I will put very few comments on the tests, but I will have detailed answers here. If you don't understand why something is wrong,and want me to explain more, just give me back your test with an indication of which questions you don't understand. Follow the same procedure if you think I have made a mistake in grading-- but then indicate what you think that mistake is.
If you answered all 10 questions, including 9 and 10, I used the higher of your score on question 9 or question 10.
1. Consider the clipping at the end of the test. It took until 1998 for Daisy to voluntarily change its gun design to prevent jammed bb's.
(a) Is this delay an example of market failure?
Answer. It seems not. The guns actually were quite safe. Improvements in quality are always being made to products, so the fact that products are not perfect when they are first invented is no sign of market failure. In 2004, car bumpers are much stronger than in 1920, but that does not prove that in 1920 it would be have been efficient to have the same strength bumpers that we have today.
Note that asymmetric information does not *always* cause market failure. Suppose the safety defect was unknown to consumers, and imposed a cost of .05 per gun on them, but it would have cost .15 to fix. The product then is at the efficient quality even without regulation.
Just because a tiny, tiny, fraction of guns have a defect that makes them unsafe if the user does stupid things like pretend to shoot his friend in the head, that does not mean the gun is badly designed, or that there is market failure.
(b) Why did Daisy change the design in 1998 and not before?
Answer. Probably it was inefficient to makethe guns so safe in 1998, but Daisy feared government regulation, since the CPSC Chair was after them. Whether or not it made sense for consumers to change the product, it made sense for Daisy.
(c) Do you think the price of the guns rose in 1999? Discuss.
Answer. It is unclear (so all credit goes for the explanation). The cost of making the guns rose, because of the design change, and the quality of the product rose too, both of which would tend to raise the price. On the other hand, the risk of lawsuits fell, which would tend to push expected costs, and hence the price, down.
2. Which of James Q. Wilson's three categories does CPSC Chairman Brown fit best-- Careerist, Professional, or Politician? In what way did she depart from normal procedures to try to get the result she wanted?
Answer. She is clearly not a Careerist, because she looks to outside the agency for approval, and does not care much about relations within the agency. She would fit either into the category of Politician, because she is looking to advancement outside the agency, or Professional, because she looks to the approval of other consumer-protection nonprofit people.
Being on TV talk shows and such is not especially a departure from normal procedures. It is not part of the regulatory procedure at all, really, but it is not against any rules for commissioners and other political appointees to make public appearances-- indeed it is quite common. But she kicked staffers off of the gun case when she thought they would disagree with her, hired outside consultants instead, and scheduled a vote on the case for just two days before she left office.
I looked for specifics in this question-- general comments such as that she wouldn't give up were not satisfactory.
3. The new Chairman, Harold Stratton, asked Daisy if they would consent to him departing from usual procedures. Why did he want to change the usual procedure, and why did Daisy first object and then agree to it? (I'm not asking *what* procedure he wanted: *why* did he want the new procedure?)
Answer. The question is why Mr. Stratton wanted to be able to talk to the parties separately rather than with both sides separately. The answer is that he wanted each side to be free to speak its mind off the record. The answer cannot be that he was biased and knew which way he would vote in advance anyway, because then the procedure would not have mattered to him or to anybody else.
Daisy was afraid he'd get a biased view under that procedure, because they would not be able to rebut the arguments of the staff.
Later, Daisy decided that this was the only way they'd get a settlement, because they saw that Mr. Stratton voted against a settlement when he did not have the opportunity to collect extra information that way.
4. List the three broad causes of market failure and give an example of each.
Answer. 1. Asymmetric Information. A seller knows the shoes he is selling are defective, but consumers do not, and so end up buying products they do not value.
2. Market power. One company is the only seller of diamonds, and keeps the quantity supplied low to drive up the price.
3. Externalities. A paper mill pollutes a river, hurting everyone who lives downstream.
Almost everyone did well on this question.
