1. 1. Introduction to Price Fixing: Legal and Economic Foundations Antitrust Law Fall 2015 NYU School of Law Dale Collins SLIDES FOR CLASS

2. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com 2

3. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com 3 Demand Curve Price Quantity Demand curve

4. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com 4 Revenues Price Quantity Demand curve Revenues

5. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com 5 Profits and Costs Price Quantity Demand curve Marginal cost curve Profits Costs

6. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com 6 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

7. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Profits and Costs The calculus version 7 Price Quantity Demand curve Marginal cost curve Profits Costs Profits Quantity MR > MCMR < MC MR = MC

8. Antitrust Law Spring 2015 NYU School of Law Dale Collins 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 8

9. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Monopolist Firm A monopolist choice of output q affects the market-clearing price p 9 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.

10. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Moving to the Competitive Outcome Why a monopolist does not want to price at the competitive price 10 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

11. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Gains from Cartelization Why firms in a competitive market have an incentive to form a cartel 11 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

12. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Public Policy of Price Fixing Modern view on why monopolies are bad:  Increase price and decrease output  Shift wealth from consumers to producers  Create economic inefficiency (“deadweight loss”)  May (or may not) have other socially adverse effects Decrease product or service quality Decrease the rate of technological innovation or product improvement Decrease product choice 12

13. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Public Policy of Price Fixing Output decreases: Prices increase: 13 Quantity MC MR Aggregate demand curve Price Competitive outcome: p = MC Monopoly outcome: MR = MC

14. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Shift in wealth from inframarginal consumers to producers*  Total wealth created (“surplus”): A + B  Sometimes called a “rent redistribution” Public Policy of Price Fixing 14 Quantity MC MR Aggregate demand curve Price A B CompetitiveMonopoly ConsumersA + BA Producers0B * Inframarginal customers here means customers that would purchase at both the competitive price and the monopoly price

15. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com “Deadweight loss” of surplus of marginal customers*  Surplus C just disappears from the economy  Creates “allocative inefficiency” because it does not exhaust all gains from trade Public Policy of Price Fixing 15 Quantity MC MR Aggregate demand curve Price C * Marginal customers here means customers that would purchase at both the competitive price and the monopoly price

16. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com 16 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

17. Antitrust Law Spring 2015 NYU School of Law Dale Collins 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 17

18. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Too Much Cheating Single-period cartel game 18 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

19. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Failure to Agree on Distribution of Rents Infinitely repeated games 19 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

20. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Unit 1: Lessons Life  Never spell antitrust with a hyphen  Blue Book your citations  Understand the difference between Type I and Type II errors and pay attention to them  Almost all questions I will ask in class will have a simple answer Corollary: If you give a complex answer, it will likely not be the right answer 20

21. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Unit 1: Lessons Economics and economic models  Firms maximize profits (subject to their available technology) Corollary: The answer to the question “Why did the firm do X?” is almost always “To make more profits” The next question is “How does X enable the firm to make more profits”  Consumers maximize their utility (subject to their budget constraints)  Demand curves slope downward Corollary: The more it costs, the less you want it  In normal markets, firms maximize profits when they set price or output so that MR = MC  In normal competitive markets, Marginal revenue is equal to price So firms price so that p = MC 21

22. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Unit 1: Lessons Cartels  Firms form cartels to increase their profits Cartels work by decreasing the ability or incentive of customers to substitute between member firms This makes the firm’s residual demand curve more inelastic and allows the firm to raise price  Cartels are hard to form and maintain because: Market conditions may destabilize any cartelization effort Members need to collectively agree on a rule to allocate monopoly rents There is a strong short-run incentive on the part of individual members to cheat  But there are long-run benefits to firms from participating in cartels, so— Cartels can exist (sometimes for long periods of time) But typically operate imperfectly 22

23. Antitrust Law Spring 2015 NYU School of Law Dale Collins AppliedAntitrust.com Lessons Public policy  When cartels are successful Raise price and lower output Shift wealth from consumers to producers Create economic inefficiency (“deadweight loss”) 23