Antitrust Laws and Competition in the Modern Economy

Part I: ANTITRUST

Chapter 3 Introduction to Antitrust

There is no such thing as unconstrained competition in the modern economy Some constraints need to be placed on what firms do, and those constraints comprise antitrust (or competition) law, enforcement, and policy The purpose of antitrust is to make markets work better by preserving competition Industrial organization (also called industrial economics)

Competition and Welfare Welfare Tools There are five key assumptions of the perfectly competitive model Vocabulary Pareto optimality (also called Pareto efficiency or economic efficiency) Price equals marginal cost The price-taking assumption Pareto criterion The compensation principle Economic surplus

Monopoly versus Competition Example

Is the Compensation Principle Compelling? The role of an economist is not to determine what society should care about but rather what policies are most effective at achieving a society s objectives, whatever they may be The allocation of income and wealth is an increasingly important issue in the U.S. This rise in inequality has become an issue of concern to the body politic

Some Complications Vocabulary Natural monopolies Oligopoly theory Product differentiation E.H. Chamberlin More relevant to antitrust policy is the intermediate case, where economies of scale are moderate but not small relative to market demand

X-Inefficiency Two types of inefficiency from monopoly are allocative inefficiency and X-inefficiency Monopoly-Induced Waste A third source of inefficiency created by monopoly is competition among agents to become a monopolist Discuss rent-seeking behavior, unions, and market domination

Estimates of the Welfare Loss from Monopoly What is one method for estimating the traditional deadweight welfare loss (DWL)? Review Arnold Harberger s pioneering study Keith Cowling and Dennis Mueller s approach to estimating DWL

Innovation: Monopoly versus Competition Minor innovation case Consider the entire welfare ledger associated with a comparison of monopoly and competition An extensive body of research in economics has managed to identify some relevant forces pertaining to how the incentives and ability to innovate vary between monopoly and competition Large cost reductions inducing price reductions are termed major inventions; for minor inventions, market price is unaffected (A major invention can also be defined as one that makes the inventor s monopoly price below the original marginal cost)

Innovation: Monopoly versus Competition Major innovation case Consider the case of a major cost-reducing invention Jean Tirole and the replacement effect Appropriability and ability Competition still comes out ahead of monopoly, but it remains an open question whether monopoly or competition is more effective at innovation Kenneth Arrow and Joseph Schumpeter

Industrial Organization The primary task of industrial organization is modeling and understanding situations of imperfect competition Harvard economists developed a general approach to the economic analysis of markets that is based on three key concepts: 1) Structure 2) Conduct (or behavior) 3) Performance The structure-conduct-performance paradigm (SCPP)

Defining the Market and Market Power The debate on the market definition George Stigler s view The distinction between substitution and new entry What does it mean for a firm to have market power? The price-cost margin: (P MC)/P

Structure Vocabulary The concept of concentration Entry conditions Entry barrier Product differentiation Conduct Define conduct, collusion, explicit collusion, and tacit collusion Marlboro Friday

Performance The performance component contains two elements: efficiency and technical progress (or innovation) Dynamic efficiency Government The two major categories of policy examined in this book are antitrust and regulation The Robinson-Patman Act of 1936

Antitrust Purpose and Design of Antitrust Laws Antitrust law and the antitrust authority are commonly referred to as competition law and the competition authority, respectively, in other parts of the world The purpose of antitrust (or competition) law is to maintain a competitive marketplace by prohibiting certain practices that allow a firm or firms to create, enhance, or extend market power The distinction between protecting competition and protection competitors: the Supreme Court of Earl Warren (1953 1969) The standard of consumer welfare: If consumers are made worse off then the practice is to be prohibited Robert Bork and The Antitrust Paradox

Antitrust Purpose and Design of Antitrust Laws Consider the welfare standard in other countries: The Competition Act of Canada, the European Union, and The Competition Act of 1998 in South Africa The costs of applying the standard, such as administrative costs and costs associated with making errors in the enforcement of antitrust laws A type I error is false positive and a type II error is false negative In setting the bar for concluding that firms have violated antitrust law, it is useful to keep in mind that choosing antitrust over the heavier hand of regulation is an admission that market forces are generally desirable

U.S. Federal Antitrust Law and Enforcement Antitrust laws The Sherman Act of 1890, along with the Clayton Act and the Federal Trade Commission (FTC) Act in 1914, form the substantive framework for U.S. antitrust policy Consider instances where companies are exempt from the antitrust laws, e.g. the Webb-Pomerene Act of 1918

U.S. Federal Antitrust Law and Enforcement Categories of anticompetitive offenses The per se rule (or the rule of reason) Also refers to tests of inherent effect and evident purpose Justice Thurgood Marshall Examine its consistencies with economic analysis The inherent nature of price fixing

U.S. Federal Antitrust Law and Enforcement Enforcement and remedies Antitrust laws are enforced by private actions and, at the state level, by attorney generals The outcomes of antitrust cases are varied: the most common outcome is by settlement; government cases frequently end by consent decrees or orders; and merger cases are often settled by the use of so-called remedies Fines or prison sentences may be used in criminal cases brought under the Sherman Act In private cases, successful plaintiffs can win treble damages

Global Competition Law and Enforcement Competition law began in 1889 when Canada passed its law, followed by the United States in 1890 In the past thirty years, competition laws have spread like wildfire with more than 100 countries now having adopted legislation that prohibits certain practices associated with the exercise of market power Most competition laws are similar in what they prohibit, but there is considerable variation in how the laws are interpreted Consider the differences in competition policy between the U.S. and the European Union

Summary and Overview of Part I This chapter has reviewed the primary laws, methods of enforcement, and exceptions to those laws; the field of industrial organization; and the case for competition and against monopoly Chapter 4 focuses on collusive pricing and recent innovations in enforcement policies Chapter 5 examines entry and dynamic competition Chapter 6 introduces the topic of merger and focuses on horizontal merger Chapter 7 describes vertical mergers and vertical restraints Chapter 8 covers monopolization practices Chapter 9 focuses on New Economy markets