Why are Anti -Trust laws needed?• Consumers are as well off as they can be in

competitive markets in regards to price and quantity.

• Most markets are imperfectly competitive, that is oligopolistic or monopolistic, which hurt consumers welfare with higher prices - lower quantity.

• It is the potential lack of competition and efficiency with imperfect competition which gives government a rational to step in and reestablish competitive conditions in these industries.

• Potential tradeoff: Government has the potential to make things worse by intervention as well.

Anti -Trust laws:The basis for action

• Written in response the the abuses of the “Trusts” formed in the late 19th century, the so called “Robber Baron” era...

• Examples:

Jay Gould who manipulated railroad stocks to gain a monopoly on railroads

John Rockefeller, by getting kickbacks from railroads on oil freight, obtained a monopoly on oil production (Standard Oil Trust)

Anti -Trust laws:The basis for action• Sherman Act (1890) made illegal:...contracts or conspiracy to “Restrain Trade...”...“a monopoly or any attempt to monopolize an

industry.• Questions: What does “restraint of trade” mean? What defines a monopoly? Answer: The court system (Supreme Court)

interprets the law and decides...…in 1914 Congress passed further legislation to be

more specific...

Anti -Trust laws:The basis for actionClayton Act and the Federal Trade Commission(1914)• The following acts are illegal if their effects are to

“substantially lessen competition or tend to create a monopoly”

• Price Discrimination• Tying contracts. These agreements between supplier and purchaser

prevent the buyer from using the products of a competitive supplier

• Interlocking directorates - same person can’t sit on the board of directors in the same industry

• Corporate stock acquisition intended to reduce competition

• FTC - enforce the prohibition against “unfair methods of competition in commerce” &...

...“unfair or deceptive” conduct

Enforcement and Interpretation of Anti-Trust laws

• Initiation of cases before the courts can come from the U.S. Government or Private Citizens

• Private citizens need to demonstrate an injury or threat of injury

• The Anti-trust division of the Justice department decides which cases to prosecute (this sometimes depends on who is President and/or Attorney General)

• The FTC sets trade regulations and looks for anti-trust violations

• Any remedies or penalties are formally decided by the Courts.

Possible Remedies and Penalties• Courts have much discretion in choice of remedy:1. Forbid the continuation of illegal acts2. Force the defendant to dispose of the “Fruits of their

wrong”3. Restore competitive conditions...…this can be done in the following ways a.Consent decrees(75 to 80% of gov’t initiated civil

suits) between the Justice department and the defendant that is overseen by the Courts.

These can be done before or during a trial and take take on many forms.

Example: Microsoft in 1994 to allow OEM’s to put on software other than Microsoft’s

AT&T consented to being broken up into different companies in 1984

Possible Remedies and Penalties• Criminal Actions If found guilty of violating the Sherman act it is now a

felony. However, Courts have limited criminal proceedings so

most violators are not put in prison.• Treble Damages For private cases the plaintiff will receive three times the

actual damages imposed on him.Example: In 1986 the USFL won it’s case against the NFL

for restraint of trade…...and the jury awarded the USFL $1 in damages……so the USFL received $3 and folded the next year The jury found that while the NFL was a monopoly and

using predatory tactics they did not control television rights…

…and it was mismanagement of the USFL that caused it problems

Courts interpret the laws• Early 20th Century: The rule of reason 1911 Standard Oil: Found in violation of the

Sherman act because of it’s conduct, not because it dominated the oil market(90%)

Only “unreasonable conduct” is found guilty, not mere size.

1920 U.S. Steel: Not guilty. “Size alone is not an offense.

• Mid 20th Century, the Alcoa case... Found guilty of a monopoly in primary aluminum

ingots because of their expansion of capacity. Illegal monopolies can be inferred from acts other

than “unreasonable business practices; for example controlling 90% of the market…

…the principle of the “relevant market” takes precedence over the “rule of reason”

Courts interpret the laws: Relevant market• Alcoa: relevant market was aluminum ingots, not

metals(copper, zinc, steel, etc) where Alcoa did not have a dominant market share...

...Court ruled the other metals were not good substitutes…this is the concept of cross elasticity in production.Further cases:1956 DuPont: was not guilty of a monopoly in cellophane

production. Other packaging material was included in the “relevant market”

1969 IBM: 72% general purpose computing machinesIBM argued it was because of superior products & service:

Case dropped in 1982 because it was not winnable1984 AT&T: controlled virtually all telephone service(no

good substitutes)1984 NCAA: Found guilty of restraint of trade in college

football telecasts. Market defined as college football, not entertainment

Price Fixing • 1940 - Socony-Vacuum Oil Co.

This combination of firms formed for purpose of price fixing which the court ruled is always “unreasonable”

• 1961 - General Electric, Westinghouse, & others

Price fixing conspiracy ; executives fined & jailed

• 1992 - Ivy League universities accused of price fixing conspiracy for tuition, faculty salaries, and financial aid.

Consent decree signed to cease colluding.

Anti -Trust Law and Mergers• A Merger is the joining of two firms into one. It will tend to concentrate economic power, but does

not necessarily reduce competition in a given market• Three types of Mergers 1.Horizontal Merger - competing firms in the same

market form a single firm. Example: Bank One & First Chicago-NBD 2. Vertical Merger - A firm becomes one with a

supplier Hypothetical Example: Comcast cable purchasing

HBO or other programming channels 3. Conglomerate Merger - between two firms selling

goods in unrelated marketsExample: Liquor company and a Newspaper company

Anti -Trust Law and Mergers• Why do firms pursue Mergers?1. Gain plant capacity in the face of increasing demand

for a firm’s product2. Diversify into a new market(Conglomerate )3. Speculative gain - sell off parts of a corporation to

make profit4. Increase the size of the firm5. Get rid of competition The FTC reviews most potential mergers and

evaluates their effect on competition in a given market.

