Final

When does a merger generate cost efficiencies?

- A merger may lower costs - If MC drops "a lot" and market power rises "a little", then the merger could lower prices, making consumers better off - Even if prices rise, the efficiency gains from lower costs could easily swamp deadweight loss

third-degree price discrimination

- The firm can split the market into groups - It charges a different price to each group Ex: split by men vs. women, young vs old, or geographic regions Looking at the picture: Above two graphs are the profits of the firm if they price discriminate. If the firm cannot price discriminate (bottom graph), horizontally add the demand curve. Any price above two only type A customers will buy. Any price under two, add the quantity demanded from type A plus type B. Profit maximizing price is still 5. Because the demand from type B does not kick in until a price of 2, it is not worth it for the firm to try and attract those customers. It would give up too much profit to even try.

second-degree price discrimination

- The firm charges different prices depending on the amount that the customer purchases - Also called "nonlinear pricing" (or "quantity discounts") The firm does not know the individual willingness-to-pay of each customer, but they do know something about how the willingness-to-pay is related to the quantity the customers want to purchase. Looking at the picture: What per unit price would maximize profits? If the firm charged a single per-unit-price, the optimal price would be $10 per unit. Then type A and type B customers would purchase one unit, but not two units. The firm can do better by offering nonlinear pricing. If it offers one unit for $10 and two units for $14.99. Then type A customers purchase a single unit and type B customers purchase two units. Customers sort themselves based on the number of units they purchase.

What is strategic behavior?

- very broad category - attempts to change the circumstances under which you compete - cooperative (actions that make it easier for firms in a market to coordinate their actions and to limit their competitive responses) and non-cooperative (maximize its profits by improving its position relative to its rivals) Textbook Definition: Strategic behavior is a set of actions a firm takes to influence the market environment so as to increase its profits. The market environment comprises all factors that influence the market outcome (prices, quantities, profits, welfare), including the beliefs of customers and of rivals, the number of actual and potential rivals, the production technology of each firm, and the costs or speed with which a rival can enter the market.

What is upward pricing pressure?

- we want a simple, transparent way to flag problematic mergers - the HHI is one example. But is has problems - UPP is an alternative that can be justified within a Bertrand model

How do authorities measure market power?

1) Authorities often look at market shares a) if market share is high, does the firm have market power? b) look at HHI c) but must define the market d) problems (ad hoc, does a firm violate antitrust law if a competitor exits?) 2) Could look directly at p-MC, but it's hard to measure MC 3) Can indirectly observe MC using the Lerner markup formula 4) Upward pricing pressure

What options does a rival firm have to counter predatory pricing?

1. Merge with the other firm - Enables itself to charge a high price immediately 2. Fixed price contracts -("If I am driven out of the market you will be forced to pay monopoly prices. Lets make a contract now") -a drop in the incumbent's price would not hurt it because its sales would be at the pre-specified price 3. Reduce output, exit, or switch industries (temporarily) - reduce output during periods of predation to minimize the harm

What kind of advantage would be helpful for predatory pricing?

1. Size -not clear if this actually helps -Why wouldn't somebody lend to a small firm if it is not believable that the large firm will continue to incur losses forever? -Moreover, such a theory does not explain why other large firms fail to enter. For example, if small firms are at a disadvantage in competing with large firms, competi- tion among large firms will ultimately dominate the economy. Therefore, predation should not necessarily lead to monopoly profits even when small firms are ineffective competitors. 2. Reputation -can scare off firms with the threat of predatory pricing -differences in firms' beliefs about their rivals can result in successful predation. 3. Cost advantage

What are the three necessary conditions for price discrimination

1. The firm must have market power (the ability to set price above MC profitably). It can't be a price taker. 2. The firm must be able to prevent resale. -If the customers that are charged a low price can resell to the customers that would be charged a higher price, it will undermine the ability of the firm to engage in the price discrimination. 3. The firm must have some information about customers' willingness-to-pay (must be able to identify whom to charge the higher price) -It needs to be able to tell who to charge the high price to and who to charge the low price to

integration to assure supply

A common reason for vertical integration is to assure the supply of important inputs. Assurance of supply is important in markets where price is not the sole device used to allocate goods. A firm has an incentive to produce its own supplies to meet its predictable level of demand and to rely on other firms for supplies to meet its less stable demand.

What is predatory pricing?

One firm lowers its price to drive its rival out of the market. Then it can enjoy a monopoly once it's rival is gone.

What is the goal of antitrust?

