Industrial Organization
Exam Two
Friday May 16
Spring 2014

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I. Antitrust
A. Major Laws
1. Sherman Act 1890
2. Clayton Act 1914
3. Federal Trade Commission Act 1914

B. Enforcement Agencies
1. Department of Justice
2. FTC
3. private

C. Enforcement varies
1. stricter periods
2. lax periods
3. political climate
a. Presidential appointees
b. new laws and amendments
c. public sentiment
4. court cases
a. precedent
b. economic theory

D. Antitrust case outcomes
            1. Settlement
            2. Consent decree
            3. Verdict
                    a. cease and desist
                    b. fines, prison
                    c. structural remedy
                    d. damages (private)
                            -treble  

E. Problems of Monopoly
        1. high price, low quantity, excess profits
        2. lack of market discipline
            a. managerial slack
            b. x-inefficiency
        3. impact on other markets
            a. inputs, outputs
            b. extend monopoly
        4. Rent seeking
            a. devote resources to obtain monopoly power
            b. political influence   

II. Alternatives to Antitrust  

A. Natural Monopoly
1. economies of scale
2. a single producer is most efficient
3. Monopoly power
B. Public ownership
1. not profit maximizing
2. operate at efficient scale
3. keep price low, quantity high
4. incentive problems
5. widely used in some countries
            6. cycle of nationalization and privatization
C. Economic Regulation
        1. government approves rates (prices), services, returns, investments
        2. Federal and State agencies
            a. FCC
            b. Public Service Commissions or Public Utility Commissions
D. Price regulation
        1. optimal price may be below ATC
            a. fixed costs are often high in natural monopolies
            b. P < ATC: short run loss/ long run exit
        2. Ramsey pricing
            a. price closest to marginal cost that allows firm to break even
            b. average cost pricing
        3. asymmetric information problems
            a. firm may not accurately reveal costs
            b. incentive to over-build 
E. Regulated Industries (US history)
a. telephone
            a. electricity
            b. natural gas
            c. railroads
            d. trucking
            e. airlines
F. Regulatory Problems
    1. information
    2. incentives & efficiency
    3. cross-subsidy
    4. regulatory creep
        a. agencies extend boundaries beyond natural monopoly
     5. capture
        a. over time, industry's influence over regulators may grow
        b. firms may use regulation to reduce competition
    6. deregulation

III. Monopolization

A. Sherman Action, Section Two

1. Standard Oil (1911)
2. American Tobacco
a. dominant firm created by mergers
b. antitrust case (1911)
c. break-up
3. US Steel
a. dominant firm created by mergers
b. antitrust case
c. not guilty
i) price umbrella allowed rivals to thrive
ii) US Steel lost market share

B. Rule of Reason
1. Dominant market share alone is not illegal
a. economies of scale
b. superior management
c. efficiency
2. Conduct matters
3. Each case judged on its specifics

IV. Price Fixing

A. Sherman Action, Section One
1. Addyston Pipe and Steel (1898)
2. Trenton Potteries (1927)
3. Socony Vacuum
a. gasoline retailing
b. dancing partners
c. “reasonableness” is not a defense: guilty
4. ADM
a. Lysine price fixing
b. antitrust case
c. penalties

B. Per Se illegal
1. Price fixing by competitors is broadly prohibited
2. Courts do not need to consider reasonableness or efficiency arguments
3. Very clear standard

V. Mergers
A. Types of mergers
1. Horizontal mergers
2. Vertical mergers
3. Conglomerate mergers
4. International mergers

B. Rule of Reason
1. market power vs efficiency
a. substantially lessen competition (price increases)
b. economies of scale, management (cost decreases)
2. most mergers are small, and legal
3. even large horizontal mergers are considered on the specifics of the case
4. market definition
a. product
b. geographic

