Category: Essential Economics for Business 7e and 6e

Why did a competition authority change its mind on one aspect of this merger?

In January 2022, Microsoft announced its plan to acquire Activision Blizzard for $68.7 billion. Activision Blizzard is one of the largest games publishers in the world and famous for titles such as Call of Duty and World of Warcraft. Sales revenue from Call of Duty: Modern Warfare II was over $10 billion within ten days of its release in 2022. Given Microsoft’s ownership of the Xbox, one of the three devices that dominate the market for gaming consoles, the deal was always likely to raise competition concerns.

Potential competition issues

Following Phase 1 and 2 merger investigations by the Competition and Markets Authority (CMA) a number of competition issues were raised. One particular concern was in the market for gaming consoles and the potential impact of the merger on the future availability of Call of Duty (CoD). Some of the key findings of the initial research undertaken by the CMA were that:

  • Sony’s PlayStation was a much closer rival for the Xbox than the Nintendo Switch, which tends to offer more family-orientated games.
  • PlayStation users spend significant amounts of gametime playing CoD.
  • Game availability is a key factor that influences console purchase decisions.
  • Twenty-four percent of PlayStation users who play CoD stated that they would not purchase future versions of the console if CoD was unavailable on the platform.

These findings suggest that there are commercial incentives for Microsoft to limit the availability of CoD on the PlayStation. For example, the newly merged business could make future versions of the game exclusive to the Xbox – total exclusivity. Alternatively, it could adopt a policy of partial exclusivity. For example, it could only make versions of CoD available on the PlayStation that exclude some of its more popular features.

There are costs to Microsoft of implementing a policy of total or partial exclusivity. For example, 76% per cent of PlayStation users who play CoD stated that they would not switch consoles if future versions of the game were made unavailable. By making CoD exclusive to Xbox users, Microsoft would lose revenue from forgoing potential sales of the game to this group of users. The firm may also suffer reputational damage if there was a social media backlash against an exclusivity decision.

However, these costs of implementing a policy of exclusivity could be outweighed by the potential benefits. These include:

  • The additional sales of consoles as some users switch from the PlayStation to the Xbox to gain access to CoD.
  • the sale of CoD and other games to these additional Xbox users.

To quantify these costs and benefits, the CMA used a financial model that includes information on the amounts of money users typically spend on the Xbox platform and CoD over a five-year period. This ‘lifetime value of customers’ model found that it would be profitable for Microsoft to implement a policy of exclusivity post-merger.

The CMA also noted that in the majority of cases where Microsoft had previously acquired gaming studios, the subsequent release of games had been made exclusive to the Xbox.

CMA findings

Following its analysis of the case, the CMA published its provisional findings on the 8th February 2023. One key finding was that the merger would harm consumers, as it would lead to a substantial lessening of competition in the supply of console gaming services. The CMA argued that the acquisition should proceed only if Activision Blizzard sold off the parts of its business responsible for producing CoD. This is a structural remedy.

Microsoft rejected these findings and argued that the financial modelling used by the CMA was based on inaccurate data. In its formal written response to the competition authority the company argued that:

  • The potential gains from a policy of exclusivity had been calculated over a five-year period whereas the costs (i.e. the forgone sales of CoD) had only been calculated over a one-year period. More accurate analysis should compare both the potential gains and losses over a five-year period.
  • When more recent data are used to calculate the amounts of money users typically spend on the Xbox platform and CoD over a five-year period, the figure is lower than in the original work by the CMA.

Revised CMA findings

Having adjusted its analysis to take account of these criticisms, the CMA published an update to its Provisional Findings on 24th March 2023. In this update the competition authority stated that:

The analysis now shows that it would not be commercially beneficial to Microsoft to make CoD exclusive to Xbox following the deal, but that Microsoft will instead still have the incentive to continue to make the game available on PlayStation.

Therefore, just six weeks after publishing its Provisional Findings the CMA changed its conclusion and stated that the merger would not result in a substantial lessening of competition in the market for the supply of console gaming services in the UK.