Efficiency... but some disagree Also seems to be an emphasis on preserving a competitive environment Also seems to be a tendency to put more weight on welfare of buyers. But not always (ex bidder collusion)

What is entry deterrence?

Might be profitable to "scare off" a potential entrant

What can happen with joint production of substitutes?

it can result in higher prices

measuring market power - price vs MC

It is difficult to measure marginal cost and therefore difficult to measure the deviation between price and marginal cost, even if the courts stated how substantial a deviation must be to constitute significant market power.

When is joint production more valuable for related products?

Notice the price of product one affects the demand of product two and vice-versa.

When do mergers allow the merged firm to increase their prices?

Second term depends on the cross-price elasticity. For substitutes, the cross-price elasticity is positive. The markup is larger because there is the usual markup plus a positive term. Intuitively, the firm is taking into account that if they increase the price of product one, they divert customers to product two, which they now also own.

How do the Horizontal Merger Guidelines specify a market?

The Merger Guidelines specify that a market is the smallest group of products and the smallest geographical area such that a hypothetical monopoly of all those products in the area could raise price by a certain amount (for example, 5 or 10 percent) above any prevailing or likely future levels. One problem with this definition is that according to the definition, a small group of firms could constitute a market even though fringe firms existed that produced the identical product.

What is the difference between market power and the change in market power?

Whether a firm currently has market power is one thing. Whether the firm will acquire more market power through a merger is another question Ex 1: Betrand duopoly - Neither firm has market power as P=MC and equilibrium is at competitive equilibrium. If these two firms merge, they would be a monopolist. (no market power to complete market power) Ex 2: Two monopolists of unrelated products - If the two monopolists merge, their market power does not change at all as their products are unrelated

market power

A firm has market power if it is profitably able to charge a price above that which would prevail under competition (usually taken to be marginal cost)

What is tying/bundling? What are some reasons for it?

Consumer can buy one good only if she buys another. Ex: - shoes and shoelaces - cars and tires - tuition and fees Reasons: 1. Efficiency - consumers prefer assembled goods - save on search costs (customers are willing to pay someone to fully assemble computer rather than find all parts and assemble themselves) 2. Evade Regulations - especially regulations like price controls. When bundled, can charge higher price 3. Secret Price Discounts - maybe regulators, other customers, or competitors 4. Assure quality - customers will not blame company for poor quality 5. Price discrimination

When does joint production increase the returns to scope?

Cost synergies Ex: Why do chicken processing plants produce breasts, drumsticks, and wings? Why not specialize? There are obvious cost synergies. Once you've produced 2 chicken breasts, the marginal cost of producing two drumsticks is very low. This would be true even if the demand curves were unrelated.

What is the value of joint production if products are completely unrelated?

No value When demand and costs are unrelated, there is no value in producing those products under the same roof. In order for joint production to make sense, it needs to be the case that either the demand, costs, or both are related.

first-degree price discrimination

- "Perfect" price discrimination - The firm charges each customer her willingness-to-pay Extracts all of the consumer surplus from the customers

What are the social benefits of vertical integration?

1) Lower transaction costs - difficult to anticipate everything in a written contract - holdup problem if buyer or seller creates a specialized asset 2) Assure supply - quantity or quality 3) Correct a market failure - reputation externalities (For example, by owning or controlling all its restaurants, McDonald's can ensure a uniform quality, which results in a positive reputation) - service agreements 4) Avoid government rules - price controls - profit restrictions - taxes along production chain or across national borders 5) Eliminate the market power of a buyer or seller - dairy farmers could integrate forward to get around a creamery monopoly - a creamery could integrate backward to get around a milk cartel

How can firms vertically integrate to exercise market power?

1) f(E,L) has a constant returns to scale 2) E and L are produced at constant marginal cost m and w 3) The energy producer is a monopolist 4) The final good firms are competitive If the downstream production process uses variable proportions, the monopoly has an incentive to vertically integrate. It integrates if its increase in profits exceeds the cost of integration. Unlike the fixed-proportions production function, it is a smooth curve, showing that the products are (imperfect) substitutes. As a result, as the relative costs of the inputs change, as shown by a shift in the slope of the isocost line, the firm substitutes more of the now less expensive input for the more expensive input. With a variable-proportions production function, if the upstream energy monopoly increases its price to the competitive downstream industry, firms in that industry substitute more labor for the monopoly's product. If the monopoly raises its price by a dollar, the price of the final good no longer necessarily increases by a dollar, and the amount of E used falls by relatively more than Q does. In short, if downstream firms have some ability to substitute between inputs (vari- able-proportions production process), the upstream monopoly does not have complete control over the downstream industry. Every time it raises its price, the downstream industry substitutes away from its input and this substitution, though it constrains the market power of the monopoly, leads to inefficient production, because efficiency re- quires the slope of the isoquant to equal the slope of the isocost line. That slope equals the ratios of the inputs' marginal costs. Downstream firms are using too much L and too little E. This inefficiency means that there are less profits for the monopoly to seize. If the upstream firm integrates forward so that it monopolizes the downstream in- dustry, it has complete control and can use the inputs in the most efficient combina- tion. Thus, its profits increase. If profits increase by more than the cost of vertical integration, the firm vertically integrates.

