Chapter 1. Economic Underpinnings

A. Introduction
This chapter introduces the concept of market power and explains the
sources of market power in communications industries. The chapter
continues with a discussion of market definition, which is a key element
in the analysis of whether a firm has market power. It concludes with a
general overview of potential anticompetitive effects that flow from the
exercise of market power, with a particular focus on vertical foreclosure
theories. Vertical foreclosure refers generally to the use of vertical
integration or other vertical restraints by an input supplier to achieve
market power in an output market. In communications networks, a
supplier of a key input may also be a downstream competitor, which may
have implications for how the vertically integrated firm and its
customers/competitors deal with each other. The application of the
vertical foreclosure concept is neither simple nor straightforward.
Vertical integration concerns remain a significant driver of
communications policy, and of antitrust litigation initiated by frustrated
B. An Introduction to Market Power in Communications Markets
The chief goal of the federal agencies charged with enforcing the
U.S. antitrust laws is to prevent the acquisition of an increased ability to
exercise market power and to prevent the illegal maintenance of market
power. For example, mergers are prohibited under Section 7 of the
Clayton Act if their effect “may be substantially to lessen competition, or
to tend to create a monopoly”1 or are prohibited under Section 1 of the
Sherman Act if they constitute a “contract, combination … or conspiracy
1. 15 U.S.C. § 18.
2 Telecom Antitrust Handbook
in restraint of trade.”2 The 1992 Merger Guidelines of the federal
antitrust agencies lay out the enforcement policy of the agencies with
respect to mergers. The “unifying theme of the Guidelines is that
mergers should not be permitted to create or enhance market power or to
facilitate its exercise.”3 Antitrust enforcement against monopolization or
attempted monopolization is also based on core principles focused on
“market power and separating the legitimate, procompetitive ways it is
acquired and preserved, from the illegitimate, anticompetitive ways.”4
The Federal Communications Commission (FCC) uses a different
framework for evaluating mergers than that of the 1992 Merger
Guidelines, but a key component of the evaluation is a determination of
whether a merger “will allow firms . . . to exercise increased market
power through either unilateral or coordinated anticompetitive
The analysis of whether or not a merger results in an increased ability
to exercise market power starts with a proper definition of the relevant
market or markets in which the merger is to take place. The 1992
Merger Guidelines take the position that a merger “is unlikely to create
or enhance market power or to facilitate its exercise unless it
significantly increases concentration and results in a concentrated
market, properly defined and measured.6 The FCC takes a similar
position, arguing that the starting point for the determination of whether
a merged firm will have an increased ability to exercise market power is
the definition of the relevant market or markets in which that power
would be exercised.7
Market power is generally defined as “the ability profitably to
maintain prices above competitive levels for a significant period of
2. 15 U.S.C. § 1.
MERGER GUIDELINES § 1.43 (1992) (with Apr. 8, 1997 revisions to
Section 4 on efficiencies) [hereinafter 1992 MERGER GUIDELINES],
reprinted in 4 Trade Reg. Rep. (CCH) ¶ 13,104.
4. Joel I. Klein, Rethinking Antitrust Policies for the New Economy,
Haas/Berkeley New Economy Forum, May 2000, available at
5. Application of WorldCom, Inc. and MCI Communications Corp.,
Memorandum Opinion and Order, 13 F.C.C.R. 18025, ¶ 16 [hereinafter
WorldCom/MCI Order].
6. 1992 MERGER GUIDELINES, supra note 3, § 1.0 (emphasis added).
7. WorldCom/MCI Order, supra note 5, ¶ 16.
Economic Underpinnings 3
time.”8 In the economic model of “perfect competition,” prices are at
competitive levels if they are set equal to the marginal cost of the firms
in the industry.9 Thus, another way of expressing the definition of
market power is that it involves the ability to set and sustain prices above
marginal cost.10
Whether a firm will find it profitable to set prices above competitive
levels is almost entirely a function of the demand conditions facing that
firm.11 A firm in a perfectly competitive industry is a “price taker,”
meaning that it can sell all it wants at the prevailing market price, but it
cannot affect market price. However, a firm with market power in the
above-defined sense faces a downward sloping demand curve, meaning,
as it increases price, it will sell smaller quantities of a particular good.
Any firm that faces such a downward sloping demand curve will set its
profit-maximizing price at a level above marginal cost, even if it faces
substantial competition.12
However, this definition of market power may be misleading. For
example, a firm might have a product that is sufficiently differentiated
from other products that it faces a downward sloping demand curve and
can charge a price above marginal cost. Nonetheless, as long as entry by
other firms is possible, the firm is not likely to be able to earn monopoly
profits.13 The ability to exclude competition is often an important
element of market power, and one which is a hallmark of competitive
concerns in communications industries, as discussed more fully in
Section E of this chapter.
Thus, a more useful definition of market power for antitrust purposes
might be where “a firm or a group of firms is able profitably to maintain
8. 1992 MERGER GUIDELINES, supra note 3, § 0.1.
9. Marginal cost is the increase in cost associated with an additional unit of
MICROECONOMICS 85 (6th ed. 2005).
10. Another related way to define market power is the ability to raise price by
11. For a discussion of the relationship between market power and the
demand faced by a firm, see Gregory Werden, Demand Elasticities in
Antitrust Analysis, 66 ANTITRUST L.J., 363, 363-414 (1998).
12. PINDYCK & RUBINFELD, supra note 9, at Ch. 10. This situation may arise
in markets with differentiated products, scale economies, or oligopolistic
structure. Id.; see also DENNIS W. CARLTON & JE FFREY M. PERLOFF,
MODERN INDUSTRIAL ORGANIZATION, Chs. 6 and 7 (3d ed. 2000).
13. See, e.g., CARLTON & PERLOFF, supra note 12, at 76.

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