Lecture 7: Introduction to competition policy

The Theory of Competition Policy

a.​ Aim: Enhancing consumer welfare
b.​ Promoting efficient and competitive market structure
c.​ Preventing anti-competitive behaviour through antitrust law
d.​ Regulating mergers to prevent excessive market concentration

Antitrust Statutes
a.​ Introduced & heavily used in the US
b.​ Sherman Act (1890)
i.​ Cartels (formal collusion)
1.​ Any contract, combination or conspiracy that restraints trade or commerce
between states or with foreign nations is declared illegal
2.​ This target agreements like price-fixing, bid-rigging or market allocation,
which restrict competition and harm consumers
3.​ Examples:
OPEC (Organization of the Petroleum Exporting Countries): a legal
organization of oil-producing nations, operating as a cartel by coordinating
oil production levels to influence global oil prices.
ii.​ Monopolizations
1.​ Any company and individual attempting to gain exclusive control or a
significant share of it or combine or conspire with other person to
monopolize any part of trade or commerce across states or with foreign
nations is declared illegal
2.​ This section address by firms to dominate a market and eliminate
competition through unfair practices
3.​ Examples: [Link]
c.​ Clayton Act (1914)
i.​ Price discrimination
ii.​ Tie-ins and exclusive dealing
iii.​ Mergers that lessen competition
d.​ Federal Trade Commission Act (1914)
i.​ “Unfair” methods of competition

Cases (example to support in arguments)

a.​ Cooperation among competitors
b.​ Exclusionary actions (Looks like anticompetition but it is not)
c.​ Price discrimination (one argument for anti competitive)

Approaches of Antitrust Laws

1.​ Rule of reasons
a.​ Courts have to reason whether firms’ behaviour are anti-competitive (i.e. reduce
consumer welfare or economic welfare
 2.​ Per se rule
a.​ No reasons are required
b.​ For example, evidence like recorded conversations between managers
discussing price-fixing is enough to prove a break of competition laws

Cases
1.​ US v. Trans-Missouri Freight Association 166 U.S. 290 (1897)
a.​ Precedent case that always being referred to cases that related Sherman Acts
b.​ Case: Collusion for association of railway transport
c.​ Allegation 指控: 8 companies with agreement to set the fare in a unreasonable
price)
d.​ Defendant’s argument 被告论点: The rates are reasonable, prevent ruinous
competition (excessive competition in a market leads to unsustainable practices -
predatory pricing)
e.​ Ruling 法庭裁决: illegal; Competition will itself bring changes down to what may
be reasonable
2.​ US v. Trenton Potteries Co., 273 US 392 (1927)
a.​ Case: Collusion for a bathroom fixtures that dominate 80% market share
b.​ Allegation: Sets prices and urges others to adhere (reached economies of scale,
other firms cannot compete)
c.​ Ruling: illegal; no need to investigate whether the agreement affects prices (Price
list itself is evidences: sell under market price)
3.​ Board of Trade of Chicago
a.​ Case: Collusions, allow investors to trade after trading hours
b.​ Allegations: Agree to use the closing price for trades after the board has closed
c.​ Ruling: Legal; promotes competition. Reduce free riding problem by discouraging
trading after hours
4.​ American Column & Lumber Company v. US 257 US 377 (1921)
a.​ Case: Information exchange for a hardwood manufacturers association
b.​ Allegation: The association gatthers informations about sales, production, price
etc
c.​ Ruling: Illegal but agreed by supreme court, the provision of informations
increase competitive (Reasons: share information but did not really fix the price)
5.​ Federal Trade Commission v P&G Company 386 US 568 (1967)
a.​ Case: Merger for toiletries company
b.​ Allegation: P&G acquires Clorox (P&G does not produce liquid bleach)
c.​ Ruling: Illegal; P&G is a likely entrant into the liquid-bleach market
6.​ Utah Pie Company (small competitors) v. Continental Baking Company (large dominant
firms) 386 US 685 (1967)
a.​ Case: Predation for a baking company
b.​ Allegation: Continental Baking Company products are prices below costs in Salt
Lake City
c.​ Ruiling: illegal
7.​ IBM Corporations v US 298 US 131 (1936)
 a.​ Case: Tie-in sales
b.​ Allegation: IBM requires key-punch machines buyers to use only IBM tabulating
cards
c.​ IBM argument: Its machines may be damaged unless its card are used
d.​ Ruling: Illegal, the court has allowed the government to use other tabulating
cards
8.​ E. Kodak Co v. Image Technical Services Inc., 112 Ct 2072 (1992)
a.​ Case: Tie-in sales
b.​ Allegation: Kodak refuses to supply parts to independent repair shops
c.​ Kodak argument: It faces lots of competition in the market for photocopiers
d.​ Ruling: Illegal, consumers may be uninformed and unable to forecast repair costs

Antitrust laws play a crucial role in ensuring fair competition and preventing practices that
harm consumers or distort markets. Over the years, several landmark cases have shaped the
interpretation and enforcement of these laws. These cases highlight different forms of
anti-competitive behavior, such as collusion, predatory pricing, mergers, and tie-in sales, and
how courts have addressed them.

In **U.S. v. Trans-Missouri Freight Association (1897)** The case involved collusion among
eight railway companies that agreed to set unreasonably high transportation fares. The
companies argued that their rates were reasonable and necessary to prevent " Destructive
competition," a situation where excessive competition leads to unsustainable practices like
predatory pricing. However, the court ruled the agreement illegal, emphasizing that
competition itself would naturally regulate prices to reasonable levels, making such
agreements unnecessary and harmful to consumer welfare. This case set a precedent for
interpreting the Sherman Act and is frequently referenced in similar disputes.