5. In the patent process in the United States, if a company's scientist invents something new, his company applies to the patent office for a patent in his name, using either a company lawyer or a patent lawyer from a law firm to draw up the application. The patent examiner, a civil servant employed by the patent office who is overseen by a boss appointed by the President of the United States, reviews the application, and if he agrees that the produce is new and useful, the government issues the patent. If someone else thinks the patent was wrongly granted, he sues the company in federal court, where a judge decides whether the patent examiner was mistaken or not.
At least four examples of the principal-agent problem arise in this process. Identify four examples. In each case say who is the principal and who is the agent, and what the principal wants to prevent the agent from doing wrong.
Answer. In each example, I list the agent first and then then the principal.
Scientist-Company. The scientist might not work hard to invent patentable products.
Patent examiner--Patent Boss. The patent examiner might not be careful in looking at applications.
Patent Boss- President. The patent boss might be slack in his effort in running the patent office.
President-Voters. The President might set patent policy to give preference to certain industries in a way the voters would not like.
Judge-Voters. The judge might rule on patents to suit his own whims rather than to do what the voters want.
These are not the only correct answers.
Almost everyone did well on this question.
6. Bloomington has only one citywide daily newspaper, The Bloomington Herald-Times.
(a) Is the newspaper market in Bloomington a natural monopoly?
Answer. Yes. It has high fixed costs and low marginal costs relative to the size of the market. (b) The Herald-Times has market power. What bad consequences does this have?
Answer. The newspaper can charge more for ads and for subscriptions than otherwise, reducing sales even though the price is still well above cost.
(c) Suppose the city government were to make the Herald-Times a business regulated in the same way as electricity or local telephone service. How would the price of a newspaper be determined?
Answer. The city would estimate the costs of selling a newspaper, and would fix the price at that cost, where the cost would include the cost of capital. This would be done via rate hearings in which the company and the public could participate.
(d) What are the problems of government failure which prevent newspaper price regulation from being a good idea?
Answer. The elected officials could cooperate with the newspaper so that the newspaper would get high profits and the elected officials would get favorable coverage.
Almost everyone did well on this question.
7. A company is trying to decide how much to spend on reducing workplace accidents. It can reduce the number at a cost of $14,000 per accident up to 10 accidents per year, but reducing the number further costs $25,000 per accident. Each accident results in $5,000 of medical costs immediately, plus it reduces the worker's marginal product by $1,000/year. The economywide interest rate is 5%,and all of this company's workers are currently aged between 20 and 30. What should the company do?
Answer. It should reduce by 10 the number of accidents. Reducing by fewer would save $14,000 in costs, but each accident creates a cost of $5,000 in medical expenses plus losing about 40 years of $1,000/year in output, which even when discounted at 5% will have a present value of at least $9,000. Reducing by more than 10 would cost $25,000, but the present value of $1,000/year would only equal $20,000 if the loss were perpetual, which it is not.
8. The attached article tells the story of how blueberry growers in Maine have accused processing companies of being a monopsony conspiracy. Explain, using a diagram for price and quantity, how the processors might have conspired, why they would have profited, and why the conspiracy would lead to inefficient results.
Answer. The processors could conspire by agreeing in advance who would win in the auctions in which growers sell to processors, and at what bids. By paying lower prices, they could increase their profits even though their purchases would also have to fall. Their profits, the consumer surplus, would rise by amounts X minus Y in the diagram below. This would be inefficient because it would reduce trade and create a deadweight loss, the amount Z+Y.
Note that using market power does not shift the demand curve or supply curve. All it does is change the price and quantity. Here, the cranberry growers do not shift in their demand curve. Rather, they pick a smaller quantity to buy, thus driving down the price.
9. Two companies would each pollute 40 units if they were allowed. Suppose that Company A's marginal cost of reducing pollution from that level by amount Q equals 2Q, and and Company B's marginal cost is 5Q. Initially, each company is allowed a pollution level of 30 units, i.e. Q=10.
How much would each company pollute if we allowed them to sell their pollution rights to each other? (You can restrict yourself to integer values, e.g., 1,2,3,4...)
