Public Policy in Private Markets

Monopolization (section 2, Sherman Act)

Announcements

Case presentations: 6 groups = 3 cases Groups: Please check class website and make

sure your group is listed accurately (see Case Assignments section)

Tentative dates: Early March, Early April, Late April. Material will be posted 1 month in advance for each group.

Clickers: 1 student has been using clicker but it is not

registered. 11 students have not registered a clicker

Overview of Antitrust Laws

Sherman Act, Section 2

Monopolization

Market definition

Intent (next class) Brief history Predatory Pricing

Sherman Act, section 2

Burden of Proof:

1. Substantial market power (structural criteria)

A. Define relevant marketB. Show market power

2. Intent to monopolize (conduct criteria)

Sherman Act, section 2

Burden of Proof:

1. Substantial market power (structural criteria)

A. Define relevant marketB. Show market power

2. Intent to monopolize (conduct criteria)

Showing Substantial Market Power

A. Define Relevant Market Both product and geographic This is VERY important under Section 2 (and

elsewhere) Example: Du Pont – limit pricing (1956) Government definition: relevant market was cellophane.

Mkt share = 75% Du Pont’s definition: flexible wrapping materials (wax

paper, foil, etc.). Mkt share = 20% Du Pont persuades Court with their definition. Case

stops (intent stage is not reached)

Defining Relevant Product Market

Are convenience stores (e.g. 7-11, Dairy Mart) in the same relevant product market as supermarkets? (e.g. Stop & Shop, Big Y)?

Would the cross-price elasticity be positive or negative?

A. PositiveB. Negative

Cross price Elast = % Change in Quantity Demanded at Supermarkets% Change in Price at Convenience Stores

Defining Relevant Product Market

Are convenience stores (e.g. 7-11, Dairy Mart) in the same relevant product market as supermarkets? (e.g. Stop & Shop, Big Y)?

What would the value of the cross-price elasticity need to be to say YES?

A. -1B. -0.5C. 0D. 0.2E. 0.8

Cross price Elast = % Change in Quantity Demanded at Supermarkets% Change in Price at Convenience Stores

Defining Relevant Product Market Are convenience stores (e.g. 7-11, Dairy Mart) in the

same relevant product market as supermarkets? (e.g. Stop & Shop, Big Y)?

As an estimate, what value would the cross-price elasticity take?

A. -0.9B. -0.2 C. 0.05D. 0.3 E. 1.1

Showing Substantial Market Power

A. Define Relevant Marketi. Product (service) Market:

Physical characteristics (e.g. Du Pont case) Firm: the broader the better

Distinct customers or end users (e.g. commercial vs. retail)

Cross price elasticity: E.g.: bread and cookies, same market? Strong substitutes: high and positive cross-price

elasticity No clear cut-offs

Showing Substantial Market Power

A. Define Relevant Marketi. Product (service) Market:

Absolute price differences: if large may signal different markets (e.g. luxury cars vs. economy cars)

Unique production facilities: are both goods produced in same type of facility?

Industry recognition of each other: e.g. do they belong to the same trade association?

Showing Substantial Market Power

A. Define Relevant Marketi. Geographical Market:

Transportation costs: are they high with respect to price? E.g. construction materials, coal

Barriers to trade? (e.g. ban on cross-state shipments)

% Exported, % Imported: LIFO (little in from outside), LOFI (little out from inside); <10%

Sherman Act, section 2

Burden of Proof:

1. Substantial market powerA. Define relevant marketB. Show market power

2. Intent to monopolize

What we are studying

Sherman Act, section 2: Monopolization

1. Substantial market powerA. Define relevant marketB. Show market power

2. Intent to monopolize Brief history Predatory Pricing

Brief History on Intent

Period 1: Early Cases Evidence of abusive, predatory and/or criminal

acts. Examples: Cutting price to run competitors out of business Buying up or sabotaging competitors

Standard Oil of NJ (1911) – oil refining 90% mkt share (mergers), control of pipelines (cutting

supply to competitors), predatory prices Chief Justice White: Rule of reason – only unreasonable

attempts violated section 2 American Tobacco (1911) –

“Plug war” undercut rivals from 50¢ to 13 ¢. In sum: Market power + abuse (intent)

Brief History on Intent

Period 2: Alcoa Era Strict interpretation of Section 2 Intent assumed if market share is large, unless

market power was “unavoidable” Skill, foresight, economies of scale, patent

Alcoa Case (1945): DOJ charges Alcoa for monopolization of aluminum market

90% market share No evidence of aggressive behavior Cost advantages, patents Accusation: excess capacity, prices that are “too low” In DOJ appeal, Alcoa is found guilty Mkt power alone may be enough to violate Section 2

Brief History on Intent

Period 3: reversal of Alcoa, more needed to prove intent ATT (1974):

Largest corporation in the world ($130 bill. assets, 83% of US telephones)

22 local phone co’s + Western Electric, Bell Labs Shutting down of independent equipment manufacturers Obstructing long-distance carriers from interconnecting. Consent decree ‘82: divestiture, ($87 billion operation)

XEROX, brought by FTC in 1973 (settled ’75): Pricing below cost in high-volume copy machines

IBM: DOJ case starts in ’69, dropped in ’82 (not guilty in a separate private suit)

Intent: Predatory Pricing What is predatory pricing? “Abnormally

low prices”

Anticompetitive vs. good healthy competitive behavior?

Two approaches: Average cost approach Recovery approach

Average Cost Approach

Q

P

ATCMC

AVC

TC=Variable Cost + Fixed Cost Cost includes a normal return to capital If P>ATC: cover all costs (including return to capital)

Operate

Average Cost Approach

Q

P ATCMC

AVC

If AVC<P<ATC: operate in short run (exit in long run) Exit losses > stay losses

If P<AVC: shut down immediately (short run) Exit losses < stay losses

Operate in SR, but shut down in LR

Shut down

Average Cost Approach1. AVC Rule: if P<AVC

Must have predatory intent (economically irrational) P>AVC: not challenged

2. ATC Rule: if P<ATC May have predatory intent:

AVC<P<ATC: Are prices the result of natural variation? Special deals, oversupply, perishables

Must have predatory intent: P<AVC: Irrefutable evidence of predatory behavior

Bottom line: AVC rule: lenient (smaller range of illegal pricing). ATC rule: stricter (broader range of illegal pricing)

Average Cost Approach

Current interpretation: Supreme Court: never formally adopted AVC

rule However, some Appeals Court cases (e.g. AA in

DFW) used AVC ruleProblems:

Accounting cost is different from economic cost How to interpret it with multi-product firms?

Average Cost Approach

Q

P

ATCMC

AVC

Example 1: Increasing MC

Average Cost Approach

Q

P

ATCMC=AVC

Example 2: Constant MC=AVC

Recovery Approach

A.K.A.: “recoupment” Low prices may or may not be

“successful” Focus on consumer well-being:

Are consumers hurt? In SR consumers benefit from lower prices In LR consumers will only be hurt if predatory

pricing is successful: Competitors leave Recovery period (high price afterwards) is achieved

Recovery Approach

Worry only if recovery period is achieved

Illegal behavior: only if consumer is hurt Affected firms are not factored in

Generally, approach is not as widely accepted in court as the average cost approach

However, important in cases such as AA

Summary of Approaches

Average cost: AVC (lenient) ATC (stricter)

Recovery: Sacrifice? (How long? How much?), AND Recovery? (How soon? How much?)

Poll: What Concept is the least clear?

A. Nolo PleaB. Rule of reason v. Per se RuleC. Market DefinitionD. AVC v. ATC ruleE. Cross-price elasticity