Another significant case, **U.S. v. Trenton Potteries Co. (1927)**, involved collusion among
manufacturers of bathroom fixtures who controlled 80% of the market. These companies fixed
prices and pressured others to follow, making it difficult for smaller competitors to survive. The
court ruled the practice illegal without requiring a detailed investigation into the impact on
prices, stating that price-fixing is inherently anti-competitive. The mere existence of a fixed
price list was deemed sufficient evidence of wrongdoing, reinforcing the strict approach to
such practices under antitrust laws.

In contrast, the ruling in the **Board of Trade of Chicago** case demonstrated a more
nuanced application of antitrust principles. This case involved an agreement among traders to
use the closing price for transactions conducted after trading hours. While it was accused of
being a form of collusion, the court found the practice legal, reasoning that it encouraged
competition and reduced the "free-riding" problem by providing a clear and fair pricing
mechanism for after-hours trading. This decision highlights the importance of context in
assessing whether certain agreements promote or hinder competition.

The case of **American Column & Lumber Company v. U.S. (1921)** further illustrates the
complexities of antitrust enforcement. Here, a hardwood manufacturers association shared
data on sales, production, and prices among its members. While the court ultimately ruled the
practice illegal, it acknowledged that sharing information could increase competition as long
as it did not lead to price-fixing. This case underscores the fine line between facilitating
 market efficiency and engaging in anti-competitive behavior.

Merger cases have also been pivotal in shaping antitrust law. In **Federal Trade Commission
v. Procter & Gamble Co. (1967)**, P&G sought to acquire Clorox, a leading producer of liquid
bleach. Although P&G did not produce bleach at the time, the court ruled the merger illegal,
reasoning that P&G was a likely future competitor in the bleach market. The acquisition would
have reduced competition and strengthened P&G’s dominance, ultimately harming
consumers.

Predatory pricing, another form of anti-competitive behavior, was central to **Utah Pie
Company v. Continental Baking Company (1967)**. In this case, Continental Baking Company
was accused of selling products below cost in Salt Lake City to drive out Utah Pie, a smaller
competitor. The court ruled the practice illegal, emphasizing that such pricing strategies distort
the market and unfairly harm smaller firms, reducing overall competition.

Tie-in sales, where a company requires customers to buy a secondary product to access a
primary one, have also faced scrutiny under antitrust laws. In **IBM Corporation v. U.S.
(1936)**, IBM required buyers of its key-punch machines to use only IBM tabulating cards.
IBM argued that using other cards might damage its machines. However, the court ruled this
practice illegal, allowing competitors to supply compatible tabulating cards and preventing
IBM from unfairly restricting competition in the related market.

Similarly, in **Eastman Kodak Co. v. Image Technical Services Inc. (1992)**, Kodak refused to
supply parts to independent repair shops, effectively tying its repair services to its parts
supply. Kodak argued that it faced significant competition in the photocopier market, but the
court ruled the practice illegal. The decision emphasized that consumers often lack sufficient
information to predict repair costs, making such tie-in arrangements harmful to competition
and consumer choice.

These landmark cases illustrate the varied ways in which courts address anti-competitive
practices under antitrust laws. From outright prohibitions on collusion and predatory pricing to
nuanced rulings on information-sharing and mergers, these decisions reflect the ongoing
effort to balance market fairness, consumer welfare, and economic efficiency.

Malaysia antitrust: MyCC

Goals of Antitrust Laws - Background

a.​ Many economists think the antitrust law should promote efficiency
i.​ The problem is, often times, it is difficult to say whether certain business
b.​ Others may appeal to fairness or give more weight to consumer surplus
c.​ Some skeptics say that antitrust laws are used to help certain group of firms (eg: small
companies) and harm others
d.​ Recently, using eciency as the guiding principle gains increasing acceptance, however
Goals of Antitrust Laws
a.​ Protecting consumer welfare
i.​ Ensure access to variety
b.​ Prevent anti-competition
i.​ Preventing price-fixing agreements, anti-competitive mergers
c.​ Encourage efficiency and innovation
i.​ Improve productivity
d.​ Fair business practices
i.​ Deceptive advertising and tactics of unfair fair competitions

Lecture 8: Collusion and horizontal agreements

Theory of collusion
a.​ Explicit collusion (formal collusion)
i.​ Firms talk to set prices or quantities
b.​ Tacit collusion (informal collusion)
i.​ Firms do not directly communicate but somehow they set high prices
c.​ Outcome
i.​ Profit increase
ii.​ Consumer surplus falls
iii.​ Quantity falls, which means economic welfare decrease
d.​ Prisoner dilemma game theory: Cournot duopoly
i.​ If the two firms play the game only once
1.​ Firms have incentive to cheat on the agreement
2.​ NE: Cournot output
3.​ Collusion is unsustainable
 ii.​ If the firms play an infinitely repeated Cournot game
1.​ Cheating yields one-period gain, but at the expense of losses in the future
2.​ If the firms are sufficiently patient about future profits, collusion can be
maintained by playing, say “trigger strategy” (i.e., collude, if the other firm
cheat, then cheat forever after)
3.​ Collusion may be sustainable

Collusion are more likely to happen if

a.​ Markets are concentrated
b.​ The markets have high barriers to entry
c.​ Supply and demand are stable
d.​ The products are homogeneous
e.​ Prices can be observed quickly
f.​ Firms in the market have multiple products
g.​ Communication channel (Leavitt, 1955) ->
number of communication channel needed = (N(N-1))/2

