Chapter II. The Economic Rationale for Antimonopoly Law and Policy

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CHAPTER II

THE ECONOMIC RATIONALE FOR

ANTIMONOPOLY LAW AND POLICY

This chapter provides an overview of the economic principles

underlying the law of monopolization. First, it discusses the concept of

market power. Second, it covers standard economic models involving

market power and sets forth basic theories of competitive markets and

monopoly power. It then discusses the welfare effects of monopolies.

The chapter concludes by discussing various economic tests that have

been developed to identify conduct that violates Section 2 of the

Sherman Act.

A. Introduction to the Economic Concept of Market Power

1. Economic Concept of Market Power

Economists define market power as “the ability of a firm or group of

firms within a market to profitably charge prices above the competitive

level for a sustained period of time.”1Although any firm can raise its

price,2not every firm can profitably do so nontransiently. As a result, a

distinguishing characteristic of a firm or group of firms with market

power is that price can be raised without the firm or group of firms losing

1. See ABA SECTION OFANTITRUST LAW,MARKET POWER HANDBOOK

(2005) [hereinafter MARKET POWER HANDBOOK]. The overview

provided in this chapter borrows heavily from this earlier publication and

the reader is referred to that publication for a more complete treatment of

some of the economic concepts that are reviewed in this chapter.

2. While the economic definition of market power typically does not

mention reductions in product or service quality, economists typically

would expand the meaning of price to include the increases in real price

that result from reductions in quality. See, e.g., George Hay, Market

Power in Antitrust, 60 ANTITRUST L.J. 808 (1992).

10 Monopolization and Dominance Handbook

so many sales that the price increase is unprofitable. If there are close

substitutes or if others could easily begin producing close substitutes, a

firm will not profit from a price increase and thus, by definition, does not

have market power.

Economists typically define market power by focusing on the ability

to raise price relative to the competitive price level, rather than the actual

price level.3This is because a firm with market power may have already

exercised its market power, raising the price to a point where a further

price increase would be unprofitable because it would lead customers to

switch to other products,4even though such switchingwould not occur at

the competitive price.5As a result, by limiting focus to the ability of a

firm profitably to raise prices above their actual levels, one may

mistakenly conclude that the firm does not have market power, when in

fact it has already successfullyexploited substantial market power.

The notion that supracompetitive prices must be maintained for a

sustained period of time is important to distinguish the exercise of

market power from “opportunistic behavior,” which involves the

temporary elevation of prices above competitive levels. For example, a

firm may be able to use minor transaction costs or imperfections in

3. For example, the 1984 Department of Justice Merger Guidelines define

market power as “[the] ability of one or more firms profitably to maintain

prices above a competitive level for a significant period of time.” U.S.

DEPARTMENT OF JUSTICE,MERGER GUIDELINES (1984), reprinted in 4

TRADE REG.REP. (CCH) ¶¶ 13, 102. These guidelines have been

superseded by newer versions, but the new guidelines continue to

recognize this basic principle. See DEPARTMENT OF JUSTICE AND

FEDERAL TRADE COMMISSION,HORIZONTAL MERGERGU IDELINES (2010)

[hereinafter MERGER GUIDELINES], available at

http://www.justice.gov/atr/public/guidelines/hmg-2010.html. The most

recent version of the guidelines, adopted in August 2010, does not

formally define market power, but states that a merger “enhances” market

power “if it is likely to encourage one or more firmsto raise price, reduce

output, diminish innovation, or otherwise harm customers as a result of

diminished competitive constraints or incentives.” Id.

4. For example, a profit maximizing monopolist that faces a linear (straight

line), downward-sloping demand curve will increase its price until it

reaches a point on the elastic portion of the demand curve where further

price increases would be unprofitable. See infra n.15 for further

discussion.

5. For a similar discussion of this point see Robert Pitofsky, New Definitions

of Relevant Market and the Assault on Antitrust,90C

OLUM.L.REV.

1805, 1813-15 (1990).

The Economic Rationale for Antimonopoly Law and Policy 11

information flows to raise prices temporarily above competitive levels,

but this does not mean that the firm competes in a structural environment

that will allow it to sustain supracompetitive prices over the long run.

2. Different Degrees of Market Power

Economists often use the phrases “market power” and “monopoly

power” interchangeably.6However, some scholars have attempted to

distinguish the two terms by defining monopoly power (or “antitrust

monopoly power”) as a substantial amount of market power.7According

to these commentators, only the possession of “a high degree of market

power” is sufficient for a finding of monopolization under Section 2 of

the Sherman Act.8While all firms that face a downward sloping demand

curve have market power in the sense that they can raise their price

above the perfectly competitive level where price equals marginal cost

(economic market power), this does not mean that they all have

significant pricing discretion or the ability to foreclose competition.

Some firms deemed to have economic market power may, in fact, have

such limited control over price that courts would not find that they had

“antitrust market power.” For example, in some cases where a firm faces

a downward sloping demand curve, the amount by which a firm’s price

exceeds competitive prices (marginal costs) may not be large, especially

when there are numerous close substitutes that make the demand curve

close to horizontal. Moreover, relatively easy entry, even if there is

some product differentiation, may depress prices to the point where firms

earn few, if any, monopoly profits.9

6. See DENNIS W. CARLTON &JEFFREY M. PER LOFF,MODERN INDUSTRIAL

ORGANIZATIO N 92 (3d ed. 2000) (“The terms monopoly powerand

market power typically are used interchangeably to mean the ability to

profitably set price above competitive levels (marginal cost). . .”

(emphasis in original)).

7. William Landes & Richard Posner, Market Power in Antitrust Cases,94

HARV.L.REV. 937, 937 (1981); see also PHILLIP E. AREEDA,HERBERT

HOVENKAMP &JOHN SOLOW,ANTITRUST LAW 83-87 (1995)

(emphasizing that antitrust case law requires “monopoly power” to be

“substantial”); Hay, supra note 2 (discussing the level of market power).

8. Landes & Posner, supra note 7; see also AREEDA,HOVENKAMP &

SOLOW,supra note 7; Hay, supra note 2. See Chapter III.B.2 for a

discussion of case law addressing the level of market power that will

constitute monopoly power.

9. CARLTON &PERLOFF,supra note 6, at 194-215.