Introduction to Economic Analysis Chapter 21 Antitrust

Chapter Sherman Act LEARNING OBJECTIVES . What is the first antitrust law ?

What is antitrust anyway ?

In archaic language , a trust ( which is now known as a cartel ) was a group of acting in concert . The antitrust laws that made such trusts illegal were intended to protect competition . In the United States , these laws are enforced by . Department of ( Antitrust Division and by the Federal Trade Commission ( The United States began passing laws during a time when some European nations were actually passing laws forcing to join industry cartels . By and large , however , the rest of the world has since copied the antitrust laws in one form or another . The Sherman Act , passed in 1890 , was the piece of antitrust legislation . It has two main requirements . URL books 481

Section . Trusts , in restraint of trade illegal penalty Every contract , combination in the form of trust or otherwise , or conspiracy , in restraint of trade or commerce among the several States , or with foreign nations , is declared to be illegal . Every person who shall make any contract or engage in any combination or conspiracy hereby declared to be illegal shall be deemed guilty of a felony , and , on conviction thereof , shall be punished by not exceeding if a corporation , or , if any other person , or by imprisonment not exceeding years , or by both said punishments , in the discretion of the court . Section . Monopolizing trade a felony penalty Every person who shall monopolize , or attempt to monopolize , or combine or conspire with any other person or persons , to monopolize any part of the trade or commerce among the several States , or with foreign nations , shall be deemed guilty of a felony , and , on conviction thereof , shall be punished by not exceeding if a corporation , or , if any other person , or by imprisonment not exceeding years , or by both said punishments , in the discretion of the court . The phrase in restraint of trade is challenging to interpret . Early enforcement of the Sherman Act followed the Rule , named for noted Justice Rufus , which interpreted the Sherman Act to prohibit contracts that reduced output or raised prices while permitting contracts that would increase output or lower prices . In one of the most famous antitrust cases ever , the United States sued Standard Oil , which had monopolized the transportation of oil from Pennsylvania to the East Coast cities of the United States in 1911 . The exact meaning of the Sherman Act had not been settled at the time of the Standard Oil case . Indeed , Supreme Court Justice Edward White URL , org books 482

suggested that , because contracts by their nature set the terms of trade and thus restrain trade to those terms , and Section makes contracts restraining trade illegal , one could read the Sherman Act to imply that all contracts were illegal . Chief Justice White concluded that , because Congress couldn have intended to make all contracts illegal , the intent must have been to make unreasonable contracts illegal , and he therefore concluded that judicial discretion is necessary in applying the antitrust laws . In addition , Chief Justice White noted that the act makes monopolizing illegal , but doesn make having a monopoly illegal . Thus , Chief Justice White interpreted the act to prohibit certain acts leading to monopoly , but not monopoly itself . The legality of monopoly was further through a series of cases , starting with the 1945 case , in which the United States sued to break up the aluminum monopoly . The modern approach involves a test . First , does the have monopoly power in a market ?

If it does not , no monopolization has occurred and there is no issue for the court . Second , if it does , did the firm use illegal tactics to extend or maintain that monopoly power ?

In the language of a later decision , did the engage in the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of superior product , business acumen or historic accident ( 1966 ) There are several important points that are widely misunderstood and even in the press . First , the Sherman Act does not make having a monopoly illegal . Indeed , three legal ways of obtaining a better product , running a better business , or mentioned in one decision . It is illegal to leverage an existing monopoly into new products or services , or to engage in tactics to URL , org books ( 909 483

maintain the monopoly . Moreover , you must have monopoly power currently to be found guilty of illegal tactics . When the sued over the incorporation of the browser into the operating system and other acts ( including contracts with manufacturers prohibiting the installation of ) the allegation was not that Windows was an illegal monopoly . The alleged was trying to use its Windows monopoly to monopolize another market , the Internet browser market . defense was twofold . First , it claimed not to be a monopoly , citing the share of Apple . had a negligible share at the time . Second , it alleged that a browser was not a separate market but an integrated product necessary for the functioning of the operating system . This defense follows the standard test . defense brings up the question , What is a monopoly ?

