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  \refstepcounter{chaptercounter} \label{chap07}
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\pagestyle{fancy} \lhead[\ref{chap07}--\thepage]{}    \chead{Monopoly}   \rhead[]
{\ref{chap07}--\thepage} \cfoot{}
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 \vspace*{\fill}

  \begin{center}
\begin{Huge}
{\bf \ref{chap07}:  Monopoly}  \label{s05.0} \\

\end{Huge}

\vspace*{\fill}

\begin{quotation}
\begin{Large}

{\it ``He that withholdeth corn, the people shall curse him: but blessing shall be upon the head of
him that selleth it." }


\end{Large}
 \end{quotation}
\vspace*{\fill}
 
 



 \includegraphics[width=\linewidth]{fig06-bond-US-Steel.jpg}



  \end{center}

\vspace*{\fill}

{\small \hfill {\it October 12, 2019}}\\


{\small \hfill  \url{http://rasmusen.org/g406/reg-rasmusen.htm}, erasmuse@Indiana.edu}


 



%------------------------------------------------------
 \newpage



  \noindent
 {\bf \ref{chap07}.1.  Choosing Price and Output to Maximize Profits}\label{s05.1}

   Monopoly is  a classic source of market failure. Being the only firm in the industry means that the firm has market power, defined as the ability to increase the price without losing all its customers. All firms have this to some extent, but if market power is significant, the firm may decide to restrict output in order to drive up the price.  In diagrams, we depict  market power as a downward-sloping demand curve facing the individual firm, as opposed to a downward-sloping demand curve for the market as a whole. 
   
     Since the demand curve facing it slopes downward, a firm with market power can increase its producer surplus by reducing output and raising the price. This power is not value-creating in itself. It just shifts surplus from consumer to producer. Moreover, since the producer purposely foregoes some sales that would generate surplus, to push up the price, consumers lose more than producers gain. Still another problem is that   producers may  devote effort to  acquiring market power, creating additional waste.\footnote{An important exception is effort  in the form of innovation. If the inventor of a new product is given a monopoly on it, that actually raises surplus if he wouldn't invent the product otherwise, so it's worth providing him with profit as an incentive. If a firm in a competitive market puts effort into discovering a new market as yet unserved, so it has a monopoly, that too is innovation that deserves reward. }   

   A firm without market power simply takes the market price as given and to maximize profit compares the cost of output to that price.  It increases output  $Q$   until the marginal cost equals the price:   $MC(Q) =P$. A firm with market power needs to think about {\bf marginal revenue}\index{marginal revenue}: the change in revenue from an increase in quantity. Marginal revenue   equals the market  price if the  firm has no  market power: sell one more unit, and revenue increases by the price. Marginal revenue is less than the price for a firm with market power: produce  one more unit, and the price drops a little.



%\vspace*{24pt}
\noindent
%\begin{minipage}[c]{\linewidth}
\begin{figure}[htb]

\begin{center}
 {\sc Figure \ref{chap07}.\ref{fig05-1.pdf} \\
   Marginal Revenue }
% \vspace*{-12pt}
\refstepcounter{figurecounter} \label{fig05-1.pdf}
 \includegraphics[width=.8\linewidth]{fig05-1-monopoly.jpg}
\end{center}
\end{figure}

%\vspace*{24pt}


  The firm's tradeoff is between (a) selling more quantity and (b) keeping the price high, as Figure \ref{chap07}.\ref{fig05-1.pdf} shows. If   $Q=4$  and $P=8$ and the firm increases its output to $Q= 5$,  revenue won't rise by 8, because the price will fall.   The price falls from 8 to 7, so revenue only rises from 32 to 35, an increase of  3.  The old 4  units are now sold at 7 instead of 8, so they are collecting 28 for the firm instead of 32, a loss of 4. The new unit is collecting the new price of 7, so it is adding 7. There is a net gain of 3 in revenue.  That gain is the marginal revenue: the change in revenue when quantity rises.




The firm's marginal cost is 4 at $Q=4$, however, so increasing output to 5 reduces producer surplus.
To maximize surplus, the seller should set $Q$ so that marginal revenue equals marginal cost. Since the 
marginal revenue curve lies below the demand curve, this means that the marginal revenue curve will hit marginal cost before the demand curve, so the MR=MC rule produces less output than the P=MC rule. 

The simplest case is when the seller has zero marginal cost. Then its task is to set $MR=0$, which
means to maximize revenue because it picks quantity so that the slope of the revenue function (which is marginal revenue)  is zero.  An example is a   stadium selling tickets to a football game. If the
stadium is not filled up, the marginal cost of admitting an extra person  is approximately zero. To
maximize profit, however, some seats should be left unfilled. Increasing ticket sales would require
a drop in price that would actually reduce revenue. The stadium example illustrates why market power
leads to market failure: it would cost nothing to let more people enjoy the football game, but the
seller keeps them out anyway.

   We often use linear (straight line diagonal) demand curves in diagrams. When demand is linear, marginal
revenue is linear too, with twice as steep a slope (as in Figure \ref{chap07}.1).\footnote{Calculus
shows this. If demand is $P= a- b P$, then revenue is $R= PQ =(a- b Q)Q =  aQ- bQ^2$,
and marginal revenue is $\frac{dR}{dQ} = a - 2bQ$, just like demand but with a 2 so it descends
twice as fast.}  In drawing, remember that if the demand curve hits the  quantity axis at $Q=10$,
then the marginal revenue curve hits  at $Q=5$. Also, though the demand curve becomes flat at $P=0$,   the marginal revenue curve keeps going down below the $P=0$ axis. That is because marginal revenue can be negative, which just means that increasing output reduces revenue because the quantity rises by less than the price falls. 
 

   Another way to think of pricing with market power is using elasticities.  The{\bf  price elasticity of
demand} (which is easier to remember if you think of it as ``price sensitivity of demand'') is
\begin{equation}
  Elasticity = \frac{\text{ \% change  in  quantity  demanded}}{ \text{\% change  in  price}}
\end{equation}

   Iff the quantity demanded falls by 20\% after the price rises by 10\%,   the elasticity of demand
is -2. Economists  often just  say that the elasticity is ``2'',
 because the quantity demanded falls with price  so we can assume the elasticity is negative.    A firm with
market power is trading off price against quantity, so the elasticity is   relevant to its decision.
If the elasticity is -1,  marginal revenue is zero: if the firm increases output by 1\%, the price
falls by 1\% and revenue is unchanged. We say that demand is {\bf  inelastic} \index{inelastic}if
the price elasticity of demand is less than 1, in which case the quantity demanded falls less than
the price rises.    A monopoly never wants to choose a price and quantity where demand is inelastic,
because  reducing sales at that point by 1\%  would drive up the price more than 1\% and thus raise
revenue---  and better yet,   total production cost  would   because of the 1\% reduction.  Demand is {\bf perfectly inelastic}
\index{perfectly inelastic} if quantity demanded does not change at all when the price increases. If demand is perfectly inelastic, the demand curve is vertical and the elasticity is 0. 
 A monopoly would want to raise its price if demand
were perfectly inelastic. Demand is {\bf perfectly elastic} if the quantity changes infinitely (to
zero) as the price rises. Then, the   demand curve facing the firm  has an elasticity of $-$infinity
and is perfectly flat, just as under perfect competition.

 A general rule relating the monopoly markup of price over marginal cost to the elasticity of demand
is the {\bf Lerner Rule}\index{Lerner Rule}.\footnote{The original paper is Abba P.
Lerner, \index{Lerner} ``The Concept of Monopoly and the Measurement of Monopoly Power,''
{\it  Review
   of Economic Studies}, 1: 157--175 (1934). A good verbal discussion of its modern use is  Kenneth G.
Elzinga,\index{Elzinga}  \& David E. Mills,\index{Mills}  
\href{http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1884993}{``The Lerner Index of
Monopoly Power: Origins and Uses,'' }{\it  American Economic Review: Papers and Proceedings},
101(3): 558--564 (2011). } It says that at the profit-maximizing price:
\footnote{The rule $MR=MC$ can be written as $\frac{dP}{dQ} Q + P =MC$, so $-\frac{dP}{dQ}Q = P -MC$
and $-\frac{dP}{dQ}\frac{Q}{P} = \frac{P -MC}{P}$, but $Elasticity = \frac{dQ}{dP}\frac{P}{Q}$ and
so we get the Lerner Rule. }
\begin{equation} \label{lerner1}
 \frac{ P - MC}{P} = -\left( \frac{  1}{ Elasticity} \right)
\end{equation}
  


Remember: at the optimal price, demand must have gotten elastic,  more negative than $-1$.
If the elasticity of demand is $-2$,      the Lerner Rule tells us that the price is such that $\frac{ P - MC}{P} = -\left( \frac{  1}{ Elasticity} \right)  = - \frac{1}{-2}$, so $P-MC = \frac{P}{2}$ and $P = 2MC$.   If the elasticity of demand is  $-1.5$,        the price
is  three times marginal cost, by the same working out of the equation. 

 The Lerner Rule can be used in two ways. The firm can use it to  help choose its price.  The
analyst can use it to estimate the elasticity of demand facing the firm. The expression $\frac{P-MC}
{P} $ on the left-hand-side of equation  \eqref{lerner1} is known as the {\bf Lerner Index} of
market power.  Its biggest possible value is 1 (if MC=0, so $\frac{P-MC}{P}=1 $) and its smallest
possible value is 0 (if $P=MC$).   An analyst who saw that a  firm's price was 20 and its marginal
cost was 15 could use  equation \eqref{lerner1} to conclude that  the Lerner Index was $\frac{P-MC}
{P}= \frac{20-15}{20}  = .25$ and the elasticity of demand was $-4$.  Thus,
 to find out the elasticity of demand facing the firm, the measure of market power we are after, we
just need to know the price and  the marginal cost.




