Market Power & Monopolization

1. Market Power & Monopolization Issues in Monopolization • Market Power • Ability to raise price unilaterally & profitably above competitive (zero-profit) levels • Fairly won (innovation, scale efficiencies) or ill-gotten gains? • Law does not attack all firms/markets where market power is present

2. Real world firms have some market power • Cases of obvious monopoly are rare • “in between world” -- btw comp & monop • Q: Where in this “in between world” does antitrust become relevant? • “A”: Where damage from market power is sufficiently large

3. Significant & Insignificant Degrees of Market Power • Are there methods which measure the damage from market power? • Figure 4.1 of Kaserman & Mayo

4. A Measure of Market Power • Lerner Index: λ= (P – MC) / P • Measures the markup over cost as % of P • Note: profit max => MR = MC • MR = P(1 + 1/ η) • λ = | 1/ η | • So the lerner index, or profit-maximizing markup, is inversely proportional to the firm’s elasticity of demand

5. Forms of Monopolizing Practices • merger for monopoly • acquisition of productive assets of rivals • limit pricing • Deter entrants by pricing just low enough to make entry appear unprofitable • predatory pricing • Price below cost to bankrupt/scare rivals • raising rivals cost • Legal or contractual subterfuge; deny rivals access to essential facilities • tacit collusion: vague form of price fixing

6. Merger for Monopoly • Historical Cases of Merger for Monopoly • American Tobacco (J.B. Duke) • Standard Oil (J. D. Rockefeller) • U.S. Steel (J. P. Morgan) • 1st two were broken up by gov’t antitrust action; U.S. Steel narrowly escaped • Note: oddly, the latter was the most cartel-like in appearance; Std Oil clearly achieved significant efficiencies but was the ruthless “Microsoft” of its era

7. The Dominant Firm Model • Let a firm DF have monopolizing ambitions • Let there N identical firms in the market • Same costs, no differentiation in output • The DF acquires N/2 firms through merger • Call the remaining firms the “competitive fringe” • Model: • Find the profit max Q & P of the DF • Find the output of the competitive fringe • Assess relative profitability of the two market segments

8. Price and Output in a Market with a Dominant Firm

9. Mechanics of the DF Model • 1. The DF treats comp fringe as price takers • 2. It creates its own demand curve, DNet, by subtracting the output supplied by fringe firms at each price from the market demand curve • 3. Find MRNet associated with DNet and equate MRNet with MCDF • 4. This determines its quantity and price QDF & PDF • 5. Find fringe output at PDF on the fringe supply curve; fringe output + DF output is, by construction, total output in the market as given on the market demand curve

10. Outcomes in the DF Model • 1. The dominant firm reduces the output from what it would produce had it acted as a price taker (from QC/2). • 2. The competitive fringe increases output in response to the price increase (from QC/2 to Qff). • 3. The profits of the competitive firms therefore rise by more than those of the dominant firm (in toto or on a per plant basis).

11. The DF’s Degree of Market Power • In general, λ = (P – MC) / P = 1 / | η | • For DF, λ = 1 / | ηnet | • λ = s / { |η| + (1-s) Ef } • (see appx in K&M for derivation) • N is the elasticity of D • ηnet is the elasticity of Dnet • s is the DF’s market share • Ef is the supply elasticity of the fringe firms

12. DF’s Market Power, con’t • λ = s / { | η| + (1-s) Ef } • λ is the profit maximizing markup over MC • λ increases when • s increases • | η | decreases • Ef decreases • For the DF to have significant market power, all 3 conditions must be in place • Not easy to manage, particularly in the LR

13. Implications of the DF Model for Merger for Monopoly • 1. Consider owner of individual plant • The profits of an independent plant owner are greater than the contribution of the identical plant to the profits of the DF • As in a cartel, it is better to free ride on the output-restricting, price enhancing decisions of industry rivals. Let them cut back on output, and capitalize on the price increase that results by increasing output in response.

14. Implications of the DF Model for MFM, continued • 2. Merger for monopoly will be very difficult to achieve on a sequential firm by firm basis. • The DF is willing to pay each firm its capital costs plus the additional profits earned by the dominant firm as a result of the merger. But since the profits earned by the firm if it stays outside the dominant firm are higher, once it is clear that the intent of the merger is to cut back on output an raise price, no one will accept the DF’s merger offer.

15. Implications of DF for MFM, continued • 3. The problem of sequential merger in the merger for monopoly case can be overcome with a take-it-or-leave-it tender offer. • If the choice is to remain in a competitive market or to be part of the dominant firm, the latter is more profitable. (Above, the choice was between being a fringe firm coexisting with a dominant firm, or being merged.) • This is what J.P. Morgan accomplished in merging 66% of steel market capacity into U.S. Steel in 1901.

16. Implications of DF for MFM, continued • 4. There are profit opportunities for potential entrants. • The model thus predicts that the market share of the dominant firm will decline over time. • Again, this is what happened to U.S. Steel. By 1920 its market share had fallen to 46%; by 1925 to 42%. Note that this took roughly a quarter-century; the long run is often slow in coming. In the meantime, U.S. Steel -- and its competitors -- both enjoyed super-normal profits.

17. Summary of the DF Model • Merger for monopoly may represent a profit opportunity • The DF’s market power increases with mkt share, & decreases with demand elasticity and supply elasticity of the competitive fringe • With identical costs, competitive fringe plants get a higher rate of profit than DF • Sequential merger is a dubious strategy • LR: entry possibilities exist unless checked by barriers • Ownership strategies undermine the competitive model: we are less sure that cost and demand conditions yield a unique equilibrium, except where cheap entry and exit undermines the MFM strategy. Trust-busting may have merit to deter MFM & preserve competitive outcomes.