What are the costs of integration?

1. costs of supplying inputs may be more costly inside the firm -the cost of supplying its own factors of production or distributing its own product may be higher for a firm that vertically integrates than for one that depends on competitive markets, which serve these needs efficiently 2. there are costs of running a larger firm -as a firm gets larger, the difficulty and cost of managing it increase. The advantage of dealing with a competitive market is that someone else supervises production. 3. there are legal costs of merging

market power definition in relation to antitrust

A firm (or group of firms acting together) has market power if it is profitably able to charge a price above that which would prevail under competition, which is usually taken to be marginal cost. This ability to set price above marginal cost implicitly uses the model of perfect competition as a benchmark against which to measure the behav- ior of firms. If this definition is applied literally, probably every firm in the United States has at least a tiny bit of market power. The model of perfect competition is an extreme one that describes few, if any, actual industries. Therefore, presumably, when courts find that a firm has market power, they must mean the firm has a substantial amount of market power for some significant period of time. Unfortunately, the courts have not stated how much market power is needed. Does a price 5 percent above marginal cost for two years reflect substantial market power? Or 10 percent above for one year?

integration to eliminate externalities

A firm may integrate to internalize externalities. If all Radio Shack stores carry the same products, maintain certain standards of service, and provide advice on the use of their products, a regular customer who moves from one city to another knows what to expect from a Radio Shack in the new city. That is, there is a positive reputation externality. A consumer who likes one of the outlets knows that the others are similar. Thus, it is in the chain's best interest to maintain high uniform standards. A bad store can harm the business of all distributors and lower the profit of the firm, Tandy, that supplies the products sold by these distributors. Thus, Tandy has an incentive to integrate forward into distribution (own Radio Shack stores) to control this externality.

How is predatory pricing costly for the predatory firm?

A firm must charge a price below its marginal cost. The predatory firm will be taking losses while its rival is taking no losses. The firm incurs short-run losses to obtain long-run gains.

integration to lower transaction costs

A key reason why a firm performs productive activities itself rather than relying on other firms has to do with transaction costs, such as the expenses associated with writing and enforcing contracts. When such costs are high, a firm may engage in opportunistic behavior: taking advantage of another when allowed by circumstances. Each side may try to interpret the terms of a contract to its advantage, especially when terms are vague or even missing. The desirability of integrating increases as the transaction costs of using the marketplace rise. Contracts: The more unpredictable the future and the more complicated the contract, however, the harder it is to specify contractual terms. People have bounded rationality: a limited ability to enumerate and understand all future possibilities. In complicated contracts, it is often too difficult to specify all possible contingencies, and a signed contract may contain provisions that turn out to be undesirable to one of the parties. Specialized Assets: A specialized asset is tailor-made for one or a few specific buyers. When a firm relies heavily on one supplier for specialized products, not only is it at risk from opportunistic behavior by the supplier, but also a rival may try to interfere strategically with its supply. Ownership by the buyer diminishes the incentive for opportunistic behavior on both sides.

pure bundling vs mixed bundling (to price discriminate)

A la carte - each component sold separately (essentially not bundling) Pure bundling - one bundle, take it or leave it Mixed bundling - customers have the option to buy the components separately or as a bundle

measuring market power - elasticity of residual demand (Lerner Markup)

Estimate the price elasticity of the residual demand (the market demand net of the quantity supplied by other firms) facing an individual firm (or group of firms). This elasticity of residual demand facing a firm summarizes the ability of a firm (or group of firms acting together) to exercise market power. The price-cost margin equals the negative of the inverse of the elasticity of demand. If the elasticity is large, the firm has little market power. Sometimes economists cannot estimate a price elasticity accurately because the data are inadequate or unavailable.

horizontal relationships

Firms that produce rival products Ex: - Coke vs Pepsi - Walmart vs Target - Exxon vs BP

When do mergers affect the prices of other firms?