 \bigskip

\noindent
 {\bf \ref{chap07}.2:   Oligopoly and the Cournot Model}\label{s05.2}


 Price fixing is a form of {\bf collusion}\index{collusion}--- firms agreeing on prices, outputs, or
sales territories--- and is {\it per se} illegal. Even if firms do not collude, however, prices and
profits can still be above marginal cost if entry into the industry is difficult and the
number of firms is small.  If the cola industry has just two firms, then even if they never discuss
prices with each other, they know that it is to their mutual benefit to keep prices high and that a
price cut of one of them will be followed by a price cut of the other. Without communication between
them, though, it is hard to agree on a price in the first place and  even harder to monitor cheating
than under a cartel. Thus, we   expect prices in a two-firm industry--- a {\bf duopoly}
\index{duopoly}--- or  a several-firm industry--- an {\bf oligopoly}\index{oligopoly}--- to be lower
than in a monopoly or cartel, but higher than in a  perfectly competitive industry.  Note, however, that this
depends on the {\bf incumbent firms}\index{incumbent firms}--- the ones already in the industry---
being safe from {\bf entrants}\index{entrants}--- new firms  who start selling in the industry
attracted by the high profits. If it is easy to start up a new business in the industry ({\bf free
entry})\index{free entry} then even a monopoly could not get away with earning high profits very long. 




 The {\bf Cournot model}\index{Cournot model} is the basic model economists use to explain why
prices fall with the number of firms when there is not free entry.  In the model, each firm chooses
its  output given its expectations about the other firms' outputs. The  market price is
determined by how much consumers will pay for the total output of all the firms.

 Let's look at a specific example of a Cournot model.
  Let there be $n$  firms,  each firm  producing its output $q_i$ $ i = 1, \ldots, n$ with no
fixed cost and with a constant marginal cost of 20. Let market demand be
\begin{equation} \label{eqx}
   Q =   140-P,
\end{equation}
  where $Q$ is the total output:   $Q = q_1+q_2+ \ldots q_n$.  Firm $i$'s profit function is then
\begin{equation} \label{eqx}
   \pi_i = Pq_i - 20q_i .
\end{equation}



\bigskip
 %-------------------------------------------------------
\newpage
\noindent
 {\bf One Firm: Monopoly}

  First, suppose $n=1$, so Firm 1  is a monopoly.  Then, $P = 140-q_1$, so   Firm 1's profit, shown
in Figure \ref{chap07}.\ref{fig06-6-profit.jpg},   is
\begin{equation} \label{eqx}
    \pi_1 = (140-q_1)q_1 - 20q_1  =  (140q_1  -q_1^2) - 20q_1
\end{equation}


\begin{center}
 \vspace*{24pt}
  \begin{minipage}[c]{.8\linewidth}
\begin{center}
 {\sc Figure \ref{chap07}.\ref{fig06-6-profit.jpg} \\
Monopoly Profits with One Seller } \\

\refstepcounter{figurecounter} \label{fig06-6-profit.jpg}
 \includegraphics[width=\linewidth]{fig06-6-profit.jpg}
\end{center}
 \end{minipage}
 %\vspace*{24pt}
\end{center}





   To maximize the firm's profit, use a little calculus. Take profit's  derivative with respect to
$q_1$ and set the derivative equal to zero, the equation called the {\bf first-order condition}
\index{first-order condition} for maximization.  That yields
\begin{equation} \label{eqx}
   \frac{d \pi_1}{d q_1} =  (140   -2q_1 ) - 20 =0
\end{equation}
which solving out for $q_1$ yields $q_1 = 60$. Then, using the demand function, $P=80$, so $\pi_1 =
(80)(60) - 20(60) = 3,600.$

 This is the same result as  we would get by setting marginal revenue equal to marginal cost,
because the last equation can be rewritten as
\begin{equation} \label{eqx}
   \frac{d \pi_1}{d q_1} =  (Marginal \; revenue)  - Marginal \; cost =0
\end{equation}
 Recall that with linear demand,the marginal revenue curve slopes down twice as fast as the demand
curve, so with $P=140-Q$, we get $MR = 140-2Q$.  So calculus is a way to generate that rule.


\bigskip
 %-------------------------------------------------------



\noindent
 {\bf Two Firms: Duopoly--- The Asymmetric-Costs Case}

 So much for   monopoly. Let's do the same thing for duopoly. We will start with an asymmetric case, in which Firm 1 has a cost advantage over Firm 2:  Firm 1's marginal cost is $c_1=20$ and Firm 2's is $c_2=40$. 
   As before,  $P = 140-(q_1+q_2)$, so   Firm
1's profit  is:
\begin{equation} \label{eqx}
    \pi_1 (q_1)= (140-q_1-q_2)q_1 - 20q_1  =  (140q_1  -q_1^2 - q_2q_1) - 20q_1.
\end{equation}


Take profit's  derivative with respect to $q_1$ and set  it to zero:
\begin{equation} \label{eqx}
   \frac{d \pi_1}{d q_1} =  (140   -2q_1  -q_2) - 20 =0.
\end{equation}

 This gives us the {\bf reaction  function } \index{reaction  function} or {\bf reaction curve}
\index{reaction curve}   for $q_1$ as a function
of $q_2$.  The more output Firm 1 expects from Firm 2, the smaller will Firm 1 choose its own output
to be:
\begin{equation} \label{eqx}
  q_1 (q_2)  =  60   -\frac{q_2}{2}.
\end{equation}

  At the extremes, if Firm 1 thinks Firm 2 will set $q_2=0$, then Firm 1 chooses (``reacts with'')
its monopoly output of 60; but if  Firm 1 thinks Firm 2 will set $q_2=120$ and drive the price down
to marginal cost, then Firm 1 chooses  to produce zero.    Firm 1's  reaction curve goes
from 60 on the y-axis to 120 on the x-axis.

\bigskip

Now let's do the same for Firm 2.  Firm
2's profit  is:
\begin{equation} \label{eqx}
    \pi_2(q_2) = (140-q_1-q_2)q_2 - 40q_2  =  (140q_2  -q_2^2 - q_2q_1) - 40q_2.
\end{equation}


Take profit's  derivative with respect to $q_2$ and set  it to zero:
\begin{equation} \label{eqx}
   \frac{d \pi_2}{d q_2} =  (140  - 2q_2 - q_1 ) - 40 =0.
\end{equation}

 This gives us the {\bf reaction  function }    for $q_2$ as a function
of $q_1$.  The more output Firm 2 expects from Firm 1, the smaller will Firm 2 choose its own output
to be:
\begin{equation} \label{eqx}
  q_2 (q_1)  =  50   -\frac{q_1}{2}.
\end{equation}


At the extremes, if Firm 2 thinks Firm 1 will set $q_1=0$, then Firm 2 chooses (``reacts using'')
its monopoly output of 50 ($not$ Firm 1's monopoly output, which is 60---why not?).  If Firm 2 thinks Firm 1 will set $q_1=100$ and drive the price down
to Firm 2's marginal cost of 40, then Firm 2 chooses  to produce zero.    Firm 2's  reaction curve goes
from  100 on the y-axis to 50 on the x-axis.

 What is the value of $q_2$ that Firm 2 will actually pick?  
The two reaction equations give us two equations for two unknowns, $q_1$ and $q_2$.  We can substitute to get:
\begin{equation} \label{eqx}
  q_2 (q_1)  =  50   -  \frac{60-\frac{q_2}{2} }     {2}  =  50 - 30+ \frac{q_2}{4} = 20+\frac{q_2}{4}. 
\end{equation}

Solving this last equation yields $ q_2^*= \frac{80}{3} = 26 \frac{2}{3}$. We can substitute $q_2^*$ into $q_1(q_2) $ to get  $q_1^*= 60 - \frac{\frac{80}{3} }{2} =\frac{140}{3}=   46 \frac{2}{3}$. 

 Using the demand function, $P = 140-  \frac{140}{3} - \frac{80}{3} =67 \frac{1}{3} $.  


%\vspace*{24pt}
\begin{center}
 \begin{minipage}[c]{.8\linewidth}
\begin{center}
 {\sc Figure \ref{chap07}.\ref{fig05-2a-asym-cournot.jpg} \\
 Asymmetric Cournot Duopoly Reaction Curves } \\
\medskip
\refstepcounter{figurecounter} \label{fig05-2a-asym-cournot.jpg}
 \includegraphics[width=\linewidth]{fig05-2a-asym-cournot.jpg}
\end{center}
 \end{minipage}
\end{center}
 \vspace*{24pt}


  

\bigskip
 %-------------------------------------------------------



\noindent
 {\bf Two Firms: Duopoly--- The Symmetric-Costs Case}

 Let's do the same thing for a duopoly in which both firms have the same cost curves.  This is  simpler  than the asymmetric-cost Cournot duopoly, but its ease is deceptive, because it doesn't show so clearly how each firm is acting independently to maximize its own profits.   As before,  $P = 140-(q_1+q_2)$, so   Firm
1's profit  is
\begin{equation} \label{eqx}
    \pi_1 = (140-q_1-q_2)q_1 - 20q_1  =  (140q_1  -q_1^2 - q_2q_1) - 20q_1
\end{equation}



 Again  take profit's  derivative with respect to $q_1$ and set  it to zero.
\begin{equation} \label{eqx}
   \frac{d \pi_1}{d q_1} =  (140   -2q_1  -q_2) - 20 =0
\end{equation}

 This gives us a    reaction  function (as shown in Figure  \ref{chap07}.\ref{fig06-2.jpg})  for $q_1$ as a function
of $q_2$.  The more output Firm 1 expects from Firm 2, the smaller will Firm 1 choose its own output
to be.
\begin{equation} \label{eqx}
  q_1 (q_2)  =  60   -\frac{q_2}{2}.
\end{equation}

  At the extremes, if Firm 1 thinks Firm 2 will set $q_2=0$, then Firm 1 chooses (``reacts with'')
the monopoly output of 60; but if  Firm 1 thinks Firm 2 will set $q_2=120$ and drive the price down
to marginal cost, then Firm 1 chooses  to produce zero.  That is why Firm 1's  reaction curve goes
from 60 on the y-axis to 120 on the x-axis.



%\vspace*{24pt}
\begin{center}
 \begin{minipage}[c]{.8\linewidth}
\begin{center}
 {\sc Figure \ref{chap07}.\ref{fig06-2.jpg} \\
 Cournot Duopoly Reaction Curves } \\
\medskip
\refstepcounter{figurecounter} \label{fig06-2.jpg}
 \includegraphics[width=\linewidth]{fig06-2.jpg}
\end{center}
 \end{minipage}
\end{center}
 \vspace*{24pt}


  What is the value of $q_2$ that Firm 2 will actually pick?  If we  were to set up the same problem for Firm 2's choice of $q_2$ to maximize
profit and solve the two first order conditions together, it turns out that we would find that $q_1=
q_2$. Figure  \ref{chap07}.\ref{fig06-2.jpg}  shows Firm 2's reaction curve, and how it crosses Firm
1's reaction curve at   $q_1=q_2=40$.   Rather than finding the equation for Firm 2's reaction
curve, though,     we can set $q_2=q_1$  in Firm 1's reaction curve, so
\begin{equation} \label{eqx}
     q_1    =  60   -\frac{q_1}{2},
\end{equation}
 which solves out to  $q_1 = 40$. As a result, $q_2=q_1=40$ and $Q = q_1+q_2 = 80.$ Using the demand
function, $P = 60$. Profits are $pi_1 =  \pi_2 =   (60)(40) - 20 (40) = 1,600$ each.  Duopoly industry
profit is 3,200, which is below the monopoly industry profit of 3,600, but above the competitive
profit of 0 that would result if $P =MC =20$.