Answer. A would sell to B. If it sold 3, it would have to reduce pollution by 13, for MC =26. B would pollution 7, for MC =35.
If A sold 4, it would have MC = 28 and B would have MC =30.
If A sold 5, it would have MC = 30 and B would have MC =25.
Thus, A would sell 4 or 5 to B (either answer gets credit), and would pollute 35 or 36 units. Company B would end up polluting 44 or 45 units.
10. Consider the company in question 9. How much would each company pollute if, instead,a pollution tax of 10 per unit were imposed? (You can restrict yourself to integer values, e.g., 1,2,3,4...)
Answer. Company A would reduce pollution by 5 from 40, polluting 35 units. Its marginal cost of reduction would then equal 2Q=10. Company B would reduce pollution by 2 from 40, polluting 38 units. B's marginal cost of reduction would then equal 5Q=10.
Teenage Shooting
Opens a Window
On Safety Agency
By BRYAN GRULEY
Staff Reporter of THE WALL STREET JOURNAL
April 29, 2004; Page A1
WASHINGTON -- In the fall of 2001, the Consumer Product Safety Commission sued Daisy Manufacturing Co., the best known maker of air-powered BB guns. The CPSC, prompted by the accidental shooting of a teenage boy, sought to force Daisy to recall millions of allegedly defective guns.
Late last year, the same federal agency agreed in a settlement to drop its lawsuit. Daisy didn't recall a single gun. Instead, it agreed to spend $1.5 million on publicity and labeling to promote safe BB-gun use.
The Daisy case illustrates how politics can influence important decisions at the supposedly independent CPSC, the federal consumer-safety agency with the broadest reach. One reason for the BB-gun reversal was a switch in the CPSC's chairmanship: from a Democrat with a strong regulatory bent to a free-market Republican.
The case also shows how widely safety regulation can vary from agency to agency, and product to product. Drugs and autos are subject to myriad safety rules, but most consumer products -- including BB guns -- are not. The CPSC frequently reacts to safety issues only after hearing about deaths or injuries. The Daisy case raised the question of whether an alleged product-design flaw ought to shift blame to a manufacturer even when users fire guns at each other.
![[Mahoney]](/public/resources/images/Mahoney_JohnTucker-GE34104282004204953.gif)
The BB-gun story also suggests the buffeting any agency can face when it riles firearm owners. Since 1886, Daisy, a privately held company in Rogers, Ark., has been making air-powered long-barreled guns that introduce children to shooting. It doesn't make gunpowder firearms, but the National Rifle Association rushed to defend the company against the CPSC, asserting that an assault on BB guns was an assault on all guns.
Daisy says its products are as safe as possible. Aaron Locker, Daisy's New York attorney, says, "Guns are dangerous. These accidents don't happen unless you aim, point and fire them at somebody, which you're not supposed to do." Daisy officials declined to comment.
On May 24, 1999, it was a drizzly afternoon in Solebury, Pa., north of Philadelphia. John Tucker Mahoney took out the BB gun his father had bought for his 16th birthday two days before. Tucker, as he was known, was a strapping high-school sophomore who played varsity soccer and was a homecoming prince. He was no expert shooter, but he had two other BB guns his grandfather had taught him to handle, his parents, Jerome and Rebecca Mahoney, say.
Tucker and a friend, also 16, shot at a crow in Tucker's backyard and, later, a mailbox at the friend's house down the street, according to a February 2000 deposition the friend gave in a private lawsuit the Mahoneys filed against Daisy in federal court in Philadelphia.
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The gun seemed out of BBs, so the boys headed back to Tucker's house. Thinking the gun was empty, they took turns firing at each other, mussing their hair with blasts of air, Tucker's friend testified.
The teenagers were playing with a PowerLine Model 856, with a scope and a plastic stock made to look like wood. Tucker's father had paid $39 for it at Kmart. It came with a hand-operated air pump that increased the velocity at which BBs fly. Pumped 10 times, it could fire at 650 feet per second. At that speed, a BB can penetrate a human skull. Tucker's gun came with a printed warning: "Not a toy. Adult supervision required."