Collusion in practice (identify explicit or tacit collusion)

a.​ Railroads in the 1880s
i.​ Railroad companies form a cartel, the Joint Executive Committee (JEC) in 1879
stabilize price
ii.​ Porter (1983) examines rail rates for grain to assess whether JEC colludes
iii.​ Outcome
1.​ Prices are high initially
2.​ Breakdowns of collusion (or price wars)
3.​ The railroad companies seem to collude, but not perfectly
4.​ Conclusion: Even if cartels are legal, firms may be unable to collude
perfectly, collusion happens more frequently later
iv.​ A theoretical explanations
 1.​ The companies interact repeatedly
2.​ They use trigger strategy such as tit-for-tat (but not grim strategy)
3.​ They imperfectly observe each others’ prices

b.​ Citric acid in the 1990s

i.​ Managers of Archer Daniels Midland (ADM), a U.S. firm, initiate horizontal talks
on collusion on January 1991 with two competitors, Haarman & Reimer and
Hoffman-LaRoche
ii.​ The 3 firms agree to raise their prices towards the monopoly price; they set
quantities, monitor prices and profits by meeting every 8 weeks
iii.​ Outcome:
1.​ In 2 years, price of citric acid rises 35%
2.​ But later, it keeps declining because Chinese manufacturers, who are not
members, increase their supply
3.​ In November 1992, an ADM manager becomes an FBI-informer which
allow the FBI to tape meetings of carte
4.​ The firms are prosecuted by the U.S. Department of Justice
iv.​ A theoretical explanation
1.​ Why do the firms increase the list price step by step
a.​ Maybe because there is a large excess of citric acid in 1990
b.​ Or the firms try to avoid antitrust prosecution
c.​ Or demand and supply change in the early 1990
2.​ Why do Chinese manufacturers enter
a.​ Maybe barriers to entry not prohibitively high
3.​ Why doesn’t price decline dramatically after the firms are prosecuted
a.​ Existing buyers might have locked into long-term contracts that
fixed prices
b.​ The 3 prosecuted firms were still large, dominant players. Their
market power allowed them to retain some level control over
pricing
c.​ Nasdaq in the 1990s
i.​ Nasdaq trades are organized through market makers who earn some returns on
“spread” between bid- and ask prices
ii.​ The minimum spread was $18
iii.​ Christie and Schultz (1994) observe almost a; quotes were in even eights, eg:
$10 and $10.25 but not 10.125
1.​ If market is competitive, why aren’t spreads bid down to 0.125
iv.​ Outcome:
1.​ On the same day, the spread falls to 0.125
2.​ But there is no evidence of agreement between traders
3.​ In 1994, a class action by a group of investors alleges 37 Nasdaq traders
had colluded to keep prices high
4.​ In December 1997, the case is settled out-of-court

v.​ A theoretical explanation

1.​ The market makers are tacility colluding
2.​ They interact repeatedly and there are many market makers
a.​ And barriers to entry are low
 3.​ The service is homogeneous
a.​ And they perfectly observe each others’ prices

Policy
a.​ In EU and US - "Carrot and stick" approach
i.​ Stick
1.​ "Per se rule" on collusion, not the "rule of reason"
2.​ If firms are caught red-handed talking about prices and quantities,​
they are fined.
ii.​ Carrot : Leniency (forgiveness) Program
1.​ Companies that report collusion can get reduced penalties.
2.​ Early Reporting: The first company to report before an investigation starts
gets full or partial immunity.
3.​ Late Reporting: Companies reporting after investigations begin may still
get reduced fines if they help the case.
b.​ Malaysia - Malaysia Competition Act 2019
i.​ Prohibited Anti-Competitive Agreements: Agreements that block or distort
competition are illegal. This includes agreements that harm competition directly
or indirectly.
ii.​ Horizontal Agreements That Harm Competition: The law bans agreements
between competitors that:
1.​ Fix prices or trading conditions.
2.​ Divide markets or supply sources.
3.​ Limit production or investment.
4.​ Rig bids for contracts.

US antitrust law
a.​ Per Se Rule: This rule applies to actions like price-fixing or forming cartels, which are
automatically illegal because they harm competition. Courts don’t need to examine their
details - these actions are considered bad for the market no matter what.
i.​ Historical use:
1.​ Addyston Pipe (1899): Judge William Howard Taft applied the per se rule
to price-fixing agreements, holding that agreements between competitors
to fix prices were inherently illegal, regardless of whether the prices were
reasonable or if competition existed.
2.​ Trenton Potteries (1927): The U.S. Supreme Court confirmed the use of
the per se rule for collusion, stating that agreements to fix prices are
inherently unreasonable without the need to examine whether the prices
were reasonable.
3.​ Socony-Vacuum Case (1940): The Court reinforced the per se rule in
price-fixing cases, declaring that price-fixing agreements are illegal per
se, even if the parties argue that their agreements addressed competitive
problems or abuses.
 b.​ Rule of Reason: This rule is used for practices like mergers, which can be good or bad
for competition. Courts look closely at the purpose and effects to see if they harm or help
competition overall.
i.​ Historical Use
1.​ Appalachian Coals (1933): During the Great recession, the Supreme
Court allowed greater flexibility in business cooperation, holding that
reducing competition between parties was not automatically illegal - had
to check the situation
2.​ State Oil Co. v. Khan (1997): The Court confirmed that the Sherman Act
only bans unreasonable restrictions, and some actions need a closer look
under the rule of reason.

