Why competition policy is needed
Competition policy (called antitrust in the USA) is the law and the agencies that protect competition. A firm with market power can charge more, make less, offer less choice and become lazy. Competition pushes firms to cut prices, improve quality and innovate.
Measuring market power
- Market share: a firm's sales ÷ total market sales.
- Concentration ratio (CRn): the total share of the n largest firms. CR4 = 87% means four firms have 87% of sales.
- Herfindahl-Hirschman Index (HHI): add the squares of every firm's percentage share. 0 to 10,000; below 1500 is competitive, above 2500 is highly concentrated.
- Many laws presume a firm with about 40–50% or more may be dominant.
Main agencies: the Competition Commission of India (CCI), the European Commission, the UK Competition and Markets Authority (CMA), and the US FTC and Department of Justice.
Regulating mergers
A merger joins two firms into one. A horizontal merger joins rivals at the same stage and raises concentration most. Vertical mergers join supplier and buyer; conglomerate mergers join unrelated firms.
Large mergers must be notified. The authority asks: will this substantially lessen competition and raise prices? Then it can:
- allow the merger,
- allow with remedies, such as selling some brands or stores,
- block it.
Possible benefits weighed against harm: economies of scale, lower costs and more research (dynamic efficiency).
Cartels and abuse of dominance
Cartels (anti-competitive agreements)
A cartel is an agreement between rivals to fix prices, share out customers or areas, limit output, or rig bids. It acts like a monopoly and harms buyers. It is illegal almost everywhere; fines can reach 10% of turnover and in some countries managers can go to prison. Leniency: the first member to confess gets immunity, which makes cartels break up.
Abuse of a dominant position
Having a big share is not illegal. Abusing it is. Examples:
- Predatory pricing: pricing below cost to drive out a rival, then raising prices.
- Tying or bundling: forcing buyers to take a second product.
- Refusal to supply rivals, or exclusive deals that shut rivals out.
- Excessive or discriminatory prices.
Regulating monopolies and natural monopolies
A natural monopoly exists when one firm can supply the whole market more cheaply than two (huge fixed costs: pipes, grids, track). Breaking it up would raise costs, so it is regulated instead:
- Price cap RPI − X: prices may rise by inflation (RPI or CPI) minus X%. X forces efficiency gains. If inflation is 4% and X is 3%, prices can rise only 1%. Some sectors use RPI − X + K, where K allows investment (for example new water pipes).
- Rate-of-return regulation: profit limited to a fair percentage of capital. Weakness: little reason to cut costs.
- Performance targets: punctual trains, fewer leaks, with fines if missed.
- Other tools: nationalisation, privatisation with deregulation, or opening the network so rivals can compete (contestable markets).
Problems: regulatory failure
Regulators may lack information about true costs, rules cost money to enforce, and regulatory capture can occur when the regulator starts serving the firms it controls.
Try it
In the last 3D step, merge two small firms, then the two largest. Note the HHI change each time. At home: pick a market you know (mobile networks, airlines, cola drinks). Guess the shares of the top four firms and work out CR4 and HHI. Would a merger between the top two worry you?
Key formulas and definitions
- Market share (%) = firm's sales ÷ market sales × 100
- n-firm concentration ratio CRn = sum of the n largest market shares
- HHI = s1² + s2² + … + sn² (shares in %); maximum 10,000
- Change in HHI from a merger of shares a and b = (a + b)² − a² − b² = 2ab
- Price cap: allowed price change = RPI − X (or RPI − X + K)
Worked examples
1. Shares are 35%, 25%, 15%, 10%, 10%, 5%. Find CR3.
35 + 25 + 15 = 75%.
2. Find the HHI for shares 40%, 30%, 20%, 10%.
1600 + 900 + 400 + 100 = 3000: highly concentrated.
3. Firms with 20% and 15% merge. By how much does HHI rise?
2 × 20 × 15 = 600. (Check: 35² − 20² − 15² = 1225 − 400 − 225 = 600.)
4. Inflation is 5% and X = 2%. A rail fare is ₹200. What is the highest fare allowed next year?
Allowed rise = 5 − 2 = 3%. 200 × 1.03 = ₹206.
5. Three bus companies agree to charge the same high fares on a route. What is this and what can the authority do?
It is a cartel (price fixing). The authority can fine the firms (up to 10% of turnover), order them to stop, and give leniency to the first firm that confesses.
6. Should a regulator break up a national electricity grid monopoly? Evaluate.
Probably not: the grid is a natural monopoly; two grids would double fixed costs. Better to regulate it with a price cap and performance targets, and allow competition in generation and retail. Risks: poor information and regulatory capture.
Common mistakes
- Saying it is illegal to have a large market share. Only abusing dominance is illegal.
- Thinking all mergers are blocked. Most are allowed; only those that substantially lessen competition are blocked or changed.
- Adding shares instead of squaring them for HHI.
- Believing RPI − X lets prices rise by X%. Prices may rise by inflation minus X.