Standing in Tucker's driveway, his friend worked the pump and then fired what he thought was an empty gun at Tucker's head. In fact, there was a BB in the firing chamber. It pierced Tucker's skull just above the left ear and severed an artery in his brain. Tucker was left unable to speak, walk, eat, drink or otherwise care for himself.
Daisy started selling PowerLine models in 1972. The CPSC in its lawsuit against Daisy blamed Models 856 and 880 for at least 15 deaths and 171 injuries, most involving children. Daisy says the guns shouldn't be used by anyone under 16. Evidence introduced in the Mahoney case suggests that many children under 16 do use them.
Evidence in the case also suggests that many BB-gun accidents happen after someone fires a gun they erroneously thought was empty. Daisy has settled several lawsuits on confidential terms, without admitting liability, while publicly arguing that accidents occurred only because people violated a cardinal shooting rule: Handle all guns as if they're loaded.
BBs are fed into the firing chamber from an oblong magazine just above and forward of the trigger. Magazines can hold as many as 100 BBs, making it difficult to determine how many are left. Private lawyers for the Mahoneys discovered that a Daisy engineer had testified in 1999 in a lawsuit in federal court in Tennessee that BBs can get temporarily stuck in corners of the magazine. When that happens, the gun may seem empty, but then a BB can come unstuck, slip into the firing chamber and be discharged, according to the CPSC suit against Daisy.
The Mahoney attorneys also uncovered Daisy documents indicating the company had made design changes to their magazines in 1998 and 1999 to prevent BBs from getting stuck. But millions of older models remained in consumers' hands, and retailers continued to sell older guns that hadn't been altered, including Tucker's, Mr. Locker says. He says the alterations were merely "precautionary" and didn't mean old models posed a danger.
Daisy settled in early 2001 with the Mahoneys, agreeing to pay them $18 million without admitting any fault. But before that, in May 2000, the family had its attorneys write to the CPSC to urge "immediate action" to spare others from their son's fate.
'Independent' Agency
Congress created the CPSC in 1972 to protect the public from "unreasonable" risks of injury or death from consumer products that pose fire, electrical, chemical or other hazards. It has 470 employees and a $60 million annual budget. Its three commissioners are nominated by the president and confirmed by the Senate for staggered, seven-year terms. No more than two can be from the same party. The president chooses one as chairman.
The CPSC is an "independent" agency, similar to the Securities and Exchange Commission and the Federal Communications Commission. In theory, these agencies are less susceptible to political pressure because, by law, the president can't readily fire commissioners, as he can, for instance, the head of the National Highway Traffic Safety Administration.
While the NHTSA has written reams of safety rules for cars and trucks, and the Food and Drug Administration must approve drugs before they are marketed in the U.S., Congress has allowed most appliances, tools and toys to go on the market without regulation. That is partly because there are too many products and manufacturers for such a small agency to regulate. Congress also directed the agency to favor voluntary safety standards set in cooperation with industry and consumer groups. When it learns of deaths or injuries, it can investigate to determine whether a product should be repaired or taken off the market.
![[Brown]](/public/resources/images/Brown_Ann-GE30004282004205041.gif)
Under pressure from the NRA, Congress specifically exempted gunpowder firearms from CPSC jurisdiction in 1972 and again in 1975. The Bureau of Alcohol, Tobacco, Firearms and Explosives regulates aspects of the gun industry but not the safety of firearms themselves. Air-powered BB guns remain under the CPSC's purview, but the agency has no rules that apply to them. Manufacturers follow voluntary criteria set by an independent body that sets standards for consumer and other products.
