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Monopoly: Conception difference in law and economics

In Economics: markets are monopolistic or oligopolistic in the absence of perfect competition

Competitive market:

1. A large number of firms

2. Homogeneous products

3. Free entry into and exit from the market

4.Independence of decisions among firms

5. Complete information

In Law: monopoly is used as “a standard of evaluation”, designating a situation not in the public interest.

Subjective valuation

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Effects of Monopolies

To the economist: the way in which transactions occur and resources are allocated

Efficiency loss: A firm with monopoly power will produce at a lower output level and charge a higher price than an identical firm in a competitive market

For a lawyer

monopoly means a restriction of the freedom of business to engage in legitimate economic activities

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The Economic incentive to monopolize markets

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Pc MR MC

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Why other firms do not enter monopolistic industries?

Increasing returns to scale -- if f(x)> f(x) for any >1, then we say that IRTS prevail. In the single output case, this implies a decreasing average cost curve.(natural monopoly, high tech)

Economies of scale -- average cost is decreasing Firms may have patents on certain products forbidding

other manufacturers to produce the same product during certain period.

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Increasing return to scale

Y

Setup cost X

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Ways to Monopolize Markets

Horizontal Mergers and Conglomerates: FTC v. P&G, 1967. Clorox

Cartels-- secret (per se illegal)

1. Horizontal price fixing

2. Horizontal market division

Price Discrimination--predatory pricing

Foreclosing Entry

1. Vertical Integration

2. Advertising

3. Tie-in arrangements

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Horizontal Merger Guidelines (1992)

Theme: mergers should not be permitted to create or enhance market power, so as to confer on a seller the ability profitably to maintain prices above competitive levels for a sig. Period of time.

Analytical process: assessment of whether: 1.the merger will sig. increase market concentration 2.the merger will raise concern about potential adverse competitive

effects 3.efficiency gains would result that otherwise cannot be achieved

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Government-Induced Price Fixing and Foreclosure

Resale Price Maintenance (McGuire-Keough Act in 1952)

Occupational Licensing

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A brief outline of antitrust acts (I)

SHERMAN ACT(1890)

* Every contract, combination, or conspiracy in restraint of trade among the several states is illegal. Monopolizing trade shall be deemed guilty of a felony and punished.

*The policy goal of the common law and hence of the Sherman Act: the maximization of consumer welfare

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A brief outline of antitrust acts (II)

CLAYTON ACT(1914): limits undertakings that tend to lessen competition substantially or create a monopoly.

*Section 2, amended by the Robinson-Patman Act(1936), prohibits price discrimination. Section 3 makes many tie-in arrangements illegal.

*Section 7, amended by the Celler-Kefauver Act(1950), renders corporate mergers and acquisitions illegal if they substantially lessen competition.

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A brief outline of antitrust acts (III)

THE FEDERAL TRADE COMMISSION ACT(1914): gives the FTC jurisdiction over section 1 and 2 of the Sherman Act and over some provisions of the Clayton Act. It also forbids “unfair methods of competition.”

* Two major economic groups exempted from the antitrust laws

1. Agricultural cooperatives 2. Labor union( Norris-la Guardia Act/Wagner Act 1935)

* Views of antitrust policy1. Populist view: to advance competition so as to protect small businesses

2. Efficiency views: to promote economic efficiency; in the best interest of consumers even if it leads to considerable concentration of economic power.

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The Law’s conceptual apparatus: Rule of Reason

Three part rule of reason created by Edward White in 1911:

“inherent nature” – results in practices illegal per se, which means that there is no defense and that the court need not examine either intent or market power before pronouncing the behavior unlawful. Judging a restraint according to its character instead by its degree.

“inherent effect” or market power: refers to the inference of bad effects from some fact, e.g. the market share of the parties.

“evident purpose” or specific intent: proof of an actual intent to inflict the evils of monopoly, that is an intent to gain or maintain monopoly

through means other than superior efficiency.

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Assessment of market power

1. Define the relevant market(s) affected by a firm’s conduct ***Camera:

– narrowly defined market: camera selling between $200 and $250

– broadly defined: the market is worldwide, and includes not only all cameras, but also portrait artists and possibly transportation media because a painting and a visit are all substitutes for a picture.

– Depending on who convinces the judge, the concentration ratios will be awesome or trivial, with a large influence on his verdict.

2. Calculation of market share, examination of competitive interactions, determination of the conditions of entry, and analysis of other pertinent structural features of the market

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These are three tests to be applied to any practice or structure.