 Figure  \ref{chap07}.\ref{fig06-2.jpg} shows another line going from 30 on the y-axis to 30 on the
x-axis, labelled ``Cartel Output''. This is the combinations of $q_1$ and $q_2$ that add up to 60,
the monopoly output. Any combination on that line maximizes industry profit. The natural cartel
outcome if collusion were legal  would be $q_1=q_2=30$, but if Firm 1 is better at bargaining and
threatens to break up a cartel, it could get $q_1=32, q_2=28$. The price would be $P=80$, so Firm
2's profit would be  (80-20) (28) = 1,680, better than Firm 2 could get from Cournot duopoly if it
refused Firm 1's offer.  That kind of threatening and bargaining, though, is one reason cartels
often do not form or form but  break up as the result of bickering.

\bigskip
 %-------------------------------------------------------

\noindent
 {\bf Three or More Firms: Oligopoly to Competition}


  The beauty of the Cournot model is that it can be  extended to any number of firms. Now let there
be $n$ firms, so
  $P = 140-(q_1+q_2 + \ldots + q_n)$, and    Firm 1's profit  is
\begin{equation} \label{eqx}
    \pi_1 = \left(140- (q_1+q_2+\ldots q_n) \right)q_1 - 20q_1  =  \left(140q_1  -q_1^2 - q_1 (
q_2+\ldots q_n)\right) - 20q_1
\end{equation}



 Again  take profit's  derivative with respect to $q_1$ and set  it to zero.
\begin{equation} \label{eqx}
   \frac{d \pi_1}{d q_1} =  \left(140   -2q_1  -  ( q_2+\ldots q_n)\right) - 20 =0
\end{equation}

Firm 1's reaction curve is
\begin{equation} \label{eqx}
 q_1 =  60      -  \frac{( q_2+\ldots q_n)}{2}.
\end{equation}

If there are 3 firms   the reaction curves 
 are actually reaction planes in 3-dimensional space. The  equations are   $q_1 =
60      -  \frac{q_2 + q_3}{2}$, $q_2 =  60      -  \frac{q_1 + q_3}{2}$,  and $q_3 =  60      -
\frac{q_2 + q_3}{2}$. 


 Since the firms all are identical and solve the same kind of profit maximization problem, it turns
out that   $q_1 = q_2 = \ldots = q_n$, so $( q_2+\ldots q_n)     = (n-1) q_1$    and   we can write
\begin{equation} \label{eqx}
     q_1    =  60   -\frac{(n-1) q_1}{2} = \frac{120}{n+1}
\end{equation}

Table \ref{chap07}.\ref{tab05-04} shows what happens as the number of firms increases from 1 to 99.





\vspace*{24pt}
\noindent
\begin{minipage}[c]{\linewidth}
\begin{center}
\refstepcounter{tablecounter} \label{tab05-04}
{\sc Table \ref{chap07}.\ref{tab05-04} \\
    Cournot Industry Output Rises with the Number of Firms}\\

\bigskip
\begin{tabular}{l|cr|cr r}
\hline
\hline
 & & &&& \\
Number of & Output    &Profit  & Total   &  Price & Industry    \\
 firms ($n$) &per firm  & per firm &  output &&profit \\
  & & &&& \\
\hline
 & & &&& \\
 \: 1 &   60&  3,600 &60&80 &3,600 \\
 \: 2 &  40 & 1,600  & 80& 60& 3,200 \\
 \: 3 &  30 & 900  &90 & 50  &2,700  \\
 \: 4 &  24 &  576 & 96  &44 &2,304 \\
 \: 5    &20 & 200  & 100 &40    &2,000  \\
\: 9     & 12  &  144 &108  & 32& 1,296 \\
99    &$\approx 1$  & $\approx 1$   & $\approx 119$  & $\approx  21$ & $\approx  143$  \\
 & & &&& \\
\hline
\hline
\end{tabular}
\end{center}
\end{minipage}

  \vspace*{12pt}


 Table \ref{chap07}.\ref{tab05-04} shows that if the number of firms becomes large, the Cournot
model predicts that the price will approach marginal cost and profits will approach zero. It is
always true that as the number of firms increases, output per firm falls, industry output rises, and
the price falls.  


 

  
 
\bigskip
 %-------------------------------------------------------


\noindent
 {\bf \ref{chap07}.3:  Price Fixing} \label{s05.5}

  Price fixing is the most frequent
antitrust violation, and perhaps the most important. The two most common kinds of cases involve
industries for homogeneous products that have few sellers and bidders in auctions, whether auctions
to sell objects where the high bid wins  or auctions for procurement contracts where the low bid
wins. (A {\bf homogeneous}\index{homogeneous} product such as salt is the same whichever firm
produces it; a {\bf heterogeneous  }\index{heterogeneous} of {\bf differentiated}
\index{differentiated}product  such as perfume differs across firms.)  Probably most cases go
undetected because they are on a local scale and too small for federal authorities to intervene
(though there do exist state antitrust laws as well). Even when there is little fear of punishment,
however, cartels have a problem: making sure members obey the cartel rules.\footnote{By the way, the
now-common practice of referring to drug gangs as drug cartels misuses the word completely. A cartel
is  a group of sellers that agree to all sell at the same price. If a group of gangs agree to all
sell cocaine at a certain price, that is a cartel. If they  compete ferociously using price cuts and
automatic weapons, that is the opposite of a cartel.}



  \vspace*{16pt}
\noindent
 \begin{minipage}[c]{\linewidth}
\begin{center}
\begin{footnotesize}
\refstepcounter{tablecounter} \label{table5-2}
{\sc Table  \ref{chap07}.\ref{table5-2}\\
   The Prisoner's Dilemma}\\
\bigskip
 \begin{tabular}{lll ccc}
\hline
\hline
\multicolumn{6}{l}{\it   } \\
 &       &             &\multicolumn{3}{c}{\bf Column}\\
&       &             &   {\it Not Confess}  &   & {\it Confess}     \\
\multicolumn{6}{l}{\it   } \\
&   &  {\it Not Confess}      &     -1,-1 &    & -10, 0 \\ & {\bf Row} &&  & &  \\
  &  &       {\it   Confess}     &      0,-10  &    & {\bf -8,-8} \\
\multicolumn{6}{l}{\it   } \\
\multicolumn{6}{l}{\it Payoffs to: (Row,Column) } \\
\multicolumn{6}{l}{\it   } \\
\hline
\hline
\end{tabular}
\end{footnotesize}
\end{center}
 \end{minipage}
   \vspace*{16pt}



 The cartel enforcement problem is a good example of the Prisoner's Dilemma\index{Prisoner's
Dilemma}. In the original Prisoner's Dilemma, illustrated in Table \ref{chap07}.\ref{table5-2}, two
criminals, Mr. Row and Mr. Column,  have been captured and accused of carrying out a crime together.
They are kept in separate cells and each offered a choice: Confess or Not Confess. If neither
confess, there is still enough evidence to sentence each to 1 year in prison. If both confess, they
will each get 8 years in prison. But if one confesses and the other does not, the confessor gets off
free and the nonconfessor is sentenced to 10 years. Clearly the best thing for the prisoners jointly
is to Not Confess. For each one acting individually, however, Confess is a dominant strategy.  Think
of Prisoner Row's choice. If Prisoner Column confesses,Row  gets 8 years in prison by confessing
too, and 10 years if he chooses Not Confess, so he should confess.   If Prisoner Column doesn't
confess, Row gets 0 years in prison by confessing,   and 1 years if he chooses Not Confess, so he
should confess. Either way, Prisoner Row  does better by confessing. And so they both confess and
get a total of 16 years in prison.





  \vspace*{24pt}
\noindent
 \begin{minipage}[c]{\linewidth}
\begin{center}
\refstepcounter{tablecounter} \label{table5-3}
{\sc Table  \ref{chap07}.\ref{table5-3}\\
 The Price-Fixer's Dilemma}\\
\bigskip
 \begin{tabular}{lllccc}
\hline
\hline
\multicolumn{6}{l}{\it   } \\
 &       &      &\multicolumn{3}{c}{\bf Column}\\
&       &             &   {\it High Price}  &   & {\it Low Price}     \\
\multicolumn{6}{l}{\it   } \\
&   &  {\it High Price}      &     400, 400 &    & 200, 500 \\
 & {\bf Row} &&  & &  \\
  &  &       {\it  Low Price}  &    500, 200  &    & {\bf 300, 300} \\
\multicolumn{6}{l}{\it   } \\
\multicolumn{6}{l}{\it Payoffs to: (Row, Column) }\\
\multicolumn{6}{l}{\it   } \\
\hline
\hline
  \end{tabular}
\end{center}
 \end{minipage}
 \vspace*{24pt}


Now consider price fixers Row and Column in Table \ref{chap07}.\ref{table5-3}. They have a constant
marginal cost of  \$4 per unit for a differentiated product. If they each charge the cartel price of
\$8 that they have agreed upon  each will sell 100 units (for a profit of \$800 - \$400 each), but
if they both sell at the low, discounted price of \$5  each will sell 300 units (for a profit of
\$1,500 - \$1,200 each).  If one sells at the  low price and one sells at the high price, then the
low-priced seller sells 500 and the high-priced seller sells 50. The product is differentiated,
which is why  even a high-priced seller still gets some sales.


If both price fixers charge high prices, they each will have profits of 400.   If both choose low
prices, they will each get 300. But if one prices high  and the other prices low, the low-price firm
has profits of 500 and the high-price firm has profits of 200. Clearly the best thing for the firms
jointly is to price high. For each one acting individually, however,  Low Price  is a dominant
strategy.  Think of   Row's choice. If   Column prices high, Row's profits are 400 if he too prices
high, but 500 if he prices low.   If   Column prices low, Row's profits are 200 if he   prices high,
but 300 if he prices low. Either way,   Row  does better by  pricing low. And so both firms price
low, and industry profits are 600 instead of the 800 they could be if both stuck to the cartel
price.