When the Mahoney lawyers wrote to the CPSC, the chairman was Ann Brown, who had been appointed by President Clinton in 1993. Before that, she had spent 15 years on the board of the Consumer Federation of America, a Washington advocacy group. At the CPSC, Ms. Brown ratcheted up fines on companies and pushed for safer bunk beds and baby walkers. She frequently called parents of dead or injured youngsters to commiserate and became a mainstay on TV talk shows, lambasting products she deemed unsafe.
Over the years, the CPSC had investigated Daisy BB guns repeatedly without finding a hazard. In 1995, on Ms. Brown's watch, agency staffers had absolved the guns of the stuck-BB problem later alleged in the Mahoney case. But Ms. Brown says in an interview she was distressed to learn, five years afterward, that Daisy guns lacking the safety changes remained on the market.
She ordered another investigation. She barred staffers who had previously investigated the guns and hired outside experts. Later, one staffer removed from the new case, Ronald Reichel, said Ms. Brown "had it in for BB guns." In sworn testimony in the CPSC case against Daisy, Mr. Reichel, an electronics technician, said, "She was upset with us for not finding fault." Ms. Brown, now 67, denies that.
By the summer of 2001, President Bush had taken over the White House, and Ms. Brown was preparing to leave the CPSC. On Aug. 8, she announced what she hoped to accomplish before her Nov. 1 departure, including "a major recall of (or lawsuit regarding) a very dangerous product that kills and maims children."
At the time, CPSC staffers were pressing Daisy to recall more than seven million PowerLine 880s and 856s. The company was resisting because, it said, the guns weren't defective.
CPSC inquiries usually end with the agency deciding against pursuing a remedy or with a company consenting to a recall. If the commission and company can't agree, the agency can file an administrative lawsuit seeking to force a recall. At least two commissioners must approve that rare step. Ms. Brown scheduled a vote on Daisy for Oct. 30, two days before she was to leave office.
The NRA sprang into action. A potent lobbying group that represents firearm owners and views any regulation with suspicion, the NRA embraces BB guns as "gateway" guns that prepare young people for shooting sports with full-fledged firearms. A week before the CPSC vote, the NRA sent a "special alert" to members via e-mail, saying a Daisy recall could be used in future suits against all firearm makers. "Could this be [Ms. Brown's] last-ditch attempt at securing an anti-gun legacy?" the alert said.
Hundreds of hostile e-mails flooded the agency. "I believe that you have an agenda, and that agenda includes taking away the guns of American citizens," read a typical one. Ms. Brown says she wasn't interested in a broader attack on gun makers or owners.
Even before commissioners voted, Ms. Brown planned a press conference to announce the lawsuit, complete with a videotape of Tucker and an appearance by his mother. Ms. Brown and the commission's other Democrat, Thomas Hill Moore, voted to file the suit. Mary Sheila Gall, a Republican appointed by the first President Bush, voted no. In a written statement, Ms. Gall said the vote was "highly politicized," the timing "driven by today's 2 p.m. press conference."
![[Stratton]](/public/resources/images/Stratton_Hal-GE30104282004205123.gif)
Administrative suits are filed within the CPSC rather than in federal court. Career CPSC staffers argue the case against the manufacturer before an administrative law judge, who makes a decision that can be accepted, overturned or modified by the CPSC commissioners.
The same day the suit was filed, President Bush nominated Harold Stratton Jr. of New Mexico to replace Ms. Brown. Mr. Stratton, now 53, helped organize Lawyers for Bush in his home state in 2000. The same year, the former state legislator and attorney general co-founded the Rio Grande Foundation, a think tank that promotes "limited government, economic freedom and individual responsibility," its Web site says. He severed ties after being nominated to the CPSC.
Complicated Rules
Mr. Stratton says in an interview he couldn't do much at first about the Daisy case. Federal law and CPSC rules require commissioners to remain uninvolved in administrative trials so they can objectively review the judge's decision. "Ex parte" rules prohibit commissioners from speaking separately with staffers or a company unless both sides waive the restriction. Commissioners are, however, permitted to consider settlement offers submitted through the judge.