Lecture 9: Monopolisation
Monopoly
a.​ Market structure where a single firm is the sole producer of a product or service with no
close substitutes
b.​ Characteristic
i.​ Single seller dominates the market
ii.​ Unique product with no close substitutes
iii.​ High barriers to entry
iv.​ Price-making ability

Monopolisation
a.​ The process of a firm or a group of firm taking control of the market
b.​ Involves attempts to maintain or increase market control, preventing others from sharing
in the market
c.​ Characteristics
i.​ Use the strategic behaviour to eliminate competition
ii.​ Intention to gain or maintain market dominance
iii.​ Practices can be anti-competitive and harmful to market health
d.​ The Chicago school argues that market power deriving from monopolisation is just
temporary, except perhaps in the case of monopolies that created and maintained by
government
i.​ Eg: utility companies
e.​ The most efficient firms earn the highest rates of profit and their success enables them
to grow and achieve a relatively large market share
i.​ Consequently, market structure and profitability has nothing to do with the
exploitation of large firms; instead, it is due to efficiency
ii.​ This view is in contrast to the SCP paradigm
f.​ Amato and Wilder, 1990, p93
The debate between the revisionist and traditional schools can be summarized in terms
of their differences regarding the appropriate unit of observation in industrial economics.
The revisionist view is a story of industries consisting of both successful and
unsuccessful firms, implying that there are important inter-firm differences in profitability.
 The traditional view focuses on industry effects which are assumed to be measured by
concentration. The revisionist view thus focuses on the firm and firm-level efficiencies,
which the traditional view focuses on the market and industry-specific sources of market
power

a.​ Revisionist School - firms

Profitability differences are not just a function of market structure (e.g., concentration)
but are heavily influenced by the capabilities and efficiencies of individual firms.
b.​ Traditional School - industry
Industry-level characteristics, such as market concentration, are the primary
determinants of profitability and [Link] with high concentration
typically exhibit greater market power, enabling higher profitability. Assumes that firm
performance is largely shaped by the market structure within the industry.

Strategies of monopolisation
a.​ Predatory Pricing
i.​ Setting prices low to drive out competitors, then raising them once dominance is
achieved
b.​ Tying and Bundling
i.​ Requiring customers to buy additional products or services together with main
product
c.​ Mergers and Acquisitions
i.​ Acquiring competitors to consolidate market power
d.​ Network effects
i.​ Enhancing the value of a product as more people use it, creating barriers to entry

Monopolisation - Strategies to enhance market share

a.​ Business practices and part of competitive interactions in the marketplace, Price-cutting,
introduction of new products and promotional campaigns are reasonable responses due
to increased actual or potential competition
b.​ Bundling of various complementary components or refusals to deal with a riva firm, may
be justified by the firm’s investment in R&D
c.​ Exit-inducing and entry-deterring behaviour can improve welfare if it keeps the market
from becoming overcrowded

Patent and Monopolisation

a.​ Patent is usually granted to inventor of a new product, process, substance or invention
b.​ Legally recognised as an economic asset that can be exploited, licensed or sold by the
patent holder
c.​ In most countries, patents are awarded a finite period. In UK, the lifetime of patents of
patents was increased from 16 to 20 years - Patents Act (1977)

Patent Act (1977) - UK

 a.​ The invention must be new, not been previously used
i.​ There are certain ideas that cannot be patented, including pure scientific
discoveries, mathematical formulae, mental processes and artistic creations
b.​ The invention must be non-obvious, does no represent a trial modification that is already
known 已知的试验性修改
c.​ It must embody a genuine advance in knowledge
d.​ The invention must be capable of commercial application

Why patenting system is needed

a.​ Non-excludability - once new knowledge has been created, it is not possible to exclude
others from gaining access to the knowledge. Investor will encounter difficulties in
appropriating the rewards from their investment from their investment in acquiring the
knowledge
b.​ Non-rivalry - knowledge available to one person does not diminish its availability to
others. To marginal cost of disseminating knowledge to each additional person is very
small or zero

Question 1: Does the option for inventors to take out a patent increase welfare by improving the
inventor’s incentive to proceed? Does patent reduce welfare by conferring market power upon
the inventor, which can be used to restrict output and raise the market price
a.​ Chicago school -> company found patent able to protects their producer welfare and
surplus (profitable)
b.​ Others?

Welfare Implication of Patents

Lecture 10: Predation

A simple model
Graphic analysis:
a.​ Initially, the incumbent sets a
monopoly price. Pm
b.​ If an entrant enters, it reacts by setting
price equals, which is below cost
(below ATC)
c.​ If suffers some losses, so does the
entrant
d.​ If entrants leaves the markets, the
incumbent raises price to Pm

Problem with the simple model

a.​ How can the incumbent afford to do this?
i.​ If the incumbent has the same costs as the new competitor, it will also lose
money by using predatory pricing.
ii.​ The incumbent would need a plan to recover the losses it takes during the
predatory pricing period.
b.​ Won't the new firm re-enter the market when the incumbent raises its price again?
i.​ make the predatory pricing strategy ineffective.
ii.​ The "Chicago Attack" argues that predatory pricing only works if the incumbent
has a cost advantage. Without it, the strategy fails.

