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CHAPTER 1
INTRODUCTION
A. THE FRAMEWORK OF LEGAL ISSUES RAISED BY BASIC ANTITRUST ECONOMICS
How the Basic Economics Explains the Core Legal Concerns. In a world of perfect competition, life is good. Firms can enter and exit markets instantly and without cost, products are homogeneous, and everyone is perfectly informed. Firms are so numerous that none of them is large enough to influence prices by altering output and all act independently. Supplier competition for sales thus drives prices for products and services down to the costs of providing them. (Costs here should be understood to include capital and risk-bearing costs, and thus incorporates a normal profit that reflects the capital market rate of return necessary to induce investment in firms given the risk level.) Any firm that tried to charge more than costs would be undercut by another firm that would charge less because they would gain sales whose revenue exceeded costs. Lower cost producers would thus underprice and displace higher cost producers. Their output would be purchased whenever market buyers found that the value of the product to them exceeded its price/cost but not otherwise.
If demand increased or costs decreased so that suppliers would earn supranormal profits if their output remained constant, then the existence or prospect of those supranormal profits would induce supplier expansion or entry, increasing supply until it drove prices back down toward costs. If demand decreased or costs increased so that suppliers would earn substandard profits if their output remained constant, then they would contract or exit the market, shifting any moveable capital to more profitable ventures and reducing supply until prices rise to meet costs. The nice result is to allocate societal resources towards those markets where they can best provide value to buyers. Even nicer, it does not have to be the case that suppliers are omniscient, or even know what theyāre doingāthe market will winnow out those who guess wrong regardless.
In the real world, life is regrettably imperfect. Entry, exit or expansion are costly and take time. Products vary by brand or attributes and information is imperfect. Economies of scale mean many markets cannot sustain a large enough number of firms to leave each without any incentive to consider the effect of its decisions on market prices. But despite such unavoidable realities, typical markets are workably competitive in the sense that they produce results that are fairly close to perfect competition, at least in the long run. In any event, perfect competition provides an aspiration and useful benchmark that helps identify the sort of interferences with market mechanisms that should most concern antitrust law. The economic literature analyzing such issues can be frightfully complicated and mystifying. Luckily the essential regulatory issues flow in a simple straightforward way from the basics outlined above.
The first major concern is that firms might agree to avoid competing with each other, thus elevating prices above cost and increasing their profits to supracompetitive levels. Price-fixing agreements among competitors is a classic example. Similar results can be obtained by agreements to restrict output or divide markets or impede entry. The legal responses to such concerns about agreements to restrict competition will occupy us in Chapter 2.
A second concern is that one firm might individually be large enough to raise prices by reducing output. In the pure case of monopoly, there is only one firm and entry is impossible. Such a monopolist need not worry that, if it raises prices, it will lose business to rivals. Instead, it has incentives to raise prices above costs, up to the point that the extra profits earned from the customers willing to pay the higher price are offset by the profits lost from diminished sales to other customers who arenāt willing to pay that price. The result is higher prices, lower output, and many customers who inefficiently do not get the product even though they value it more than it costs to provide. A single buyer, called a monopsonist, raises the parallel problem that it has incentives to suppress prices below competitive levels, which suppresses output from suppliers.
True monopolists are rare. More typical is what economists call a dominant firm, which is a firm that is much larger than the other firms because it has lower costs or a better product. A dominant firm also has incentives to price above cost, but is somewhat constrained by the ability of the other firms to offer the product at their costs. The dominant firm faces what is called the residual demand that results when one subtracts from total market demand the output that the other less efficient firms provide at any given price. The dominant firm effectively faces no competition for this residual demand, and thus has similar incentives to a monopolist to increase prices above its costs. A similar result follows even if rivals are not less efficient but would have difficulty expanding or entering in response to an increase in prices.
The mere possession of monopoly or dominant power need not, however, be a concern. If a firm makes a better mousetrap, and the world beats a path to its door, it may drive out all rivals and establish a monopoly; but that is a good result, not a bad one. Dominant market power normally reflects the fact that a firm is more efficient because of some cost or quality advantage over its rivals. If a firm has acquired that efficiency advantage through productive investments in innovation, physical capital, or organization, then the additional profits it is able to earn might reasonably be thought to provide the right reward for that investment, especially since any price premium it charges cannot exceed its efficiency advantage over other prevailing market options.
