Question 1 (100% of marks)
You are the New Zealand Commerce Commission. An application for authorisation of a merger is in front of you.
Two electricity generators propose to merge. There will be a substantial lessening of competition. An archangel* has appeared to you in a dream and revealed that the value of the detriments caused by lessened competition has been accurately quantified at NZ$1 zillion.
There will also be benefits. The archangel* has told you that the value of improved quality and security of supply has been accurately costed at NZ$2 zillion.
However, a major industrial user of electricity (the archangel* says you may want to think of aluminium) is highly price-sensitive, and will immediately close when prices rise post-merger and it is unable to compete with cheaper imports. Its closure will also have immediate knock-on adverse effects on users of its output. The archangel* says that the detriments arising in the aluminium and aluminium-using sectors have been accurately costed at NZ$3 zillion.
There are no other relevant facts.
Do you authorise the merger?
Give your reasons. Write on one side of the paper. Stop writing when the bell goes.
* TRIGGER WARNING While 'archangel' is encountered in several major world religions, some examinees may find this spectral concept alarming. If so, (a) substitute any near-omniscient process or entity you are more comfortable with, and/or (b) report the matter to the college authorities, who will conduct a fair and full investigation and then harry the examiner out of academic life.
Not following your figures. Does the $1 zillion of "detriments caused by lessened competition" include the $3 zillion of detriments caused to the aluminium sector, so that $1 zillion is the net of $3 zillion detriments and $2 zillion benefits; or is the $3 zillion aluminium detriment additional to the $1 billion, so that total detriments is $4 zillion? In either case it looks as though the detriments outweigh the benefits
ReplyDeleteVery nice reply. I won't commit to any definitive response just yet as others may yet weigh in, but you've definitely got hold of one of the moving parts
DeleteI am with Wellington Haiku on being confused by whether aluminium detriments are additional to lessened competition detriments.
ReplyDeleteThe case seems to hinge on how the archangel has calculated the aluminium detriments.
The fact that the smelter is very sensitive to electricity prices suggests that the international aluminium market is competitive, with a lot of plants producing at comparable prices. As NZ pays world prices for aluminium, this means that domestic aluminium-users won't face major price increases as a result of the plant closure. (There may be some added freight costs, but international shipping is pretty cheap right now.)
This leads me to think that the adverse effects on aluminium-users in NZ will be pretty small. They will continue to pay similar input prices, albeit from different sources.
So the $3 zillion figure must arise primarily as a result of costs to employees and suppliers of the smelter. If the archangel has done anything multiplier-y then we can probably discount the majority of this figure. But even if not, it's worth asking what assumptions have been made about inflexibility in labour reallocation, fixed costs associated with firm closure, etc.
I don't have enough information to make a good decision!
Another very nice reply. You've picked up (as Wellington Haiku did) on whether the aluminium detriments are separate or already included, and that's certainly one of the moving parts. As I said to him/her/them, I'll hold fire for now on a response.
ReplyDeleteThose are also excellent questions about the quantification of the aluminium detriments. I especially liked your point that maybe the global market is competitive and that any local price increase must necessarily be small. Nice one.
Let's suppose, though, that aluminium-sector impacts haven't in fact already been included in the benefits and detriments in the electricity generation market, and that the detriments occur wholly in an aluminium or aluminium-consuming market.
Now what?
Still having a bit of trouble seeing the mechanism through which $3 zillion in additional costs for aluminium consumers arises. Local aluminium price *must* be constrained by international competition in order for the smelter to shut down in response to increased electricity input costs (rather than passing on higher costs to local consumers).
DeleteA further question: when calculating detriments from lessened competition, how are transfers between buyers and sellers treated? That is, if the electricity company put up prices, would the reduced competition detriments include the total increase in prices or only the deadweight loss?
If the latter, I could sort of see a mechanism through which we'd end up with $3zn in net costs in the downstream sector. E.G. if the aluminium-producing and -using sector was large, highly-price sensitive, and there was high potential for stranded assets or difficulty reallocating labour to other industries.
aluminium is traded internationally, but we don't know whether the archangel has determined that the detriments would be local or international. I know what I would assume, and how foolish that would be.
ReplyDeleteThanks for the comments. The archangel has told me that for these purposes the detriments are wholly local.
ReplyDeleteI'm working up to providing an 'answer' but I suspect it'll provoke more comments than the question...