Chillin'Competition

Relaxing whilst doing Competition Law is not an Oxymoron

Predictably Irrational – Behavioral Economics and Competition Law

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predictably-irrational

 

I’m currently reading Predictably Irrational, an extremely interesting and thought provoking book on behavioral economics. It challenges traditional assumptions regarding, amongst others, price theory and rational profit maximizing behavior, precisely the tenets of economic thinking that underpin competition law’s design and application.

The subject of the possible uses of behavioral economics for competition law purposes remains largely unexplored, even if now seems to be on the rise. Nevertheless, the controversy over the validity of rational choice theories is by no means new. Challenges to such theories have been rebutted in the past, sometimes brilliantly and even humoristically, by some of the most prominent antitrust scholars:

Skimming through ‘The Antitrust Paradox‘ I came across Bork’s dismissal of the objection that business are not purely, or even primarly, rational profit seekers. Bork argues -quoting Friedman- that price theory does not require the assumption of effective profit maximizing behavior, but rather that firms ‘generally behave as if they were engaged in maximization. But, in addition, he has a somehow more interesting argument when he states that:

‘[i]f required I should not hesitate to impute conscious profit maximizing to businessmen -experience with businessmen, and even more, with antitrust lawyers and consulting economists should convince anyone that profit is a goal not only consciously but constantly borne in mind‘.

(There we are, us, poor innocent antitrust professionals, turned into the quintaessential rent seekers….)

This notwithstanding, this  book on behavioral econ. certainly has a valid point. Whilst behavioral econ. is ill-suited to replace rational choice theory as the theoretical framework for competition law, this rising discipline can surely contribute to raise our awareness about the existence of unavoidable flaws in traditional analysis.

Moreover, there are surely some direct applications of behavioral economics which could be useful for competition law purposes. Let’s illustrate this through a few examples.

First, behavioral econ. may help identify systematic biases or deviations from rational prescriptions which would aid in determining whether in some instances firms are more or less likely to engage in non-profit maximizing strategies than we generally tend to believe (e.g. predatory pricing when recoupment is unlikely).

Also, some studies aim at explaining why ‘overconfident entrants’ may decide to enter into a given market ignoring unfavorable conditions and high barriers and therefore tipically fail in their attempt (if that were so, then reliance on entry rates to qualify market power should be replaced by the sole study of successful penetration).

Another possible use of behavioral econ. relates to ex post assessment of predictions on the effect of mergers. Competition authorities could increase their efforts to empirically evaluate ex post how accurately economic models used in merger control predict the effects of mergers in order to explore whether systematic deviations might also take place. I understand that US authorities are starting to follow this path (after all, the laxity of the Bush administration in the area of merger control provides for a favorable environment for such exercise), but I am not aware of such developments in other jurisdictions.

Finally, the possible uses of this disciple in the area of competition law must not necessarily be confined to analyzing why businessmen and firms engage in irrational behavior; it would surely be interesting to study when and why competition authorities behave irrationally.

(Image possibly subject to copyrights: see here)

Written by Alfonso Lamadrid

9 November 2009 at 6:43 am

Posted in Guest bloggers

2 Responses

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  1. […] relation to Alfonso’s earlier post regarding behavioral economics, I was amazed to learn today that Cass Sunstein (Harvard Law School) and Richard Thaler (University […]

  2. […] provider in the event of a price increase.  This further confirms that, as priorly discussed here, assuming profit-maximizing behavior on the part of consumers  -although perhaps inevitable and […]


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