%\begin{figure}[htb]
%\end{figure}



  If Row and Column could make a legal agreement to keep prices high, their task would be much
easier, but the courts would not enforce such a contract even before the Sherman
Act.\footnote{Courts in the common law countries of  England the United States would not enforce
cartel contracts, as being ``against public policy'' like contracts to commit crimes. Germany, on
the other hand, did enforce cartel contracts, which were common. See Steven B. Webb  \href{http://www.jstor.org/stable/2120181 }{``Tariffs, Cartels, Technology, and Growth in the German Steel Industry, 1879 to 1914,''} {\it Journal of Economic History}
 40: 309-330 (1980).   }
 Because of the antitrust laws, they cannot even hire an accounting firm to audit each other  and
find out if someone has been cheating on the cartel. To even detect cheating, price fixers have to
rely on gossip from customers--- who would like to stir up competition--- and fluctuations in their
own demand. If Row's sales go down, however, he cannot tell whether it is because Column has been
making secret price cuts to steal customers or because of random fluctuations in market demand. For
this reason, cartels tend to break down eventually.

 


  I
suggested earlier  that industries with homogeneous products would have the most successful cartels. The reason will now be clearer: if the
product sold by each firm is identical, it is easier to police a cartel and detect when one member
is trying to undercut the others. Prices are most easily compared when the product is homogeneous:
Row's salt should sell a pound of salt at the same price as Column, but if Honda and Toyota tried to
fix prices, should a Honda Accord sell for the same price as a Toyota Camry, particularly if
different  sellers include different options such as leather seating? In addition, if products are
heterogeneous, a seller can gain an advantage by increasing the quality of his product or giving the
consumer a better version at the same price.

   If there are few sellers, it is easier to come to an agreement.  When there are many firms,   one
firm  can stay  out of the cartel and  still profit from the high prices generated by the  cartel's
reduced output, so there is a free rider problem.  If the good is sold by auction, then the cartel
members can see who won and perhaps even see the price,   depending on the auction rules. This aids
in   detecting who cheated on the cartel agreement.   If Row wins the auction for a government
contract this week, and Column was supposed to win, Row has some explaining to do. Thus, the
structure of the market affects whether successful cartels form.


%-------------------------------------------------------
 

\bigskip
\noindent
{\bf \ref{chap07}.4: Regulating Monopoly: The History of Antitrust Law} \label{s06.1}

   What to do about market power has long been controversial. Perhaps the earliest discussion is in Aristotle's {\it Politics},\href{http://www.perseus.tufts.edu/hopper/text?doc=Perseus:text:1999.01.0058:book=1:section= 1259a&highlight=thales}{1.1259a}, where he writes about Thales, the first philosopher, and a ``man of Sicily". 

\begin{bigquote}
Thales, so the story goes, because of his poverty was taunted with the uselessness of philosophy; but from his knowledge of astronomy he had observed while it was still winter that there was going to be a large crop of olives, so he raised a small sum of money and paid round deposits for the whole of the olive-presses in Miletus and Chios, which he hired at a low rent as nobody was running him up; and when the season arrived, there was a sudden demand for a number of presses at the same time, and by letting them out on what terms he liked he realized a large sum of money, so proving that it is easy for philosophers to be rich if they choose, but this is not what they care about. Thales then is reported to have thus displayed his wisdom, but as  a matter of fact this device of taking an opportunity to secure a monopoly is a universal principle of business; hence even some states have recourse to this plan as a method of raising revenue when short of funds: they introduce a monopoly of marketable goods.

 There was a man in Sicily who used a sum of money deposited with him to buy up all the iron from the iron mines, and afterwards when the dealers came from the trading- centers he was the only seller, though he did not greatly raise the price, but all the same he made a profit of a hundred talents  on his capital of fifty. When Dionysius  came to know of it he ordered the man to take his money with him but clear out of Syracuse on the spot,6 since he was inventing means of profit detrimental to the tyrant's own affairs. Yet really this device is the same as the discovery of Thales, for both men alike contrived to secure themselves a monopoly.   
\end{bigquote}


Modern regulation of monopolies started in 
1603,   when Queen Elizabeth I of England granted her groom a legal monopoly on selling playing cards.
A court voided the grant, saying that monopolies were counter to the common law. ({\it  Darcy v.
Allein}, 77 Eng. Rep.  1260 (K.B. 1603)) Another source of market power was {\bf  price-fixing
agreements}\index{price-fixing agreements} or {\bf cartels}:\index{cartels} agreements between
sellers to jointly keep their prices high. Forming a cartel was not a criminal offense, but the
courts  would not enforce  an  agreement ``in restraint of trade'' unless it could be shown that the
agreement benefitted the public. An example of such a beneficial agreement would be if someone sold
a law firm under the condition that he not start a new law firm in the same city and steal back his
old clients.



 \begin{wrapfigure}{L}{2.4in}
\noindent
 \begin{boxedminipage}[c]{\linewidth}

 \renewcommand{\baselinestretch}{.9}
\begin{footnotesize}
\refstepcounter{sidebarcounter} \label{sidebar6-4}

\noindent
 {\sc Box \ref{chap07}.\ref{sidebar6-4}\\
 An Indiana Cement Conspiracy  }\\

\hspace*{16pt}
 Gus B.
(Butch) Nuckols of Builder's Concrete and Supply Co.  agreed with another company, IMI, to  fix
cement prices    from 2000 till 2004. Since cement is so heavy, competition tends to be local,
high profits  will not  attract new entrants for some time.  The FBI  found that  meetings were held
at the Nuckols horse barn in
Fishers, Indiana  to discuss price, discounts, and conditions of sale.

\hspace*{16pt}IMI  made \$225 million from the conspiracy. In a
plea bargain,  Nuckols  turned on his co-conspirators in exchange for a lighter sentence:   a
\$50,000 fine personally, a 14-month  prison sentence, and a fine of    \$4 million for his company.

\hspace*{16pt}Four executives of IMI pled guilty too. They   received fines of one to two
hundred thousand dollars,  and went to jail for 5 months and the  IMI  itself was fined  \$29
million.


\end{footnotesize}
\end{boxedminipage}
\end{wrapfigure}




 Excluding cartels from the benefits of  contract rights does have an effect, because members of a
cartel are always tempted to cheat  by reducing prices to increase the quantity they sell, at the
expense of other members of the cartel.

   In 1890, the Sherman Act\index{Sherman Act} was passed in the United States, and it remains one
of the two most important antitrust laws.  Section 1 of the Act, in its 2010 form (the fine limit
has been increased from the 1890 version), says
\begin{bigquote}
{\bf Every contract}, combination in the form of trust or otherwise, or conspiracy, {\bf in
restraint of trade or commerce among the several States, or with foreign nations, is declared to be
illegal.} Every person who shall make any contract or engage in any combination or conspiracy hereby
declared to be illegal shall be deemed guilty of a felony, and, on conviction thereof, shall be
punished by fine not exceeding \$100,000,000 if a corporation, or, if any other person, \$1,000,000,
or by imprisonment not exceeding 10 years, or by both said punishments, in the discretion of the
court. (U.S.C. Title 15, Chapter 1, \S 1)
\end{bigquote}

   Section 1 is aimed directly at price-fixing agreements.  At least two parties must be involved,
and they must make some definite agreement to restraint trade by such actions as directly
restricting output or raising prices. It says:
\begin{bigquote}
{\bf Every person who shall monopolize, or attempt to monopolize,}  or combine or conspire with any
other person or persons, to monopolize {\bf any part of the trade or commerce among the several
States,} or with foreign nations, {\bf shall be deemed guilty of a felony}, and, on conviction
thereof, shall be punished by fine not exceeding \$100,000,000 if a corporation, or, if any other
person, \$1,000,000, or by imprisonment not exceeding 10 years, or by both said punishments, in the
discretion of the court. (U.S.C. Title 15, Chapter 1, \S 2, as of 2010)
\end{bigquote}

  Section 2 is harder to interpret than Section 1. It is directed not  just against agreements, but
also at single parties who try to monopolize a market.  What ``monopolize'' means is left unclear,
and so has had to be interpreted by executive branch policy and by the courts. Early interpretation
ruled that if firms merged to form a monopoly, that was not ``monopolizing'' and so was legal.

 Courts treat Section 1 and Section 2 violations differently. Section 1 violations are {\bf per se}
\index{per se} illegal, meaning that they are illegal even if they do not cause any harm. If two gas
stations agree on a minimum price, they violate Section 1 even if they can show that there are many
other competing gas stations and they did not hurt any consumers.  Section 2 violations, on the
other hand, are subject to {\bf the rule of reason}\index{the rule of reason}: if the defendant can
show that his actions were not really intended to monopolize or did not have a bad effect, he can
escape punishment.

 Since ``monopolizing'' is a vague term, the
  Clayton Act\index{Clayton Act} was passed in 1914 to try to pin down monopolizing practices more
clearly. One section, which incorporates amendments in the 1930's called the {\bf Robinson-Patman
Act}\index{Robinson-Patman Act}\footnote{For more on this, see Donald S. Clark, ``The Robinson-
Patman Act:
General Principles, Commission Proceedings,
and Selected Issues,''\url{http://www.ftc.gov/speeches/other/patman.shtm},  June 7, 1995.} attacks
{\bf price discrimination}: \index{price discrimination}
\begin{bigquote}
  {\bf  It shall be unlawful for any person} engaged in commerce, in the course of such commerce,
either directly or indirectly, {\bf to discriminate in price between different purchasers of
commodities of like grade and quality}, where either or any of the purchases involved in such
discrimination are in commerce, where such commodities are sold for use, consumption, or resale
within the United States or any Territory thereof or the District of Columbia or any insular
possession or other place under the jurisdiction of the United States, and {\bf where the effect of
such discrimination may be substantially to lessen competition or tend to create a monopoly}  in any
line of commerce, {\bf  or to injure, destroy, or prevent competition with any person who either
grants or knowingly receives the benefit of such discrimination, or with customers of either of
them} \ldots  (U.S.C. Title 15, Chapter 1, \S 13)
 \end{bigquote}

 Section 13 does not apply to every case where a seller charges different customers different
prices, only to cases where the effect is to substantially lessen competition.     {\bf Predatory
pricing} \index{Predatory pricing} is the best example of this:  a monopoly charges below-cost prices
in some markets to drive out competing firms   and high prices   in other markets where competitors
do not operate.