Other Theories of Predatory Pricing - Do these theories make sense?

a.​ 'Deep pockets'
i.​ The incumbent firm has more financial resources to bear losses from lowering
prices, while the new competitor doesn’t.
 ii.​Criticism:If entering the market is profitable, the new competitor should be able to
borrow money to cover its losses, so the "deep pockets" argument doesn't hold.
b.​ Reputation arguments
i.​ Create the image of being a low-cost producer, even if it’s not, to scare off new
competitors, making them think they can't compete at low price

Exclusionary Strategies - Non-price strategies of predation

a.​ Strategic Investment: Firms make investments that limit or harm the ability of competitors
to compete. For example, a company might invest in technology, infrastructure, or
exclusive deals that make it difficult for new entrants or rivals to operate effectively.
b.​ Tying/Bundling Products: This involves combining essential products with non-essential
products, so that competitors can’t enter the market for the non-essential products. For
example, a company might sell a popular product together with a less popular one,
forcing customers to buy both and preventing competitors from offering just the
non-essential product.
c.​ Refusal to Supply/Essential Facilities: A firm may refuse to provide essential inputs or
resources to rivals. This makes it difficult for competitors to operate since they need
these key resources to produce their own products. An example would be refusing to sell
a critical component or service to a competitor.
d.​ Raising Cost: A firm can increase costs for itself or its competitors in order to make it
harder for new entrants to be profitable. This might include actions like imposing higher
fees or creating barriers that force rivals to spend more, reducing their ability to compete
effectively.

Policy - What should be illegal - What constitutes proof - How do we distinguish predation from
competition
a.​ Areeda-Turner Rule: Pricing below marginal cost
i.​ Profit are maximised at MC = MR, so pricing below MC is unsustainable
ii.​ Because MC is difficult to measure, use AVC instead.
b.​ ATC Rule: Pricing below Average Total Cost
i.​ Some economists argue that Areeda-Turner Rule is too easy
ii.​ Incumbent firm has sunk cost advantage, so it could predate by pricing​
between ATC and AVC
iii.​ To discourage firms from doing predation, make any pricing below ATC​
illegal (i.e., any price which makes a short-term loss).
c.​ In practice
i.​ In U.S., price below ATC can trigger for investigation
ii.​ No UE-wide legislation; some countries consider any pricing at a loss to be
illegal.
Examples
a.​ Eastman Kodak v. Image Technical Services (Refusal to Supply)
i.​ Summary; Kodak copiers were serviced by independent companies (ISOs) that
needed parts from Kodak. These ISOs competed with Kodak's own service
business. In 1987, after losing a big contract to Image Technical Services, Kodak
stopped supplying parts to ISOs. Seventeen ISOs sued Kodak.
ii.​ Outcome: The court ruled that Kodak’s refusal to supply parts was illegal
because it forced customers to rely on Kodak's service, even though the service
market could be competitive. There was no valid reason for Kodak’s policy.
b.​ Matsushita v. Zenith (1986 - Predatory Pricing)**
i.​ Summary: Zenith, a U.S. TV maker, claimed that the Japanese company
Matsushita was using its profits from Japan to lower prices in the U.S. and drive
out competition. Zenith said Matsushita sold TVs at 62% of Zenith’s price for 10
years, then planned to raise prices later.
ii.​ Outcome: The court rejected Zenith’s claim, saying Matsushita wouldn’t be able
to recover its losses even if it controlled the market for 80 years. The court also
said Matsushita could only sell at lower prices if it was more efficient.
iii.​ Predatory pricing was unlikely because Matsushita couldn’t make up for the
losses.
c.​ Microsoft I (1994 - Contractual Penalty)
i.​ Summary: Microsoft was accused of using its power to limit the choices of
companies using its operating system, Windows. Companies like Compaq, IBM,
and Dell could use other systems like UNIX. Microsoft responded by changing its
contracts, making these companies pay a fee for all computers sold, even those
not running Windows.
ii.​ Outcome: The U.S. Department of Justice investigated, and in 1994, Microsoft
agreed to stop this practice.
iii.​ Proof: Microsoft’s contract terms were seen as a way to block competition and
were unfair.

Lecture 11: Horizontal mergers

 a.​ Vertical merger: mergers between different level of productions (backward linkages or
forward linkages) (examples: intermediate goods and retailers)
b.​ Horizontal mergers: different businesses but in same level of productions

Examples of Horizontal mergers (final services to consumers)

a.​ Microsoft and Linkedin (2016)
b.​ Maxis and Astro (2018)

Why firms merge & why society may gain / lose

a.​ Horizontal merger
i.​ Rivals in the same market form one company
b.​ Reasons / Benefits for mergers
i.​ To enjoy economies
ii.​ To reduce management inefficiencies
iii.​ To gain larger market power
c.​ Why society may gain/lose
i.​ Economies of scale lowers cost
ii.​ Higher market power will increase price and lead to oligopoly formation
iii.​ Unlike price fixing, horizontal mergers are considered under the rule of​
reason

A horizontal merger occurs when two rival firms within the same market combine to form a
single company. This type of merger typically involves companies offering similar or identical
products and services.

One of the main reasons for horizontal mergers is the pursuit of economies of scale. When
two companies merge, they can combine resources, production processes, and distribution
channels, which often leads to reduced costs per unit. Larger firms can spread their fixed
costs over a larger volume of output, which helps lower the average cost of production. This
makes the merged company more competitive and potentially more profitable.

Another reason for horizontal mergers is to improve management efficiency. Smaller

companies may struggle with coordinating their operations and managing resources well,
 especially if there are overlapping roles or tasks. By merging, the companies can remove
duplicate management positions, simplify decision-making, and organize their operations
more effectively. This can help the new company use its resources better, improve leadership,
and run more smoothly. As a result, the combined company can lower costs and boost
productivity.

