ANTITRUST OUTLINE
I. Introduction
A. Preliminary Remarks
1. What is the purpose of antitrust? Is it for strictly economic purposes, or is it to serve social purposes as well?
2. Antitrust can be regarded as an “economic constitution;” that is, just as the US Constitution defines and restricts political power, so to do the antitrust laws define and restrict economic power.
3. Central message of economics: Everything Has A Cost! (Or, as Friedman would put it, “there’s no such thing as a free lunch”)
a) We live in a world of limited resources – everything involves a tradeoff.
b) This leads to the question: what should be produced? How that question is answered can be placed upon a continuum from no government intervention (i.e., anarchy) to total government control of the means of production.
(1) Even ardent free-marketers oppose anarchy – government should protect, at a minimum, property and contract rights. This prevents the problem of the tragedy of the commons.
c) This continuum can be roughly divided into three categories: total domination, regulation, and free markets.
d) The United States has examples of all three:
(1) Total government domination of all/most of production: education, atomic energy, post office, Tennessee Valley Authority
(2) Regulation: TV, radio, the legal profession
(3) Free Markets: most businesses
4. Antitrust generally embraces the Adam Smith ideal
a) Smith’s The Wealth of Nations (1776) – the “best” result is to give consumers what they want; the “invisible hand” of a free market will give it to them.
b) Thus, the system strives toward Pareto efficiency
(1) Pareto efficiency – no change will make anyone better off without making someone else worse off (e.g., no waste)
(2) Problem with Pareto efficiency: jealousy
(a) Pareto efficiency isn’t concerned with wealth distribution – only that the economy not enrich one at the expense of another. Thus, if millionaires get twice as rich but it doesn’t cost anyone else anything, Pareto efficiency is achieved. Liberals think this is bad because of the inequity of distribution; envy rears its ugly head.
c) Greed is good. Smith’s view is that everyone working toward their own self-interest produces the best results.
d) Problems with free markets: externalities. Some costs can be ignored by producers, and thus aren’t represented in the price (i.e., pollution); other services (e.g., national defense) can’t rely on the market because individuals can’t decide how much is good for them individually.
5. Schools of Economic Thought
a) The Chicago School – believes that government intervention is permissible only in very narrow circumstances. Antitrust should only be used where failure to do so would reduce output.
(1) Proponents: Friedman (macroeconomics), Stigler (microeconomics), Posner, Bork, Easterbrook
b) The Austrian School – totally laissez-faire – Government should only protect contract and property rights. So long as the government doesn’t create the monopoly, they will gradually erode.
(1) Proponents: von Mises, von Hajek, Schumpeter
c) Liberal View – suspicious of economic analysis; antitrust can serve many purposes; usually overlooks the costs of government intervention
(1) Proponents: Galbraith
B. Economics 101: The Role of Competition
1. Market Assumptions
a) Perfect Competition – There are many factors (access to information, absence of entry barriers, homogenous product, etc.), but the most important is that in perfect competition, no competitor has an effect on price. It is set naturally by the market; if a competitor cannot lower prices to the market price, he will go out of business.
b) Monopoly Power – Thus, market power is the power to control market price. Why? Because a monopolist controls supply. By limiting output, he can raise his price above the competitive level.
c) Cost – note that cost includes a reasonable profit in economics (as opposed to the accounting definition of the word)
2. Supply and Demand
a) Demand Curves are downward-sloping, representing that the public wants less of an item as it becomes more expensive; supply curves are upward-sloping, demonstrating that as an item can be sold for a higher price, more producers are willing to provide it. The intersection of these two lines is the equilibrium point; it represents where all consumer needs will be met with no waste.
b) Elasticity of demand – demand curves may be more or less steep depending on how sensitive consumers are to price changes.
3. Marginal Cost, Marginal Revenue, and Production
a) Marginal Cost (MC) – the variable cost of producing one additional unit
b) Marginal Revenue (MR) – revenue from one additional unit
c) Thus, producers will make more units so long as MC ³ MC.
d) In perfect competition, MR will = the demand curve. Why? Because less efficient competitors will fall by the wayside.
e) A monopolist’s MR is a steeper, downward-sloping curve.
(1) Why steeper? Because he can’t price discriminate – a lower price applies to all purchasers. He can’t price discriminate because arbitrageurs will pick up the slack.
4. Competition and Monopoly Compared
a) Generally speaking, monopolies result in reduced output at higher prices; monopolies reap above-perfect-competition profits, and consumers pay more for the goods.
(1) Dead-Weight Welfare Loss – Some consumers who would prefer the monopolist’s goods at the competitive price will now look for inferior substitutes. This loss is “society’s” and isn’t recouped by anybody.
b) Thus, it can be said that generally speaking, monopolies are less efficient than firms in perfect competition.
(1) Allocative efficiency – best resource allocation, i.e., customers get what they want
(2) Productive efficiency – resources produced at lowest cost
c) Condemnation of monopolies isn’t uniform, though: the government grants patents, unions are permitted, some monopolies are “natural.”
d) Oligopoly – only a few sellers, and they all recognize they are interdependent on each other.
5. Barriers to Entry
a) Blocked Access (very rare) – i.e., one firm owns all of a key raw material.
b) Economies of Scale (most important) – MC curve is so “long” that only one (or a few) firms can meet all consumer demand.
(1) This results in a “natural monopoly” – only one firm meets all of the market’s demand at the lowest price.
(2) These often end up regulated (i.e., public utilities); note that antitrust is not about regulation – it’s about avoiding regulation.
c) Capital Requirements – it’s too expensive to enter the industry to challenge an existing monopolist
(1) Chicago School – that’s unrealistic; capital markets will finance any venture, no matter how dumb (terms may be less favorable, but so what?)
d) Product Differentiation – i.e., Coke vs. Pepsi
(1) Chicago School – So what? If an entering competitor spends as much on advertising, he’ll get the same result. (Is that realistic?)
