Limiting Market Power: The Antitrust Laws

We have seen that market power—whether wielded by sellers or buyers—harms potential purchasers who could have bought at competitive prices. In addition, market power reduces output, which leads to a deadweight loss. Excessive mar- ket power also raises problems of equity and fairness: If a firm has significant monopoly power, it will profit at the expense of consumers. In theory, a firm’s excess profits could be taxed away and redistributed to the buyers of its products, but such a redistribution is often impractical. It is difficult to determine what por- tion of a firm’s profit is attributable to monopoly power, and it is even more diffi- cult to locate all the buyers and reimburse them in proportion to their purchases.

How, then, can society limit market power and prevent it from being used anticompetitively? For a natural monopoly, such as an electric utility company, direct price regulation is the answer. But more generally, the answer is to pre- vent firms from obtaining excessive market power through mergers and acqui- sitions, and to prevent firms that already have market power from using it to restrict competition. In the United States and most other countries, this is done via antitrust laws: rules and regulations designed to promote a competitive economy by prohibiting actions that are likely to restrain competition.

Antitrust laws differ from country to country, and we will focus mostly on how those laws work in the United States. But it is important to stress at the outset that in the United States and elsewhere, while there are limitations (such as colluding with other firms), in general, it is not illegal to be a monopolist or to have market power. On the contrary, we have seen that patent and copyright laws pro- tect the monopoly positions of firms that developed unique innovations. Thus Microsoft has a near-monopoly in personal computer operating systems because other firms are prohibited from copying Windows. Even if Microsoft had a com- plete monopoly in operating systems (it doesn’t—the Apple and Linux operat- ing systems also compete in the market), that would not be illegal. What might be illegal, however, is if Microsoft used its monopoly power in personal com- puter operating systems to prevent other firms from entering with new operat- ing systems, or to leverage its power and reduce competition in other markets. As we will see in Example 10.8, that was the basis for lawsuits brought against Microsoft by the U.S. Department of Justice and the European Commission.

1. Restricting What Firms Can Do

Innovation drives economic growth and enhances consumer welfare, so we are delighted when Apple gains market power by inventing the iPhone and iPad, or when a pharmaceutical company gains market power through its invention of a new life-saving drug. But there are other ways in which firms can gain market power that are not so laudable, and this is where the antitrust laws come into play. At a fundamental level, the laws work as follows.

Section 1 of the Sherman Act (which was passed in 1890) prohibits contracts, combinations, or conspiracies in restraint of trade. One obvious example of an illegal combination is an explicit agreement among producers to restrict their out- put and/or  to “fix” price above the competitive level. There have been numerous instances of such illegal combinations and conspiracies, as Example 10.7 illustrates.

Implicit collusion in the form of parallel conduct can also be construed as vio- lating the law. For example, if Firm B consistently follows Firm A’s pricing (paral- lel pricing), and if the firm’s conduct is contrary to what one would expect compa- nies to do in the absence of collusion (such as raising prices in the face of decreased demand and over-supply), an implicit understanding may be inferred.18

Section 2 of the Sherman Act makes it illegal to monopolize or to attempt to monopolize a market and prohibits conspiracies that result in monopoliza- tion. The Clayton Act (1914) did much to pinpoint the kinds of practices that are likely to be anticompetitive. For example, the act makes it unlawful for a firm with a large market share to require the buyer or lessor of a good not to buy from a competitor. It also makes it illegal to engage in predatory pricing— pricing designed to drive current competitors out of business and to discourage new entrants (so that the predatory firm can enjoy higher prices in the future).

Monopoly power can also be achieved by a merger of firms into a larger and more dominant firm, or by one firm acquiring or taking control of another firm by purchasing its stock. The Clayton Act prohibits mergers and acquisitions if they “substantially lessen competition” or “tend to create a monopoly.”