For example, consider this Cournot model. Rather than N firms, there are now N-1 firms. Price goes up because of the merger. The profits also increase. So even if the firms who participate in the merger may not increase their market power, it still can raise profits of other firms. But there may be anti-competitive effects on other firms in the industry.

How would we identify predatory pricing in practice?

How do we know if p < MC? - lower prices might reflect cost differences - learning-by-doing (A firm's cost of production decreases as it produces more because it learns how to produce the product more efficiently. Because of this effect, a firm's costs are initially high but decline over time) - promotions (form of marketing not predatory pricing) Difficult to detect, so antitrust authorities do not really focus on it.

market definition and antitrust cases

How the market is defined often determines the outcome of antitrust cases. For example, in determining whether to permit a merger, the government and the courts examine the market shares of firms, which are viewed as proxies for the firms' actual or potential market power. A firm's market share depends crucially on the market definition. Coke's share of its market will be much larger if the market is defined as colas than if it is defined as all soft drinks or all drinks.

What happens if fixed costs are high in the Stackelberg model?

If the follower were to enter, they would make negative profits. Price and profits are same as monopoly.

measuring market power - market shares

In an attempt to reach some workable solution to the problem of determining market power, analysts and the courts often define a market and then construct a measure of market share. If the market share of the firm (or firms) under analysis is high, the suggestion is that market power exists. In a merger case, the Justice Department or the FTC looks at whether there will be a significant increase in concentration as a result of the merger. There is no agreement as to exactly what share (or change in share) is "high," but many economists regard a share in the range of 30 to 50 percent as too low to indicate significant market power in an industry with a competitive fringe comprising the remainder of the market. Market shares are imperfect indicators of market power, so additional analysis of the economic conditions is necessary before one can reach a conclusion about market power. For example, if entry is easy, then the industry pricing is severely constrained regardless of whether an existing firm has a large market share. Similarly, the presence of factors that make it difficult to maintain a cartel is relevant.

Is third-degree price discrimination better or worse than non-discriminating monopoly pricing?

It depends on the shapes of the demand and cost curves. The closer imperfect price discrimination is to perfect price discrimination, the more likely it is that the price discrimination leads to a more efficient outcome than non-discriminating monopoly pricing. Three sources of inefficiency are present in third-degree discrimination. 1. The first is the usual one associated with monopoly: Price exceeds marginal cost, which results in an output restriction and hence an output inefficiency. 2. The second is a consumption inefficiency. Because different consumers pay differ- ent per-unit prices for a product, each consumer's marginal willingness to pay is not the same, which results in an inefficiency because of unexploited opportunities for further trade. 3. A third source of inefficiency is that consumers may have to expend resources that do not benefit the firm to obtain a low price. For example, the consumer may have to wait in line or travel to a distant location to obtain the low price. One way to view this means of discriminating between groups of consumers is that the monopoly forces the consumer to buy a bad (such as the time waiting in line) in order to buy the good at a low price Welfare may be higher with third-degree price discrimination than with a non-discriminating monopoly if output is higher with discrimination.

What is the optimal penalty for antitrust violations?

Landes (1983) argues it should equal the harm to others... adjusted for the probability of detection

Why are vertical restrictions used instead of vertical integration?

Manufacturers often rely on independent firms to distribute their products rather than doing their own distribution, because the costs of monitoring employees at distribution outlets exceed the costs of using independent firms.

horizontal merger guidelines

The current policy statement of the Department of Justice and the Federal Trade Commission, the Horizontal Merger Guidelines, explicitly recognizes the importance of efficiency gains in evaluating mergers. However, these guidelines suggest in general that a merger would be challenged if it has an anticompetitive effect (a price increase) even if there is an offsetting efficiency gain.

What is the issue in merger cases?

The issue in a merger case is not whether the industry is currently competitive, but whether it will become less competitive as a result of a merger. Because mergers can generate efficiencies, a merger policy that overdeters merger activity imposes a significant cost on society. Conversely, too lenient a policy leads to the creation of additional market power.

merger guidelines and efficiencies

The more recent 1984, 1992, and 1997 Merger Guidelines recognized the potential efficiency gains from mergers. These guidelines apparently are a response to the earlier rejection by the government and the Court to using proposed efficiency gains from mergers as a defense to justify a merger that increases concentration in a market. The application by the Department of Justice and the FTC of the current merger guidelines, which recognize the value of efficiencies, suggests that efficiencies alone generally do not provide sufficient justification for a merger in which prices are expected to rise. Efficiencies, however, can provide a justification for a merger that results in increased concentration if the efficiencies would lead to lower prices.