Another section of the Clayton Act tackles special contractual provisions that could help  a firm
monopolize a market. One of these is {\bf exclusive dealing contracts} \index{exclusive dealing
contracts}or {\bf total-requirements contracts}\index{total-requirements contracts} under which  the
buyer must buy the good exclusively from the one seller, even if his competitor  offers a lower
price:
\begin{bigquote}
It shall be unlawful for any person engaged in commerce, in the course of such commerce, to lease or
make a sale or contract for sale of goods, ... on the condition, agreement, or understanding that
the lessee or purchaser thereof shall not use or deal in the goods, wares, merchandise, machinery,
supplies, or other commodities of a competitor or competitors of the lessor or seller, where the
effect \ldots may be to substantially lessen competition or tend to create a monopoly in any line of
commerce. (U.S.C. Title 15, Chapter 1, \S 14)
 \end{bigquote}

   


 The most  important part of the Clayton Act   deals with mergers.
\begin{bigquote}
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. (15 U.S.C.
\S 18)
\end{bigquote}

  As with other Clayton Act provisions, this is subject to the rule of reason. Mergers are legal
unless they substantially lessen competition. Merger regulation is    the most active area of
antitrust enforcement in the United States today. Businesses over a certain size which wish to merge
are required to notify the Justice Department and the Federal Trade Commission, who scrutinize the
merger for anticompetitive effects. Either agency may then challenge the legality of the merger in
court. Ordinarily, if the agencies decide the merger would substantially reduce competition, the
companies either drop the merger or change its terms in consultation with the agencies. If some
cities are only served by  two chain store chains, for example, a merger of those two chains  might
be required to sell  some of their stores in the ``captive'' cities to a third chain  to preserve
competition. Occasionally  firms that wish to merge think that the FTC and Justice are so
unreasonable that they say they will  merge anyway. In that case,  the agency goes to a federal
court and  tries to persuade a  judge to issue an injunction blocking the merger  on the grounds
that it would   substantially lessen competition.

A major purpose of the Clayton Act was actually to reduce competition in one   area of the economy:
labor markets. The Sherman Act  and the common law had been used to punish labor unions, which are
cartels in which workers agree to sell their labor jointly at a price above the market level. These
are heavily regulated by labor laws, but are exempt from antitrust laws and much of labor law is
devoted to encouraging workers to organize, to  increase the price at which they sell their labor,
and to be able to  use exclusive-dealing contracts to shut out workers not in the union. The Clayton
Act says:
\begin{bigquote}
The labor of a human being is not a commodity or article of commerce. {\bf Nothing contained in the
antitrust laws shall be construed to forbid the existence and operation of labor, agricultural, or
horticultural organizations, instituted for the purposes of mutual help, and not having capital
stock or conducted for profit,} or to forbid or restrain individual members of such organizations
from lawfully carrying out the legitimate objects thereof; {\bf nor shall such organizations, or the
members thereof, be held or construed to be illegal combinations or conspiracies in restraint of
trade,} under the antitrust laws. (15 U.S.C. \S 17)
\end{bigquote}

  As one would expect, since labor cartels are legal, they are common. They are heavily regulated,
however, by the National Labor Relations Board, which uses a multitude of rules to determine how a
labor union may be organized, what happens if competing unions both wish to one company's workers,
whether the union can require  the firm to fire  competing workers who refuse to the join the union,
and so forth.

	An example that shows the market power of a labor cartel can exercise    is
Local 1 of the International Alliance of Theatrical Stage Employees in New York City. Carnegie Hall
has five stagehands, who hang the lights, move furniture around, and so forth. The highest-paid is
the props manager, who earns
\$423,000  cash per year plus \$107,000 in benefits and deferred compensation.  The lowest-paid, an
electrician, earns \$403,000.  Admittedly, the workweek can last up to 80 hours, during busy times
during the heavy season, but the contrast to the incomes of aspiring musicians is amazing. Of
course, Carnegie Hall pays especially well.
  Average  stagehand compensation at  Avery Fisher Hall and  the Alice Tully Hall in Lincoln Center
is only   \$290,000 per year.  But a successful monopoly can do well even in a market with demand as
seemingly fragile as    classical music backstage
labor.\footnote{\href{http://www.northjersey.com/news/opinions/68164552.html?page=all} {``For
Backstage Labor, Rich Rewards,''} James Ahearn, {\it Northjersey.com}  (November 1, 2009).}


    One of the most important things to note about antitrust law is that it does not make monopoly
illegal. Rather, it makes {\bf monopolizing}\index{monopolizing} illegal.  If a company grows to
dominate its industry because it has low costs or good products, that is perfectly legal. Moreover,
the firm can restrict its output by following the MR(Q) = MC(Q) rule and that is legal too. There is
still market failure, but the potential for government failure in breaking up large, successful
firms is too great to make a law against mere size a good idea.  Letting the government control the
firm's prices and practices is also too fraught with risk. Both sources of government failure are
acute: the government would not know how to run the business, and the government might have the
objective of favoring politically powerful groups. Thus, the law focuses on practices which add to a
firm's market power for reasons that do not help consumers, practices such as practically all price-
fixing agreements and some mergers.  The law goes well beyond price-fixing and mergers to suspicious
practices such as predatory pricing, tie-in requirements, and exclusive dealing, but those
practices, while still monitored and sometimes punished, are not the focus of antitrust activity.


\bigskip
 %-------------------------------------------------------

\noindent
{\bf Antitrust Law in Europe}


Article 101 (formerly article 81) of the   Treaty on the Functioning of the European Union
prohibits cartels and other ``concerted practices,'' in a way comparable to the Sherman Act's
Section 1.\footnote{Treaty on the Functioning of the European Union (consolidated text), Official
Journal  of the European Union September 5, 2008,\url{http://eur-
lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2008:115:0047:0199:EN:PDF.}}
Article 102 is like the Sherman Act's Section 2. It says, ``Any abuse by one or more undertakings of
a dominant position within the common market... shall be prohibited as incompatible with the common
market insofar as it may affect trade between Member States.''\footnote{For more, see
Baumgardner\index{Baumgardner}, Larry  (2005)  ``Antitrust Law in the European Union
The law is changing---but to what effect?''  {\it Graziadio Business Report}, 11, 3.  \url{
http://gbr.pepperdine.edu/2010/08/antitrust-law-in-the-european-union/}.}     The laws are enforced
by the  European  Commission and by the antitrust authorities of each of the 20-plus nations of the
European Union.




  EU antitrust policy is administered by the {\bf Competition Commissioner}\index{Competition
Commissioner}, one of 27 commissioners of the {\bf European Commission}\index{European Commission}.
He is appointed by the {\bf Council of the European Union}\index{Council of the European Union}
(informally, the {\bf Council of Ministers})\index{Council of Ministers} which is composed of one
representative of each EU country.\footnote{EU governance is confusing. There also exists a Council
of Europe and a European Council, which are different from the Council of the European Union.} In
addition, member countries continue to have their own antitrust agencies, e.g. the United Kingdom's
\url{http://www.competition-commission.org.uk/}{Competition Commission}.

The European Union's main legislative branch is the {\bf European Parliament}\index{European
Parliament}, which is elected directly by voters according to a country's population.  {\bf EU
directives}\index{EU directives} are rules which  member countries are supposed to implement by
passing their own national laws and regulations in accord with the rule.    {\bf EU regulations}
\index{EU regulations} are rules which take effect immediately and bind every member country (note
that ``regulation'' has a particular legal meaning  here, contrasting with directives).  The
European Parliament does not make  antitrust law, the  rules for which  are issued by the European
Commission and the Council of Ministers.\footnote{European Parliament, ``General Competition Policy
and Concerted
Practices,''\url{http://www.europarl.europa.eu/parliament/expert/displayFtu.do?language=en&id=
74&ftuId=FTU_3.3.1.html} (September 2006). }




Regulations say that the Competition Commissioner can block any merger which ``significantly impede
effective competition,'' a standard similar to the Clayton Act's and  equally open  to  widely
varying interpretations.\footnote{Council Regulation 139/2004 on The Control of Concentrations
Between Undertakings (the EC Merger Regulation), art. 1, 2004 O.J. (L 24) 1.} The Commission  has
issued Merger Guidelines based on how many firms are in a market  to let businesses know which kinds
of mergers it is likely to challenge.\footnote{Guidelines on the Assessment of Horizontal Mergers
under the Council Regulation on the Control of Concentrations between Undertakings, 2004 O.J. (C 31)
5.}

 In 2001 the EU blocked a merger of General Electric and Honeywell, even though American authorities
had already approved it.  GE's CEO said, ``The European regulators' demands exceeded anything I or
our European advisers imagined and differed sharply from antitrust counterparts in the U.S. and
Canada.''\footnote{Andrew Ross Sorkin, \href{http://www.nytimes.com/2004/05/30/business/dealbook-a-trustbuster-s-song-is-ending-but-a-coda-is-possible.html}{``A Trustbuster's Song Is Ending, but a Coda Is Possible,''}
{\it  New York  Times}, May 30, 2004,   C3.}    The  personal views of whoever is Competition
Commissioner are extremely important. Another notable case involved Microsoft, which in 2004 was
fined \$600 million for anti-competitive tactics, a much more severe penalty than in its  settlement
with U.S. antitrust authorities.