Daisy made such an offer in May 2003. The company proposed to spend $1.5 million on a five-year campaign to buy ads on TV and in shooting magazines to publicize safety rules such as "Treat Every Gun As If It Were Loaded." Daisy also offered to add warnings to its packaging. In return, the CPSC would drop its suit.
Administrative Law Judge William Moran blasted the offer as "empty," noting Daisy already had launched the publicity campaign. The CPSC staff refused to support a deal unless it involved a recall, arguing that the safety campaign would be valuable but insufficient. "In the real world, children make mistakes," the staff said in its brief.
With the Democrat Mr. Moore and the Republican Ms. Gall still in place, Mr. Stratton was the swing vote. He says he wanted to talk to the staff and Daisy separately. But Daisy refused to waive the ex parte rules because it didn't trust the staff, Mr. Locker says. Ms. Gall voted to accept the settlement. Mr. Moore said no. Mr. Stratton says he "didn't know enough about the case" to go along with a settlement, so he said no, too.
In October, the company resubmitted its offer, with two important differences. First, Daisy avoided Judge Moran and went directly to the commissioners because the judge "was biased," Mr. Locker says.
Second, Daisy asserted that the CPSC suit had resulted in a doubling of the company's annual liability-insurance premium, to $2.4 million. A recall would produce a rate "so prohibitive that Daisy would be forced out of business," the company's chief executive, Lewis Ray Hobbs, said in an affidavit. Daisy doesn't disclose its financial performance. Documents in the CPSC case show that it has annual revenue of about $55 million.
Daisy now agreed to waive the ex parte rules. Mr. Stratton met first with the CPSC staff, who wanted to subject Daisy's doomsday financial claims to expert analysis and cross-examination at trial. But Mr. Stratton says he decided the agency didn't have a strong case and that pursuing Daisy was distracting the staff from assessing other products.
On Oct. 22, six Daisy representatives, including Messrs. Hobbs and Locker, brought a stack of financial documents to a CPSC conference room where they met with Mr. Stratton. The commissioner says he had been skeptical of Daisy's financial claims, but became convinced after scouring the documents with the help of an aide who previously had worked as a bank-loan officer.
Four days after the meeting, Tucker Mahoney died in a Pennsylvania hospital from complications related to his brain injury. He was 20.
By a 2-1 vote, with Mr. Moore dissenting, the CPSC approved the settlement on Nov. 14, the day Daisy's liability insurance was due to expire. In a written statement, Mr. Stratton said the "burdensome and inefficient" suit would have led to "years of costly litigation" but no new knowledge about Daisy products. He conceded BBs could get stuck in the gun but said injuries were preventable if people didn't aim at each other.
Yesterday, Tucker Mahoney's parents filed suit in federal court in Philadelphia, seeking to undo the Daisy settlement. They alleged that the CPSC failed to follow proper procedures in settling. A spokesman for the CPSC said it hadn't seen the lawsuit. Daisy declined to comment.
Write to Bryan Gruley at bryan.gruley@wsj.com1
Kerasotes movie ban at Von Lee argued in courtBy JOHN R. WILKE Staff Reporter of THE WALL STREET JOURNAL
As more of the world's markets become dominated by a few big companies, a rare form of antitrust abuse is raising new concern: When corporations illegally drive down the prices of their suppliers.
On the coast of Maine, blueberry growers alleged last year that four big processors conspired to push down the price they would pay for fresh wild berries. A state-court jury agreed last year and awarded millions in damages. In South Carolina, International Paper Co. faces a lawsuit that it conspired with its timber buyers to depress softwood prices in several states. In Alabama and Pennsylvania, federal antitrust enforcers last year targeted insurance companies that imposed contracts forcing down fees charged by doctors and hospitals. The insurers abandoned the practice.
The power to drive down prices is an issue as well in a Federal Trade Commission investigation of R.J. Reynolds Tobacco Co.'s pending $2.6 billion acquisition of BAT PLC's Brown & Williamson unit, lawyers close to the case say. The FTC, they say, is looking at whether the combined company could force tobacco-leaf growers to accept lower prices. Other major U.S. cigarette makers recently reached a settlement with tobacco farmers valued at $1.2 billion to resolve a private lawsuit accusing them of secretly agreeing to avoid competitive bidding at tobacco auctions.