The simple answer to this question depends on whether there are good substitutes in the minds of consumers , so that they may substitute an alternate product in the event of bad behavior by the seller . By this test , had an operating system monopoly in spite of the fact that there was a rival product , could increase the price , tie the browser and player to the operating system , or even disable Word Perfect , and most consumers would not switch to the competing operating system . However , second defense , that the browser wasn a separate market , was a much more challenging defense to assess . The Sherman Act provides criminal penalties , which are commonly applied in is , when groups of join together and collude to raise prices . Seven executives of General Electric ( GE ) and , who colluded in the late to set the prices of electrical turbines , each spent several years in jail , and incurred over URL , org books 484

100 million in . In addition , Archer Daniels Midland executives went to jail after their 1996 conviction for the price of lysine , which approximately doubled the price of this common additive to animal feed . When highway contractors are convicted of , the conviction is typically under the Sherman Act for monopolizing their market . KEY TAKEAWAYS A trust ( now known as a cartel ) is a group of firms acting in concert . The antitrust laws made such trusts illegal and were intended to protect competition . In the United States , these laws are enforced by the Department of Justice ( Antitrust Division and by the Federal Trade Commission ( The Sherman Act , passed in 1890 , is the first significant piece of antitrust legislation . It prevents mergers and cartels that would increase prices . Having a monopoly is legal , provided it is obtained through legal means . Legal means include superior product , business acumen or historic Modern antitrust investigations involve a test . First , does the firm have monopoly power in a market ?

If it does not , no monopolization has occurred and there is no issue for the court . If it does , did the firm use illegal tactics to extend or maintain that monopoly power ?

The Sherman Act provides criminal penalties , which are commonly applied in cases . Clayton Act LEARNING OBJECTIVES . What other major antitrust legislation exists in the United States ?

What is predatory pricing and why is it illegal ?

Is price discrimination illegal ?

URL books 485 Critics of the Sherman Act , including famous President Teddy Roosevelt , felt the ambiguity of the Sherman Act was an impediment to its use and that the United States needed a more detailed law setting out a list of illegal activities . ACT , 15 . was passed in 1914 and it adds detail to the Sherman Act . The same year , the Act was passed , creating Trade ' which has authority to enforce the Clayton Act as well as to engage in other consumer protection activities . The Clayton Act does not have criminal penalties , but it does allow for monetary penalties that are three times as large as the damage created by the illegal behavior . Consequently , a , motivated by the possibility of obtaining a large damage award , may sue another for infringement of the Clayton Act . A plaintiff must be directly harmed to bring such a suit . Thus , customers who paid higher prices or that were driven out of business by exclusionary practices are permitted to sue under the Clayton Act . When Archer Daniels Midland raised the price of lysine , pork producers who bought lysine would have standing to sue , but pork consumers who paid higher prices for pork , but who didn directly buy lysine , would not . Highlights of the Clayton Act include Section , which prohibits price discrimination that would lessen competition Section , which prohibits exclusionary practices , such as tying , exclusive dealing , and predatory pricing , that lessen competition Section , which prohibits share acquisition or merger that would lessen competition or create a monopoly The language lessen competition is generally understood to mean that a price increase becomes possible that is , competition has been harmed if the in the industry can successfully increase prices . Section is also known as because of a 1936 amendment by that name . It prohibits price discrimination that lessens competition . Thus , price discrimination to consumers is legal under the Clayton Act the only way price discrimination can lessen competition is if one charges different prices to different businesses . The logic of the law was articulated in the 1948 Morton Salt decision , which concluded that lower prices to large chain stores gave an advantage to those stores , thus injuring competition in the grocery store market . The discounts in that case were not , and it is permissible to charge different prices based on costs . Section rules out practices that lessen competition . A manufacturer who also offers service for the goods it sells may be prohibited from favoring its own service organization . Generally manufacturers may not require the use of the URL books 486