\bigskip
 %-------------------------------------------------------


\noindent
{\bf Enforcement}

   The first way the antitrust laws are enforced is the same way as most federal laws are enforced:
by the {\bf Department of Justice}.\index{Department of Justice} One division of the Justice
Department is the {\bf Antitrust Division}, \index{Antitrust Division}which has a staff of
economists and lawyers ready to find and prosecute violations of the Sherman and Clayton Acts.   The
Justice Department can bring both criminal and civil actions.



 \begin{wrapfigure}{L}{.5\linewidth}
\noindent
  \begin{boxedminipage}[c]{\linewidth}
 \renewcommand{\baselinestretch}{.9}
\begin{footnotesize}
\refstepcounter{sidebarcounter} \label{sidebar05-2}

\noindent
 {\sc Box \ref{chap07}.\ref{sidebar05-2} \\
 A Rogue's Gallery of Price Fixers, and Regulators}\\


 \includegraphics[height=.18\linewidth]{fig05BjornSjaastadOdfjell.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05brooks_2.jpg}\hfill
 \includegraphics[height=.18\linewidth]{fig05davidge_2.jpeg}\hfill
 \includegraphics[height=.18\linewidth]{fig05debney.jpg}\hfill
 \includegraphics[height=.18\linewidth]{fig05kim.jpg}\\




 \includegraphics[height=.18\linewidth]{fig05koehler.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05whitacre.jpg} \hfill
  \includegraphics[height=.18\linewidth]{fig05tennant.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05taubman.jpg} \hfill
 %\includegraphics[height=.18\linewidth]{fig05sommer.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05rpratt.jpg}\\


    \includegraphics[height=.18\linewidth]{fig05baye-michael.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05carlto.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05farrell.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05katz_michael.jpg} \hfill
 \includegraphics[height=.18\linewidth]{fig05Salinger-Michael.jpg}

\end{footnotesize}
 \end{boxedminipage}
\end{wrapfigure}



Violations of the Sherman Act can be prosecuted as {\bf  criminal violations}\index{criminal
violations}. This means that the accused   must be found guilty ``beyond a reasonable doubt,'' and
may be punished with prison time of up to 20 years (since Sarbanes-Oxley raised the limit in 2002)
as well as fines.  The {\bf reasonable doubt standard}\index{reasonable doubt standard} is a high
hurdle.  The government may prefer to bring the case as a {\bf civil action}\index{civil action}.\footnote{Examples of complaints by the Justice Department and the FTC are: 
 \href{http://www.jdsupra.com/legalnews/complaint-in-us-v-apple-and-hachette-e-26600/}{ ``Complaint: United States v. Apple  Inc., Hachette Book Group, et al.''
United States District Court for the Southern District of New York'' (April 12, 2011) } and  
\href{http://www.ftc.gov/os/caselist/0610197/complaint.pdf}{``TC Group-Riverstone-Carlyle-Kinder Morgan Complaint''} (2007).}
 



There, the firm or person  must be found to have done something illegal  {\bf by the preponderance
of the evidence}\index{by the preponderance of the evidence}; that is, more likely than not.  A
civil action can result in fines, and also in orders from the court called {\bf injunctions}
\index{injunctions}that can call for the firm to have special government oversight, to cease some
business practice, or even to split up into smaller firms. Or, the government and the firm may
settle a suit by a {\bf consent decree}\index{consent decree}, an agreement enforced by the court
under which the firm agrees to behave in a certain way.

 The other agency that enforces antitrust law is the {\bf Federal Trade Commission}\index{Federal
Trade Commission} or FTC, which was created in 1914 at the same time as the Clayton Act was passed.
The FTC only brings civil cases, not criminal cases. If it brings a complaint, the complaint is
judged by an FTC hearing overseen by an {\bf administrative law judge} \index{administrative law
judge}from within the FTC  who recommends a course of action to the Commission's five members at the
end of the hearing. The Commission then votes on a decision similar to a court injunction.

Besides the two agencies, private parties can enforce the antitrust laws through civil actions. The
private party, typically a customer or a competitor of the company charged with wrongdoing,  must
show that it has been harmed, and by how much. Ordinarily if someone is found liable in a civil suit
he must pay the party who brought the suit (the plaintiff) the damage the court decides he caused.
(Punitive damages are possible, but unusual.)  The antitrust laws, however, say  that private
parties can collect {\bf treble damages}:\index{treble damages} that is, if the plaintiff can prove
he lost \$1 million dollars due to the defendant's monopolizing practices, he can collect \$3
million from the defendant.\footnote{On the other hand, treble damages aren't always high. A jury
agreed that  the National Football League (NFL) did ``willfully acquire or maintain monopoly
power,'' but estimated the resulting damage to the rival United States Football League at only a
nominal \$1 (it would have been in financial trouble anyway). When trebled, that came to a measly
\$3 award.  \href{http://sportsillustrated.cnn.com/vault/article/magazine/MAG1065099/index.htm}
{``The Award Was Only Token:
The USFL Proved Part of Its Case against the NFL only to See the Jury Throw the Winners for a
Loss,''}, Craig Neff,  {\it Sports Illustrated} (August 11, 1986).} Defendants are rarely sentenced
to prison time in antitrust cases and criminal and civil fines are low relative to the potential
gains from violations, so the treble damages from private suits are perhaps the biggest punishment
violators face. Often, private parties can  wait until the government has proved a case  and then
pile on with private suits, much of the work having been done for them.

   Who can sue for damages is an interesting legal question. The U.S. Supreme Court ruled in {\it
Hanover Shoe, Inc. v. United Shoe Machinery Corp.} (392 U.S. 481 [1968]) that the direct purchaser
of the overpriced product can sue for the price difference even if it resold the product and passed
the cost on to its own customers. Thus, if a cartel of plastic companies sold plastic to bottle
companies which then raised their prices to soft drink companies, the bottle companies could sue for
the entire plastic overcharge.  What about the indirect purchasers, the soft drink companies?  The
U.S. Supreme Court ruled in  {\it Illinois Brick Co. v. Illinois} (431 U.S. 720 [1977]) that only
the direct purchasers could sue, since otherwise there would be duplicative suits and it would be
hard to track down all the indirect purchasers. Many states, however, have passed ``Illinois Brick
repealer'' statutes that allow the indirect purchasers to sue in state court.
 \footnote{See Dennis W. Carlton, , \index{Carlton}\href{http://www.jstor.org/stable/30033739}
{``Does Antitrust Need To Be Modernized?''} {\it The Journal of Economic Perspectives},   21(3):
155--176 (Summer  2007);  Edward D.   Cavanagh,\index{Cavanagh}\href{http://heinonline.org/HOL/Page?handle=hein.journals/lyclr17&div=8&g_sent=1&collection=journals}{   ``Illinois Brick: A Look Back
and a Look Ahead,''} {\it  Loyola Consumer Law Review}, 17: 1--51 (2004).}


  Why have this threefold enforcement?  We must go back to government failure and the principal-
agent problem.  Each of these three enforcers--- the Justice Department, the FTC, and private
parties--- has different incentives. The Justice Department is headed by the Attorney-
General\index{Attorney-General}, who is appointed by the President and who can be fired by him.
Thus, the Justice Department is subject to political influence. This is not an entirely bad thing,
because the President has, after all, been elected to execute the laws in a certain way, so if his
degree of enforcement is more severe or more lax, that is the result of voter choice.   There is
potential, however, for favoritism in prosecutions.

 Thus, when Congress established the Federal Trade Commission in 1914, they set it up as an {\bf
independent agency}\index{independent agency}. What this means is that although its five members are
appointed by the President, they cannot be fired by him, and their seven-year terms are staggered so
that when the Presidency changes parties, the President inherits the old Commission members
appointed by his predecessor. He must wait for their terms to end before he can appoint his own
people. Moreover, no more than three of the five members may be of the same political party.

  If the Justice Department decides not to investigate a tying arrangement or challenge a merger,
the FTC can do so  instead, and vice versa. Moreover, if both of them are too reluctant to enforce
the laws, private parties can bring treble-damage suits. Thus, the overlapping authority  can
overcome the problem of one agency, an agent for the voters as principal, is slack in its effort.

  In practice there do  not seem to have been important policy differences between the FTC and the
Justice Department. They cooperate well, and they split investigation of proposed mergers  so each
can specialize in certain industries rather than duplicating effort.\footnote{For more on the history and politics and anti-trust regulation, see 
\href{http://www.nber.org/chapters/c12565.pdf}{``Antitrust and Regulation,''}
Dennis W. Carlton  \& Randal C. Picker, a chapter in {\it  Economic Regulation and Its Reform: What
Have We Learned?} National Bureau of Economic Research  (2011).}


\bigskip

\noindent
 {\bf \ref{chap07}.5:  Mergers} \label{s06.2}

Certain   business action might be either
surplus-increasing or surplus-reducing, and so are subject to the ``rule of reason'' in antitrust
law.
Section 1 of the Sherman Act  makes illegal  ``every contract, combination in the
form of trust or otherwise, or conspiracy, in restraint of trade,'' while Section 2 makes it illegal
to
 ``monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to
monopolize.''
  Not only are there lots
of monopolizing practices, but for each one we could talk about several surplus-increasing
motivations and
several surplus-reducing motivations and how common each of these is. This makes
monopolizing a fun and important area for academic researchers, but it runs into diminishing
returns. Prosecutors are not eager to bring complicated cases, and judges do not look forward to
having to decide them, since the cases turn on difficult arguments being explained by expert
witnesses using mathematics and game theory. This is not laziness, but rationality; prosecutors and
courts have limited resources and if they can deal with five price-fixing cases in the time
required  to analyze one predatory pricing case, they should do it--- particularly since they might
end up punishing someone for predatory pricing when he actually was engaged in surplus-increasing
severe price competition.   In practice, by far the most important monopolizing practice regulated
is merger, since  unlimited merger would clearly hurt competition severely and the least justifiable
mergers are easy to detect.   The illegality of other practices is important, though, because they
too are sometimes punished and the mere threat of government action curtails the most abusive
behavior.

  The most important  suspicious  practice  is the merger of two or more firms. After it became
clear that the courts would use the Sherman Act to punish cartels firms turned to merger, and {\bf
the Great Merger Wave} \index{the Great Merger Wave} took place around 1900, mergers that involved a
substantial fraction of U.S. manufacturing.\footnote{See George  Bittlingmayer,\index{Bittlingmayer}  \href{http://heinonline.org/HOL/Page?handle=hein.journals/jlecono28&div=9&g_sent=1&collection=journals}{
``Did Antitrust Policy Cause the Great Merger Wave?'' } {\it  The Journal of Law and Economics},
28:  77--118 (April  1985).}  The hope was that the courts would interpret the Sherman Act to
mean that although agreements between firms to raise prices were illegal, it would still be legal to
merge the firms--- in which case, as has been explained, it is not illegal for a firm to use its
market power to raise its own prices unilaterally.  In response, the courts began using the Sherman
Act against mergers in 1904 in the {\it Northern Securities}\index{Northern Securities} case and in
1914 the Clayton Act clarified that mergers could be  illegal monopolization, saying, you will
recall, that:



\begin{bigquote}
\hspace*{16pt} No person \ldots shall acquire, directly or indirectly, the whole or any part of the
stock or other share capital and no person\ldots  shall acquire the whole or any part of the assets
of another person \ldots  where\ldots 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.(15 U.S.C. \S 18)
\end{bigquote}



Mergers {\it can be}, not {\it are},  illegal monopolization. It is hard enough to think of surplus-
maximizing reasons for competitors to agree with each other to raise prices that the law makes such
agreements per se illegal. It is easy, though, to think of  surplus-maximizing  reasons for two
competitors to agree to merge. The new merged firm might have lower costs, either because of
economies of scale or because one of the firms has managers who are better at managing. On the other
hand, with fewer firms in the industry, competition falls, so the new firm might have cost curves
just the same  or worse but be better able to raise prices, a bad motivation.


