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 Monopolizing Practices: Merger and Predation

July 25, 2010 

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\noindent
Eric Rasmusen, Department of Business Economics and Public Policy, Kelley School of Business, Indiana University. BU 438, 1309 E. 10th Street, Bloomington, Indiana,
47405-1701. (812) 855-9219. Fax: 812-855-3354. \href{mailto:erasmuse@indiana.edu}{erasmuse@indiana.edu}, \url{http://rasmusen.org}.

 
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Predatory Pricing
• US Supreme Court, Brooke Group (1993)
"there is a consensus among
commentators that predatory pricing
schemes are rarely tried and even more
22
tried, rarely successful."
No successful suits since then.
• Europe is much harsher. In 2002 a
German court ordered Wal-Mart to
increase its sugar and milk prices.
Predatory Pricing
• The US policy is that predatory pricing
occurs only if its purpose is to drive out
competitors AND the price is below
“average avoidable cost” (AAC)
23
cost AAC).
• AAC is similar to average variable cost,
but it includes any fixed (doesn’t depend
on Q) but not sunk (can’t be recovered by
stopping production) cost of producing the
range of products.
The FTC Statements on the
Justice Dept. Report
• The Justice Dept. issued a report
suggesting to the courts that Sherman Act,
Section 2 be applied more carefully
24
2, carefully.
• Three FTC Commissioners disagreed with
Justice.
• The FTC Chairman, Kovacic, agreed with
Justice.
 
The Three Commissioners’ Two
Big Themes
The welfare of consumers is the goal, not
economic efficiency.
 
Economic theory is not the same as law.
The Three Commissioners: The
Justice Report’s 4 Premises
1. The search for market power drives innovation.
2. Overenforcement of laws is worse than
underenforcement.
3. It is too costly to try to control monopolization
as much as we do.
4. Per se rules are better than rule of reason.
The Three Commissioners:
Specific Areas of the Law
1. Predatory pricing
2. Loyalty discounts (repeat customers get a
discount)
3. Price bundling (a discount for buying two
products together)
4. Tying (you MUST buy two products together)
5. Refusals to sell to rivals
6. Exclusive-dealing contracts
Chairman Kovacic’s Response
The courts have moved towards
looking only at economic effects--- not to
protecting small firms or forestalling
political power of large firms.
The Chicago School scholars brought in
economic theory.
The Harvard School scholars brought in
a concern for usable court tests.
Both worried about government failure-
-- overdeterrence and the limitations of
courts.


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\Section 7 Clayton Act, 15 U.S.C. \Section 18
 

Acquisition by one corporation of stock of another

No person engaged in commerce or in any activity affecting commerce shall acquire, directly or indirectly, the whole or any part of the stock or other share capital and no person subject to the jurisdiction of the Federal Trade Commission shall acquire the whole or any part of the assets of another person engaged also in commerce or in any activity affecting commerce, where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.

No person shall acquire, directly or indirectly, the whole or any part of the stock or other share capital and no person subject to the jurisdiction of the Federal Trade Commission shall acquire the whole or any part of the assets of one or more persons engaged in commerce or in any activity affecting commerce, where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition, of such stocks or assets, or of the use of such stock by the voting or granting of proxies or otherwise, may be substantially to lessen competition, or to tend to create a monopoly.

This section shall not apply to persons purchasing such stock solely for investment and not using the same by voting or otherwise to bring about, or in attempting to bring about, the substantial lessening of competition. Nor shall anything contained in this section prevent a corporation engaged in commerce or in any activity affecting commerce from causing the formation of subsidiary corporations for the actual carrying on of their immediate lawful business, or the natural and legitimate branches or extensions thereof, or from owning and holding all or a part of the stock of such subsidiary corporations, when the effect of such formation is not to substantially lessen competition.
 