What is the marginal revenue curve under first-degree price discrimination?

The perfectly discriminating monopoly sells more than the non-discriminating monopoly because it makes an incremental profit on each additional sale. By charging each consumer a different price, the perfectly discriminating monopoly avoids the adverse second effect on marginal revenue that a non-discriminating monopoly faces. That is, the discriminating monopoly does not decrease revenues on the first units sold when it sells additional units at a lower price. The effect on marginal revenue of eliminating the second effect is that the demand curve becomes the marginal revenue curve. The monopoly lowers price to only the additional customer and so gains that price as an increase in its revenues from selling one more unit.

What is the problem with firms with successive vertical monopolies?

The problem with the successive monopolies is that the distributor has an incentive to restrict output and raise price. The manufacturer does not want its distributor to restrict output further (or, equivalently, to increase its price above the wholesale price) because profits from the distributor's markup go to the distributor, not the manufacturer. The manufacturer wants as efficient a distribution system as possible (that is, with the smallest distributor's markup). Ideally, the manufacturer wants to induce competition at the distribution level in order to drive to the wholesale price. There are many instances, however, when it is not possible to have competition in distribution, so the manufacturer is stuck with a monopolistic distributor. Manufacturers can use vertical restrictions to induce a monopoly distributor to behave more competitively.

legal standing

The right to bring a suit Only a party that suffers an injury that the antitrust laws were designed to prevent is permitted to sue. For example, suppose that if two firms merge, they will become very efficient and reduce price. Rival firms would be harmed by the merger, yet they have no legal standing to sue to block the merger under the antitrust laws because the goal of the antitrust laws is to generate low prices to consumers

Why do antitrust authorities tend to be less skeptical of vertical integration than horizontal integration?

There is a lot more scope for vertical integration and/or vertical restrictions to increase efficiency.

What must be true for predatory pricing to be successful?

This strategy is likely to be successful only if the firm can survive low prices longer than its rivals can. In many cases, however, the firm has no ability to convince its rivals that it is willing to maintain low prices for as long as it takes to drive them out of business. If the firm succeeds in driving out its current rivals and then raises its price, new rivals may enter the market, and the incumbent must again lower its price to drive out those firms. For the predation to be successful, potential entrants must believe that it does not pay to enter this business because of the incumbent's pricing behavior. Only then can the incumbent raise its price to the monopoly level with no fear of inducing entry. If the predator succeeds in forcing its rivals into bankruptcy, it should try to gain control of their assets or see that they are permanently withdrawn from the market. Other- wise, when the incumbent raises its price, a rival could again use those assets or another firm could buy the assets and compete. Even if a rival's assets are purchased by a firm in another market, they could always be redeployed to compete against the predator.

Fixed costs in the Stackelberg model

To model entry deterrence. The leader does not pay the fixed costs because it is already in the industry.

What is price discrimination?

a firm price discriminates if it charges different customers different prices that are not due to cost differences Ex: A delivery service that charges a higher price to customers that are further away, it is not price discrimination because the price difference is related to the difference in cost of delivering the product.

Who is worse off when there are successive vertical monopolies?

both consumers and firms are worse off with successive monopolies than when there is a single, integrated monopoly. These losses provide a strong incentive to integrate. If the manufacturer and the distributor are both monopolies, each adds a monopoly markup (the difference between its price and its marginal cost is positive), so consumers face two markups instead of one. This double markup provides an incentive for firms either to vertically integrate or to use vertical restrictions to promote efficiency and thereby increase joint profits. Consumers facing the double markup buy less output, than when there is an integrated firm. As a result, they are worse off. The firms' collective profits are also lower.

When is it harder to engage in predatory pricing?

firms are identical -With no differences between the firms, why should any firm believe that another firm is willing to suffer losses greater than those of its rival for as long as necessary to drive the rival from the market? lots of competitors well-developed capital markets (the rival firm can go to capital markets and ride out the storm until the predatory pricing ends)

Sherman Act

first - 1880 - Outlaws explicit cartels - Outlaws monopoly, sort of. Interpreted to allow monopoly but outlaw "bad acts" The courts' interpretation of the Sherman Act left doubt as to whether the Act prohibited certain industry behavior. As a result, in 1914, legislators passed additional antitrust legislation: the Clayton Act and the Federal Trade Commission Act.