\bigskip

\noindent
 {\bf  Concentration Levels} 


  Since the number of firms   matters to the amount of competition, it is useful to quantify the  {\bf concentration}
\index{concentration} of a market: how few firms sell in it.
A simple measure is the {\bf four-firm concentration ratio}\index{four-firm concentration ratio}:
the percentage of market sales by the top four firms. Thus, if the firms in an industry have market
shares of   30\%, 25\%, 20\%, 15\%,    5\%,  4\%, and 1\%, the four-firm concentration ratio is
90\%.  That is rather crude, since it doesn't care about how evenly the top four firms split the
market.  The same level would be reached by an industry in which one firm had an  87\% market shares
and 13 other firms had  shares of 1\% each.



\begin{footnotesize}
 \vspace*{24pt}
\noindent
 \begin{minipage}[c]{.8\linewidth}
\refstepcounter{tablecounter} \label{tab05-05}
\begin{center}
{\sc Table  \ref{chap07}.\ref{tab05-05} \\
  Concentration Ratios  }\\
 \bigskip
\begin{tabular}{lr | r| rrrr | r }
\hline
\hline
  &  &    &   & & & &  \\
 Industry & NAICS   & Estab's & \multicolumn{4}{|c|}{No. of Firms } & Herf.  \\
  &   Code &   &     4  & 8  &20  & 50   &   Index\\
  &  &    &   & & & &  \\
 \hline
  &  &    &   & & & &  \\
  Food Manufacturing& 311 &  21,355  & 14 &22&37& 50 &102\\
  Sugar and Confectionery & 3113 & 1,631  &37  &49&66& 83 & 667 \\
 Product Manufacturing &  &    &   & & & &  \\
   Sugar   Manufacturing& 31131 & 37 &59 &78&96& 100 &904\\
Beet Sugar Manufacturing &  311313 &  12 & 81 &98&100& 100 &x\\
  &  &    &   & & & &  \\
\hline
  &  &    &   & & & &  \\
 Dog and Cat Food & 31111&  199  & 71 & 83&92& 98& 2,325 \\
Manufacturing &  &    &   & & & &  \\
Retail  Bakeries &311812 &  6,101&   3 &6 &9&18 & 7   \\
 Accommodation and  & 72 &  634,361  &  5 & 10&17 & 23 &x \\
Food Services &  &    &   & & & &  \\
Hotels (except casino hotels)  & 72111 & 48,108   &22   &28 & 35&  42 &x\\
 and motels &  &    &   & & & &  \\
 National Commercial  & 5221101 &  46,809  & 55  &69 &83 & 90&x  \\
 Banks &  &    &   & & & &  \\
 &  &    &   & & & &  \\
\hline
\hline
\end{tabular}\\
\end{center}
{\it  Notes:}  \url{http://factfinder.census.gov/}.  One company can have many establishments, e.g.  Hilton hotels. For some industries
the Herfindahl Index is not published.

 \end{minipage}
\end{footnotesize}

\vspace*{24pt}



  A more sophisticated approach is  the {\bf Herfindahl Index}\index{Herfindahl
Index}:\footnote{The government and others call this the ``{\bf Herfindahl-Hirschman  Index}
\index{Herfindahl-Hirschman  Index}'' or ``HHI'' in documents, but that's too long a name, and in
common practice  government people and economists just say ``Herfindahl  Index''--- Too bad for
Professor Hirschman,  a more important scholar than Herfindahl, but better for everyone else.}
The Herfindahl is calculated by summing the squares of the individual firms' market shares,   and
thus gives proportionately greater weight to the larger market shares. Table
\ref{chap07}.\ref{tab05-09} shows how that works out. Table \ref{chap07}.\ref{tab05-05} also has
examples.  When using the Herfindahl, the agencies consider both the post-merger level of the
Herfindahl and the increase in the Herfindahl resulting from the merger. The increase in the
Herfindahl  is equal to twice the product of the market shares of the merging firms. \footnote{The
Herfindahl Index does have a theoretical justification. If the firms are Cournot competitors with
different marginal costs, they will have different market shares. The Herfindahl Index equals the
weighted average  of their market shares  multiplied  by the industry elasticity of demand (and
multiplied by -10,000). }






 \begin{center}
\begin{minipage}[c]{ \linewidth}
\begin{center}
\begin{footnotesize}
 \refstepcounter{tablecounter} \label{tab05-09}

{\sc Table \ref{chap07}.\ref{tab05-09} \\
 Herfindahl Examples} \\
 \bigskip
\begin{tabular}{llr}
\hline
\hline
 & & \\
Industry &   Computation & Herfindahl Index\\
 & & \\
\hline
 & & \\
 Entirely monopolized &(100*100) & 10,000  \\
 & & \\
 One firm has 70\% of sales and the other has  30\%  & (70*70+30*30)    &  5,800 \\
 & & \\
 Two firms split  the market evenly &(50*50 + 50*50)  &5,000\\
 & & \\
 One firm has 50\% and 50 others have 1\% each &  (50*50+ 50*1*1) &2,550 \\
 & & \\
  Five firms split the market evenly & (5*(20*20))  &2,000\\
 & & \\
  Ten firms split the market evenly &(10*(10*10)) & 1,000 \\
 & & \\
    100 firms split the market evenly & (100*(1*1)) & 100 \\
 & & \\
\hline
\hline
\end{tabular}
\end{footnotesize}
 \end{center}
\end{minipage}
\end{center}









  Thus, antitrust law allows mergers, but is suspicious of them.  Federal law requires any two large
firms that wish to merge to submit information to the FTC and the Justice Department on the likely
effects on price. If the FTC or Justice object to the merger, they can try to block it.

   Since the statute is not clear on what it means for a merger to substantially reduce competition,
the agencies have to decide what mergers to block and the courts have to decide whether the agencies
are interpreting the law correctly.  Companies would like to know which mergers are going to be
allowed, since setting up a merger only to have it blocked by the FTC results in a lot of wasted
effort. Thus, the FTC and Justice have  issued  regulations  declaring what kinds of mergers are
likely to be blocked. A  regulation called  ``Horizontal Merger Guidelines'' was issued in 2010 for
{\bf horizontal mergers}\index{horizontal mergers}, which are mergers between firms selling
competing products.\footnote{U.S. Department of Justice and the Federal Trade Commission,
\url{http://www.justice.gov/atr/public/guidelines/hmg-2010.html} {``Horizontal Merger
Guidelines,''}  (August 9, 2010).} An example would be a merger between Ford Motor Company and
Toyota, which both sell  cars.   Another memo, ``Non-Horizontal Merger Guidelines,'' not revised
since 1984, covers   vertical  and  conglomerate mergers. \footnote{U.S. Department of Justice,
\url{http://www.justice.gov/atr/public/guidelines/2614.htm}{``Non-Horizontal Merger Guidelines,''}
(June 14, 1984).  } {\bf Vertical mergers} \index{Vertical mergers} merge two companies when one
company (the {\bf upstream firm}\index{upstream firm}) sells to another company (the {\bf downstream
firm}\index{downstream firm} which in turn sells to consumers. An example would be   a merger of
U.S. Steel   and  with the  Ford Motor Company. {\bf Conglomerate mergers} \index{Conglomerate
mergers} merge   companies that sell unrelated products, such as a merger of the Ford Motor Company
with  Pepsi.  Horizontal mergers  generally reduce competition, and the main question   is whether
they substantially reduce it. Conglomerate mergers do not reduce competition, since the two firms
are in different markets and market concentration is unchanged by the merger. Vertical mergers are
the most complicated to analyze,  since they can reduce competition but in more subtle
ways.\footnote{ One's first thought  is that once the firms merge vertically, the upstream firm will
stop selling to competitors of the downstream firm, so downstream competition will be reduced. The
flaw in that reasoning is that if the upstream firm found it profitable to sell to all the
downstream firms before the merger, it will still be profitable afterwards, so trying to stifle
competition there would actually hurt the merged firm's profits.  There are counter-arguments, but
they would take too  long to explain.}

 The {\it 2010 Horizontal  Guidelines}\index{ 2010 Horizontal  Guidelines}  try to inform businesses
what mergers will be allowed without tying the hands of the antitrust agencies. The {\it
Guidelines} talk about objective criteria for market concentration, for example, but they are also
careful to say that if the Justice Department finds a memo saying ``Of course, the main reason why
we're merging is so we can increase prices and gouge consumers,'' the merger can be declared
illegal. The {\it Guidelines} are written for companies trying to comply with the law in good faith.
An  unprincipled firm cannot say, ``But the guidelines didn't say I couldn't do X!'' and be excused.




 The {\it Guidelines} establish that what the agencies really care about is whether the merger will
raise prices, which is what economists focus on.
Earlier antitrust policy focussed on a more legalistic definition of the market, trying to use a
more objective and predictable measure of how concentrated the market was. An example of such an
approach (not a real example--- just a simple one for discussion)  would be to say that two firms
can  merge   if and only if  they wouldn't have over 30\% of the market after the merger.  This
rule would make for neither good economics nor good law.

 The economic problem is that such a simple rule ignores whether the merger  really  affects market
power or not. In one market, two firms with market shares of 16\% would be forbidden to merge  even
though neither could raise price above cost because entry by new competitors is easy.  In another
market, two firms with market shares of 14\%   would  be allowed to merger  even though  there
exists only one other firm in the market (with the remaining 72\% of sales) so a triopoly would be
converted to a duopoly.