In addition, horizontal mergers can help companies gain larger market power. When two firms
combine, their market share increases, which gives them more control over pricing and other
aspects of the market. With greater market power, the merged firm may be able to influence
prices and set terms that benefit its business. However, this increased power can also lead to
concerns about market dominance and reduced competition.

While horizontal mergers may offer several benefits, they can have both positive and negative
effects on society. On the positive side, the economies of scale generated by a merger can
result in lower costs for consumers, as companies may pass on savings from increased
efficiency. This could lead to lower prices, higher-quality products, or improved services.

On the downside, the increased market power resulting from a horizontal merger may allow
the merged company to raise prices or reduce the variety of products available, as there is
less competition in the market. In some cases, this can lead to the formation of an oligopoly,
where only a few large firms dominate the industry. As a result, consumers may face higher
prices and fewer choices, reducing overall welfare.

It’s important to note that, unlike price-fixing agreements, horizontal mergers are generally
evaluated under the "rule of reason" in antitrust law. This means that regulators will check
whether the merger would likely harm competition or consumers. The merger is not
automatically deemed illegal; instead, regulators look at factors such as market concentration,
potential benefits, and the effects on competition to determine if the merger should be
allowed.
Benefit & costs : Perfect competition in pre-merger stage
 Analysis:
a.​ Consider a merger between two firms
b.​ Before merger, the average costs of
the firms are AC0 and price is P0
c.​ After merger, costs fall to AC1, but
higher market power leads to higher
price, P1
d.​ This causes deadweight loss equal A1
and cost savings in the amount of A2
Conclusion:
a.​ A relatively small percentage cost
reduction will off set a relatively larger
price rise, which makes society
indifferent to the merger

Benefit & costs : Imperfect competition in pre-merger stage

Analysis:
a.​ Consider a more realistic setting
where the market is not​
perfectly competitive
b.​ Before merger, price P0 is higher than
pre-merger cost, AC0
c.​ The deadweight loss now equal B1,
which is larger than A1
i.​ the cost saving is still a
rectangle of similar size, B2​
Conclusion
Conclusion:
a.​ If pre-merger market is not
competitive, the reduction in cost​
necessary to offset a rise in price is
larger
b.​ Other firms in the market will increase
their prices as well, which may lower
economic welfare further.

Policy towards horizontal merger - US legislative framework - Antitrust laws

a.​ Sherman Act (1890)
 i.​ Cornerstone of U.S. antitrust law, designed to prevent anti-competitive practices.
However, the Sherman Act did not initially contain specific provisions regarding
mergers.
b.​ Strengthened by Clayton Act (1950)
i.​ No company that is involved in business can buy all or part of another company’s
stock if doing so would greatly reduce competition between the two companies,
limit trade in any region, or help create a monopoly in that business sector. If the
merger would create a monopoly (where one company controls too much of the
market), it can also be blocked.
c.​ Amended by Celler-Kefauver Act (1950)
i.​ No company involved in business can buy all or part of another company’s stock
or assets if the result of the purchase would greatly reduce competition or help
create a monopoly in any part of the country or in any type of business. This also
applies to companies regulated by the Federal Trade Commission.
ii.​ The Celler-Kefauver Act made sure companies couldn’t find clever ways to avoid
this rule by buying assets instead of stocks.

Policy towards horizontal merger - US legislative framework - Merger Guidelines

a.​ The process is elaborated by Merger Guidelines
b.​ The 1968 guidelines puts emphasis on market shares
i.​ If a merger would result in a firm having too large of a market share, it was likely
to be scrutinized and potentially blocked.
c.​ Revision in 1982 considers entry conditions
i.​ If the new entry was difficult or unlikely if the merged firms raised price, the
merger would be more likely to be challenged.
d.​ Revision in 1992 redefines the relevant market
i.​ A market was defined in terms of both products and geography.
ii.​ The guidelines introduced the SSNIP test (Small but Significant and
Non-transitory Increase in Price) to help define the relevant market. If a
hypothetical monopolist could raise prices by at least 5% for a year without losing
customers to other products or regions, then that was considered the relevant
market.
iii.​ It determines the competitive landscape and whether the merger would give the
merged entity market power within this defined market.
iv.​ Relevant market - merger will not be recommended for regulators
e.​ In applying the guidelines, DOJ and FTC use HHI index
i.​ The HHI is calculated by summing the squares of the market shares of all firms in
the market:
1.​ Unconcentrated market: HHI < 1000
2.​ Moderately concentrated market: HHI between 1000 and 1800
3.​ Highly concentrated market: HHI > 1800
ii.​ The HHI measures how concentrated a market is, and the increase in HHI after a
merger helps determine how much the merger increases market power. If the
 post-merger HHI is high, and the merger causes a large increase in HHI, the
merger will be further reviewed.
f.​ Mergers examined by DoJ from 1999 to 2000:
i.​ DOJ and FTC received 4,926 merger proposals
ii.​ Of all these proposals, only 80 were looked into by the Department of Justice and
the FTC as possible threats to competition (meaning that they believed the 80
mergers could harm consumers by reducing competition).
iii.​ 36 settled between firms & DoJ (find a solution)
iv.​ 38 investigation abandoned or restructured (gave up)
v.​ 6 court challenges: 3 dropped by DoJ, 1 conditional merger
vi.​ 2 mergers ruled against.