"Price fixing and other forms of collusion are just as unlawful when the victims are sellers rather than buyers," R. Hewitt Pate, the Justice Department's antitrust chief, told a Senate Judiciary Committee hearing late last year. The hearing aired farmers' concerns that a few giant agribusinesses now control commodity prices in many markets.
Mirror Image
Usually relegated to the back pages of law books, this mirror image of monopoly is known as monopsony or, when more than one company is involved, oligopsony. It arises when one or more companies gain enough buying power to push their suppliers' prices down.
It isn't a new legal theory, but it is getting more attention now because of the rise of giant companies in a global marketplace. Buyer muscle has become more visible in recent years as markets become more concentrated through mergers and joint ventures. In meatpacking, the business of slaughtering cattle and pigs, four companies control 80% of the market. In four out of 10 U.S. cities, a single health insurer has at least a 50% market share. Concentration is also rising in markets from aluminum refining to baby food.
Most of the time, there is nothing wrong when big companies squeeze suppliers for lower prices. Hard bargaining by profit-minded business buyers can help drive down prices for consumers.
But if dominant buyers use their clout to distort the market and push prices down, the legal theory goes, consumers ultimately can lose. That's based on the assumption that producers will stop innovating, or producing at all, if they can't get a fair price. Monopsony, which has been found to violate federal antitrust statutes, can be alleged in either government or private suits.
Wal-Mart Lesson
Finding the fine line between healthy, price-cutting competition and harmful price- reducing monopsony has historically made government antitrust enforcers cautious about taking action in this area. Wal-Mart Stores Inc. illustrates the problem. The world's largest retailer has enormous power to squeeze suppliers, who have repeatedly asked regulators to rein it in. But many economists see Wal-Mart as an example of how buyer power can benefit consumers. Despite its size, Wal-Mart doesn't control the retail marketplace, and so far there's no clear evidence that its hard bargaining limits supplier output or lessens efficiency.
Because of this need to weigh consumer welfare carefully, the government brings fewer monopsony cases than monopoly cases. "The link between buyer power and consumer harm can be really hard to prove," says David Balto, a former policy director at the FTC who is now at the law firm of White & Case in Washington.
Some of the biggest recent cases have been brought by private companies. Altria Group Inc.'s Philip Morris USA and the other major cigarette makers -- except R.J. Reynolds -- agreed last year to settle a suit filed against them by American tobacco farmers in federal court in Greensboro, N.C. The manufacturers, without admitting wrongdoing, agreed to give the farmers $212 million in cash and to buy billions of dollars in tobacco over 10 years.
The farmers had alleged that cigarette makers and middleman tobacco buyers illegally conspired to push down prices by rigging bids, among other practices. After the suit was filed in late 2000, cigarette makers shifted to purchasing directly from growers at higher prices, and by last fall, the familiar sing-song chant of tobacco auctioneers had died across much of the south.
According to the allegations in the suit, buyers met before auctions to exchange bidding data and traveled on each other's corporate jets to and from tobacco auctions. The result: Philip Morris's buyer, which purchases some 65% of U.S. tobacco, would bid first and set the price, with the rest of the buyers placing "tie bids," the suit said.
Peter DeSantis, a veteran auctioneer who has sold bales of burley tobacco in barns from Florida to Tennessee, said in a sworn statement in 2002 that despite the appearance of active bidding "there's been virtually no price competition" since the mid-1990s. Robert Cage, a past winner of the World Tobacco Auctioneering Championship, said in a separate 2002 sworn statement, "Tobacco auctions have really been a tobacco allocation system for many years."
