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US price gouging and EC competition law: notes and comments

This page is for notes and comments on US price gouging and EC competition law | viewpoint: Franck.

Comment by Matt [Wed Oct 26 05:19:15 2005]

A key part of your response to Becker is that "an actual or hypothetical negotiation would be expected to result in most of the value being transferred to the rescuer."

Actually there is no reason to assume that. Both sides lose out if the ship goes down. The rescuer who fails to reach agreement bears an opportunity cost: a share of the cargo she could have won is lost. Ignoring the (possibly important) facts that one side may lose their lives and the legal ramifications for survivors, the negotiation positions of both sides are equal.

"Becker identified the short timescales for any transaction, but seemed not to realise that the relevant effect of these short timescales is the impossibility of competition (you cannot invite tenders for other ships to rescue you), rather than the purported impossibility of negotiation."

Your entire competition analysis is flawed, because you do not realize that competition is missing from both sides of the rescue negotiation. A negotiation between a sinking ship and a rescuer is actually conducted between two monopolists. The rescuer cannot extract higher surplus from the sinking ship by threatening to go elsewhere. Similarly, the sinking ship cannot go elsewhere for help. The negotiation is a zero sum game with the only decision being how to divide up the fixed surplus made available by rescue.

This is actually a problem faced by all firms who invest in sunk assets who must deal with vertically related firms. Consider the owner of the only sea dock in town negotiating docking charges with the only shipping firm visiting that port. There is a fixed amount of surplus to be divided up (the monopoly rents on boat transport to and from the town) but, in this case, no time limit on negotiations. Without agreement, nobody gets any surplus.

Becker is right to say that timescales matter, because no specific law is required to deal with the port example above. There is no competition failure per se. There are non-legal responses the parties can make to solve the problem, in particular by vertically integrating (one firm buys out the other), by writing a long term contract, or by not investing in sunk assets in the first place (e.g. renting a floating dock). It is only timeframe, not the lack of competition, that prevents a complete negotiation or these alternatives from coming into force as they do elsewhere; only under a severe time constraint are overriding laws needed.

I think you are right to recognize (as most do not, for some reason) that competition can still be working when prices rise in an emergency and when it is working there is no need to intervene. An interesting question what the best response is when competition fails: is it to tolerate monopoly pricing, or to impose caps and bear under-supply?

I think a simple static welfare diagram is instructive. Ignoring for the moment distributive effects, the DWL of monopoly is the standard small triangle but the DWL from a partly or entirely missing market under price caps is potentially far larger. What this means is that if competition fails in an emergency it may be (and I suspect will be) better (from a total surplus perspective) to have gasoline at monopoly prices than to have the price capped and bear the surplus losses by having less or no gasoline available at all.

The objection to this is that at monopoly prices the monopolist makes a killing and, despite lower overall surplus with a price cap, consumers may well be better of with a price cap than without. Therefore, the price cap is preferred.

We can argue all day about which is preferred, but it is probably worth considering the effect of monopoly prices on entry, and by that I mean an increase in the number of firms or individuals doing whatever the monopolist did to get to his monopoly position in the first place. Capping prices discourages entry. It may be precisely because of the legal or moral constraints on monopoly pricing under emergencies that produced a market failure in the first place.


Response by Franck [Wed Oct 26 11:09:18 2005]

Thank you Matt for these comments.

I'll concede that I am not sure that the rescue ship would be able to extract most of the value. But it was not a completely baseless point: I thought it had actually happened in the case referred to by Posner as a source for the law of salvage at sea.

It would also seem consistent with a simple game theory model under which delay in doing a deal causes at least as much harm to the sinking ship's captain as to the rescue ship's captain. If their losses were equal, which would be the simplest model (under which they both face the probability of losing their share of the cargo if the rescue fails because of delay in reaching an agreement), then I would expect 50-50 sharing. But all the refinements of that model that I can think of, such as the potential loss of life on the sinking ship (but not on the rescue ship, if there is no rescue), the ability of the rescue ship (but not of the sinking ship) to influence timing unilaterally by providing interim assistance, or to mitigate loss by part-unloading the cargo, would tend to lead to a greater share being captured by the rescue ship.

Because of this, the story of a two thirds share related by Posner did not surprise me. But I probably went too far in claiming a universal expectation that this would always be the case.

I agree with you that the above would not be a reputable competition analysis. To be more precise, it is not a competition analysis at all: it does not consider competition. I don't think I claimed that anything like that would constitute a competition analysis.

Turning to your more substantive point, I agree that a deal will almost certainly be made to rescue the ship, or to grant access to the port in your hypothetical example, irrespective of any legal prohibition on excessive charges. The only difference that the law makes in these examples is to the level of the price charged, not to the economic activities undertaken.

But I think a price can be unfair and unjust even if it has no direct effect on trade between the parties. I do not fall for the fallacy that an economic calculation of the effects of a pricing decision is either feasible (taking account of second-, third- etc. round effects), or necessarily relevant to justice.

Admiralty courts, US common law courts, courts applying EC competition law and probably many others appear to have found, each in their own ways, that some forms of exploitation were unjust. I do not think that the basis for that decision in any of the cases that I referred to was anything to do with facilitating the transaction under dispute: that transaction had already happened anyway in most of these cases. Because of this, the point that the sensible transaction would happen irrespective of the legal regime, whilst true, is not of great assistance in understanding the logic of these precedents.

The idea of considering consumers and producers asymmetrically and of preferring consumers if the question of preference arises has force in some cases. But I don't think it really helps with the salvage at sea cases either: a hole in the ship's hull may well turn a supplier (of transport services) into a customer (of rescue services), but I am not sure that that makes it a consumer in the sense used in antitrust cases relating to merger or agreements where the interests of consumers may be an important factor.

Your final point about entry is of course entirely correct. I had hoped to convey the same idea by referring to actual or potential effective competition as being sufficient to prevent a dominant position and therefore preclude any Article 82 restrictions on exploitative prices, and I have tried to clarify my drafting. But if there is no scope for entry in the relevant market, as assumed in the case of rescue at sea (where the market is for the rescue of a particular sinking ship), then price restraints cannot deter competitive constraints from entry as there would be nothing to be deterred. In such a case it seems reasonable to me that the law should provide protection from unfair exploitation (if the conditions in which a sinking ship finds itself dependent of its rescuer are considered "abnormal").


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Last changed by Franck at 11:16 AM on Wednesday 26 October 2005.

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Reckon Open "US price gouging and EC competition law | viewpoint: Franck | notes" 2005-10-26T11:16:05