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DEPARTMENT OF ECONOMICS  EC337 Industrial Economics 2:Market Economics, Competition and Regulation Insertyour ID number here:  1510790 TAKE HOME PROBLEM SET Answer BOTHquestionsSection A (40 marks)Section B (60 marks) ·        This take-home problem set isworth up to 20 marks of your final mark on this module (i.e. up to 20% of thetotal marks available) and for visiting students not taking the final exam itis worth 100 marks·        The take-home problem set will be marked out of 100 and forstudents taking the final exam it will be adjusted pro rata to a mark out of 20·        Write your answers in a suitableword processing package and convert the final file into *.pdf format and uploadvia the e-submission system managed by the Department ·        You must adhere to the word count limits – penalties will applyfor exceeding the word count (mathematical notation will be excluded from theword count but ALL other text included)·        The take-home problem set is partlymodelled on the final exam structure but differs in detail from the final examwhere you must answer the two questions in section A each worth 25 marks and answerone question from a choice of three questions in section B worth 50 marks Thedeadline for submission of your answers is nolater than 23:55, Wednesday 10thJan 2018 (UK time)SECTION A one question 1.

      Market Definition a.      In no more than 200 words describethe salient economic characteristics of a relevant market. 10 marksMoreover, relevant markets mayhave various economic markets combined made of products that are sufficientlysubstitutable. In addition, relevant markets foster competitive behaviour.Consequently, anti-trust enforcement agencies may recognise such markets withan aim to ensuring competition is encouraged, upheld and continued to benefitconsumers.  Relevant markets are identifiablethrough Hypothetical Monopolist testing.

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The test finds that relevant marketsmust adhere to the relevant product and geographic markets. This means theproducts sold must be viewed as substitutable by the consumers given theproducts’ characteristics, prices and intended use. The definition also makesreference to the location of manufacture and/or sales. A hypotheticalprofit-maximising firm in such a market without price regulation would always bethe sole producer of those products in that area. The firm is likely to impose”small but significant and non-transitory increases in price” which tends totypically be a 5-10% increase, while successfully maintaining positive profits.

Therefore, a relevant market is a group of products and a geographic area whichis small enough to satisfy this test.  Word Count: 172  b.      In no more than 200 words describecritical loss analysis.  10 marksAs with the HypotheticalMonopolist test, Critical Loss Analysis (CLA) is also a simple algebraic toolused to identify anti-trust markets.

CLA addresses the amount of sales requiredto be forgone to make a hypothetical price rise unprofitable i.e. if priceswere raised by x%, the rise/fall of profits depends on the response of quantity.

 Critical Loss is the smallestpercentage loss in sales that makes a 5% or 10% increase in price, by ahypothetical monopolist, unprofitable. I will use a basic model to explain CLA. Suppose we have anindustry with market price p and quantity q. For a monopolist, an increasein price would cause profits gained to be equal to ?p(?q+q). The subsequentfall in quantity sold would cause a profit reduction of (p-c)?q. Equating bothequations enables us to find Critical Loss (?q*/q*):Then dividing through by pq,thus allowing to solve for ?q*/q*:In the above equation, the Gross Margin (m) represents the price-cost markup (or the ‘Lerner Index’).

Forinstance, if the SSNIP=10% and the Gross Margin=30%, Critical Loss would beequal to 25%. In this case, if quantity sold fell by 25% or more, negativeprofits would realise.Word Count (without mathematicalnotation): 196 c.      Suppose that the estimated actualloss associated for a 5% price increase for local radio advertising is nogreater than the estimated critical loss for a 5% price increase.  In no more than 200 words explain whatinference can be made about the relevant market. 10 marksActual Loss (AL) is the actual percentagedecrease in sales (observed or predicted) due to increasing price by 5% or 10%.

