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- Absent entry barriers, if a dominant firm set price above competitive level, new firms would enter and force prices down.
- Suppose dominant firm enjoys economies of scale, while entry can only occur on a small scale
- Dominant firm has lower unit costs of production.
- Dominant firm may set prices at a level low enough to make entry unattractive, while still maintaining price above competitive level.
- Dominant firm forgoes some supernormal profits in short-run
- By deterring entry it enjoys higher profits over time.
- Such a pricing strategy is referred to in the economics literature as 'limit pricing'.
- Milgrom, P. and Roberts, J., (1982): Limit Pricing and Entry with Incomplete Information: An Equilibrium Analysis, Econometrica, 50: 443-60.
- Predation may constitute a particular variant of limit pricing.
- Previous example assumed that entry only possible at a small scale level so costs are higher than incumbent.
- Suppose entry possible at a sufficient scale to achieve same level of economies as incumbent.
- Entrant may believe increased supply due to large scale entry would push prices down to such a degree that entry would be unprofitable.
- Depends, to some extent, on incumbent not reducing its output in response to new entry, i.e. accommodating entry.
- May be in incumbent's interest to reduce output in response to entry in order to keep prices up.
- Incumbent could deter entry if it could somehow commit itself to maintaining existing level of output in the face of entry.
- One means of doing this would be to invest in increased capacity, raising fixed costs, indicating that it would have to maintain output to cover fixed costs.
- Outlawing limit pricing would be highly problematic.
- 'difficult to see virtue in rule that would require dominant firm to always charge as much as possible in SR or be accused of predatory behaviour.'
- Klein (2001) The Microsoft Case: What Can a Dominant Firm do to Defend its Dominant Position, Journal of Economic Perspectives 15(2)
- Dominant firm may charge prices which are well above the competitive level.
- ECJ has considered prices to be unfairly high when the economic value of the goods or services is well below the price charged for such goods or services. Case 26/75 General Motors v. Commission [1975] ECR 1367.
- Economic value determined on basis of production and supply costs of the goods or services, or by reference to prices for comparable goods. Case 27/76 United Brands v. Commission [1978] ECR 207.
In Lucazeau v Sacem the ECJ concluded that:
'When an undertaking holding a dominant position imposes scales of fees for its services which are appreciably higher than those charged in other member states, and where a comparison of the fee levels has been made on a consistent basis, this difference must be regarded as indicative of an abuse of a dominant position. In such a case it is for the undertaking in question to justify the difference by reference to objective dissimilarities between the situation in the member state concerned and the situation prevailing in all the other member states.' [1989] ECR 2811.
Court judgement in Sacem disturbing:
- How is economic value of product to be determined if the market does not constrain pricing decisions.
- Danger that a firm could be fined for charging a price which the Commission later decides exceeds the economic value of the product.
Office of Fair Trading - prices can be considered excessive if they allow undertakings to sustain greater profits than would otherwise occur in a competitive market, i.e. 'super-normal profit'.
Prices would not be considered abusive if they occur for short periods within competitive markets, if they reflect superior efficiency, or if they occur in markets where there is innovation to improve products and/or processes.
OFT Guideline 402.
- US law only concerned with conduct that is designed to maintain or strengthen dominant position.
- EU law – conduct can be abusive even if it does not maintain or strengthen dominant position.
- EU – pure exploitation of market power e.g. excessive pricing can breach competition law
- Vickers, J., Abuse of Market Power, speech to European Association for Research in Industrial Economics, September 2004, www.oft.gov.uk/NR/rdonlyres/948B9FAF-B83C-49F5-B0FA-B25214DE6199/0/spe0304.pdf
- Commission now less likely to pursue claims of excessive pricing than in the past.
- Common in public utilities, e.g. gas, electricity, telecommunications.
- Justification based on importance of sectors and need to protect consumers against abuse of monopoly power.
- But regulation has serious weaknesses.
- Measures to promote greater competition in such industries may be superior to regulation.
- See P. Massey: Is Irish Utility Regulation Failing Consumers? ESRI, Quarterly Economic Commentary, winter 2004 available at: http://www.esri.ie/pdf/QEC1204SA_Massey_Is Irish Utility Regulation failing Consumers.pdf
Sale of different units of a good or service at different prices where the differential is not equivalent to differences in the cost of supply.
Three conditions necessary for price discrimination:
- The firm must have some degree of market power giving it some control over price.
- It must be able to segregate its customers into groups with differing price elasticities of demand, i.e. there must be different markets.
- There must be no scope for arbitrage, i.e. customers paying the lower price must not be able to sell to those being charged the higher price.
Three Types of Price Discrimination
- Involves charging each individual customer the maximum price which they would be prepared to pay.
- Normally difficult to engage in first degree price discrimination because it is difficult to prevent arbitrage.
- MMC found that British Gas engaged in first degree price discrimination.
- In the case of scarce goods, sealed bid auctions represent a means of engaging in first degree price discrimination.
- Involves volume discounts.
- Soft drinks. Six packs may be sold at a lower unit price than individual cans. Simple rationale.
- Some consumers only want an individual can and will pay higher price. Others might be prepared to buy more than one can if unit price is lower or might buy none at all at the high price charged for an individual can. Such consumers might purchase six packs at lower unit price.
- Firm gains by charging a high price to those consumers wishing to purchase individual cans, while simultaneously charging a lower unit price to those consumers who are prepared to purchase more than one can, but only at the lower price.
- Two tier tariffs represent another form of second degree price discrimination. Common in utilities where consumers pay a fixed charge for access plus a separate charge for each unit of the product consumed.
- Second degree price discrimination commonly observed in many consumer goods markets.
- Often occurs in oligopolistic markets rather than in those with dominant firm.
- Arises where different prices are charged to different groups of consumers.
- Traditionally airline tickets a good example. Discounted tickets offered subject to certain conditions.
- Cinemas charge lower prices for afternoon shows than for evening shows. Market is segmented because many people work in the afternoon and cannot go to the lower price show.
- Retailer discounts for OAPs.
Price discrimination frequently welfare enhancing.
- But may be exploitative and result in monopoly pricing.
- Actual instances of price discrimination require careful analysis to see if they should be regarded as anti-competitive.
- e-commerce could facilitate price discrimination between customers, resulting in market prices which relate more closely to customers willingness to pay. Auctions one means of practising first degree price discrimination.
- E-commerce may also facilitate greater use of yield management systems which are a tool for second degree price discrimination.
- Potential for e-commerce to dramatically increase information available to e-retailers may enable far more sophisticated forms of third degree price discrimination than was previously possible.
- Efficiency justification for price discrimination will tend to be strong in e-commerce markets. Office of Fair Trading, (2000): E-commerce and its Implications for Competition Policy, Discussion Paper no.1.
- 'applying dissimilar terms to similar contracts, thus putting a trading party at a competitive disadvantage'
- Thus price discrimination, which places a buyer at a competitive disadvantage, is prohibited under national and EU law, unless there is some objective justification for the difference - would not appear to prohibit price discrimination in the case of consumers.
- Commission held that regular shippers to a port could not be charged less for pilot services than others, unless there was some justifiable economy of scale. OJ 1997 L301/27, [1998] 4 CMLR 91.
- Port of Genoa
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