a tool with which it is possible to estimate the risk of a merger giving rise to unilateral effects. Unilateral effects may result from a merger between A and B because customers that would switch between A and B in response to a price increase are, post-merger, “internalised” by the merged entity. a new emphasis was placed on the degree to which competing products were close or distant substitutes to each other – a concept implemented in the term. The proportion of sales of good W lost as a result of a price change for good a that are “diverted” to good b is the diversion ratio Dab between two firms a and b.
Dab specifically proposed a merger that would be more troubling from a competitive point of view, ceteris paribus, with a greater benefit for this diversion ratio. In the output of good b, the price-cost margin was won. “If this margin were “high,” particularly with respect to the margin earned in the production of good a, the combined company would be very pleased to divert sales of a to sales of b; not so much if the margin earned on the production of a was “small. Increased focus was then concentrated on the commodity Dab(Pb-Cb), the value of a sales to the combined company, which was distracted by the price rise for a to b sales, a value called the “Gross Upward Pricing Pressure Index” (GUPPI).
Vertical agreements in competition law (vertical arithmetic)
This is the last economic tool that will be discussed in the assignment, it is relevant in cases of vertical agreements. Where a merger brings together two companies with strong market positions and complementary offerings, it raises the question how pricing will change and how competition will be affected. This includes vertical mergers between companies at different levels of the supply chain, and conglomerate mergers between suppliers of products that are assembled by customers into a single system. The two most useful models of neoclassical economics will be recalled here: the double marginalization problem and the free-rider problem.
Double marginalization is a vertical externality that occurs when two firms with market power (i.e., not in a situation of perfect competition), at different vertical levels in the same supply chain, apply a mark-up to their prices. This double markup creates a loss of deadweight since the final product is priced higher than the optimum monopoly price that would be set by a vertically integrated corporation, resulting in underproduction. The loss of surplus caused by monopolistic rivalry is compounded by this deadweight loss. In vertical deals, the free-rider model defines the advantages to be drawn from sticky and minimum costs. The model demonstrates how buyers benefit when retailers of a specific product or service spend more money in the production of sales-related services after a higher markup because they are not competing on price due to minimum resale price maintenance.
Indian economy and competition laws
It is one thing to have a competition law in effect, and another is to enforce its provisions. The fact that the Indian economy is going through a period of sharp inequality between those who have and those who have not is not to be denied. The stark difference between various classes of people from the bottom to the top of the economic ladder is a harsh fact. Although we see an almost vulgar show of opulence at one end of the continuum, there is a feeling of desperation at the other end of the spectrum, not knowing where the next meal is going to come from.
There are, of course, many reasons for this discrepancy, but there has been a change in thinking from curbing monopoly and unfair trade practices to promoting competition for the good of the common citizen with the implementation of regulatory measures to curb anti-competitive behavior.
In order to fulfill the mandate of the Constitution to ensure fairness, social, economic and political, as well as to ensure the ownership and control of the material resources of the society, both the executive and the persons entrusted with the execution and realization of the objects of the Competition Act, 2002, are allocated in such a way as to subserve the common good and to ensure that the operation.
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