In response to these changes an ex-CMA lawyer stated that:

This is extremely unusual. Restating your provisional findings is something ‘you would rather die than do’.
It is important to remember that the investigation by the CMA also raised concerns about the impact of the acquisition on competition in the cloud gaming market. These concerns remain unaffected by these updated findings and a final report will be published by the CMA at the end of April.

Competition authorities from 16 different countries/regions are also investigating the deal, including the Federal Trade Commission in the USA and the European Commission. It will be interesting to see if these authorities agree on the potential impact of the merger on competition.

Articles

CMA documentation

Questions

  1. Under what circumstances could a merger result in a substantial lessening of competition?
  2. Summarise the thresholds that have to be met by a potential merger before it is investigated by the Competition and Markets Authority.
  3. Explain the direct and indirect network effects that exist in the console gaming market. To what extent do they create barriers to entry?
  4. Outline some different ways that Microsoft could introduce a policy of partial exclusivity for the Call of Duty franchise of games.
  5. What would be the impact of a policy of exclusivity on the cross price elasticity of demand between Xbox and PlayStation consoles?
  6. Outline the difference between behavioural and structural remedies for merger.
  7. Discuss why the acquisition of Activision by Microsoft might reduce competition in the cloud gaming market.

The United Nations International Panel on Climate Change (IPCC) has just published its most comprehensive report so far. It finds that ‘human activities, principally through emissions of greenhouse gases, have unequivocally caused global warming’. This has led to widespread and rapid changes in climate and biodiversity and to more extreme weather patterns, such as droughts, floods and hurricanes. What is more, the distribution of these effects is uneven, with communities who have contributed the least to current climate change being disproportionately affected.

At the 2015 COP21 climate change conference in Paris (see also), it was agreed to adopt policies to limit the increase in global temperatures to ‘well below’ 2°C above pre-industrial levels and to make an effort to limit it to 1.5°C. Global temperatures have already risen 1.1°C above 1850–1900 levels and are set to reach 1.5°C in the early 2030s. Every increment of global warming will intensify ‘multiple and concurrent hazards’.

Deep, rapid and sustained reductions in emissions would slow down the rise in global temperatures, but even with such reductions, temperatures will still exceed 1.5°C in the next few years and, even under the best-case scenario, would not fall below 1.5°C again until the end of the 21st century. Under more pessimistic scenarios, global temperatures could rise to 2.7°C above pre-industrial levels by the end of the century under an intermediate greenhouse gas emissions scenario and to 4.4°C under a very high emissions scenario. Anything above 2°C would be likely to have catastrophic effects. The longer countries wait to take action, the greater the rise in global temperatures and hence the greater the damage and the more costly it will be to rectify it.

‘For any given future warming level… projected long-term impacts are up to multiple times higher than currently observed (high confidence). Risks and projected adverse impacts and related losses and damages from climate change escalate with every increment of global warming (very high confidence). Climatic and non-climatic risks will increasingly interact, creating compound and cascading risks that are more complex and difficult to manage (high confidence).’ (Paragraph B2)

But the report is not all ‘doom and gloom’. It is possible to limit global warming to 1.5°C or only a little over by making rapid, deep and, in most cases, immediate greenhouse gas emissions reductions in all sectors and reaching net zero emissions in the early 2050s. Science and technology have the answers – answers that are now much cheaper and more available than back in 2015 when the 1.5°C target was agreed. But what it does require is doing ‘everything, everywhere, all at once’. And that requires political will and the right economic incentives.

The politics and economics of achieving net zero

In terms of the politics, there is general global agreement by governments about the likely effects of climate change. And most governments agree that action needs to be taken. However, there are three key political problems.

The first is that the costs of action will be borne now, while the benefits of action will accrue over a much longer period of time. This links to the second problem – the mismatch between the lives of governments and the long-term effects of climate change. If governments put off doing anything now and merely promise that something will be done in the future, they will not have to take unpopular actions, such as raising taxes on energy, private transport and certain goods or banning various activities. Future governments will have to sort things out, by when, although the problems will be greater, the existing politicians will no longer be in power.