Cases
a.​ Staples and Office Depot, two office superstore (OSS) chains in the U.S., merged
b.​ Relevant market
i.​ FTC: OSS chains; OSS different from non-OSS firms because OSS carries a
broader range of office supplies
ii.​ Defendants: the market of office supplies, which include non-OSS such as
Wal-Mart, Kmart and Target (whose market share is more than 80%)
b.​ HHI
i.​ The judge agrees with FTC's definition of relevant market; so, the merger is
“unsafe”
ii.​ So, benefits and costs analysis has to be done
c.​ Benefits and costs analysis
i.​ Price increase (absent the effect of any cost savings)
1.​ FTC and defendants use sophisticated econometric analysis to estimate
the price​
Increase
2.​ FTC: Price will increase by 7.3%
3.​ Defendants: The increase is only 2.4%
ii.​ Cost savings
1.​ FTC argues that 43% of cost savings claimed by defendants could have
been achieved​
without merger; so, these are excluded
2.​ only cost savings passed on consumers should be counted, i.e., 15%,
which is only 1.4% of sales
iii.​ Price increase (after the pass-through rate and cost savings)
1.​ FTC: Price would increase by 7.1%
2.​ Defendants: Price would decrease by 2.2%
iv.​ Outcome
1.​ The judge ruled against the merger
This case focuses on the proposed merger between **Staples** and **Office Depot**, two
major office supply retailers in the U.S. The key issue in the case was whether the merger
would harm competition and raise prices, and this was largely determined by how the relevant
market was defined.

### Key Points Explained:

1. **Relevant Market**:
- The **FTC (Federal Trade Commission)** argued that the relevant market should focus on
only **office supply superstores (OSS)**, like Staples and Office Depot, because they offer a
broader range of office supplies compared to general retailers (e.g., Walmart, Target).
- The **defendants (Staples and Office Depot)** argued that the market should be broader
and include **non-OSS retailers** like Walmart, Kmart, and Target, which sell office supplies
but also offer other products. These stores make up a large share of the market, over
**80%**.

2. **HHI (Market Concentration)**:

- The **Herfindahl-Hirschman Index (HHI)** measures market concentration, and a higher
HHI indicates less competition.
- The court sided with the **FTC**'s narrower definition of the market (only OSS), which
resulted in a higher market concentration after the merger. This meant that the merger would
likely reduce competition between Staples and Office Depot, leading to higher prices for
consumers.

3. **Benefits and Costs of the Merger**:

- Both sides presented models to predict the impact on prices.
- The **FTC** estimated that the merger would lead to a **7.3% price increase**.
- The **defendants** argued that the price increase would be much smaller, about **2.4%**.
- **Cost Savings**: Staples and Office Depot argued that the merger would result in
significant cost savings, which could lead to lower prices. However, the **FTC** countered
that most of these savings could be achieved without the merger and that only a small
percentage would benefit consumers directly (about **1.4%** of sales).

4. **Price Changes After Considering Cost Savings**:

- After considering how much of the cost savings would actually reach consumers, both
sides revised their price estimates.
- The **FTC** still predicted that prices would rise by **7.1%** after accounting for cost
savings.
- The **defendants** argued that prices would actually fall by **2.2%** after passing on cost
savings to consumers.

5. **Outcome**:
- The judge sided with the **FTC**, blocking the merger.
- The primary concern was that the merger would reduce competition significantly, leading to
higher prices for consumers, despite the potential cost savings.

In summary, the case illustrates how market definition and concentration (HHI) are key to
analyzing mergers and their potential effects on competition and prices. The FTC’s narrower
market definition and concerns about price increases led to the merger being blocked.
Lecture 12: Vertical mergers

Why firms merge & why society may gain / lose

a.​ Vertical merger
i.​ Firms at different stages of production merge into a single firm
ii.​ Examples
1.​ Computer makers and component manufacturers
2.​ Speedboat makers and on-board motor producers
b.​ Reasons for mergers
i.​ To enjoy economies
ii.​ To lower transactions costs
1.​ Costs of co-ordinating transactions
2.​ Costs of search and matching in markets
3.​ Motivation costs
iii.​ To overcome double marginalization
iv.​ To monopolize related markets.

A vertical merger occurs when two firms operating at different stages of production combine to
form a single company. This type of merger is common in industries where companies rely on
each other for parts or services, and the goal is to streamline operations and reduce costs.
Some examples of vertical mergers include Computer makers and component manufacturers
and Speedboat makers and on-board motor producers.

There are several reasons why companies choose to engage in vertical mergers. One of the
main advantages is the ability to achieve economies of scale. By merging, companies can
increase their production capacity, which often leads to lower costs per unit. Combining
resources, facilities, or technology allows firms to spread their costs over a larger output,
making production more cost-effective.

Another important reason for vertical mergers is the potential to lower transaction costs.
Transaction costs include the expenses associated with negotiating contracts, managing
relationships with suppliers, and ensuring the quality of purchased products. When companies
merge vertically, they eliminate the need to negotiate and manage multiple suppliers. This
leads to savings in time and money and makes the production process more efficient. Within
the broader category of transaction costs, several specific costs are reduced, Costs of
Coordinating Transactions. When firms operate separately, they need to coordinate activities
with external companies, which can result in inefficiencies and delays. Vertical mergers
simplify this coordination by aligning operations within a single firm, reducing complexities in
scheduling, communication, and [Link] money searching for suitable suppliers or
partners. Vertical mergers eliminate these costs, as the companies involved are already part
of the same firm, removing the need for external searching and matching. Motivation Costs: In
separate firms, each company may have different goals or incentives. For example, a parts
manufacturer may not prioritize the final product's market performance. A vertical merger
aligns the interests of both companies, reducing conflicts and enhancing cooperation.