manufacturer own service . For example , an automobile manufacturer can require the use of replacement parts made by the manufacturer , and many car manufacturers have lost lawsuits on this basis . In an entertaining example , Mercedes prohibited Mercedes dealers buying Bosch parts directly Bosch , even though Mercedes itself was selling Bosch parts to the dealers . This practice was ruled illegal because the quality of the parts was the same as Mercedes ( indeed , identical ) so Mercedes action lessened competition . Predatory involves pricing below cost in order to drive a rival out of business . It is relatively for a to engage in predation simply because it only makes sense if , once the rival is eliminated , the predatory can then increase its prices and recoup the losses incurred . The problem is that once the prices go up , entry becomes attractive so what keeps other potential entrants away ?

One answer is reputation a reputation for a willingness to lose money in order to dominate the market could deter potential entrants . Like various rare diseases that happen more often on television shows than in the real world ( Tourette syndrome ) predatory pricing probably happens more often in textbooks than in the real world . The also has authority to regulate mergers that would lessen competition . As a practical matter , the and the divide responsibility for evaluating mergers . In addition , other agencies may also have jurisdiction over mergers and business tactics . The Department of Defense has oversight of defense contractors , using a threat of we re your only The Federal Communications Commission has statutory authority over telephone and television companies . The Federal Reserve Bank has authority over national and most other banks . Most states have antitrust laws as well , and they can challenge mergers that would affect commerce in the respective state . In addition , attorneys general of many states may join the or the in suing to block a merger or in other antitrust actions , or they can sue independently . For example , many states joined the Department of Justice in its lawsuit against . states jointly sued the major record companies over their minimum advertised prices ( MAP ) policies , which the states argued resulted in higher compact disc prices . The MAP case settlement resulted in a modest payment to compact disc purchasers . The had earlier extracted an agreement to stop the . KEY TAKEAWAYS The Clayton Act was passed in 1914 and adds detail to the Sherman Act . The , which has authority to enforce the Clayton Act , as well as engage in other consumer protection activities , was created the same year . URL books 487

The Clayton Act does not have criminal penalties , but it does allow for monetary penalties that are three times as large as the damage created by the illegal behavior . Highlights of the Clayton Act include Section , which prohibits price discrimination that would lessen competition Section , which prohibits exclusionary practices , such as tying , exclusive dealing , and predatory pricing , that lessen competition Section , which prohibits share acquisition or merger that would lessen competition or create a monopoly The language lessen competition is generally understood to mean that a significant price increase becomes possible that is , competition has been harmed if the firms in the industry can successfully increase prices . Predatory pricing involves pricing below cost in order to drive a rival out of business . The DO and the divide responsibility for evaluating mergers . Most states have antitrust laws as well , and they can challenge mergers that would affect commerce in the respective state . Price Fixing LEARNING OBJECTIVE . What is price fixing and how does it work ?

Price which is called in a bidding context , involves a group of firms agreeing to increase the prices they charge and restrict competition against each other . The most famous example of price is probably the Great Electrical Conspiracy in which GE and ( and a smaller , the prices of turbines used for electricity generation . Generally these turbines were the subject of competitive ( or , in this case , bidding , and the companies set the prices by designating a winner for each bidding situation and using a price book to provide identical bids by all companies . An amusing element of the URL books 488

