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University of Iowa School of Law
Hovenkamp, Herbert J.

Economic Issues
Market Power & Defining a Market
1)      Market Power: The ability to raise prices (or decrease output) above Marginal Cost and make a profit
Directly Measuring Market Power
1)      Process
a)      Look at the relation between Marginal Cost and Price
b)      Lerner Index: Ratio of the difference between price and marginal cost (MC) to the price (P): . Index is from 0 to 1, with 0 being pure competition, and 1 being complete control by a firm.
c)       Could also try looking at how a firm behaves after cost shoks
2)      Problems
a)      Difficult to get accurate data (direct measures were largely disfavored after Alcoa because econometric tools were expensive, but now electronic tools make them easier)
3)      Benefits
a)      Allows us to measure market power even when there are varying degrees of substitutability
Indirectly Measuring Market Power – Market Share Proxy
1)      Introduction
a)      Test: Market share in a relevant Market
i)        Market Share: Percentage of the Relevant Market the firm controls
ii)       Relevant Market: Smallest grouping of sales where
(1)    Elasticity of demand and supply are low enough to permit a firm with 100% market share to charge unacceptably high prices/lower output for an unacceptable period of time
(a)    Unacceptably High Prices: Generally 10% above some measure of cost (Prices are not justified by high costs)
(b)   Unacceptable Period of time: Defend the decreased output for at least 1 year
b)      Three relevant factors
i)        Market share
ii)       Elasticity of demand and supply
iii)     Types of markets (Geographic, Product, Virgin/Secondary, etc.)
c)       Process
i)        Process
(1)    Start with a small market
(a)    If consumers will leave the market (or producers will sell products in the market), then the market is too small.
(2)    Then, gradually increase the market until there is no longer elasticity
(a)    If a firm does not fear consumers leaving (or producers entering) a defined market, then it is an appropriate measure.
(3)    Question: How would we know if the geographic market is too large?
(a)    If there is a smaller market that is not elastic, then then it is not the “smallest market”?
d)      Problems with using Market Share Proxy
i)        Does not account for firms outside the market that may have an impact on market power
2)      Market share
a)      Process
i)        Identify a measure (either by goods or products)
ii)       Identify percentage
b)      Market shares as an indicator of market power
i)        §1 Tie in claims
(1)    30% is not enough (Jefferson Parish Hospital)
(2)    40% is probably enough
ii)       §2 tying claim requires closer to 60% market share
iii)     Under §2 (according to Alcoa)
(1)    90% is definitely enough
(2)    64% may or may not be enough
(3)    33% is not enough
c)       Complicated to measure market share when goods are not fungible
i)        If goods are fungible, can measure either by units sold or income from goods sold (just need to be consistent)
ii)       If goods are not fungible, how to measure market share? Measure by goods sold, or profits?
(1)    Test: Look at how consumers substitute goods (do they substitute units or money?)
(a)    Example: Car industry. Consumers substitute units, not cost (would not buy 2 Dodges, just because they cost the same as one Ford).
(b)   Example 2: Consumers might buy more of a cheaper battery than an expensive one. Here it might be good to look at profits.
3)      Measuring the Relevant Market
a)      Elasticity
i)        Elasticity of Demand
(1)    Definition: The rate at which customers will switch from Firm A to Firm B if Firm A raises prices above Marginal Cost.
(2)    Problem: Courts cannot tell marginal cost just by looking at market prices, because of the Cellophane Fallacy. As a result, it is difficult to tell if there is high demand elasticity.
(a)    Solution: Look for “cost shocks,” (like when the price of raw materials increases dramatically), and see how the firm reacts. If the firm does not have raise prices, it likely is selling at above Marginal Cost. If it does have to raise prices, it is more likely to be selling at about Marginal Cost.
(b)   Solution 2: Look for unique costs that fluctuate, and see if ∆ changes price according to these unique costs (if not, then likely charging above MC).
(i)      Example: If a market is defined as “Movie theaters and Cable TV,” and the cable company has a unique tax costs. You can look at whether ∆’s prices fluctuate with tax changes
(3)    Factors in Elasticity of Demand
(a)    Substitutes
(i)      Definition:
1.       Substitutes compete with other things defined as “substitutes”
2.       Substitutes do not compete with non-substitutes
(ii)    Test:
1.       Best Test: If Firm A starts charging monopoly prices (prices above Marginal Cost), then consumers will substitute in Firm B’s product.
2.       Look at price changes. If price changes by A & B follow each other (increase/decrease in the same direction) they are substitutes. If the price changes are divergent (when A increases price, B decreases price), then they are complements.
(iii)   Difference between substitutes and complements
1.       Complements are not in the same market (don’t compete against each other), which substitutes are (or can be)
a.       When A & B are complements, if A increases in price, B must decrease (or both will lose sales)
2.       Substitutes compete against each other for consumers
a.       When A & B are substitutes, if A increases price, B can increase price (or remain the same), since it will not lose sales.
(b)   Cellophane Fallacy: When there are significant differences in Marginal Costs of two products, it may only seem like products are elastic (meaning consumers will move away from a firm charging monopoly prices ab

right: Strong copyrights (software can be strong), weak copyrights (literature).
(iv)  Reputation/Good Will – Not usually significant
b)      Types of Markets
i)        Geographic Market
(1)    Casey’s example: How far are consumers willing to travel?
(a)    Caseys showed that it had a large geographic market by giving people $1 for giving their address, and showing that people came from all around (not just the small town) to fill up their gas)
(b)   By doing this, Caseys shows that consumers were willing to travel from far away to use its services
(2)    Alcoa Example: Foreign importers and tariffs
(a)    The court found the relevant market to be the US, because tariffs kept foreign imports out of the US market
(b)   However, it recognized that the imports would keep Alcoa in check if its tried to raise prices too much
ii)       Product Market
iii)     Virgin vs. Secondary Market (analyze this the same way as any other market)
(1)    Durable product problem: When a product is reusable, a manufacturer creates its own competition simply by producing a good
(a)    Alcoa – the court only considered the virgin market as the “relevant market” even though secondary aluminum competed somewhat. This was because Alcoa “controlled” the virgin market, and thus controlled the secondary market. As a result, it excluded the secondary market.
(b)   This leads a lot of manufacturers to simply rent their goods rather than selling them
(2)    Alcoa – If a firm controls the virgin market, do not count the secondary market (because the firm controls that too).
(3)    Also, consider that the secondary market may not be a good competitor with the virgin market.
iv)     Vertically-Integrated goods (fabrication for own uses vs. those sold to other firms)
(1)    Test: Internal fabrication should be counted as part of the market to the extent it affects independent fabrication
(a)    Alcoa – The court included vertically-integrated goods because consumers do not care who produced the ingot (meaning, the amount of Aluminum sold to fabricators was affected by the amount of aluminum Alcoa gave to itself)
(b)   Caseys – Half the stores are independently owned as franchises, so when the court is determining relevant market, it would include anything Caseys sold to itself and its franchisers, it wouldn’t just exclude half of whatever Caseys sold).