Ec 360- Midterm Set 4

Front 1

What do defendants and plaintiffs prefer when it comes to market definition?

Back 1

Defendants prefer a broad market definition, while plaintiffs prefer a narrow definition

Front 2

How to calculate Cross-elsticity of demand

Back 2

2 products (Product a and Product b). Are they substitutes?


Θab = (%ΔQa/%ΔPb)

High elasticity of two products means that they are in the same market.
How high does the cross-elasticity of demand (Θ) need to be?

Front 3

Defining geographic markets.

Back 3

1. Demand-side geographic substitutability-
-If there is a price increase, will there be substitution to other sellers to make price increase profitable?
*If yes, then market is expanded until answer is no.

2. Supply-side geographic substitutability-
-If all producers in area raise prices, would this be unprofitable by supply response of firms located outside designated area?
*If yes, then market is expanded until answer is no.

Front 4

Describe geographic markets.

Back 4

Smaller products have larger markets because it costs less to ship and the opposite if true for larger/heavier products.

Front 5

Evidence on geographic markets

Back 5

1. Shipment patterns of firms located in area under consideration
2.Evidence of buyers actually shifting purchases among sellers in differing geographic areas
3. Differences in price movements of relevant product
4. Transportation costs
5. Costs of local distribution
6. Excess capacity of firms outside area of consideration

Front 6

Defining product markets

Back 6

1. Demand-side product substitutability-
-Willingness and ability of consumers to switch purchases to other product that serves the same function

2. Supply-side product substitutability-
-The capability and willingness of firms that a re currently producing some other good to easily adapt their productive capacity to manufacture the good in question

Front 7

Evidence on product markets

Back 7

1. Evidence of buyers perceptions that the products are/not substitutes
2. Differences in price movements of products or similarities of price movements in a period that are not explainable by common parallel changes
3. Similarities or differences between the products customary usage, design, physical composition, ext.
4. Evidence of sellers perceptions that products are/not substitutes, particularly if business decisions are based on those perceptions

Front 8

Types of evidence used to define markets

Back 8

1.Revealing arbitrage

2. Empirical Test by Elzinga and Hogarty:
a) % of product consumed in an area that is also produced in that area
b) % of product produced in an area that is also consumed in that area
*Limited to geographic dimension (not product)

Front 9

Cross-Elasticity of Demand and Supply

Back 9

Problems:
1. Incorrect correlations
2. Requires econometrics (Complex)
3. Delays of price changes are unaccounted

Front 10

Modern Approaches to define markets

Back 10

1. Partial adjustment approach by Horowitz

2. Causality by ME Slade
*variables X a& Y are prices of a product in a geographic area, find causal relationship between X & Y

3. Residual Demand Approach-
*Using econometrics and the price elasticity of that demand curve is calculated

Front 11

What is the Lerner Index?

Back 11

The Lerner Index (λ) is a measure of firm’s level of power in a market. The Lerner Index is given by the difference between a monopolist’s price (Pm) and the competitive price (Pc) divided by the monopolist’s price (Pm).

Front 12

What range of values can the Lerner Index portray?

Back 12

The Lerner index ranges from a maximum of 1 to a minimum of 0, with lower values implying lower market power.

Front 13

How can the Lerner Index be modified to only use the price elasticity of demand?

Back 13

If we have:
λ= (Pm - Pc)/Pm

We know that Pm= MC
We also know that MR=MC for a monopolist.

We can re-write as:
(Pm - MC)/Pm = (Pm - MR)/Pm

We know that MR= P(1+ 1/η)

Where η is the price-elasticity of demand

We can re-write as:
λ= -(1/η)
or
λ= 1/|η|

Front 14

Why does λ= 1/|η| make sense intuitively?

Back 14

As the firm's demand becomes more elastic, the monopoly power (e.i. power over price) falls

Front 15

What is the Lerner Index for the Dominant Firm model?

Back 15

λ= S/(η+ ε(1-S))

S= share of total output accounted for by the dominant firm
η= price elasticity of market demand
ε= price elasticity of supply of the fringe producers

Front 16

What are the structural determinants of market power?

Back 16

1. η= price elasticity of market demand
*Sell output in a relatively price inelastic market
2. S= Market share
3. ε= price elasticity of supply of the fringe producers
*Primarily determined by entry a barriers

Front 17

Describe the Relation ship between Market Definition and the Structural Determinants of Power.

Back 17

If we define a market too narrowly (we excluded products that are close substitutes), this will mean that market share will be overstated. If we stop here, market power will be incorrect.

If we use the 2 remaining Structural Determinants of Power (price elasticity of market demand & price elasticity of supply of the fringe producers), there should be some correction.

Front 18

Describe Monopoly Power in Practice.

Back 18

We know that in reality all firms have some market power. Market power is continuous, some have much, some have little, but there is no absolute.

If a firm has little market power, it is NOT optimal pursue antitrust violation because the small market power only reduces social welfare by a small amount but litigation would reduce social welfare by a greater amount if a suit brought up.

Front 19

Monopoly profit vs. Lerner Index

Back 19

We say that a firm enjoying excess economic profits is likely a monopoly.

It id difficult to calculate economic profit. We CANNOT use accounting profits

Economic profit:
π= PQ -C*Q-D-iV

Where D= economic depreciation (not accounting), and iV= Opportunity cost on the owned assets of the firm