scheme was the means by which the companies the winner in any given competition they used the phase of the moon . The phase of the moon determined the winner , and each company knew what to bid based on the phase of the moon . Executives from the companies met often to discuss the terms of the arrangement , and the Department of Justice ( acquired a great deal of physical evidence in the process of preparing its 1960 case . Seven executives went to jail and hundreds of millions of dollars in were paid . Most convicted are from small . The turbine conspiracy and the Archer Daniels Midland lysine conspiracy are unusual . There is evidence that large vitamin manufacturers conspired in the price of vitamins in many nations of the world . Far more common conspiracies involve highway and street construction , electricians , water and sewer construction companies , or other businesses . Price seems most common when owners are also managers and there are a small number of competitors in a given region . As a theoretical matter , it should be for a large to motivate a manager to engage in price . The problem is that the can write a contract promising the manager extraordinary returns for successfully prices because such a contract itself would be evidence and moreover implicate higher management . Indeed , Archer Daniels Midland executives paid personal of , and each served years in jail . Thus , it is to offer a substantial portion of the rewards of price to managers in exchange for the personal risks the managers would face from engaging in price . Most of the gains of price accrue to shareholders of large companies , while large risks and costs fall on executives . In contrast , for smaller businesses in which the owner is the manager , the risks and rewards are borne by the same person , and thus the personal risk is more likely to be by the persona return . We developed earlier a simple theory of cooperation , in which the grim trigger strategy was used to induce cooperation . Let us apply that theory to price . Suppose that there are and that they share the monopoly um equally if they collude . If one cheats , that can obtain the entire monopoly until the others react . This is clearly the most the could get from cheating . Once the others react , the collusion breaks down and the earn zero ( the competitive level ) from then on . The cartel is feasible if of the monopoly forever is better than the whole monopoly for a short period of time . Thus , cooperation is sustainable ( The side of the equation gives the from present value of the share of the monopoly . In contrast , if a chooses to cheat , it can take at most the monopoly , but only temporarily . How many will this sustain ?

The inequality to . Suppose the annual interest rate URL books 489 is and the reaction time is is , a that cheats on the cooperative agreement sustains for a week , after which time prices fall to the competitive level . In this case , i is a week worth of interest ( is the Value of money received in a week ) and therefore . According to standard theory , the industry with a weeklong reaction time should be able to support cooperation with up to a thousand firms . There are numerous and varied reasons why this theory fails to work very well empirically , including that some people are actually honest and do not break the law , but we will focus on one reason here . The cooperative equilibrium is not the only equilibrium , and there are good reasons to think that full cooperation is unlikely to persist . The problem is the prisoners dilemma itself generally the participant to turn in the conspiracy can avoid jail . Thus , if one member of a cartel is uncertain whether the other members of a conspiracy are contacting the , that member may race to the threat of one confession may cause them all to confess in a hurry . A majority of the conspiracies that are prosecuted arise because member who feels guilty , a disgruntled spouse of a member , or perhaps a member who thinks another member is suffering pangs of them in . Lack of in the other members creates a prophecy . Moreover , cartel members should lack in the other cartel members who are , after all , criminals . On average , prosecuted conspiracies were about years old when they were caught . Thus , there is about a 15 chance annually of a breakdown of a cons , at least among those that are eventually caught . KEY TAKEAWAYS Price fixing , which is called bid rigging in a bidding context , involves a group of firms agreeing to increase the prices they charge and restrict competition against each other . The most famous example of price fixing is probably the Great Electrical Conspiracy in which GE and fixed the prices of turbines . The companies used the phase of the moon to determine the winner of government procurement auctions . Theoretically , should be easy to sustain in practice , it does not seem to be . URL books 490

Mergers LEARNING OBJECTIVE . How does the government decide which mergers to block and which to perm it ?