6. Good things about monopolies
a) More money for R&D efforts, so more innovation (studies on this are unclear) (Schumpeter)
b) Theory of second best – Antitrust is a mistake because fixing a (supposed) problem likely leads to more problems. (highly theoretical) (Graglia: this theory wipes out the incentive to do anything)
c) Also: adjustment pains, social responsibility (“Naderites”), countervailing power
C. Enacting the Antitrust Laws
1. Background
a) Three years prior to the Sherman Act, the government started regulating railroads via the ICC.
b) Concern over ruthless tactics of large corporations led to the enactment of the Sherman Act, and antitrust was born; its principal driving force was a populist desire to “get” guys like John D. Rockefeller and J.P. Morgan.
2. The Sherman Act (1870) (15 USC §§1-7)
a) The Sherman Act is very short, with only two substantive provisions
(1) §1: “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal.”
(2) §2: “Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be deemed guilty of a felony.”
(3) Note the Sherman Act is a criminal statute – it carries criminal sanctions; also, it permits private suits for treble damages (note that if the government brings and wins an action, a plaintiff can use that victory to get his own damages – it is prima facie evidence of a violation) as well as injunctive relief.
b) It’s not clear that the Sherman Act does anything besides give the courts the power to create a “federal antitrust common law.”
(1) Graglia: the act probably wasn’t meant to have any real effects. Why? It passed unanimously (didn’t Rockefeller have any supporters?); there was no enforcement provision; if the act was meaningful, there’d be no need for later antitrust legislation.
(2) Not much happened in the early years of the act.
(a) E.C. Knight (1895) was the first time the act was adjudicated (20 years after the act’s passage); recall from Constitutional Law I that the court denied the federal government power over sugar producers because “manufacturing isn’t commerce.”
(b) There were a few cases involving railroads afterwards, but not much happened for another sixteen years.
(c) 1911 – the Standard Oil and American Tobacco cases – the court announces the “rule of reason” – that the act only applies to unreasonable restraints.
(i) In other words, “ev
(b) Are re-startup costs really that high?
(c) Should we reward poor planning?
(d) There is no historical proof of this justification
(3) Reducing uncertainty – i.e., cartel reduces price swings without affecting average price.
(a) But this stability is artificial stability – it doesn’t reflect actual costs and demand
(4) Financing desirable activities – e.g., R&D, moving slow moving items of cultural worth (i.e., excess profits on John Grisham novels underwrite books of poetry)
(a) Shouldn’t the market determine the literature sold? Why should Grisham fans subsidize poetry?
(b) Why would a monopolist carry slow merchandise? Why would he benefit a small number of consumers at the expense of his other consumers?
(5) Countervailing power – if there is a single buyer (monopsonist/oligopsonist) or supplier (monopolist/oligopolist), there is unequal bargaining power that a cartel can help deal with (ex.: labor unions are a cartel formed to deal with this problem)
(a) Isn’t it better to deal with the monopoly rather than create a second one via the cartel?
(b) How low can the monopsonist drive the price? To cost? That’s the competitive result. Below cost? Monopsonist wouldn’t want to do that since he would drive suppliers out of business and then will himself be dealing with a monopolist
(c) A word on unions: they face all the same problems of any other cartel (many sellers of labor, only a few buyers); thus they must create entry barriers. Which is why violence often ensues – if you can’t erect a legal barrier, you’ve got to call in the Mafia.
2. Recall that §1 forbids contracts, conspiracies, agreements, etc. in restraint of trade; therefore, for there to be a §1 violation, there must be two parties involved (i.e., not restraints but agreements in restraint of trade)
a) Does this mean that businessmen can’t restrict their freedom? NO. All contracts restrict one’s freedom.
b) How about agreements not to compete? Problem: there could be no mergers or even partnerships – everyone would have to be a sole proprietor.
3. Early Cases
a) US v. Trans-Missouri Railroad (1897) – 18 railroads associate to set rates west of the Mississippi River; Held: §1 violation; courts won’t look to reasonableness
(1) Railroad argument: Statute only applies to unreasonable agreements, and the railroad’s prices are “reasonable.”
(a) Problem: if that can be used as a defense, the courts will be acting as rate regulators – and they aren’t equipped to do so.
(b) says “every” restraint and it ought to mean “every” restraint
(i) Note Justice Peckham backs off of this approach when it comes to covenants not to compete
(c) Note that this argument prevailed at trial, and only lost by one vote in the Supreme Court
(2) Railroad argument: Railroads are exempt because of high fixed costs
(a) But this is only a problem if there is excess capacity – in which case, it’s expected that price won’t cover fixed costs and firms will leave the industry until equilibrium is achieved.
(i) Railroad response: they have lots of built-in overcapacity; thus they are a natural monopoly (which eventually leads to heavy regulation by the ICC)
(b) Railroads say that these costs will run small railroads out of business – which brings up the fundamental question of the rationale for antitrust. Chicago school says “so what?” Is antitrust to minimize harsh results or to maximize economic efficiency?
(3) Also note: the railroads’ rates were not yet regulated by the ICC at this time, which is why a Sherman Act action could be brought.
b) US v. Addyston Pipe & Steel (1899; 6th Cir.) – Pipe manufacturers enter a combination to raise prices for ¾ of the US. Held: Agreements among competitors not to compete are prohibited unless “merely ancillary” to a legitimate transaction (‘the rule of ancillarity’)
(1) Only “naked” agreements not to compete are prohibited – if &ldq