If the FTC feels competition is unduly reduced it can take the firms to court to prevent the merger.

Horizontal Mergers are most closely looked at since they have the greatest potential to reduce competition…

Anti -Trust Law and Mergers• 1982/84 Guidelines on Mergers Uses the Herfindahl-Hirshcman Index(HHI) It uses market shares of firms in an industry to

determine if a merger should be allowed. Takes each firms market share, squares it, then adds

up all the numbers.

Measuring the impact on competition from Mergers

Firm 1 = 30%Firm 2= 18%Firm 3 = 15%Firm 4 = 11%Firm 5 = 9%Firm 6 = 7%Firm 7 = 5%Firm 8 = 5%

Suppose an industry has 8 firms with the following market shares:

302 + 182 + 152 + 112 + 92 +72 + 52 + 52

900 + 324 + 225 + 121 + 81 + 49 + 25 + 25

1,750

What does this number mean?

Herfindahl-Hirshcman Index(HHI)

1,000

1,800

HHI

No Challenge

Challenge merger if index is raised by 100 points as a result

Challenge Merger if index is raised by 50 points as a result

Unconcentrated

Moderate Concentration

Concentrated

An HHI of 1,750 is considered Moderately Concentrated

Other IndustriesLaundry Equipment 2855Breakfast Cereal 2253Motor Vehicles 2676Chocolate Products 2188Pet Food 1299Computers 680Newspapers 241Milk 181Women’s Clothing 61

Herfindahl-Hirshcman Index(HHI)

1,000

1,800

HHI

No Challange

Challenge merger if index is raised by 100 points as a result

Challenge Merger if index is raised by 50 points as a result

Unconcentrated

Moderate Concentration

Concentrated Firm 1 = 30% Firm 5 = 9%

Firm 2= 18% Firm 6 = 7%Firm 3 = 15% Firm 7 = 5%Firm 4 = 11% Firm 8 = 5%

An HHI of 1,750 is considered Moderately Concentrated

Suppose Firm 4 & 5 wish to Merge.Should they be allowed to based on the guideline?

{202} Post Merger

- {112 + 92} Pre-Merger

=400 - 202

198

Firm 5 & 8?{142}

Post Merger

- {92 + 52} Pre-Merger

=196 - 106

90

Airlines Share

American 15.7%

United 12.1%

Delta 11.8%

Southwest 11.5%

Continental 7.5%

Northwest 7.0%

US Airways 4.7%

America West

3.9%

JetBlue 3.9%

Alaska 2.6%

Herfindahl-Hirshcman Index(HHI)

Anti -Trust Law and Mergers• In 1997 the FTC has new rules that may relax the

total reliance on the HHI index. The result could be some mergers may now be

allowed that would previously been prohibited base on the HHI index. Why?

1. Efficiencies that result from the merger may offset the rise in the index

The lowering of costs could mean lower prices for consumers.

2. Improved management could lead to lower costs3. Economies of scale could lower costs4. If market is contestable (that is entry is easy), the

consumer will benefit and the government will let the merger proceed.

5. Mergers may also be allowed to meet foreign competition

The Anti-Trust Enforcement Debate

• How aggressive should the Anti-Trust division of the DOJ be in prosecuting violators?

• Will it benefit consumers in the long run?

• Is it effective in promoting efficiency or does it detract from it?

The Anti-Trust Enforcement Debate The case for anti-trust enforcement:1. Monopolies & Oligopolies tend to charge higher

prices and produce lower quantities than the efficient outcome and hurt consumers.

2. Prohibit certain conduct that is detracts from an efficient market:

• Unfair or Deceptive practices Helps efficiency because accurate information is critical

to a well functioning capitalist economy• Price Fixing or collusion• Price discrimination, if it reduces competition• Highly concentrated industries Controlling 90% of the market is assumed to be bad3. The deterrent factor of anti-trust laws

The Anti-Trust Enforcement Debate The case against anti-trust enforcement 1.Remedies may not work as well as advertised

Are regulations a penalty for success?

Only go after firms that do too welltoo well, produce products that end up dominating their market

2.There may be a need for large strong firms due to foreign competition

3. Possible effects on research, development, & growth …only big firms can afford to undertake research

4. Contestable markets and more efficient capital markets make anti-trust less needed

5. Too much power goes to the government

Thoughts on Anti-Trust policy

• Question to ask when it comes to high market concentration is this:

Would a High market share survive an attempt to charge high prices and earn economic profit?

If not, then the market concentration will not matter, because firms will not be able to raise price to get economic profit.

The Microsoft case• Court: a monopoly in computer operating systems

which is it’s relevant market...

…if it wished to it could charge a price above competitive levels and still keep most of it’s business

• By tying it’s web browser to it’s operating system and also practicing predatory pricing to maintain it’s monopoly it acted unlawfully.

• It unfairly leverages it’s market dominance to other products like web browsers and to harm any firm that tries to compete…

…and so it harms consumers indirectly by limiting choice and innovation (distorts competition)

The Microsoft case Counter arguments• Microsoft public benefits Reduced learning costs for computer use with

standardized operating system Encouraged writing of application software “Browser war” accelerated development of

internet Knowledge based industries inevitably, and possibly Knowledge based industries inevitably, and possibly

desirably, tend toward dominant firmsdesirably, tend toward dominant firmsLawrence Summers, Secretary of Treasury“…with very large fixed costs and very small marginal

costs the only incentive to produce anything is to gain temporary monopoly power so that firms can recoup their large fixed costs”

Constant pursuit of monopoly power becomes the central driving issue in information technology