The Department of Justice ( and the Federal Trade Commission ( share responsibility for evaluating mergers . Firms with more than 50 million in assets are required under the Act to with the government an intention to merge with another . The government then has a limited amount of time to either approve the merger or request more information ( called a second request ) Once the have complied with the second request , the government again has a limited amount of time before it either approves the merger or sues to block it . The government agencies themselves don stop the merger , but instead they sue to block the merger , asking a federal judge to prevent the merger as a violation of one of the antitrust laws . Mergers are distinct from other violations because they have not yet occurred at the time the lawsuit is brought , so there is no threat of damages or criminal penalties the only potential penalty imposed on the merging parties is that the proposed merger may be blocked . Many proposed mergers result in settlements . As part of the settlement associated with GE purchase of Radio Corporation of America ( in 1986 , a small appliance division of GE was sold to Black Decker , thereby maintaining competition in the small kitchen appliance market . In the 1999 merger of oil companies and Mobil , a California , shares in oil pipelines connecting the Gulf with the Northeast , and thousands of gas stations were sold to other companies . The 1996 merger of and Scott Paper would have resulted in a single company with over 50 of the facial tissue and baby wipes markets , and in both cases of production capacity and the brand name preserved competition in the markets . Large bank mergers , oil company mergers , and other large companies usually present some competitive concerns , and the majority of these cases are solved by divestiture of business units to preserve competition . A horizontal merger is a merger of competitors , such as and Mobil or two banks located in the same city . In contrast , a Vertical merger is a merger between an input supplier and input buyer . The attempt by book retailer Barnes and Noble to purchase the intermediary , a company that buys books from publishers and sells to retailers but doesn directly sell to the public , would have resulted in a vertical merger . Similarly , Disney is a company that sells programs to television stations ( among other activities ) so its purchase of network ABC was a vertical merger . The Warner merger involved several vertical relationships . For example , Time Warner is a URL books 491

large cable company , and cable represents a way for to offer broadband services . In addition , Time Warner is a content provider , and delivers content to Internet subscribers . Vertical mergers raise two related problems foreclosure and raising rivals ' refers to denying access to necessary inputs . Thus , the Warner merger threatened rivals to Internet service ( like ) with an inability to offer broadband services to consumers with Time Warner cable . This potentially injures competition in the Internet service market , forcing Time Warner customers to use . In addition , by bundling Time Warner content and Internet service , users could be forced to purchase Internet service in order to have access to Time Warner content . Both of these threaten foreclosure of rivals , and both were resolved to the government satisfaction by promises that the merged would offer equal access to rivals . Raising rivals COStS is a softer version of foreclosure . Rather than deny access to content , Time Warner could instead make the content available under disadvantageous terms . For example , American Airlines developed the Sabre computerized reservation system , which was used by about 40 of travel agents . This system charged airlines , rather than travel agents , for bookings . Consequently , American Airlines had a mechanism for increasing the costs of its rivals by increasing the price of bookings on the Sabre system . The advantage to American Airlines was not just increased revenue of the Sabre system but also the hobbling of airline rivals . Similarly , banks offer free use of their own automated teller machines ( ATMs ) but they charge the customers of other banks . Such charges raise the costs of customers of other banks , thus making other banks less attractive and providing an advantage in the competition for bank customers . The and the periodically issue horizontal merger guidelines , which set out how mergers will be evaluated . This is a procedure for each product that the merging companies have in common . The procedure starts by identifying product markets . To identify a product market , start with a product or products produced by both companies . Then ask if the merged parties can raise price by a small but and increase in price , also known as a ( pronounced snip ) A is often taken to be a price increase , which must prevail for several years . If the companies can increase price by a , then they are judged to have monopoly power and consumers will be directly harmed by the merger . This is known as effect because the merging parties will increase price unilaterally after the merger is consummated . If they can increase prices , then an additional product has to be added to the group generally the best substitute is added . Ask whether a hypothetical monopoly seller of these three products can raise price . If it can , an antitrust market has been if it can not , yet another substitute product must be added . The URL books 492

process stops adding products when enough substitutes have been that , if controlled by a hypothetical monopoly , would have their prices increased . The logic of product market is that , if a monopoly wouldn increase price in a meaningful way , then there is no threat to price increase won be large or won last . The market is by the smallest set of products for which consumers can be harmed . The test is also known as the hypothetical monopoly test . The second step is to identify a geographic market . The process starts with an area in which both companies sell and asks if the merged company has an incentive to increase price by a . If it does , that geographic area is a geographic market . If it does not , it is because buyers are substituting outside the area to buy cheaply , and the area must be expanded . For example , owning all the gas stations on a corner doesn let one increase price because an increase in price leads to substitution to gas stations a few blocks away . If one company owned all the stations in a radius , would it be to increase price ?