The third problem concerns the distribution of the costs and benefits of action. The major emitters of carbon are the rich countries, while the major sufferers are poor people in countries subject to drought, flooding and rising sea levels. Not surprisingly, who should cut down on emissions and pay for the mitigation necessary in many of the poorer countries is a difficult political issue, which is why it’s much easier to say what needs to be achieved overall than precisely what measures should be taken by which countries.

These problems reflect the fact that many, if not most, of the environmental costs of production and consumption are external costs – costs borne, not by the direct producer or consumer, but by other people at other places and/or in the future.

Nevertheless, the relative costs of moving to greener production and consumption are falling. The costs of renewable energy, including solar power, onshore and offshore wind and hydroelectric power are falling relative to that generated from fossil fuels. At the same time, the take up of electric cars is likely to continue rising as battery technology improves. This does, of course, require an increase in charging infrastructure. Domestic heat pump technology is improving and home insulation methods are becoming more efficient.

Persuading consumers and firms to take account of environmental externalities could in part be achieved by education. It makes it much easier for politicians to take appropriate action now if their populations are on board. There has been increasing awareness over the years of the environmental impact of people’s actions. People have become more willing to take responsibility for the world that future generations will inherit. This is helped both by education in schools and colleges and by frequent items in the media.

But incentives also have a major part to play. To internalise environmental externalities, external costs could be taxed and external benefits subsidised.

The effect of a carbon tax on production

The use of taxes to reduce activities with negative environmental externalities is illustrated in the diagram (click here for a PowerPoint). It takes the case of carbon emissions from coal-fired electricity generation in a large country. To keep the analysis simple, it is assumed that all electricity in the country is generated from coal-fired power stations and that there are many such power stations, making the market perfectly competitive.

It is assumed that all the benefits from electricity production accrue solely to the consumers of electricity (i.e. there are no external benefits from consumption). Marginal private and marginal social benefits of the production of electricity are thus the same (MPB = MSB). The curve slopes downwards because, with a downward-sloping demand for electricity, higher output results in a lower marginal benefit (diminishing marginal utility).

Competitive market forces, with producers and consumers responding only to private costs and benefits, will result in a market equilibrium at point a in the diagram: i.e. where demand equals supply. The market equilibrium price is P0 while the market equilibrium quantity is Q0. However the presence of external costs in production means that MSC > MPC. In other words, MEC = b – a.

The socially optimal output would be Q* where P = MSB = MSC, achieved at the socially optimal price of P*. This is illustrated at point d and clearly shows how external costs of production in a perfectly competitive market result in overproduction: i.e. Q0 > Q*. From society’s point of view, too much electricity is being produced and consumed.

If a carbon tax of d – c is imposed on the electricity producers, it will now be in producers’ interests to produce at Q*, where their new private marginal costs (including tax) equals their marginal private benefit.

But this brings us back to the politics of measures to reduce emissions. People do not like paying higher taxes. In his latest Budget, the UK Chancellor, Jeremy Hunt, decided not to raise fuel duties by the 12p that had been previously planned, despite fuel prices having recently fallen. Meanwhile, charging prices for electric cars have risen.

Other economic measures

A simpler method for dealing with environmental externalities is ban certain activities that omit CO2. For example, in the UK there will be a ban on the sale of new petrol and diesel cars and vans from 2030 (with the exception of some low-emission hybrids until 2035). In the EU there will be a similar ban from 2035. Clearly, such measures are only suitable when there are non-emitting alternatives.

Another alternative is a cap-and-trade system, such as the European Emissions Trading Scheme. It involves setting quotas for emissions and allowing firms which manage to cut emissions to sell their surplus permits to less efficient firms. This puts a price pressure on firms to be more efficient. But the quotas (the ‘cap’) must be sufficiently tight if emissions are going to be cut to desired levels. Nevertheless, it is an efficient way of cutting emissions as it gives a competitive advantage to low-emission producers.

