Public Policy in Private Markets Monopolization (section 2, Sherman Act)

Announcements Case presentations: 1 case has been assigned  Case 8, K&W, 5 th edition  Debate date: March 6 th. Video due to me: March 2 nd.  There will be a homework on that day Clickers:  The number of points for iclicker on a day will be equal to the number of questions on that day (e.g. 1 question = 1 point; 5 questions = 5 points). Your 10% of in-class work will be computed as the fraction of total iclicker points in the semester. Homework 1 posted, due Feb. 14, in class, group work is encouraged.

Overview of Antitrust Laws

What we are studying Sherman Act, section 2: Monopolization 1. Substantial market power A. Define relevant market B. Show market power 2. Intent to monopolize  Brief history  Predatory Pricing

What we are studying Sherman Act, section 2: Monopolization 1. Substantial market power A. Define relevant market B. Show market power 2. Intent to monopolize  Brief history  Intent: Any behavior that is used to perpetuate and extend monopoly power with the use of abusive practices (e.g. predatory pricing, sabotaging competitors)

Intent: Predatory Pricing What is predatory pricing? “Irrationally low prices” Anticompetitive vs. good healthy competitive behavior? Two approaches:  Average cost approach  Recovery approach

Question Which of the following best characterizes average variable costs (AVC) and average total costs (ATC)? A.AVC does not include fixed costs and ATC does B.ATC>=AVC C.ATC=AVC in the long run D.ATC and AVC are always upward sloping

Average Cost Approach Q P ATC MC AVC TC=Variable Cost + Fixed Cost Cost includes a normal return to capital If P>ATC: cover all costs (including fixed costs, and return to capital) Operate

Average Cost Approach Q PATC MC AVC If AVC<P<ATC: operate in short run (exit in long run)  Exit losses > stay losses If P<AVC: shut down immediately (short run)  Exit losses < stay losses Operate in SR, but shut down in LR Shut down

Average Cost Approach 1. AVC Rule: if P<AVC  Must have predatory intent (economically irrational)  P>AVC: not challenged 2. ATC Rule: if P<ATC  May have predatory intent: AVC<P<ATC: Are prices the result of natural variation? Special deals, oversupply, perishables  Must have predatory intent: P<AVC: Irrefutable evidence of predatory behavior Bottom line:  AVC rule: lenient (smaller range of illegal pricing).  ATC rule: stricter (broader range of illegal pricing)

Average Cost Approach Current interpretation:  Supreme Court: never formally adopted AVC rule  However, some Appeals Court cases (e.g. AA in DFW) used AVC rule Problems:  Accounting cost is different from economic cost  How to interpret it with multi-product firms?

Average Cost Approach Q P ATC MC AVC Example 1: Increasing MC

Average Cost Approach Q P ATC MC=AVC Example 2: Constant MC=AVC

Recovery Approach A.K.A.: “recoupment” Low prices may or may not be “successful” Focus on consumer well-being:  Are consumers hurt? In SR consumers benefit from lower prices In LR consumers will only be hurt if predatory pricing is successful:  Competitors leave  Recovery period (high price afterwards) is achieved

Recovery Approach Worry only if recovery period is achieved  Illegal behavior: only if consumer is hurt  Affected firms are not factored in Generally, approach is not as widely accepted in court as the average cost approach  However, important in cases such as AA

Summary of Approaches Average cost:  AVC (lenient)  ATC (stricter) Recovery:  Sacrifice? (How long? How much?), AND  Recovery? (How soon? How much?)

Microsoft Case (1): Evidence of Intent 1970’s: personal computers are introduced  1985: Microsoft introduces first commercial software for PCs Relevant Market:  Product: OS for PCs : 50% for all OS, >70% for IBM compatible PC’s  Geographic: National

Microsoft Case (1): Evidence of Intent Pre-announcement of software  DR-DOS (rival), 1990, captures 10%  MS-DOS 5.0 announced, but inexistent Exclusionary licensing:  Microsoft charges license fees based on all computers shipped by manufacturer (OEM), with or without MS-DOS: consumer paid twice for non-MS-DOS  Penalties to non-MS-DOS OEMs (higher fees, less support, no credit)  OEMs forced to install MS-DOS Incompatibilities:  Denying software developers access to application programming interface (API)

Microsoft Case (1): Details Microsoft’s view:  Large market share = superior product  Competitive market, large market share is not guaranteed  Practices are good and transparent competition  Consumers have gained  Remedies will hurt innovation rate

Microsoft Case (1): Details Consent decree (6/95):  OEM contracts limited to 1 year  No minimum commitment on OEM contracts  Elimination of non-disclosure agreements for beta testers

Next time Second Microsoft case (1998)

Poll: What Concept is the least clear? A.Nolo Plea (16/36%) B.Rule of reason v. Per se Rule (9/20%) C.Market Definition (9/20%) D.AVC v. ATC rule (3/7%) ???? E.Cross-price elasticity (15/33%)

On a scale from 1-10 what is your understanding of: (10=awesome, 1=no idea) Nolo Plea More Polling AVC v. ATC rule Cross-price elasticity