Reynolds, the manufacturer planning to fight the suit, has agreed to buy Brown & Williamson, combining the second- and third-largest U.S. cigarette makers. The FTC is looking into two potentially harmful effects of the deal. To prevent the combined company from gaining the power to raise consumer prices in some markets, the FTC could force the sale of two or three cigarette brands as a condition of federal approval.
In addition, the FTC is expected to investigate whether the deal will create a danger of monopsony, based in part on evidence of bidding conspiracies in the tobacco farmers' private lawsuit, lawyers close to the case say.
Reynolds has denied all of the accusations in the farmers' suit and said that it has had no part in any alleged auction conspiracy. The company has also said that it expects the FTC to approve the Brown & Williamson deal without the forced sale of any cigarette brands.
Beef and Pork
In agriculture, beef and pork producers complain bitterly that the Justice Department, which shares antitrust responsibilities with the FTC, has failed to police the meat market. Private antitrust actions are pending against each of the industry's four largest meatpackers. These slaughtering operations buy animals from cattle ranchers, feedlots, and farmers and sell the meat to large food distributors.
The suits all claim that meatpackers illegally manipulate the market to keep prices low. In each case, the companies are fighting the allegations. One suit, a class action brought by cattlemen against industry giant IBP, a unit of Tyson Foods Inc., has just gone to trial in federal court in Montgomery, Ala.
The most recent government monopsony cases have been in insurance and agriculture. In 2000, the Justice Department demanded the sale of grain silos and terminals as a condition of approving Cargill Corp.'s acquisition of Continental Grain Co. This action was meant to protect farmers in the Midwest who otherwise would have had only one buyer for their soybeans and wheat.
In 1999, the Justice Department found that Aetna Inc.'s acquisition of Prudential Insurance Co.'s health-care unit could unfairly drive down doctors' bills in Houston and Dallas. The department forced the companies to sell assets in both cities.
Pulpwood Prices
In two previously unreported health-care cases, the Justice Department last year investigated alleged monopsonistic contract terms imposed on doctors and hospitals by a Blue Cross plan in Alabama and by Highmark, a Pennsylvania insurer. The contracts demanded preferential rates and had the effect of discouraging doctors from offering lower prices to others. Both companies denied wrongdoing but withdrew the provisions that were under federal scrutiny.
In the paper industry, consolidation hit hard in the pinewoods of South Carolina, according to a lawsuit pending in federal court in Columbia. Timber owners there allege that giant International Paper illegally wields monopsony power over them, driving down pulpwood prices statewide by more than 35% over three years. International Paper has become the world's largest paper maker -- and biggest timber buyer -- largely as the result of a string of acquisitions since 1995.
In order to be more competitive in global markets, International Paper imposed a new "Quality Supplier" system on its timber buyers in 2000. But these intermediary firms, which buy the right to harvest timber owned by individual landowners, were all told what to bid by International Paper, the suit alleges. Buyers who strayed from this secret conspiracy by offering higher bids faced retaliation or were dropped by International Paper, the suit says.
The suit quotes an International Paper manager saying to a group of buyers that he saved "tons of money" with the supplier program, which was then extended to other states. Landowners in South Carolina, Georgia, North Carolina and Virginia got less for their harvested timber, and the value of their land declined, the suit says.
Referring to International Paper's recent acquisitions of Federal Paperboard, Union Camp and Champion Paper, Russ Berke, a lawyer for the landowners says in an interview, "The Justice Department let all of those mergers go forward without looking very closely at the effect on suppliers."
In its answer filed in court, International Paper said it created the supplier program "to improve efficiency and reliability and reduce costs." It said that it doesn't have enough market share to influence prices, calling the monopsony claims "economic sophistry." The company has filed a motion to have the suit dismissed.
In state court in Rockland, Maine, a jury found last November that four berry processors colluded over four years to set the price they would pay for wild blueberries raked from wind-swept fields in Washington County. A group of growers sued, winning $18.7 million in damages.
The processors deny any wrongdoing and say they will appeal. If the jury verdict stands, the judgment amount will be tripled under state law, to $56.1 million. The processors say that having to pay that sum would put them out of business.