C. Laws
1. Sherman Act Section Two (1911)
a. prevents mergers to create a monopoly
b. only prohibits extreme instances
2. Clayton Action, Section Seven (1914)
a. prevents mergers that substantially lessen competition
b. level of enforcement varies
i. at times, relatively small horizontal mergers have been prohibited
ii. Other times larger mergers have been allowed
3. Cellar Kefauver Amendment (1950)
4. Hart Scott Rodino Act (1976)
a. requires prior notification for large mergers
b. FTC and Department of Justice review
c challenged mergers usually dropped by firms before court case

D. Cases
1. Brown Shoe
a. relatively small horizontal merger
b. some vertical elements
c. divestiture
2. Coca-Cola Dr Pepper
a. highly concentrated market
b. challenge
c. block merger; restrict future mergers by Coke

E. Merger Guidelines
1. signal to firms by FTC & Dept of Justice
2. large horizontal mergers in concentrated markets are most likely to be challenged
a. if Herfindahl Index < 1500, mergers safe
b. if 1500<Herfindahl <2500
i) small mergers safe (change in H<100)
ii) large mergers challenged (change in H>100)
c. if Herfindahl >2500
i) most mergers by big firms challenged
ii) very small mergers safe

V. Antitrust and anticompetitive business practices

A. Antitrust Statutes
1. Sherman Act
a. Section One
b. Restraint of Trade
                                i) price fixing
                                ii) quantity
                                iii) any kind of agreement to divide markets
2. Clayton Act
a. Section Two
i) Price discrimination
ii) that substantially lessens competition
b. Section Three
i) Tying
1.) Tie-in sales or bundling
                            2.) requirement to buy multiple products together
                            3.) extend market power from one product to tied product
ii) Exclusive dealing
iii) that substantially lessens competition
3. Federal Trade Commission
a. Section Five
i) unfair methods of competition
ii) deception
iii) broad antitrust authority

B. Resale Price Maintenance
1. Vertical price fixing
a. manufacturer sets retail price
b. Sherman Act, Section One
c. reduces competition between retailers
2. Cases
a. Dr Miles (1911)
- per se violation
b. Leegin (2007)
i) makes efficiency argument: fixed prices = better service
ii) Supreme Court changes to rule of reason standard  

C.   Price discrimination
1. Necessary conditions
a. monopoly power
b. separate segments by willingness to pay
c. prevent resale
2. Welfare effects
a. less consumer surplus
b. more profit
c. less deadweight loss
3. Laws
a. Clayton Act, Section two
b. Robinson Patman Act
4. Utah Pie Case

D. Joint monopoly
        1. Breakfast cereal case
            a. highly concentrated
            b. high prices, high profits
            c. little entry
        2. What barriers to entry in cereal?
            a. product proliferation
            b. advertizing
        3. Case did not go far enough to establish precedent

E. Strategic Behavior                       
1. Predation
        1. Strategic behavior aimed at causing rivals to exit
        2. Predatory pricing
            a. pricing below cost
i) Areeda-Turner rule
ii) P < MC or P< AVC
            b. widespread accusations 
        3. competing theories
            a. predation is irrational
            b. predation may be rational, but it's too costly
            c. reputation effect
                i. predatory pricing as an investment
                ii. accept losses now
                iii. discourage future competition
                iv. "irrational" behavior can maximize long-run profits
        4. AA- Legend Airlines case
            a. AA: vigorous response to new entrants
            b. very low prices drove Legend to bankruptcy
            c. AA raised prices after Legend's exit
            d. "insufficient evidence"

2. Entry & Contestability
        1. Free entry will prevent monopoly pricing
            a. high profits attract entry
            b. entrants lower prices and displace incumbents
            c. monopolies will not elevate prices because they fear entry
        2. barriers to entry
            a. ownership of critical resources
            b. Legal restrictions
            c. trade secrets
            d. imperfect capital markets
            e. sunk costs
            f. information problems
            g. strategic behavior
                    i) predation
                    ii) limit pricing
                    iii) excess capacity
        3. Airlines
            a. appeared to be contestable
            b. barriers to entry
                i) landing slots
                ii) gates         

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Industrial Organization and Public Policy

Chuck Stull

Department of Economics

Kalamazoo College