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1. Introduction to Price Fixing:Legal and Economic Foundations
Antitrust LawFall 2014 Yale Law School
Dale Collins
SLIDES FOR CLASS
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
2
Demand Curve
Price
Quantity
Demand curve
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
3
Revenues
Price
Quantityq
p
Demand curve
Revenues
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
4
Profits and Costs
Price
Quantity
Demand curve
Marginal cost curve
q
p
Profits
Costs
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
5
Profits and Costs
Price
Quantity
Demand curve
Marginal cost curve
q
p
Profits
Costs
Profits
Quantity*q
*
MR > MC MR < MC
MR = MC
Firm can make more profits by increasing q, since incremental revenue gains exceed incremental costs
Firm can make more profits by decreasing q, since incremental costs exceed incremental revenue gains
*q
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
Competitive Firms Competitive firms take prices as given
→ Individual output decisions do not affect the market-clearing pricePrice
Quantity
Demand curve
Marginal cost curve
qc
cpProfits
Costs
(Perceived) marginal revenue curve (MR = p)
When price does not change as the firm expands output, the firm will produce every unit for which p MC
p MC p MC
Increasing q increases profits
Increasing q decreases profits
6
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
Monopolist Firm A monopolist choice of output q affects the market-clearing price p
7
Price
Quantity
Demand curve
Marginal cost curve
mq
mp
Profits
Costs
Marginal revenue curve
When price decreases as the firm expands output, MR is less than p since in order to sell an additional unit the firm has to decrease the price for all units.
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
Moving to the Competitive Outcome Why a monopoly does not want to price at the competitive price
8
Price
Quantity
Demand curve
Marginal cost curve
Incrementallosses from lower prices on old sales
Incrementalcosts ofnew sales
mq
cq
mp
cp
Incrementalprofits from new sales
Incremental profit = Incremental revenues from new sales at lower price – incremental losses on old sales at lower price – incremental costs of new sales at lower price
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
Gains from Cartelization Why firms in a competitive market have an incentive to form a cartel
9
Price
Quantity
Marginal cost curve
Profits gained from old sales at higher prices
Avoided costs from reduced sales
mq
cq
mp
cp
Any q in this region yields higher aggregate profits than the competitive equilibrium
Demand curve
cq
Foregoneprofits from reduced sales
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
Obstacles to Cartel Formation The law
Cartel agreements are unenforceable (contract law) Cartel agreements are illegal (antitrust law)
Lack of sufficient market dominance Too few competitors join the cartel Too easy for new competitors to enter the market
Too much cheating on the cartel rule (incentive incompatibility) Not enough market transparency to tell if there is cheating
Failure to agree on distribution of monopoly rents
10
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
Too Much Cheating Single-period cartel game
11
45, 45 0, 50
50, 0 25, 25Competitive
Competitive
Monopoly
MonopolyFirm 2
Firm
1
Firms split monopoly profits of 90
Competitive firm takes total competitive profits of 50 against firm charging monopoly price
Firms split competitive profits of 50
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
Failure to Agree on Distribution of Rents Infinitely repeated games
12
Price
Quantity
Marginal cost curve
IncrementalProfits
IncrementalCosts
mq
cq
mp
cp
Folk theorem: Any q in this region is an equilibrium in an infinitely repeated game
Demand curve
Antitrust LawFall 2014 Yale Law SchoolDale Collins
www.appliedantitrust.com
13
Public Policy of Price Fixing
Quantity
MC
Aggregate demand curve
pc
qc
Price
Quantityqm
pm
MC
MRAggregate demand curve
Price
Perfectly Competitive Market
Consumer surplus
Perfect Monopoly Market
Producer surplus (monopoly rents)
Dead-weight loss
1. Shift in wealth from consumers to producers2. 2. Deadweight loss3. May retard innovation