Class 2 Antitrust, Winter, 2018 Introduction: Market Power 11/19/2018 Class 2 Antitrust, Winter, 2018 Introduction: Market Power Randal C. Picker James Parker Hall Distinguished Service Professor of Law Ludwig & Hilde Wolf Teaching Scholar The Law School The University of Chicago Copyright © 2000-18 Randal C. Picker. All Rights Reserved.

Demand Curve Idea: Consumers will buy more at lower prices 11/19/2018 Demand Curve Idea: Consumers will buy more at lower prices P Q Demand Curve 10 P = 10 – Q November 19, 2018

Competitive Outcome: Price = Marginal Cost 11/19/2018 Competitive Outcome: Price = Marginal Cost P Q Demand Curve 10 Consumer Surplus P = 10 – Q MC = 4 PC Total Revs (TR)/Total Costs (TC) Marginal Cost QC November 19, 2018

Taking Stock Competitive Quantity At P = MC Meaning at 10 - Q = 4 PC = 4, QC = 6 November 19, 2018

Taking Stock Amount of Consumer Surplus Just area of red triangle = ½ * base * height Meaning ½ * 6 * 6 = 18 This is the extra social value generated by the competitive process November 19, 2018

Why Are Monopolies Bad? The Simple Answer Reduced Output 11/19/2018 Why Are Monopolies Bad? The Simple Answer Reduced Output A monopolist will produce less than would be produced under competitive conditions The output reduction makes society worse off November 19, 2018

What Do Monopolists Do? First Answer Same answer, different way Maximize profits Same answer, different way Set Marginal Revenue = Marginal Cost MR = MC November 19, 2018

Deriving Marginal Revenue 11/19/2018 Deriving Marginal Revenue TR = P x Q = (10 – Q) x Q = 10Q – QxQ Differentiate TR with respect to Q: November 19, 2018

Monopoly Outcome: Marginal Revenue = Marginal Cost 11/19/2018 Monopoly Outcome: Marginal Revenue = Marginal Cost P Q Demand Curve 10 CS P = 10 – Q PM Profits DWL MC = 4 MR = 10 – 2Q PC TC Marginal Cost DWL = Deadweight Loss QM QC Marginal Revenue November 19, 2018

Taking Stock Monopoly Outcomes MR = MC  10 – 2Q = 4 so QM = 3 and PM = 7 Consumer surplus = ½ * 3 * 3 = 4.5 Profits = 3 * (7 – 4) = 9 DWL = 4.5 November 19, 2018

Taking Stock Comparing the Competitive Outcome and the Monopoly Outcome Comp: SWF = 18 Monop: SWF = 13.5 18 split into three components and the 4.5 DWL is the difference in SWF between the two situations November 19, 2018

Bottom Line Monopolies reduce output to boost profits 11/19/2018 Bottom Line Monopolies reduce output to boost profits That transfers value from consumers to the monopolist The monopolist declines to make sales that would increase social welfare November 19, 2018

Wrinkle Two-Part Pricing How do we assess that? Require consumers to pay a membership fee to access the good Set that price = 18 (17.99 if you like) and then set the price of the good at 4 How do we assess that? November 19, 2018

Answer If … Demand curve really is that of a representative consumer and all consumers are identical, this will work Once in the door consumers will face the correct social price for the good—marginal cost—and will buy the competitive amount November 19, 2018

Answer If … Does this work in reality? The monopolist fully extracts the social surplus through the membership fee and no DWL arises Does this work in reality? November 19, 2018

Du Pont (US 1956) Key Questions How does du Pont’s position in cellophane arise? Does that matter? What does it tell us about whether du Pont has market power or how it is exercising that market power? November 19, 2018

Du Pont (US 1956) Key Facts Does du Pont have market power? Cellophane “market” is 75% du Pont and 25% Sylvania with the latter’s position limited by patent licenses Cellophane is 20% of flexible packaging materials “market” Does du Pont have market power? November 19, 2018

Says the Court Substitutes? “Determination of the competitive market for commodities depends on how different from one another are the offered commodities in character or use, how far buyers will go to substitute one commodity for another.” November 19, 2018

Says the Court Cross-Elasticity of Demand? “What is called for is an appraisal of the ‘cross-elasticity’ of demand in the trade. See Note, 54 Col. L. Rev. 580. The varying circumstances of each case determine the result. In considering what is the relevant market for determining the control of price and competition, no more definite November 19, 2018

Says the Court Cross-Elasticity of Demand? “rule can be declared than that commodities reasonably interchangeable by consumers for the same purposes make up that ‘part of the trade or commerce,’ monopolization of which may be illegal.” November 19, 2018

Cross-Elasticities Key Idea 11/19/2018 Cross-Elasticities Key Idea How much does a rise in the price of one good change the quantity consumed of a second good? November 19, 2018

Defining Cross Elasticity 11/19/2018 Defining Cross Elasticity The percentage change in quantity of good 1 divided by the percentage change in price of qood 2. Formally: November 19, 2018

Examples Increase of price of McDonald’s hamburger: 11/19/2018 Examples Increase of price of McDonald’s hamburger: How many more hamburgers are sold by Burger King? How much more chicken is sold by KFC? How many more meals are sold by Alinea? How many more pairs of shoes are sold? November 19, 2018

And in du Pont Itself Conclusion “That market is composed of products that have reasonable interchangeability for the purposes for which they are produced—price, use and qualities considered. While the application of the tests remains uncertain, it seems to us that du Pont should not be found to monopolize cellophane” November 19, 2018

And in du Pont Itself Conclusion “should not be found to monopolize cellophane when that product has the competition and interchangeability with other wrappings that this record shows.” November 19, 2018

Merger Guidelines: Mergers and Markets Don’t necessarily need to define the market “The Agencies’ analysis need not start with market definition. Some of the analytical tools used by the Agencies to assess competitive effects do not rely on market definition, although evaluation of competitive alternatives available to customers is always necessary at some point in the analysis.” November 19, 2018

MG: Mergers and Markets Substitutes and Market Definition “Market definition focuses solely on demand substitution factors, i.e., on customers’ ability and willingness to substitute away from one product to another in response to a price increase or a corresponding non-price change such as a reduction in product quality or service.” November 19, 2018

MG: Market Definition: The HMT 11/19/2018 MG: Market Definition: The HMT The Hypothetical Monopolist Test “The Agencies employ the hypothetical monopolist test to evaluate whether groups of products in candidate markets are sufficiently broad to constitute relevant antitrust markets. The Agencies use the hypothetical monopolist test to identify a set of products that are reasonably interchangeable with a product sold by one of the merging firms.” November 19, 2018

MG: Market Definition: HMT 11/19/2018 MG: Market Definition: HMT The Hypothetical Monopolist Test “The hypothetical monopolist test requires that a product market contain enough substitute products so that it could be subject to post-merger exercise of market power significantly exceeding that existing absent the merger.” November 19, 2018

MG: Market Definition and SSNIP 11/19/2018 MG: Market Definition and SSNIP Defining SSNIP “Specifically, the test requires that a hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future seller of those products (“hypothetical monopolist”) likely would impose at least a small but significant and non-transitory increase in price (“SSNIP”) November 19, 2018

MG: Market Definition and SSNIP 11/19/2018 MG: Market Definition and SSNIP Defining SSNIP “on at least one product in the market, including at least one product sold by one of the merging firms.” November 19, 2018