Vertical mergers can also help firms overcome double marginalization. Double marginalization
occurs when two firms in the supply chain each add a markup to their prices, leading to higher
 costs for consumers. When firms merge vertically, they can set a single price structure that
eliminates these additional markups, potentially lowering prices for the end consumer

Finally, vertical mergers can be motivated by the desire to monopolize related markets. By
merging, firms can gain greater control over their production process and possibly dominate
markets related to their core business. This may reduce competition and increase profitability.

Double marginalization
a.​ Definitions

a.​ Suppose there are an upstream firm

and a downstream firm; each has
some market power
b.​ The upstream firm sets PU > MCU to
the downstream firm; it makes positive
economic profit
c.​ The downstream firm sets PD > MCD
to retail customers
d.​ So, price is marked-up twice, i.e.,
double marginalization
e.​ If the two firms merge, they do not do
the first mark-up: The merged firm​
internalizes upstream and
downstream stages of production
f.​ This merger increases profit and
lowers price to consumers. The
merger benefits consumers and both
firms.

b.​ Non-integration v. integration

Motor Maker - Monopoly
a.​ Suppose there are an upstream firm
(motor maker) and downstream firm​
(boat maker)
b.​ Each of them is a monopolist in its own
market
c.​ Suppose further it costs C, in addition
to the cost of a motor, for the boat​ Boat Maker - Monopoly
maker to produce a boat
d.​ The boat maker produces output such
that MRB = MCB
e.​ – But, MCB = PM + C so that MRB =
PM + C
f.​ – So, PM = MRB - C: Demand curve
for motors is MRB shifted down by C
g.​ Outcome under integration v.
non-integration
i.​ Price is lower
ii.​ Quantity is higher
iii.​ Profits and consumer surplus
are higher
Why might vertical mergers be bad? It can lead to market foreclosure
a.​ Consider oligopolistic markets
i.​ Input foreclosure
1.​ Consider an intermediate-good producer that supplies parts to some
final-good producers
2.​ Suppose the intermediate-good producer merges with one of the
final-good Producers
3.​ The newly-merged firm may restrict output to other final-good
producers
ii.​ Customer foreclosure
1.​ Consider many intermediate-good producers but only one final-good
producer
2.​ Suppose an intermediate-good producer merges with the final good
producer
3.​ The merged firm may restrict its purchases of intermediate goods
from intermediate-good producers
 Input foreclosure Customer foreclosure

Policy towards Vertical Foreclosure

a.​ Rule of reason
i.​ Benefits of removing double-marginalization (and other benefits) v. potentially
anti-competitive effects due to foreclosure
b.​ Analyses are more difficult
i.​ Market definitions in the upstream and downstream markets
ii.​ Complex upstream-downstream relationships
iii.​ Have to estimate the probability of foreclosure and welfare gains/losses
c.​ Evolution of policy in the US
i.​ In the 60's the US gov't challenged many vertical mergers
ii.​ In the 80's few were challenged
iii.​ Now vertical integration is not a concern except when one of the markets​
becomes very concentrated

Case: US Time Warner & Turner / TCI

a.​ Summary:
i.​ Time Warner, Turner Broadcasting System and TCI planned to merge
b.​ Vertical dimension: cable programming (upstream) is an input into cable​
service (downstream)
c.​ FTC's concerns
i.​ Market competition:
 1.​ The merger could reduce competition by giving too much control over
both program supply and cable services.
2.​ TCI might use its influence to limit other competitors’ access to popular
programs.
ii.​ Consumer harm:
1.​ The merged company might force customers to buy unpopular channels
bundled with popular ones, reducing their choices.
d.​ FTC Decision
i.​ TCI’s role: TCI could only hold a passive stake in the merged company and could
not control its operations.
ii.​ No bundling: Time Warner could not bundle popular channels with less popular
ones.
iii.​ Regular reporting: Time Warner had to regularly report to the FTC to ensure
compliance.
iv.​ Ending agreements: TCI and Turner Broadcasting had to cancel their long-term
agreement to prevent unfair advantages.
e.​ Summary
i.​ The FTC allowed the merger but added rules to protect competition and
consumers. These rules prevented the companies from abusing their power in
the market and ensured other competitors and customers were treated fairly.

Empirical evidence “Rosengren and Meehan (1994)” - In general, does vertical Merger harm
rival firms
a.​ Study about 30 episodes of vertical integrations that were challenged by the FTC in
1963-1982
b.​ Examine data on stock market values of integrating firms, rivals in the market, and
unaffected firms
c.​ Research question
i.​ Do rivals' stock prices fall either (i) when a merger is announced or (ii) when
result of FTC enquiry in announced (compared to unaffected firms)?
ii.​ In other words, do investors react to the threat of possible foreclosures by selling
stocks of the firms?
f.​ Event study analysis
i.​ Daily stock prices of merged firms are gathered for 200 days prior to merger
announcement and 10 days after announcement
ii.​ "Rivals" stock values measured as weighted portfolio of rival firms over same
period
iii.​ "Unaffected" firms stock values measured as weighted portfolio of rms in same
industrial classification but deemed unaffected
iv.​ Basic analysis is to compare changes in stock prices of rival firms to changes in
stock prices of unaffected firms before and after a merger is announced
g.​ Findings: No evidence of market foreclosure