In the case, where AL>CL, the relevant market can be assumed to be widerthan the market currently considered. This is because there are closesubstitute goods that consumers turn to as a result of the price increase,causing the price increase to fail to realise profits. The firm is thereforehindered by competition forces.

Thus, widening the market would diminish theextent of rivalry.  For this question the 5% priceincrease results in AL?CL. In this case, we can infer that there exist no closesubstitutes, potentially due to the lack of competition in the market. Thisconsequently allows the firm to utilise market power and thus exerciseprice-setting power, which in turn will adversely affect the consumer. Moreover,another reason for AL?CL may be due to a relatively larger increase in theprice of substitute goods, if the cross elasticity is sufficiently large (ACritical Analysis of Critical Loss Analysis, O’Brien and Wickelgren, 2004). AsAL?CL, we can also assume that the market for local radio advertising forms theboundary for the relevant market.

                 Word Count: 197               d.      In no more than 200 words describehow competition authorities like the Competition and Markets Authority in theUK typically operationalise critical loss analysis in merger cases.10 marksThe Competition and Markets Authority (CMA) is mainly responsiblefor investigating mergers which could stifle competition, and conductingresearch in markets where competition problems arise.

Furthering the earlieranswer, CLA is commonly used to assess mergers, as evidenced below. One example of a merger case isthat conducted by the Office for Fair Trading (OFT) in 2008. Dunfermline Press(who owned 23 local and regional papers in the UK and 3 in Berkshire) acquiredBerkshire Regional Newspapers portfolio from Trinity Mirror plc (six localnewspaper titles). As they both advertised the supply of newspapers, thequestion arose as to whether the relevant market was only local newspaperadvertising, or whether it included advertising in other sources of media (e.g.

local radio). Dunfermline Press conducted a telephone survey of 300+ advertisers,where all participants were asked about a hypothetical 10% increase in price.Consequently, 13% said they would no longer advertise, while 48% would spendless on advertising, producing an Actual Loss in excess of 13%. Dunfermlinethen estimated that AL>CL, suggesting that the market for local advertisingwas wider than just newspapers.

In order to maintain competition, the OFTcleared acquisition subject to divestiture of one local title.                  Word Count:198    SECTION B onequestion 2.      Vertical Restraints a.      A manufacturer of product X setsout contractual terms and conditions applicable to distributors selling productX.  In no more than 300 words outline anddescribe the competitive characteristics of the three main categories ofvertical restraints that may be applied by the manufacturer.  15 marksThis part will be marked according to the University’s 20-point scale: https://warwick.

ac.uk/services/aro/dar/quality/categories/examinations/marking/ug2017/                        In this case, vertical restraints arecompetition restrictions between the manufacturer and distributor of product Xthrough a contractual agreement. Exclusivityclauses form three main categories of vertical restraints, coveringgeography, brands, and customers.  One category of exclusive clausesis Exclusive Distribution. This restraint places a restriction onterritory by fixing the number of retailers permitted to sell a brand in anarea, limiting intra-brand competition. The main intentions of doing so, fromthe manufacturer’s standpoint, are control and costs.

For manufacturers, it ischeaper to form contracts with fewer distributors than many due to improved managementof production and storage costs, and distribution. For retailers, benefits fromsuch a contract arise due to the subsequent lack of competition in theirgeographical areas, resulting in greater sales.  Exclusive Dealing restricts the downstream distributor’s ability to sell competitorbrands, limitinginter-brand competition.

It is considered to be vital for the manufacturer inorder to maintain product image, safety and reputation. It also enablesmanufacturers the chance to exercise control over their retailing chains forstrategic purposes. Exclusive Dealing also causes the prevention of free ridingamongst downstream firms (which reduces investment levels below that of thesocial optimum welfare maximising level), thus solving the Horizontal ExternalityProblem.  Finally, Selective Distribution allowsmanufacturers to choose which type of distributors to use. By restricting thesale of their brand to certain retailer types will enable the manufacturer totarget a particular clientele to maximise sales. It will also allow amanufacturer to gain price-setting power.

