Public Policy in Private Markets

1. Public Policy in Private Markets Monopolization (section 2, Sherman Act)

2. 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

3. Overview of Antitrust Laws

4. Sherman Act, Section 2 • Monopolization • Market definition • Intent (next class) • Brief history • Predatory Pricing

5. Sherman Act, section 2 Burden of Proof: • Substantial market power (structural criteria) • Define relevant market • Show market power • Intent to monopolize (conduct criteria)

6. Sherman Act, section 2 Burden of Proof: • Substantial market power (structural criteria) • Define relevant market • Show market power • Intent to monopolize (conduct criteria)

7. Showing Substantial Market Power • 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)

8. 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? • Positive • Negative Cross price Elast = % Change in Quantity Demanded at Supermarkets % Change in Price at Convenience Stores

9. 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? • -1 • -0.5 • 0 • 0.2 • 0.8 Cross price Elast = % Change in Quantity Demanded at Supermarkets % Change in Price at Convenience Stores

10. 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? • -0.9 • -0.2 • 0.05 • 0.3 • 1.1

11. Showing Substantial Market Power • Define Relevant Market • 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

12. Showing Substantial Market Power • Define Relevant Market • 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?

13. Showing Substantial Market Power • Define Relevant Market • 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%

14. Sherman Act, section 2 Burden of Proof: • Substantial market power • Define relevant market • Show market power • Intent to monopolize

15. What we are studying • Sherman Act, section 2: Monopolization • Substantial market power • Define relevant market • Show market power • Intent to monopolize • Brief history • Predatory Pricing

16. 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)

17. 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

18. 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)

19. Intent: Predatory Pricing • What is predatory pricing? “Abnormally low prices” • Anticompetitive vs. good healthy competitive behavior? • Two approaches: • Average cost approach • Recovery approach

20. Average Cost Approach ATC MC P • TC=Variable Cost + Fixed Cost • Cost includes a normal return to capital • If P>ATC: cover all costs (including return to capital) AVC Operate Q

21. Average Cost Approach MC P ATC • 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 AVC Operate in SR, but shut down in LR Shut down Q

22. Average Cost Approach 1. 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)

23. Average Cost Approach Current interpretation: • Supreme Court: never formally adopted AVC rule • However, some Appeals Court cases (e.g. AA in DFW) used AVC rule Problems: • Accounting cost is different fromeconomic cost • How to interpret it with multi-product firms?

24. Average Cost Approach MC ATC • Example 1: Increasing MC P AVC Q

25. Average Cost Approach • Example 2: Constant MC=AVC P ATC MC=AVC Q

26. 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

27. 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

28. Summary of Approaches • Average cost: • AVC (lenient) • ATC (stricter) • Recovery: • Sacrifice? (How long? How much?), AND • Recovery? (How soon? How much?)

29. Poll: What Concept is the least clear? • Nolo Plea • Rule of reason v. Per se Rule • Market Definition • AVC v. ATC rule • Cross-price elasticity