When is vertical integration unnecessary?

fixed proportions production If the downstream production process uses fixed proportions, the upstream monopoly does not have an incentive to vertically integrate. It makes the same profit whether it integrates or not. In a fixed-proportions production process it is impossible to substitute one input for another. As the diagram shows, E*=Q*. That is, the industry output and the amount of energy used are the same whether the industry is vertically integrated or not. The energy monopoly's profit is the same as before. Thus, because the upstream firm earns the same profit whether it integrates or not, if there is any cost to integration, it chooses not to integrate. What is the intuition be- hind this result? When the nonintegrated monopoly raises its price for a unit of E by $1, the marginal cost of the downstream firm (m w) rises by $1, so the price to consumers also goes up by $1. That is, the energy monopoly can perfectly control the final price consumers pay without vertically integrating. Not only can it raise the price, but also it captures all the resulting profits. None go to the competitive industry, which merely passes on higher energy costs to consumers. The reason that the nonintegrated monopoly can control the downstream price perfectly is that the downstream firms cannot substitute away from the input produced by the monopoly.

Clayton Act

second - 1940 - Outlaws price discrimination that lessens competition - Prohibits tie-ins and exclusive dealing that lessen competition - Prohibits mergers that reduce competition - Prohibits competing firms from having interrelated boards of directors - Injured party can get Treble damages (three times actual damages) plus attorneys' fees

Federal Trade Commission Act

third - 1914 - Created the FTC 1) Enforces antitrust laws 2) Adjudicates disputes 3) Consumer protection and prevents deceptive advertising - Prohibits "unfair" methods of competition

vertical restrictions

upstream firms may impose vertical restrictions on downstream firms. With vertical restrictions, the firms don't integrate, but they impose restriction on each other on how they can behave These include: - Resale/retail price maintenance ("if you sell our tv's you may not sell them for less than price ___") - Service agreements - Minimum quality - Exclusive dealing

exclusive dealing

vertical restriction manufacturer forbids their distributors to sell the products of competing manufacturers (If the distributor also sells the competing products of a second manufacturer)

How much would the leader need to produce to deter the follow from entering?

~q1 is the amount they would need to produce to keep firm 2 out

Should all stages of production occur inside a firm or in the market?

Coase (1937) "The Nature of the Firm" Argued the way to think about which activities occur inside the firm and which activities occur outside the firm is by thinking about transaction costs. If the transaction costs of engaging in a transaction outside the firm are lower than inside the firm, than that particular transaction will not occur inside the firm.

Explain the UPP formula

D12 is the diversion ration. It says what fraction of sales that are lost from product one when you raise its price are diverted to product two. P2-C2 is the difference between the pre-merger price and the pre-merger cost of product two. E1 represents any cost efficiencies that might be realized by the merger. C1 is the marginal cost of product one before the merger. First term captures the incentive to raise the price on product one. It says if I raise the price on product one, I'll capture some of the lost sales in the form of product two times how much profit I will make on those diverted sales. Subtraction term represents the reduction in marginal cost of product 1 as a result of the merger. It shows any force pushing down the price of product one.

How do the authorities define the market?

Start with a particular firm and look at the closest substitute to that firm. They imagine a monopolist that produces both of those products. Could that monopolist raise prices by 5%? If not, add the next closest product and ask the question again. Continue until the hypothetical monopolist can raise prices. Then, you call this collection of products the market.

integration to avoid government intervention

A vertically integrated firm can avoid price controls by selling to itself. For example with steel. Because transactions within a company are unaffected by price controls, a buyer who really wants steel can get it by purchasing a steel company and producing all the steel it needs. Purchasing a steel company is thus a simple way to avoid price controls Similarly, taxes encourage vertical integration. Depending on where firms are lo- cated, they may be subject to different taxes. For example, tax rates differ by state as well as by country. A vertically integrated firm may be able to shift profits from one lo- cation to another simply by changing the transfer price at which it sells its internally produced materials from one division to another. By shifting profits from a high tax jurisdiction to a low tax jurisdiction, a firm can increase its profits. The Internal Revenue Service is, of course, aware of such shifting and insists that firms use internal transfer prices that reflect prices in the marketplace. Government regulations create incentives for a firm to vertically (or horizontally) inte- grate when the profits of only one division of a firm are regulated.

How is antitrust law enforced?