 For instance, if Gucci used both Lidl and Harvey Nichols asdistributors, the average customer willingness to pay would be lower than ifGucci simply used Harvey Nichols. Due to the diminished brand image, theutility obtained by the consumer would also subsequently fall. Word Count: 296 b.      Suppose the manufacturer of X limitsintra-brand competition among distributors. Is this restriction of competitive rivalry defendable?  In no more than 300 words explain yourreasoning.    15 marksThis part will be marked according to the University’s 20-point scale: https://warwick.

ac.uk/services/aro/dar/quality/categories/examinations/marking/ug2017/                The limitations on intra-brandcompetition is due to the manufacturer agreeing on exclusive distribution ofproduct X with the distributor. Although this may be deemed anti-competitive bythe CMA due to an attempt of the manufacturer to monopolise an area, such arestriction also has advantages which will be addressed in this answer. This particular restriction wouldreduce consumer choice below the socially optimal level, which would be a causefor concern for the CMA.

It could also encourage upstream firms to charge thedistributors higher prices to largen profits. This would indirectly be filteredinto higher market prices which would be incurred by customers.  However, such a clause isjustifiable when addressing other market concerns. Horizontal externalities mayarise when many retailers sell the same brand.

In a given market with severaldistributors, one firm is likely to under-invest in things such as marketingand after-sales servicing, assuming other distributors of the same brand willmake such investments. The distributor can reap the benefits of other distributors’investments without spending anything, thus minimizing costs and potentiallyreducing prices to attract an entire client base. This is a form offree-riding.

However, if all distributors adopt the same mentality, similar tothat shown in the Prisoner’s Dilemma, every distributor will under-investcompared to that which will achieve the social optimum. Although pricereductions will benefit consumers, they will also incur costs such as a lack ofaccess to information and lower product quality. I will consider the case of BMW (manufacturer) and itsrelationship with showrooms (distributors). Instead of using severaldistributors who may free-ride upon one another (and thus refrain frominvesting in things such as advertising and free test drives), BMW distributesits cars exclusively to ensure necessary investments are made to reach sociallyoptimal levels.                 Word Count: 298 c.      In a competition case in the UKcurrently under appeal to the Competition Appeal Tribunal, golf clubmanufacturer Ping Europe Limited (Ping) has been fined £1.

45 million forbanning UK retailers from selling its golf clubs online.  Imagine you have been commissioned by a newspaperto prepare a summary of the economicarguments of both parties in the case (CMA and Ping).  In no more than 600 words write a clear andconcise account for the newspaper.30 marksThis part will be marked according to the University’s 20-point scale: https://warwick.ac.

uk/services/aro/dar/quality/categories/examinations/marking/ug2017/  On 24th August 2017,golf club manufacturers Ping Europe Limited (Ping) received a £1.45 millionfine by the Competition and Markets Authority (CMA) due to anti-competitivepractices 1.  The CMA is the UK’s maincompetition enforcement authority, with the primary aim of promotingcompetition for the benefit of consumers 4.

Ping has received theaforementioned fine as the firm banned UK retailers from selling its golf clubsonline, thus violating the TFEU Article 101 and the UK Competition Act 1998. Bothof these cover anti-competitive agreements which restrict or preventcompetition both within the UK and between EU member states respectively 1.  In October 2017, Ping finalised anappeal via the Competition Appeal Tribunal under Section 46 of the CompetitionAct 1998 3. Their main reason behind the banning of online sales was due tothe importance of Dynamic Face-to-Face Custom Fitting.