Probably not because there would still be substitution to more distant stations . Suppose , instead , that one owned all the stations for a radius . Then an increase in price in the center of the area is not going to be thwarted by too much substitution outside the area , and the likely outcome is that prices would be increased by such a hypothetical monopoly . In this case , a geographic market has been . Again , parallel to the product market , a geographic market is the smallest area in which competitive concerns would be raised by a hypothetical monopoly . In any smaller area , attempts to increase price are defeated by substitution to sellers outside the area . The product and geographic markets together are known as antitrust market ( relevant for the purposes of analyzing the merger ) The third and last step of the procedure is to identify the level of concentration in each relevant antitrust market . The Index ( is used for this purpose . The is the sum of the squared market shares of the in the relevant antitrust market , and it is because it measures the margin in the model . Generally , in practice , the shares in percentage are used , which makes the scale range from to . For example , if one has 40 , one has 30 , one has 20 , and the remaining has 10 , the is 402 301 20 102 . Usually , anything over is considered very concentrated , and anything over is concentrated . Suppose with shares and merge , and nothing in the industry changes besides the combining of those shares . Then the goes up by ( This is referred to as the change in the . The merger guidelines suggest that the government will likely challenge mergers with ( a ) a change of 100 and a concentrated URL books 493

, or ( a change of 50 and a very concentrated . It is more accurate in understanding the merger guidelines to say that the government likely won challenge unless either ( a ) or ) is met . Even if the suggests a Very concentrated industry , the government is unlikely to challenge if the change in the is less than 50 . Several additional factors affect the government decision . First , if the are already engaging in price discrimination , the government may quite small geographic markets , possibly as small as a single customer . Second , if one is very small ( less than ) and the other not too large ( less than 35 ) the merger may escape scrutiny because the effect on competition is likely small . Third , if one is going out of business , the merger may be allowed as a means of keeping the assets in the industry . Such was the case with Greyhound takeover of , a merger that produced a monopoly of the only intercity bus companies in the United States . Antitrust originated in the United States , and the United States remains the most vigorous enforcer of antitrust laws . However , the European Union has recently taken a more aggressive antitrust stance , and in fact it has blocked mergers that obtained tentative approval , such as GE and . Antitrust is , in some sense , the applied arm of oligopoly theory . Because real situations are so complex , the application of oligopoly theory to antitrust analysis is often challenging , and we have only scratched the surface of many of the more subtle issues of law and economics in this text . For example , intellectual property , patents , and standards all have their own distinct antitrust issues . KEY TAKEAWAYS Firms with large assets are required to notify the government prior to merging . Many proposed mergers result in settlements . A horizontal merger is a merger of competitors . In contrast , a vertical merger is a merger between an input supplier and input buyer . Vertical mergers raise two problems foreclosure and raising rivals costs . Foreclosure refers to denying access to necessary inputs . Raising rivals costs is a softer version of foreclosure because it charges more for inputs . Mergers are evaluated by a procedure that involves looking at product market , geographic market , and effects . URL books 494

A product market is a set of products sufficiently extensive that a monopolist can profitably raise price by a small but significant and increase in price , also known as a ( pronounced snip ) The logic of product market definition is that , if a monopoly increase price in a meaningful way and there is no threat to consumers , any price increase wo be large or wo last . The market is defined by the smallest set of products for which consumers can be harmed . The test is also known as the hypothetical monopoly test . The second step is to identify a geographic market , which exactly parallels the product market , looking for an area large enough that a hypothetical monopolist over the product market in that geographic market would profitably raise price by a . The product and geographic markets together are known as a relevant antitrust market ( relevant for the purposes of analyzing the merger ) The third and last step of the procedure is to identify the level of concentration in each relevant antitrust market . The Index ( is used for this purpose . Several additional factors , including price discrimination and failing firms , affect the government decision to sue and thus block mergers . Antitrust is , in some sense , the applied arm of oligopoly theory . URL books 495