Manageable by counsel and courts in the litigation process.

the rule of reason was not composed of any particular substantive rules but was entirely a mode of analysis, a system for directing investigation and decision. This was in keeping with the dynamic principle of the law, by which substantive rules would evolve and alter as economic understanding progressed. The only constant element was the mode of analysis (the three-part rule of reason).

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Case I. Standard Oil of N.J. v. United States (1911)

Central charges against the old Standard Oil company:

– Control of 90 percent of the nation’s refining capacity largely through the acquisition of rivals

– Local price cutting: oft-told tale of Standard’s use of predatory techniques to gain and hold monopoly

Chief Justice White’s opinion:

– placing of all the associated corporations under the control of NJS raised a “prima facie presumption” of wrongful intent. The nature of wrongful intent is crucial. The intent was not to maintain market size through “normal methods” (superior efficiency) -- which would have been proper -- but to do it by “new means of combination” that gave greater control and power to exclude others.

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Weakness of White’s opinion

• The court was alleged to have claimed the power to make subjective choices between “good trusts” and “bad trusts”. This was a very substantial factor in the demand for more legislation.

• The court adopted uncritically the idea that it is easy for one firm to injure another by means other than superior efficiency (it is normal and proper), and they accepted the notion, that vertical integration, local price cutting, bargaining for preferences from suppliers, and the like provide the means by which such injury is improperly inflicted.

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Case II: FTC v. Procter and Gamble Co. (1967)

Case: a product-extension merger. P&G sought to expand into the household liquid bleach market by acquiring the assets of Clorox, the leading producer of liquid bleach.

Arguments by the Court:

– P&G was a potential entrant in the market and knowledge of this fact kept the price competitive in the industry.

– P&G’s huge assets gave it unwarrented leverage in the market and the potential power of predatory pricing.

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Case II: FTC v. Procter and Gamble Co. (1967)

Argument by P&G co.:

– The merger will increase the efficiency of the industry and offer consumer better products at lower cost.

Justice Douglas’s opinion for the court:

– Possible economies cannot be used as a defense to illegality: The creation of efficiency by merger is irrelevant to the merger’s legality.

– Efficiency is really a “competitive advantage” or a “barrier to entry” and is therefor anticompetitive

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Case III: US. V. Microsoft Co. (May 18, 1998 ~)

Plaintiff: U.S Dept. of Justice, 19 state attorneys general, and AG of District of Columbia

Defendant: MS.co. Background:

– 1990: the FTC’s legal staff, but not its economics staff, recommended that FTC bring a case focusing on MS’s licensing practices with personal manufacturers

– 1995: an appellate court approved the consent decree--MS should not enter into any license agreement conditioned upon the licensing of any other covered product, OS or other product, but this provision should not prohibit MS from developing integrated products.

– Disputes over the scope and interpretation of the decree soon arose. The core dispute is that MS think the IE browser was part of the OS, not a separate product

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Disagreed opinion between M.S. And Govt.(I)

I. Assessment of Market Power:

– The government alleged: MS. Was a monopolist in the relevant market comprising Intel-compatible personal computer operating systems.(90% or more market share)Another operating system would be hard pressed to displace Windows directly.

– Response of the MS’s chief economics expert: the competition in the personal computer software market was among “platforms, ” not operating systems. --MS faced significant competition from existing and future software platforms, any one of which could emerge as the new standard for desktop computing. (Mac OS, Linux, and various middleware including Sun’s Java)

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Disagreed opinion between M.S. And Govt.(II)

II. Catastrophic entry: Market with sig. network effects, technological progress, and production economies of scale can exhibit catastrophic entry, by which way one product dominates the market until another product is sufficiently superior that it becomes the new network bandwagon. -- Computer software markets may be characterized by a succession of temporary monopolies; In such a market, rivalry can take the form of competition to become a dominant firm-- competition for the market, rather than competition within the market.

** Govt. asserted that MS preserved its monopoly by using exclusionary and predatory tactics to block catastrophic entry, while MS claimed that it was just competing in the face of huge forces of change in the industry.

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Disagreed opinion between M.S. And Govt.(III)

III. Monopoly price or not?

** MS. Argue that MS. did not behave like a firm with monopoly power; by their calculation that the monopoly price of Windows should have been at least 16 times that price actually charged.

