1. 1. Introduction to Price Fixing: Legal and Economic Foundations Antitrust Law Fall 2014 Yale Law School Dale Collins SLIDES FOR CLASS

2. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com 2 Demand Curve Price Quantity Demand curve

3. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com 3 Revenues Price Quantity Demand curve Revenues

4. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com 4 Profits and Costs Price Quantity Demand curve Marginal cost curve Profits Costs

5. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com 5 Profits and Costs Price Quantity Demand curve Marginal cost curve Profits Costs Profits Quantity MR > MCMR < MC MR = MC Firm can make more profits by increasing q, since incremental revenue gains exceed incremental costs Firm can make more profits by decreasing q, since incremental costs exceed incremental revenue gains

6. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com Competitive Firms Competitive firms take prices as given  → Individual output decisions do not affect the market-clearing price Price Quantity Demand curve Marginal cost curve Profits Costs (Perceived) marginal revenue curve (MR = p) When price does not change as the firm expands output, the firm will produce every unit for which Increasing q increases profits Increasing q decreases profits 6

7. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com Monopolist Firm A monopolist choice of output q affects the market-clearing price p 7 Price Quantity Demand curve Marginal cost curve Profits Costs Marginal revenue curve When price decreases as the firm expands output, MR is less than p since in order to sell an additional unit the firm has to decrease the price for all units.

8. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com Moving to the Competitive Outcome Why a monopoly does not want to price at the competitive price 8 Price Quantity Demand curve Marginal cost curve Incremental losses from lower prices on old sales Incremental costs of new sales Incremental profits from new sales Incremental profit = Incremental revenues from new sales at lower price – incremental losses on old sales at lower price – incremental costs of new sales at lower price

9. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com Gains from Cartelization Why firms in a competitive market have an incentive to form a cartel 9 Price Quantity Marginal cost curve Profits gained from old sales at higher prices Avoided costs from reduced sales Any q in this region yields higher aggregate profits than the competitive equilibrium Demand curve Foregone profits from reduced sales

10. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com Obstacles to Cartel Formation The law  Cartel agreements are unenforceable (contract law)  Cartel agreements are illegal (antitrust law) Lack of sufficient market dominance  Too few competitors join the cartel  Too easy for new competitors to enter the market Too much cheating on the cartel rule (incentive incompatibility)  Not enough market transparency to tell if there is cheating Failure to agree on distribution of monopoly rents 10

11. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com Too Much Cheating Single-period cartel game 11 45, 450, 50 50, 0 25, 25 Competitive Monopoly Firm 2 Firm 1 Firms split monopoly profits of 90 Competitive firm takes total competitive profits of 50 against firm charging monopoly price Firms split competitive profits of 50

12. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com Failure to Agree on Distribution of Rents Infinitely repeated games 12 Price Quantity Marginal cost curve Incremental Profits Incremental Costs Folk theorem: Any q in this region is an equilibrium in an infinitely repeated game Demand curve

13. Antitrust Law Fall 2014 Yale Law School Dale Collins www.appliedantitrust.com 13 Public Policy of Price Fixing Quantity MC Aggregate demand curve Price Quantity MC MR Aggregate demand curve Price Perfectly Competitive Market Consumer surplus Perfect Monopoly Market Producer surplus (monopoly rents) Dead-weight loss 1.Shift in wealth from consumers to producers 2.2. Deadweight loss 3.May retard innovation