Conclusion

If the problem of global warming is to be limited to 1.5°C, or only very little above, multiple solutions will need to be found and there must be a combination of political will, economic incentives and the mobilisation of scientific and technical know-how. As the Secretary-General of the United Nations, António Guterres, stated in launching the new report:

This report is a clarion call to massively fast-track climate efforts by every country and every sector and on every timeframe. In short, our world needs climate action on all fronts – everything, everywhere, all at once.

Report

Videos

Articles

Questions

  1. Why might countries not do ‘everything, everywhere, all at once’ to avert climate change?
  2. What might an optimist conclude from the ICC report?
  3. To what extent is climate change an economic problem?
  4. On a diagram similar to the one above, show how a subsidy could be used to internalise positive externalities.
  5. How might countries reduce the consumption of fossil fuels in the most efficient way? Are they likely to want to do this? Explain.
  6. Is a ‘cap-and-trade’ (tradable permits) system (a) an effective means of reducing emissions; (b) an efficient system?

The mandates of central banks around the world are typically focused on controlling inflation. In many cases, this is accompanied by operational independence from government, but with the government setting an inflation target. The central bank then chooses the appropriate monetary policy to achieve the inflation target. This is argued to provide the conditions that can deliver lower and less variable inflation rates – at least over the longer term.

However, some economists argue that this has the potential to create the conditions for greater economic volatility and financial instability. The events surrounding the collapse of Silicon Valley Bank (SVB) – the largest since the global financial crisis – have helped to reignite these debates.

Inflation targeting central banks

The theoretical foundations for delegating monetary policy to central banks with mandates to meet an inflation rate target is often attributed to the paper of Fynn Kydland and Edward Prescott published in the Journal of Political Economy in 1977. It argues that if governments, rather than independent central banks, operate monetary policy, systemically-high inflation can become established if low-inflation announcements by governments lack credibility. Delegation of monetary to a central bank with an inflation rate target, however, can create the necessary conditions for credibility. This, in turn, gives the public confidence to maintain lower and more stable inflationary expectations than would otherwise be the case.

To mitigate the problem of a potential inflationary bias, it is argued that governments should delegate monetary policy to a conservative central banker: one that places less weight on output or employment stabilisation and more weight on inflation stabilisation than does society. However, as identified by Kenneth Rogoff in his paper published in the Quarterly Journal of Economics in 1985, this raises the spectre of greater volatility in output and employment when economies are buffeted by supply shocks.

Inflation–output stabilisation trade-off

The inflation–output stabilisation trade-off identified by Rogoff has particular relevance to the macroeconomic environment experienced by many countries in recent times. As economies began to open up after the pandemic, demand–supply imbalances saw the emergence of inflationary pressures. These pressures were then exacerbated by the Russian invasion of Ukraine, which drove up commodity prices.

Rather than pursuing a less contractionary policy in the face of these supply shocks so as to avoid recession, central banks stuck to their inflation mandates and hence raised interest rates significantly so as to bring inflation back to target as soon as possible. But this hampered economic recovery.

Inflation–financial stability trade-off

Yet the recent financial turmoil suggests a further inflation–stability trade-off: an inflation–financial stability trade-off. By raising interest rates, different sectors of the economy are liable to greater financial distress. This distress has contributed to the collapse of Silicon Valley Bank and Signature Bank, and led to a significant injection of funds by large US banks into First Republic. The fear is of a contagion within the financial sector, which then spills into other sectors of the economy.

The debate about central bank mandates and the weight attached to inflation stability relative to other objectives is therefore centre stage of macroeconomic policy debates.

Articles

Questions

  1. Explain the argument that the delegation of monetary policy can help to keep the average rate of inflation lower.
  2. How might the monetary policy responses of central banks to an inflation shock create the possibility of an inflation–output stabilisation trade-off?
  3. What do you understand by a Taylor rule? Could this help to alleviate the inflation-output stabilisation trade-off?
  4. Some economists argue that there is less of a trade-off between inflation and output stability with demand-pull inflation because of a so-called ‘divine coincidence’ in monetary policy. Why might this be the case?
  5. What do you understand by the term ‘financial distress’? What metrics could be used to capture this for different sectors of the economy?
  6. Explain how financial contagion can spread both within and between different sectors of the economy.