A) Federal Trade Commission - Administrative courts - Decision can be appealed to federal court B) Department of Justice - Federal court - Can bring civil and criminal suits C) Private litigation - Private parties can sue for treble damages - Plaintiff must have standing i) can be complicated ii) plaintiff must suffer an injury that the antitrust laws were designed to prevent - A significant share of antitrust litigation

What do the Horizontal Merger Guidelines require after the market is specified?

After defining the market, the Merger Guidelines require that the government de- termine whether the proposed merger will greatly increase concentration (and hence, presumably, market power). Concentration is measured using a Herfindahl- Hirschman Index (HHI), which is the sum of the squared market shares (expressed as percentages) of firms in the industry. The Merger Guidelines do not regard a merger between two firms as raising concerns about competition if the postmerger HHI in the industry is below 1000. If the postmerger HHI is between 1000 and 1800, the merger does raise concerns if the change in the HHI resulting from the merger is 100 points or more. If the industry's postmerger HHI is over 1800, the merger raises concerns about competition if the change in the HHI resulting from the merger is 50 points or more. The application of the Merger Guidelines implicitly assumes that after a merger, the firms involved will be able to maintain their premerger market shares and the merged firm will enjoy a market share equal to the sum of the premerger shares of the firms that are merging. When this assumption is not reasonable, the analysis should be modified in order to properly reflect the merged firms' market share. The Merger Guidelines recognize that other factors (such as ease of entry) in addition to market concentration influence market behavior. Both the Department of Justice and the FTC consider those factors before deciding to challenge a merger.

Goals of antitrust laws (textbook)

Most economists believe the antitrust laws should have the very simple goal of promoting efficiency. That is, they should prevent practices or amalgamations of firms that would harm society through the exercise of market power. Some analysts, however, argue that the actual objective of these laws is not efficiency, and that these laws were passed to help certain groups and harm others. For example, some argue that the antitrust laws are designed to help small firms that compete with large firms, whether or not efficiency is increased. The view that the guiding principle of the antitrust laws should be efficiency, rather than the taking of resources from one group and granting them to another, has gained increasing acceptance among legal and academic scholars. One appeal of such a simple proposition is that it provides a clearer guide as to what antitrust policy should be than does the alternative view of helping "deserving" groups. Even if one accepts the proposition that the goal of the antitrust laws is to promote efficiency, economists often have difficulty determining which practices result in inefficient behavior. For example, suppose that two firms merge and the resulting reduction in competition causes price to rise. That sounds bad. However, suppose that, as a result of the merger, the merged firm develops a new and better product or provides the same product but offers better services or develops a lower-cost method of production than before. That sounds good. Should the antitrust laws ban all mergers if they significantly eliminate competition, or should they also pay attention to the potential efficiency gains and balance the two? Requiring courts to apply sophisticated economic analyses to evaluate behavior may be unrealistic. Moreover, the courts must often deal with economic problems that economists have not yet analyzed. Courts don't have the luxury of taking as much time as necessary to solve a problem. Still, it is hard to argue that economic knowledge should be ignored. Use of economics in antitrust proceedings has increased worldwide. As a result, litigation is more complicated because economic analysis can now be the centerpiece of a case, and different countries can have conflicting analyses.

What are the reasons for vertical integration?

Most of the reasons that firms choose to vertically integrate have to do with reducing costs or eliminating a market externality. Firms choose the least costly approach: Only if a firm can perform most of the necessary production steps less expensively than if it relied on other firms does it vertically integrate. In general, a firm needs a good reason to vertically integrate because integration can involve substantial costs. In some cases, firms can avoid integration by having outside firms perform some functions for them or by using detailed contracts.

What is consumer surplus under first-degree price discrimination? How is it different than perfect competition and monopoly?

No consumer surplus. Perfect Competition: Consumer surplus is maximized under competition and eliminated (and captured) by a perfectly discriminating monopoly. Therefore, perfect price discrimination entails no efficiency loss (the price on the last purchase still equals marginal cost), but does affect the distribution of income Monopoly: A non-discriminating monopoly charges a single price, pm, and produces Qm, where its marginal revenue, MR, equals its marginal cost, MC. Consumers have a small amount of consumer surplus, which is smaller than the consumer surplus under competition. The perfectly discriminating monopoly produces more than the non-discriminating, single- price monopoly. The single-price monopoly produces too little; it is inefficient.

When is it easier to engage in predatory pricing?

Predatory is easier if there are large sunk costs of entry.

Does price discrimination increase or decrease welfare?

