We're now going to take a closer look at another important instrument of competition policy, abuse control. Let's look at techniques of defining markets and of measuring, market power. So what does abuse control mean in the first place? Abuse control, just to recap, is about banning the abusive exploitation of a dominant market position, or anti competitive practices, that will tend to lead to such a dominant position. How do you assess if a firm is abusing it's power? So, you first define what the relevant market is, he then assess whether the company is actually dominant in the respective market, and then you look at the company's behavior and see if that harms or excludes competitors from this specific market. So, there are three dimensions in which we can define a market. First of all, the product market. So what products and/or services are similar? What products compete with each other? Second, the geographic market. So which, so how far would a consumer be willing to travel to purchase a, purchase a product? In other words which geographic area is relevant? And that will, depends very strongly on the kind of product in question. If you're looking for ice cream for consumers, then the geographically relevant market may not be longer than one street. If you're looking for cars for end consumers, then the relevant market might well be one state or at least one metropolitan area. So the third one is the consumer market, as a market, as a way of defining a market. So which consumers or consumer groups are interested in, in, in purchasing a product. So to define the relevant markets, the, well anti-trust authorities have defined a number of different techniques. And we're going to first going to look at the hypothetical monopolist or SSNIP test, so HM or SSNIP. So the question that's being asked here is can a hypothetical monopolist, the HM, increase its profits by imposing a small but significant and non transitory increase in price that's where we get the acronym SSNIP from. So, what does that mean, and what's the result of that? Well, if the answer is no, so that a hypothetical monopolist would actually lose profits, so he would lower his profits if he increased his prices this would mean that the market has to include the next closest substitute, and we repeat the test. If a hypothetical monopolist can indeed increase profits by increasing prices, then we would have a correctly specified market. This is going to basically go on and on, up until you define the market correctly, meaning that if we looked at the number of firms that are currently active in the, in the market, and, we hypothetically assume that these were all replaced by a single one firm, by a single monopolist, If that monopolist could increase profits by increasing prices, then we're looking at the right definition of the market. And we'll look at this in a, in a video quiz. So, you might wonder, well doing or thinking of the hypothetical monopolies or the HM or SSNIP test, what are the forces that keep firms from increasing or keep a profit from rising if we increase prices. Well, there are basically two forces. There's demand side substitution, simply meaning that if you increase prices people are going to buy something else. So, if you're looking let's say for the market for ice cream, and you're looking at, strawberry ice cream, If you increase the prices for strawberry ice cream, people would simply start buying other types of ice cream. Which means that there is demand side substitution. Secondly there could be supply side substitution in the sense that if you start increasing prices other firms, other competitors, would enter the market and therefore would make it impossible for you to raise prices to the same extent and actually increase profits. So therefore, that also tells us something about the kind of information that we need, if we want to perform a hypothetical monopolist or SSNIP test. Basically, we need information on market demand elasticity, in other word, by how much does my quantity, the quantity demanded increase or decrease, if we change prices. And supply elasticity, in what way does supply change, if we increase prices, if market prices increase? And for this, an important concept is the concept of cross price elasticity. Cross-price elasticity allows us to assess the relationship of two products to each other. So if cross-price elasticity is positive, then products are substitutes. If it's negative, these goods are complements. So, let's spend a second on assessing what that means, or in interpreting what that means. Cross-price elasticity, gives us a description of what's going to happen if one firm increases their price, or if the price one product increases. If cross-price elasticity is positive, that means that a price increase by product A is going to lead to a demand increase for product B. And that, of course, is the case if you've got two products that are substitutes, because if one of them becomes more expensive, the other one becomes more attractive relatively speaking to the one who's price has just increased. A set of cross-price elasticities, will give us a good picture of which products are closely related to each other, and therefore constitute a single market. So, let's look at this in a shortened video quiz. So, how do we measure market power and how do we actually market-measure concentration? Well concentration can be first of all measured by the number of firms. IIf we simply take the number of firms, of course the more firms there are in an industry, the less concentrated the market is going to be. So if we take the inverse of the number of firms, then the higher value of C is going to mean a higher degree of concentration, and of course here the highest concentration would be if you only have a single firm. The second measure and that's slightly more nuanced is the so called N-firm concentration ratio. That is simply the market share of the n largest firms, Right? So, we simply add up the market shares of the, say, four largest firms, to make sure that that we cover the four largest, the four most powerful firms in an industry. So this is of course much more useful, than the number of firms simply counting the number of firms, because, here, we take into account that larger firms of course, have a larger impact on concentration than smaller firms. What we're leaving out here,is the fact that of course the fifth largest firm could be almost as large as the fourth largest. And within the four largest, it could be one firm dominating all three others that remain in the four largest. Another, and an even more detailed measure of market concentration, is the so call Herfindahl-Hirschman Index, or HHI. And what you do there is you basically take the shares, the market shares of all the firms in the industry, you square each of those market shares, and you take the sum of all these squares. And that's going to give you values anything between zero, and ten thousand. Where zero would basically mean an infinite number of tiny, tiny firms and ten thousand would be the Herfindahl index of just a single monopolist. And this is often used as a guideline for merger and competition authorities to see, well, what is an acceptable level of concentration and when should authorities start looking into a merger more closely to see if it actually creates too much market power. So, if a Herfindahl index is below 1000 we talk about acceptable concentration. And if you do the math you'll find that this is more than 10 firms competing evenly in a market. If the Herfindahl index is somewhere between 1000 and 1800, we talk about moderate to high concentration in which case, merger just might possibly be allowed, but there might be some conditions imposed on it. And above 1800, above a Herfindahl index of 1800, It's almost certain that a merger is going to be investigated in quite some detail. So, if we simply look at the different measure of market power for two hypothetically examples here. So, if we look at market A and market B we've got eight firms, and we've got the market shares in each of those markets ordered by their size. So looking at the number of firms, or the inverse of the numbers of firms, we have one dived by eight in both cases. If we look at the C4 concentration ratio. So that is adding up the number of the four largest, firms in the industry, we get 75% for market A and we get 75% for market B. So are these two markets identical in terms of their concentration? Well not necessarily because just visually looking at this, you'll see that in market B there is one firm with 40% market share, which is actually, three times as much as the second largest firm in the industry. In market A you'll have three firms that basically have that have the same market share of 20% each. So if we take the Herfindahl index, remember this is the sum of the squares of all the market shares in the industry. You'll find an Herfindahl index of 2170 for market B and 1600 for market A. And why do we get that? Where does that come from? It comes from the fact that in market B, there is one firm that is more powerful than most of the others, than all of the others. And so, if we square all of these numbers, you'll see that more powerful firm become, get more weight in entering the Herphinal Index. So, we'll do this is a shortened video quiz. So as you can see, it's getting more and more complicated to differentiate what's in line with, or in breach with competition policy. But hang in there, you've almost made it through this module. [BLANK]