  As the name suggests, the firm intended toensure that each customer was offered enhanced product choice and customersatisfaction, a benefit which cannot be offered online. This point is extendedfurther within the appeal; representatives argue that the fine is unfair as thedecision is incorrect to characterise Ping’s Internet Policy as a competition restrictionas it pursues a legitimate aim of custom fitting, and customer satisfaction. Onthis basis, Ping drew the conclusion that the fine imposed upon them by the CMAwas unjust as Ping never intentionally chose to be anti-competitive.Subsequently, instead of accepting the £1.45 million fine, Ping sought to annulthe fine, and that the costs of the appeal were covered by the CMA 3. Moreover,the network externality effect can be used as an argument for Ping to defendsuch selective distribution.

This effect suggests that if a producer makes itsproduct available to many distributors, the brand value may diminish, resultingin consumers’ willingness to pay to also fall 7. The lack of such a restraintcould also be at the cost of lower service quality and lower availability inthe long term 4.   The CMA is not unfamiliar withsuch anti-competitive behaviour. Even prior to this case, in March 2016, OxeraConsulting and Accent undertook market research as assigned by the CMA to studybusinesses’ incentives to use vertical restraints, and subsequent effects one-commerce. As alluded to earlier, findings suggested that firms’ reasoningbehind such restraints was in an attempt to prevent free-riding, maintain pre-and after-sales service quality, and protect brand image 4, all of which canbe applied to Ping.

 However, the CMA similarly hasvalid reasons to rebut Ping’s appeal. By the end of 2016, it is estimated thatconsumers in the UK will have collectively spent £126 billion on online goodsand services due to the privilege of using Direct Comparison Tools 5.Therefore, the CMA has understandably dedicated much time to ensuringcompetition is appropriately sustainable on the internet too.

Ann Pope, aSenior Director for Antitrust enforcement, issued a statement saying such bansenforced by Ping prevents all retailers from competing to attract internetusers to find the best deals, and also prevents retailers from reaching a largeconsumer base on online platforms 5. On this basis, the European Commission’sGuidelines on Vertical Restrictions (2010) has dubbed such restrictions ofcompetition as being “hardcore”.    In conclusion, although effortswere made by Ping to either nullify or reduce the fine, the appeal is yet to beresponded to.

The CMA’s intent with the fine is to both punish the golf companyfor their anti-competitive behaviour and deter other firms who may be temptedto follow suit.  Word Count: 593 To prepareyour report in part (c) you will find it helpful to use lecture notes fromTopic 9 and to do some desk-based research by visiting the following sites: 1 https://www.gov.

uk/government/news/cma-fines-ping-145m-for-online-sales-ban-on-golf-clubs CMA media release 2 https://www.gov.uk/cma-cases/sports-equipment-sector-anti-competitive-practices CMA Timeline for case with links to various documents3 http://www.catribunal.org.

uk/237-9999/1279-1-12-17-Ping-Europe-Limited.html Competition Appeal Tribunal case details and documentation 4 http://ec.europa.eu/competition/antitrust/e_commerce_files/competition_and_markets_authority_en.pdf CMA submission to the European Commission on the draft sector inquiryreport on E-Commerce – a useful piece outlining several issues, some relevantto this case  5 https://www.

hausfeld.com/news/eu/uk-enforcement-agency-issues-statement-of-objections-to-ping-on-online-sale German law firm summary of case – includes discussion ofexperience in Germany of similar cases (short document) 6 http://www.klgates.

com/files/Publication/7fbd8efb-cb87-44bb-8dc4-d1f348fddba6/Presentation/PublicationAttachment/cd700e9e-b5dc-4176-b554-d5d901ae86f1/1012-059_Practice_Note-The_Internet_and_Competition_Law.pdf Lexis-Nexis short document on the Internet and competition law 7 https://www.slaughterandmay.com/media/64575/the-eu-competition-rules-on-vertical-agreements.pdf Document produced by leading law firm looking at verticalagreements in general, including VABER (Vertical Agreements Block ExemptionRegulations) and MVBER (Motor Vehicle Block Exemption Regulations) Note part (c)makes use of the fact this is a take-home problem set    Dr. Chris DoyleModule Leader EC33720 December 2017

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