Under perfect price discrimination, welfare goes up. (relative to case where monopoly price is charged) - a monopoly creates DWL (socially optimal transactions not taking place) - under perfect price discrimination a monopoly does not need to create DWL because it can charge each customer their full willingness-to-pay so that all socially optimal transactions occur. -But the monopolist extracts all surplus from those transactions. Consumers are left with no surplus, but also there is no DWL. Under third-degree price discrimination, welfare effects are ambiguous. - if total output falls, the welfare falls - if total output rises, then welfare may rise - the more output rises, the more likely welfare rises (rule of thumb: does the third degree price discrimination increase or decrease the firm's output relative to the single price charged by the monopoly?)

vertical relationships/integration

Vertical relationships occur between suppliers Vertical Integration: when multiple stages of production occur within one firm. (For example, if Toyota decided to manufacture their own parts)

resale price maintenance

Vertical restriction a manufacturer sets a minimum price that retailers may charge. Such agree- ments create an incentive for retailers to compete for customers in other dimensions, such as sales effort. For example, if the wholesale price the distributor pays is $10, and the minimum resale price is $20, each dealer has an incentive to spend up to $10 to at- tract customers. Thus, up to $10 per unit is invested in advertising, training sales staff, or fancy showrooms. Minimum price restrictions channel competition among distributors toward sales effort and away from price cutting. They lead to more sales effort than occurs without them.

How high would FC need to be for deterrence to be profitable?

We need profits of deterrence to be greater than profits of allowing the follower to enter.

current market power vs ability to acquire additional market power

Whether a firm currently has market power is a much different question from whether, as a result of a merger, it could acquire and exercise additional market power. The first question, whether price is already elevated significantly above competitive levels, can be answered directly by comparing price and marginal cost or in- directly by looking at the elasticity of demand facing the firm. The second question, whether price will rise significantly above its current level as a result of the merger activity, can be answered directly by predicting how price will change or indirectly by predicting how the elasticity of demand facing the firm will change as a result of the merger.

When is bundling profitable? When is it not?

Which pricing scheme gives you the highest profit depends on both how much your various customers are willing to pay for the two dishes and your costs of produc- ing these dishes. For pure or mixed bundling to pay, your restaurant must sell more food than with individual pricing. Selling more, however, will increase profits only if revenue rises by more than costs. Suppose you have only three types of customers—a, b, and c, with valuations of the two dishes in Figure 10.5—and that your cost of producing a dish is $3 for halibut and $2 for pie. If you price each dish separately, you maximize your profit by charging $11 for the halibut and $8 for pie. At these prices, Customers a and b buy only pie and Customer c buys only halibut. You earn $6 $8 (price of pie) $2 (cost of pie) on each of the two servings of pie you sell and $8 $11 $3 on the halibut, for a total profit of $20. Because Customer a was willing to pay $10 for a piece of pie and the price is only $8, you are not capturing all the consumer surplus. If you only sell a pure bundle, you charge $12 and earn a profit of $21 ($12 $5) 3, where $5 is the combined cost of producing both dishes. You make more by bundling than selling separately because customers who value one dish greatly put a lower valuation on the other. As a result, bundling allows you to sell more dishes. You sell two servings of pie and one of halibut with separate prices, whereas you sell three servings of pies and three of halibut with pure bundling. Using mixed bundling, however, you can do even better. You set the bundle price at $12, the price of halibut at $10.99, and the price of pie at $9.99. Customer a buys only the pie (the bundle costs $2.01 more and that customer only values halibut at $2), Customer b buys the bundle, and Customer c buys only the halibut (you sell two servings of pie and two of halibut). You make $7.99 each from Customers a and c and $7 from Customer b for a total of $22.98. You sell more dishes with pure bundling—three of each—than with mixed bundling—two of each. The reason your profit is lower with pure bundling is that you're selling dishes to customers who value those dishes at less than your cost of production. With the pure bundle, Customer a values the halibut at $2, which is less than your cost of $3, and Customer c values the pie at $1, which is less than your cost of $2. As a result, selling those extra dishes doesn't benefit you. If you sell Customer a the bundle, you make $7 profit. On the other hand, if you sell Customer a the pie at $9.99, you make $7.99 profit. Thus, you benefit from discouraging that customer from buying the halibut. With mixed bundling you are capturing essentially all the consumer surplus. With these same customers, if you had no cost of production, you would maximize profit by using pure bundling. With no cost of production, you want to sell lots of dishes. In general, depending on your customers' tastes and your costs of production, any of the three pricing methods could maximize your profit.