In two previous posts, one at the end of 2019 and one in July 2021, we looked at moves around the world to introduce a four-day working week, with no increase in hours on the days worked and no reduction in weekly pay. Firms would gain if increased worker energy and motivation resulted in a gain in output. They would also gain if fewer hours resulted in lower costs.

Workers would be likely to gain from less stress and burnout and a better work–life balance. What is more, firms’ and workers’ carbon footprint could be reduced as less time was spent at work and in commuting.

If the same output could be produced with fewer hours worked, this would represent an increase in labour productivity measured in output per hour.

The UK’s poor productivity record since 2008

Since the financial crisis of 2007–8, the growth in UK productivity has been sluggish. This is illustrated in the chart, which looks at the production industries: i.e. it excludes services, where average productivity growth tends to be slower. (Click here for a PowerPoint of the chart.)

Prior to the crisis, from 1998 to 2007, UK productivity in the production industries grew at an annual rate of 6.1%. From 2007 to the start of the pandemic in 2020, the average annual productivity growth rate in these industries was a mere 0.5%.

It grew rapidly for a short time at the start of the pandemic, but this was because many businesses temporarily shut down or went to part-time working, and many of these temporary job cuts were low-wage/low productivity jobs. If you take services, the effect was even stronger as sectors such as hospitality, leisure and retail were particularly affected and labour productivity in these sectors tends to be low. As industries opened up and took on more workers, so average productivity fell back. In the four quarters to 2022 Q3 (the latest data available), productivity in the production industries fell by 6.8%.

If you project the average productivity growth rate from 1998 to 2007 of 6.1% forwards (see grey dashed line), then by 2022 Q3, output per hour in the production industries would have been 21/4 times (125%) higher than it actually was. This is a huge productivity gap.

Productivity in the UK is lower than in many other competitor countries. According to the ONS, output per hour in the UK in 2021 was $59.14 in the UK. This compares with an average of $64.93 for the G7 countries, $66.75 in France, £68.30 in Germany, $74.84 in the USA, $84.46 in Norway and $128.21 in Ireland. It is lower, however, in Italy ($54.59), Canada ($53.97) and Japan ($47.28).

As we saw in the blog, The UK’s poor productivity record, low UK productivity is caused by a number of factors, not least the lack of investment in physical capital, both by private companies and in public infrastructure, and the lack of investment in training. Other factors include short-termist attitudes of both politicians and management and generally poor management practices. But one cause is the poor motivation of many workers and the feeling of being overworked. One solution to this is the four-day week.

Latest evidence on the four-day week

Results have just been released of a pilot programme involving 61 companies and non-profit organisations in the UK and nearly 3000 workers. They took part in a six-month trial of a four-day week, with no increase in hours on the days worked and no loss in pay for employees – in other words, 100% of the pay for 80% of the time. The trial was a success, with 91% of organisations planning to continue with the four-day week and a further 4% leaning towards doing so.

The model adopted varied across companies, depending on what was seen as most suitable for them. Some gave everyone Friday off; others let staff choose which day to have off; others let staff work 80% of the hours on a flexible basis.

There was little difference in outcomes across different types of businesses. Compared with the same period last year, revenues rose by an average of 35%; sick days fell by two-thirds and 57% fewer staff left the firms. There were significant increases in well-being, with 39% saying they were less stressed, 40% that they were sleeping better; 75% that they had reduced levels of burnout and 54% that it was easier to achieve a good work–life balance. There were also positive environmental outcomes, with average commuting time falling by half an hour per week.

There is growing pressure around the world for employers to move to a four-day week and this pilot provides evidence that it significantly increases productivity and well-being.