**While DJ’s chief economist argue that MS.’s prices were consistent with long-run monopoly pricing once one takes into account factors that encourage MS to restrain its prices, such as the value of growing its installed base, raising demand for complementary products, and discouraging software pirating.

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Central Charges again MS.(I)

MS. Used several types of contractual arrangements that tended to exclude competitors

I)Exclusionary Behavior -- entails denying rivals access to some resource of set of consumers in order to raise the rivals’ costs and weaken their ability to compete.

– With online & Internet service providers

– With personal computer manufactures

– Offered Internet content providers preferential, no-cost placement on the IC Channel bar in return for their agreement to promote on the as their browser of choice

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Central Charges again MS.(II)

II)Predatory Conduct: is any business strategy that is profitable only because of the long-run benefits of eliminating one or more competitors. Typically it involves an initial stage during which a firm offers a product at an unprofitably low price as a means of driving rivals from the market and facilitating the later exercise of market power.

MS. Practices as predatory– Pricing IE below cost: give it away for free and paid Apple to use its

browser. --Valid business model because it generate future revenues, e.g by selling advertising.

– Tying and bundling: MS. Refused to offer customers the option of taking Windows without the browser. -- No different from including a file management program with the operating system; Lower distribution and transaction costs; other OS vendors also bundled browsers with their OS.

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Did MS. Harm Consumers?

In the short run:

– Predation can benefit consumers in the short run while harming them in the long run because of higher prices and a reduction of investment in R&D. But the availability of free browsers may have allowed MS. to raise or avoid lowering the price of Windows. To the extent that MS. internalized the benefits from free browsers through the windows price, the short run consumer benefits from giving away IE and bundling it with Windows were limited.

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Difficulties in assessing the long-run effects of MS’s actions

1. There is the matter of predicting what will happen in the market subject to rapid technological change.

2. The link b/t the degree of competition and the degree of innovation is complex--The continuing development of Apples’ OS suggests that significant innovation by firms with much smaller sales than MS is feasible.

3. Even if one has found there would be greater competition and more innovation absent MS’s actions, as a matter of theory the linkage b/t innovation and welfare is ambiguous.

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Remedies

1. Conduct remedies: such as mandatory unbundling of IE from Windows, deal directly with MS’s challenged behavior. --difficult to enforce and may not be sufficient to deter MS from engaging in other behavior that has similar effects.

2. Structural divestiture: into two parts: one receive the Windows OS; the other would receive the applications programs and all other MS lines of business.

– the proposed breakup of a huge company would certainly entail substantial direct costs of reorganization.

– The concern w.r.t. pricing: “double marginalization problem”--the sum of the OS and application prices set by an integrated monopolist will be lower than the sum of those prices when set separately by two ind. firms each with sig. market power

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The economy is an artifact, very much (though not entirely) a product of human construction. The most fundamental social process is the definition and creation of socioeconomic reality. Two characteristics of the socioeconomic process are selective perception of and a

necessity of choice between conflicting interests. Although much of the organization and performance of the economy is a

matter of the unintended and unforeseen consequences of aggregated individual and subgroup activity, a key factor nonetheless is deliberative government decision making(choice) and action. To the extent that government is such a participant in the social formation of the economy, economic performance is pro tanto a result of government, in any economic system.

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Three main issues in the antitrust policy

First was the conflict over the goals of antitrust policy; this conflict was not only about desirable social policy but also about the proper decision-making role of a judge in our system of government.

Second was how to judge the legality of agreed elimination of competition. E.g. the problem of defining a market, within which the existence of competition or some form of monopoly is to be determined, which has remained an area calling for further economic research at either the theoretical or empirical level.(concentration ratio/market share--plaintiff sets the market as narrow as possible, but the defendant does in the opposite way)

Third was the identification of practices that injured rivals, not as vigorous competition does, but somehow improperly.

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This thrust a dangerously heavy burden upon the enforcement agencies and the federal courts. Competition is inherently a process in which rivals seek to exclude one another. Efficiency tends to exclude firms that are less efficient. Since congress was clearly not passing the law with the intent of destroying competition and efficiency, the courts and the enforcement agencies were necessarily given the task of distinguishing between those exclusionary practices that were competitive, that created or reflected efficiency and those that were anticompetitive and not so related to efficiency. This task remains beyond the law’s economic competence in our time. Inability to make the distinction raises the danger that the courts and the enforcement agencies will identify competition and efficiency as

processes to be stopped in the name of preserving competition.