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1992 HORIZONTAL MERGER GUIDELINES
a) Post-Merger HHI Below 1000. OK.
b) Post-Merger HHI Between 1000 and 1800. An
increase in the HHI of less than 100 points is OK. A
bigger increase needs analysis.
) P t M HHI Ab 1800 A i i th
36
c) Post-Merger Above 1800. An increase in the
HHI of less than 50 points is OK. An increase of
more than 100 is presumed to be “likely to create or
enhance market power or facilitate its exercise,“
but “the presumption may be overcome” by showing
that competition would be vigorous anyway.
7/25/2010
7
Examples
(1) Two firms have market shares of 10\% and 15\%,
and all other firms are tiny. Can the two firms merge?
(2) Two of the firms have market shares of 5\% each.
C th ?
37
Can they merge?
(3) Two firms have market shares of 10\% each. Can
they merge?
Case 2: Merger Reduces Cost and
Price
Each of the two firms in the industry has TC = 2 + 3Q, so MC=3
and FC =2. Each produces 10 units, so TC = 2 + 3*10 = 32 for each
firm. Average cost is 3.2 and marginal cost is 3. The price is 4.
Industry profit is 4*20 - 2(2 + 3*10) = 80 - 2*32 = 16.
38
The merger allows the firms to share complementary technologies
and reduce marginal cost. Therefore, after the merger, there is just
one firm, with TC = 2 + .5Q.
The firm could reduce output from 20 to 15 and the price would rise
to 5. Its profit would be 15*5 - [2 + .5(15)] = 75- 9.5 = 65.5.
But the firm prefers to increase output from 20 to 30, which
drives down the price to 3. Its profit is 30*3 - [2 + .5(30)] = 90 -
17 = 73.
Case 3: Merger Reduces Costs but
Raises Price
Each of the two firms in the industry has TC = 3Q, so MC=3 and FC
=0. Each produces 10 units, so TC = 3*10 = 30 for each firm.
Average cost is 3 and marginal cost is 3. The price is 4.
Industry profit is 4*20 - 3*20 = 80-60 = 20.
39
The merger allows the firms to share complementary technologies and
reduce marginal cost. Therefore, after the merger, there is just one
firm, with TC = 2Q.
The firm could increase output from 20 to 30, which drives down
the price to 3. Its profit would be 30*3 - 30*2 = 90-60 = 30.
But the firm prefers to reduce output from 20 to 15 so the price
will rise to 5. Its profit would be 15*5 - 15*2 = 75 - 30= 45.
Table 7.1 Minimum \% cost
reduction to make a merger raise
PS+CS
\%Price Elasticity of demand
Increase 3 2 1 .5
40
5 .43\% .28 .13 .06
10 2.00 1.21 .55 .26
20 10.37 5.76 2.40 1.10
Staples-Office Depot Merger (1997)
• The FTC and Justice were notified
(Hart-Scott-Rodino Act)
Wh t i th t ti ti ?
41
• What is the concentration ratio?
• Staples, Office Depot and Office Max
clearly competed. Who else? What is the
market?
Price and Cost Effects
• Assume no cost change. The FTC said the
merger would raise prices 7.3\%. Staples
said 2.4\%.
• What are cost savings? The FTC said
42
g
1.4\% of sales, passed along to
consumers. Staples said more, and being
passed along was irrelevant.
• What is the ultimate price effect? The
FTC said a 7.3\% increase. Staples said a
2.2\% decrease.
7/25/2010
8
An Efficient Merger?
Use the FTC numbers: Costs fall by 1.4\% of sales, prices rise by
7.3\%.
Suppose the elasticity of demand is 1, which is average loosely
speaking.
Table 7.1 says a merger is OK if costs fall by .55\% or more,
prices rise by 10\% and the elasticity is 
10\%,  

Even if the elasticity is 2, if costs fall by 1.21\% or more, the
merger is OK.
But the FTC and the Court said the efficiency analysis wasn’t
going to decide the case.


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{\bf  Questions You Should Be Able to Answer}

    

 


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{\bf  Terms to Know}

 
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{\bf  Homework Questions}

 HERE PUT EXAMPLES WITH DIFFERENT NUMBERS THAN IN THE TEXT
 

 
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