Typically the antitrust laws are instead focused on anticompetitive conduct that is used to obtain or maintain monopoly or dominant market power at levels that were not earned through productive efforts. A dominant firm has incentives to use anticompetitive conduct to exclude rivals from the market, impair rival efficiency, or impede the sort of rival expansion and entry that would drive down prices toward more competitive levels. So does a firm that, while not yet dominant, thinks such anticompetitive conduct will help it obtain dominance. Because a firm that obtains or maintains monopoly or dominant market power can exploit it unilaterally, it also has incentives to engage in such anticompetitive conduct unilaterally, rather than requiring agreement or coordination with rivals. Chapter 3 will address how the law seeks to identify such unilateral anticompetitive conduct and distinguish it from procompetitive unilateral conduct.
Firms with market power might likewise have incentives to enter into agreements with suppliers or buyers to try to exclude rivals, diminish their efficiency, or impede their expansion or entry. Because these agreements are up or down the supply chain, they are generally called āverticalā agreements, in contrast to the āhorizontalā agreements entered into by rivals at the same level. They thus involve concerted action but also involve firms who use such vertical agreements to obtain or maintain single firm market power. Chapter 4 addresses these sets of cases.
Firms might also engage in unilateral conduct or vertical agreements that antitrust law fears will impede competition among downstream firms. One form of unilateral conduct that some laws seek to condemn on this score is price discrimination among buyers that distorts their ability to compete downstream. Similar concerns have been raised about vertical agreements to restrain resale by buyers, including agreements to fix the prices that distributors can charge downstream, or to limit where or to whom they can sell. As we will see, legal liability for such conduct or agreements has been the subject of strong economic critique, based mainly on the observation that firms typically have little incentive to impede competition among downstream firms. Such issues will be addressed in Chapter 5.
Chapter 6 then addresses how to prove the existence of an agreement, and addressed a third concern: that some markets have few enough firms that each has an influence on prices and output. and can notice and respond to the actions of each other. If so, then even without an explicit agreement, such firms may be able to coordinate to restrict output and raise prices. This is called oligopolistic coordination. The big difficulty this raises is whether such coordination can be condemned without proof of an agreement, especially when oligopolistic firms cannot avoid knowing that their pricing and output decisions will affect the behavior of other firms.
The final major concern, addressed in Chapter 7, is that rivals might merge or combine into one firm. Horizontal mergers can have anticompetitive effects if the resulting firm has monopoly or dominant market power, or the structure of the rest of the market means the merger will create an oligopoly or exacerbate its ability to coordinate on higher prices. The difficulty is determining when this is the effect of a merger and whether the merger is justified by any greater efficiencies it might create. Vertical mergers between firms up and down the supply chain raise issues similar to vertical agreements that might exclude or impair rival competition. Mergers between firms that are not related horizontally or vertically are called conglomerate mergers, which raise issues if they eliminate potential horizontal competition or enable the merged firm to engage in anticompetitive exclusionary conduct.
In addressing all the above issues, antitrust courts and regulators must also face the problem that many markets span multiple antitrust regimes. In particular, on global markets, firms are subject to regulation under U.S. and EU antitrust law. As we shall see throughout the book, those laws often vary significantly from each other and from antitrust regulation in other nations, which offers a useful lens for analyzing the relevant issues. But when should a nation regulate conduct that either occurs or has effects extraterritorially, and what does one do about the international conflicts in antitrust regimes that result when multiple nations seek to regulate the same conduct? Further, what does one do with conduct that anticompetitively harms markets (typically outside the U.S. and EU) in a way that no individual antitrust authority has strong incentives to pursue? Chapter 8 addresses those topics.
Graphing the Basic Economics. The prior section explains the basic relevant economics using simple words. But some might find graphical depictions more helpful. In a competitive market, the situation is represented by Figure 1. The X-axis indicates the market quantity Q. The Y-axis indicates the market price P. The line marked D is the demand curve, which indicates what quantity buyers would demand at each price. As price (P) goes up, the quantity demanded (Q) goes down because making a product more expensive means fewer buyers will find the value of the product worth the price. That is why the demand curve goes down. The line marked MC indicates the marginal cost of production. It generally increases as quantity goes up, mainly because increasing market quantity generally requires bidding away resources from other markets or because sellerās plants are operating at output levels where their marginal costs of operation would increase if they made more. The MC curve is also the same as the supply curve, S, which indicates the quantity the mark...