The antitrust laws also limit possible anticompetitive conduct by firms in other ways. For example, the Clayton Act, as amended by the Robinson-Patman Act (1936), makes it illegal to discriminate by charging buyers of essentially the same product different prices if those price differences are likely to injure competition. Even then, firms are not liable if they can show that the price dif- ferences were necessary to meet competition. (As we will see in the next chap- ter, price discrimination is a common practice. It becomes the target of antitrust action only when buyers suffer economic damages and competition is reduced.) Another important component of the antitrust laws is the Federal Trade Commission Act (1914, amended in 1938, 1973, 1975), which created the Federal Trade Commission (FTC). This act supplements the Sherman and Clayton acts by fostering competition through a whole set of prohibitions against unfair and anticompetitive practices, such as deceptive advertising and labeling, agree- ments with retailers to exclude competing brands, and so on. Because these prohibitions are interpreted and enforced in administrative proceedings before the FTC, the act provides broad powers that reach further than those of other antitrust laws.

The antitrust laws are actually phrased vaguely in terms of what is and what is not allowed. They are intended to provide a general statutory framework to give the Justice Department, the FTC, and the courts wide discretion in inter-preting and applying them. This approach is important because it is difficult to know in advance what might be an impediment to competition. Such ambiguity creates a need for common law (i.e., the practice whereby courts interpret stat-utes) and supplemental provisions and rulings (e.g., by the FTC or the Justice Department).

2. Enforcement of the Antitrust Laws

The antitrust laws are enforced in three ways:

1. Through the Antitrust Division of the Department of Justice. As an arm of the executive branch, its enforcement policies closely reflect the view of the administration in power. Responding to an external complaint or an internal study, the department can institute a criminal proceeding, bring a civil suit, or both. The result of a criminal action can be fines for the corpo- ration and fines or jail sentences for individuals. For example, individuals who conspire to fix prices or rig bids can be charged with a felony and, if found guilty, may be sentenced to jail—something to remember if you are planning to parlay your knowledge of microeconomics into a successful business career! Losing a civil action forces a corporation to cease its anti- competitive practices and often to pay damages.
2. Through the administrative procedures of the Federal Trade

Again, action can result from an external complaint or from the FTC’s own initiative. Should the FTC decide that action is required, it can either request a voluntary understanding to comply with the law or seek a formal commission order requiring compliance.

3. Through private proceedings. Individuals or companies can sue for treble (three-fold) damages inflicted on their businesses or property. The pros- pect of treble damages can be a strong deterrent to would-be violators. Individuals or companies can also ask the courts for injunctions to force wrongdoers to cease anticompetitive actions.

U.S. antitrust laws are more stringent and far-reaching than those of most other countries. In fact, some people have argued that they have prevented American  industry  from  competing  effectively  in  international  markets. The laws certainly constrain American business and may at times have put American firms at a disadvantage in world markets. But this criticism must be weighed against their benefits: Antitrust laws have been crucial for maintaining competition, and competition is essential for economic efficiency, innovation, and growth.

3. Antitrust in Europe

As the European Union has grown, its methods of antitrust enforcement have evolved. The responsibility for the enforcement of antitrust concerns that involve two or more member states resides in a single entity, the Competition Directorate, located in Brussels. Separate and distinct antitrust authorities within individual member states are responsible for those issues whose effects are felt largely or entirely within particular countries.

At first glance, the antitrust laws of the European Union are quite simi- lar to those of the United States. Article 101 of the Treaty of the European Community concerns restraints of trade, much like Section 1 of the Sherman Act. Article 102, which focuses on abuses of market power by dominant firms, is similar in many ways to Section 2 of the Sherman Act. Finally, with respect to mergers, the European Merger Control Act is similar in spirit to Section 7 of the Clayton Act.

Nevertheless, there remain a number of procedural and substantive differ- ences between antitrust laws in Europe and the United States. Merger evalua- tions typically are conducted more quickly in Europe, and it is easier in practice to prove that a European firm is dominant than it is to show that a U.S. firm has monopoly power. Both the European Union and the U.S. have been actively enforcing laws against price fixing, but Europe imposes only civil penalties, whereas the U.S. can impose prison sentences as well as fines.

Antitrust enforcement has grown rapidly through the world in the past decade. Today, there are active enforcement agencies in over one hundred countries. While there is no formal world-wide antitrust enforcement body, all enforcement agencies meet at least once each year through the auspices of the International Competition Network.

Source: Pindyck Robert, Rubinfeld Daniel (2012), Microeconomics, Pearson, 8th edition.