Market Power and Regulation
Jean Tirole, a French economist focusing on industrial organization and microeconomics, won the 2014 Nobel Prize. Unlike many other Nobel winners, he is not a fan of free-market. When a market is dominated by a small number of firms, supracompetitive price will be charged on consumers. If these companies are left unregulated, there could be deadweight loss. Based on game theory and asymmetric information theory, Tirole suggests that regulators adjust regulation policies according to specific conditions of each industry instead of leaving it all to market force.
In class, we’ve discussed game theory and asymmetric information. Imperfect information in the market allows one party to take advantage of the other. This happens between buyers and sellers as well as firms and regulators. As for game theory, players will choose strategies with the best payoffs. A game involving sequential moves also allows players to obtain some information about the other player.
These ideas are also the fundamentals of Tirole’s work. For example, companies know much more about their business than the government. In the case of a natural monopoly, such as a telecommunications firm, free-market competition does not help. When new firms want to enter the market, the leading monopolist can use strategies like predatory pricing to kick them out. A monopolist in one market can also extend its monopoly power to another market via vertical integrations. Of course, government does not want it to hurt consumers with high price. Price cap seems to be a possible solution. But regulators indeed do not know what the cost of production is and what the company spends on innovations and development, which is significant and beneficial to the society. Firms will lose incentives to innovate while facing a hard price cap. What they will do is to save cost rather than offer low prices.
Tirole suggests, based on use of action design and game theory, that rather than try to force firms into a single form of contract, regulators should give them a choice. The choice would tell regulators what sorts of firm they are dealing with. Think about a two-person bargaining game with imperfect information, a player’s action might convey some information about his type. Firms, in this game, have to at least reveal some information of their cost levels, depending on the contract they choose.
Links: http://www.economist.com/news/finance-and-economics/21625824-jean-tirole-has-won-nobel-prize-economics-his-work-competition-its
https://www.washingtonpost.com/news/wonk/wp/2014/10/13/jean-tirole-won-the-2014-nobel-prize-in-economics-for-actually-showing-us-how-the-real-world-works/
https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2014/advanced-economicsciences2014.pdf