  The legal problem is that the rule is not actually so simple. It depends completely on how one
defines ``market''. Lawyers can spend endless hours arguing about that.   In the Cellophane Case,
was Dupont selling in the market for  ``cellophane'' (of which it had a 75\% market share) or
``flexible packaging material'' (of which cellophane was only 20\%).  {\it U.S. v. E. I. du Pont},
351 U.S. 377 (1956).  In the     ReaLemon Case,   was Borden selling in the market for   lemon juice
in plastic lemons  or did the market include natural lemons too? (are ReaLemons like real lemons?)
{\it Borden. v. Federal Trade Commission},
 {674 F.2d 498}    (6th
Cir. 1982).  In the 2000's,  were   Whole Foods and Wild Oats competing with ``premium, natural, and
organic supermarkets'' or with
``grocery stores and supermarkets''?  {\it FTC v. Whole Foods Markets, Inc.},
 {
 533 F.3d 869} (D.C. Cir.  2008).


 The {\it Guidelines} use a different approach to decide  what group of products makes up   ``a
market'' when   trying to figure out how many firms currently are in the market of the proposed
merger.  The
{\bf    Hypothetical Monopolist Test}\index{Hypothetical Monopolist Test} asks whether if a single
firm was the only seller of a group of products, it  ``likely would impose at least a small but
significant and non-transitory increase in price ({\bf ``SSNIP''})\index{SSNIP} on at least one
product in the market, including at least one product sold by one of the merging firms.''  A ten-
percent increase counts as significant.  So, perhaps would be a 4\% increase. The    Guidelines are
vague on that point.

 


   The {\it Guidelines} make use of the Herfindahl Index as a way to screen mergers. They say:
\begin{bigquote}
\hspace*{16pt}The Agencies generally classify markets into three types:
\begin{itemize}
   \item  Unconcentrated Markets: HHI below 1,500

    \item  Moderately Concentrated Markets: HHI between 1,500 and 2,500

    \item Highly Concentrated Markets: HHI above 2,500
\end{itemize}

\hspace*{16pt}The Agencies employ the following general standards for the relevant markets they have
defined:
\begin{itemize}
\item  Small Change in Concentration: Mergers involving an increase in the HHI of less than 100
points are unlikely to have adverse competitive effects and ordinarily require no further analysis.

 \item  Unconcentrated Markets: Mergers resulting in unconcentrated markets are unlikely to have
adverse competitive effects and ordinarily require no further analysis.

  \item  Moderately Concentrated Markets: Mergers resulting in moderately concentrated markets that
involve an increase in the HHI of more than 100 points potentially raise significant competitive
concerns and often warrant scrutiny.

\item   Highly Concentrated Markets: Mergers resulting in highly concentrated markets that involve
an increase in the HHI of between 100 points and 200 points potentially raise significant
competitive concerns and often warrant scrutiny. Mergers resulting in highly concentrated markets
that involve an increase in the HHI of more than 200 points will be presumed to be likely to enhance
market power. The presumption may be rebutted by persuasive evidence showing that the merger is
unlikely to enhance market power.
\end{itemize}
\end{bigquote}

%\end{minipage}


 
 Consider an example. 
One firm has 50\% and 50 others have 1\% each. 
The Herfindahl is 2,550 (50*50+ 50*1*1) so the industry is {\it concentrated}.   
 Can 12 of the small firms merge? 
They would  contribute 144 to the  Herfindahl instead of 12,
  an increase of 132.  
Such a merger {\it often warrants scrutiny} because it is in a {\it concentrated industry} even tho
it is small.

 


   Concentration measures are not really what we're worried about, but they  are numbers, and
relatively objective numbers, and that tends to focus the attention of policymakers, lawyers,
judges, and people generally. The subjective element gets shifted, but it doesn't disappear. In fact
it is crucial. Where it goes is into the definition of ``market'' that you use to measure the market
shares that go into the Herfindahl Index. If Microsoft's  market is ``software'', its    market
share is moderate. If the  market  is  ``operating systems'' its   market share is huge. If the
market  is ``perfectly Windows-compatible operating systems'',  it is  an absolute monopoly.



Despite all of the details on measuring concentration,
 the {\it Guidelines}  say not to rely too much on the Herfindahl Index:
\begin{bigquote}
The purpose of these thresholds is not to provide a rigid screen to separate competitively benign
mergers from anticompetitive ones, although high levels of concentration do raise concerns. Rather,
they provide one way to identify some mergers unlikely to raise competitive concerns and some others
for which it is particularly important to examine whether other competitive factors confirm,
reinforce, or counteract the potentially harmful effects of increased concentration.
\end{bigquote}


 



 



 %-------------------------------------------------------



\bigskip
 \noindent
{\bf The Staples-Office Depot Merger}

  When Staples and Office Depot proposed to merge in 1997, they presented evidence to the FTC and
the Justice Department  that their costs would fall enough to increase total surplus. The two firms
were by far the biggest office supply firms, though, so it was clear their market power would
increase.  The companies argued that the market should include anybody selling office supplies,
including big-box companies like Wal-Mart and K-Mart, but this case was not decided by looking at
concentration ratios.\footnote{See Harrington et al,;  and Federal Trade Commission,
\url{http://www.ftc.gov/opa/1997/04/stapdep.shtm}{``FTC Rejects Proposed Settlement in
Staples/Office Depot Merger:
Says Deal Would Still Violate Antitrust Laws and Lead to Higher Prices for Office Supplies,''}
(April 4, 1997); John Broder, \href{http://www.nytimes.com/1997/07/01/business/office-depot-and-staples-merger-halted.html}{ ``Office Depot and Staples Merger Halted,''} {\it The New York Times}
  (July 1, 1997). } 

 The companies said their joint costs would fall. The Justice Department let the FTC decide what to
do, and the FTC was skeptical about how big the cost savings would be. The FTC said that average
cost would fall by 1.4\%    and the merger would raise prices by  7.3\%. Staples
said  that if   there weren't   any cost savings at all, prices would rise by  2.4\%, but  there
would be cost savings, so the ultimate effect would be a 2.2\% fall in prices.

 What about total surplus, though? Obviously, if Staples were right     it would rise because both
consumer and producer surplus would rise. But what if the FTC was right?  


 

   Staples and the FTC went to court to decide whether the merger was legal. The judge ruled that it
was not. He ruled that total surplus was not relevant, only consumer surplus, and that the merger
would raise prices and so would violate the Clayton Act. Indeed, Professor Carlton reports that only
New Zealand and Canada have antitrust laws which hold total surplus to be the goal, not consumer
surplus.\footnote{See p.\ 157 of Carlton,\index{Carlton} Dennis W.,
\href{http://www.jstor.org/stable/30033739}{``Does Antitrust Need to Be Modernized?''} {\it The
Journal of Economic Perspectives},  21:  155--176 (Summer  2007). }

  Thus, companies that want to merge have to show not only that their costs would fall  but that
costs would fall enough that even consumers would benefit.  Most mergers can pass this test, but not
all, as the Staples case shows.


 %-------------------------------------------------------

\bigskip

 %-------------------------------------------------------

\noindent
 {\bf \ref{chap07}.6: Conclusion} \label{s06.5}

  The theme in this chapter has been that there are business practices such as merging with another
firm that sometimes have   good, surplus-increasing  motivations    and sometimes have  bad,
surplus-reducing   (but  producer-surplus-{\it increasing}) motivations. The enforcement agencies
and the judges have to decide which is the real motive in a given situation. Knowing some economics
is clearly  helpful to figuring that out. A major purpose of antitrust law is to deter egregiously
bad behavior, but to the extent that the law is successful,  we would not actually observe that bad
behavior, and in fact we do not. Cartels can be kept secret and still work, but mergers and
predatory pricing cannot, so the cases most commonly brought involve secret price cutting.


 
  Antitrust law addresses the market failure caused by market power. It does not address high
monopoly prices directly. Having a monopoly is legal, and so is charging high prices using market
power.  Because of government failure, it would be imprudent for the antitrust authorities to try to
regulate prices or to break up companies simply because they are large and successful. Rather,
antitrust law addresses the creation of market power by means which do not create surplus, only
redistribute it. In this chapter, we have looked at the behavior of firms with market power, whether
in isolation as a monopoly or in strategic interactions with each other as a duopoly or oligopoly.
We've also looked at how antitrust laws are enforced and at its first priority: preventing price
fixing.  In the next chapter we will look at other monopoly-creating behaviors such as mergers and
predatory pricing.



          



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\begin{center}
{\sc   Review Questions  }
\end{center}
 \begin{enumerate}

\item How does a firm with market power choose price and output to maximize
   profits?

\item How does the Prisoner's Dilemma describe the incentive problem of cartels?

 
\item  What is the Cournot Model and how does one solve for its equilibrium price?

 


\item
 Under what conditions are mergers illegal in the United States?

\item How would you decide whether a merger would increase market power too
   much?

\item How has the law treated cartels in the 19th century and in the present?

\item How do the Sherman Act and the Clayton Act differ?

\item How is antitrust law enforced in Europe and in the United States?
 

    

\end{enumerate}



%\newpage
  %  \vspace{1in}
%\cleardoublepage
\begin{center}
{\sc   Readings }
\end{center}
 \begin{enumerate}


\item
\href{https://www.law360.com/articles/875833/print?section=competition} {``\$54B Deal Will Spawn Daunting Anthem-Cigna, Expert Says,''}  {\it Law360}.



\item
\href{http://www.wsj.com/articles/eu-to-fine-truck-makers-over-price-fixing-and-other-collusion-1468861361}  { `` EU To Fine Truck Makers over Price-Fixing and Other Collusion:
Total Fines of Around \$3.3 Billion after a Probe by Antitrust Authorities,'' }  {\it The Wall Street Journal}.


 

\item
\href{http://www.bbc.com/news/business-35028380}  { ``Canada's Maple Syrup 'Rebels' ,''} {\it The BBC}.

 
\item
 \href{http://www.economist.com/news/finance-and-economics/21568364-how-antitrust-economists-are-getting-better-spotting-cartels-scam-busters}{``The Scam Busters:
How Antitrust Economists Are Getting Better at Spotting Cartels,''} {\it The Economist}. 
 



\item
\href{https://www.washingtonpost.com/opinions/george-will-a-strike-against-rent-seeking/2014/12/31/ba5a1686-9109-11e4-ba53-a477d66580ed_story.html?utm_term=.dd6d67cc1820}{``A Strike against Rent-Seeking," } George Will, {\it The Washington Post}. 


 


\end{enumerate}


 \end{document}