Articles

Questions

  1. What are the possible advantages of moving to a four-day week?
  2. What are the possible disadvantages of moving to a four-day week?
  3. What types of companies or organisations are (a) most likely, (b) least likely to gain from a four-day week?
  4. Why has the UK’s productivity growth been lower than that of many of its major competitors?
  5. Why, if you use a log scale on the vertical axis, is a constant rate of growth shown as a straight line? What would a constant rate of growth line look like if you used a normal arithmetical scale for the vertical axis?
  6. Find out what is meant by the ‘fourth industrial revolution’. Does this hold out the hope of significant productivity improvements in the near future? (See, for example, last link above.)

Prices of used fully electric cars (EVs) are falling in the UK, even though prices of used internal combustion engine (ICE) cars are rising. According to Auto Trader (see the first two articles below), in February 2023 the average price of used petrol cars rose by 3.3% compared with January and the price of used diesel cars rose by 1.4%. But the price of used EVs fell by 9.1%. This follows a fall of 2.1% in January.

But why are used EV prices falling? After all, the last few years has seen a drive to replace ICEs with EVs and hybrids, with many consumers preferring electric cars to petrol and diesel ones. What is more, vehicle excise duty is currently zero for EVs (and will be until 2025) and the sale of new ICEs will be banned from the end of the decade. The answer lies in demand and supply.

On the demand side, many existing and potential EV owners worry about the charging infrastructure. The number of EVs has grown more rapidly than the number of charging points. In 2020 there was one charging point per 16 cars; by 2022 this had worsened to one per 30 cars. Also the distribution of charging points is patchy and there is a lack of rapid and ultra-rapid chargers. Increasingly, people have to queue for access to a charger and this can substantially delay a journey and could mean missed appointments. There were many pictures in the media around Christmas of long queues for chargers at service stations and supermarkets. Poor charging infrastructure can be more of a problem for second-hand EVs, which tend to have a smaller range.

Also on the demand side is the price of fuel. After the Russian invasion of Ukraine and the rise in oil prices, the price of petrol and diesel soared. This increased the cost of running ICE vehicles and boosted the demand for EVs. But the war also drove up the price of natural gas and this price largely determines the wholesale price of electricity. With government subsidies for electricity, this constrained the rise in electricity prices. This made running an EV for a time comparatively cheaper. More recently, the price of oil has fallen and with it the price of petrol and diesel. But electricity prices are set to rise in April as government subsidies cease. The cost advantage of running an electric car is likely to disappear, or at least substantially decline.

Another substitute for second-hand EVs is new EVs. As the range of new EVs increases, then anyone thinking about buying an EV may be more tempted to buy a new one rather than a used one. Such demand has also been driven by Tesla’s decision to cut the UK prices of many of it models by between 10% and 13%.

The fall in demand for used EVs is compounded, at least in the short term, by speculation. People thinking of trading in their ICE or hybrid car for a fully electric one are likely to wait if they see prices falling. Why buy now if, by waiting, you could get the same model cheaper?

On the supply side, EV owners, faced with the infrastructure problems outlined above, are likely to sell their EV and buy an ICE or hybrid one instead. This increases the supply of used EVs. This is again compounded by speculation as people thinking of selling their EV do so as quickly as possible before price falls further.

In many other countries, there is much more rapid investment in charging infrastructure and/or subsidies for purchasing not only new but used EVs. This has prevented or limited the fall in price of used EVs.

Articles

Questions

  1. Draw a supply and demand diagram to illustrate what has been happening in the market for used EVs.
  2. How has the price elasticity of (a) demand and (b) supply affected the amount by which used EV prices have fallen?
  3. Identify substitutes and complements for used electric vehicles. How relevant is the cross-price elasticity of demand for these complements and substitutes in determining price changes of used EVs?
  4. Draw a diagram to illustrate the effect of speculation on used EV prices.
  5. What is likely to happen to used EV prices in the months ahead? Explain.
  6. How are externalities in car usage relevant to government action to influence the market for EVs? What should determine the size of this intervention?
  7. Devise a short survey for people thinking of buying an EV to determine the factors that are likely to affect their decision to buy one and, if so, whether to buy a new or used one.