Public Policy in Private Markets

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

Announcements • Case presentations: 1 case has been assigned • Case 8, K&W, 5th edition • Debate date: March 6th. Video due to me: March 2nd. • There will be a homework on that day • Clickers: • The number of points for iclicker on a day will be equal to the number of questions on that day (e.g. 1 question = 1 point; 5 questions = 5 points). Your 10% of in-class work will be computed as the fraction of total iclicker points in the semester. • Homework 1 posted, due Feb. 14, in class, group work is encouraged.

Overview of Antitrust Laws

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

What we are studying • Sherman Act, section 2: Monopolization • Substantial market power • Define relevant market • Show market power • Intent to monopolize • Brief history • Intent: Any behavior that is used to perpetuate and extend monopoly power with the use of abusive practices (e.g. predatory pricing, sabotaging competitors)

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

Question • Which of the following best characterizes average variable costs (AVC) and average total costs (ATC)? • AVC does not include fixed costs and ATC does • ATC>=AVC • ATC=AVC in the long run • ATC and AVC are always upward sloping

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 fixed costs, and return to capital) AVC Operate Q

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

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)

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 from economic cost • How to interpret it with multi-product firms?

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

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

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?)

Microsoft Case (1): Evidence of Intent • 1970’s: personal computers are introduced • 1985: Microsoft introduces first commercial software for PCs • Relevant Market: • Product: OS for PCs • 1991-1993: 50% for all OS, >70% for IBM compatible PC’s • Geographic: National

Microsoft Case (1): Evidence of Intent • Pre-announcement of software • DR-DOS (rival), 1990, captures 10% • MS-DOS 5.0 announced, but inexistent • Exclusionary licensing: • Microsoft charges license fees based on all computers shipped by manufacturer (OEM), with or without MS-DOS: consumer paid twice for non-MS-DOS • Penalties to non-MS-DOS OEMs (higher fees, less support, no credit) • OEMs forced to install MS-DOS • Incompatibilities: • Denying software developers access to application programming interface (API)

Microsoft Case (1): Details • Microsoft’s view: • Large market share = superior product • Competitive market, large market share is not guaranteed • Practices are good and transparent competition • Consumers have gained • Remedies will hurt innovation rate

Microsoft Case (1): Details • Consent decree (6/95): • OEM contracts limited to 1 year • No minimum commitment on OEM contracts • Elimination of non-disclosure agreements for beta testers

Next time • Second Microsoft case (1998)

Poll: What Concept is the least clear? • Nolo Plea (16/36%) • Rule of reason v. Per se Rule (9/20%) • Market Definition (9/20%) • AVC v. ATC rule (3/7%) ???? • Cross-price elasticity (15/33%)

On a scale from 1-10 what is your understanding of: (10=awesome, 1=no idea) More Polling Nolo Plea AVC v. ATC rule Cross-price elasticity

Public Policy in Private Markets