Monopolization law is most commonly applied to dominant firms. Examples include IBM, Microsoft, Eastman Kodak, Boeing, Xerox, Gillette, etc. Historical Cases: Standard Oil, U.S. Steel, Alcoa, IBM.

Monopolization: Section 2 of the Sherman Antitrust Act. "Every person who shall monopolize, or attempt to monopolize, or combine or conspire … to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be deemed guilty of a felony."

• Monopolization is illegal
• Attempted monopolization is illegal
• Conspiracy to monopolize is illegal

Grinnell Case (1966): "The offense of monopoly under section 2 of the Sherman Act has two elements: (1) the possession of monopoly power in the relevant market, and (2) the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident."

Monopolization is the exercise of monopoly (or market) power. Indication of monopoly power is given when price is elevated above marginal cost, as given in the Lerner Index:

MR = dTR/dQ = P(Q) + [dP(Q)/dQ]*Q = P*[1 - (1/Ed)] …note: Ed > 0

From profit maximization, MR = MC

(P-MC)/P = 1/Ed

The left-hand side of the equation above is known as the Lerner Index, and indicates market power.

Note that monopoly is a type of market structure. A firm can achieve a monopoly or dominant position by having a superior product or method of production, and "the successful competitor, having been urged to compete, must not be turned upon when he wins." [Alcoa case]

Key Problem: How to distinguish the acquisition and maintenance of monopoly from superior product/production vs. anti-competitive activities such as predatory pricing, conspiracy, etc.

Real World: In the U.S. we don't have pure monopolies with blockaded entry, instead we have more oligopolistic market structures where firms with dominant market shares must contend with imperfect substitute products made by rival firms.

Thus whether or not a firm has a "dominant" share of a market depends critically on how we define markets. A classic case is given by U.S. v. DuPont (1956) - the cellophane case.

The question was whether or not cellophane represented its own market, or whether one should also include other types of flexible food wrapping materials such as wax paper and foil. If the market were just cellophane, then DuPont would have had a 75 percent market share and would probably have been found guilty of monopolization at that time. The court ruled that the relevant market should include other products that are reasonably interchangeable, and thus included wax paper and foil (reducing DuPont's share to 18 percent).

In addition to demand substitutes (which determines the relevant antitrust product market) one should also look at supply substitutes, including firms currently producing the product that can expand their capacity, firms that are currently producing non-substitutes that can switch to producing the product or a close substitute, or entry by new producers.

Key Cases:

Standard Oil (1911): Organized by the Rockefellers. Found guilty of monopolization. Broken up into 33 geographically distinct companies.

How did the Rockefellers build Standard Oil?

Accused of:

• Engaging in predatory pricing to drive competitors out of business (P < AC (variable or total) to drive competitors out, then raise price above ATC to recoup losses). Chain store paradox… Case: Matsushita v. Zenith (1986)… But predatory pricing may make more sense in an acquisition, where the loss period is much foreshortened. Celler-Kefauver Amendment to the Clayton Act section 7 no longer allows the creation of monopoly through horizontal merger.
• Buying key input suppliers (pipeline companies) to foreclose intermediate good markets to rival oil companies.
• Using their dominant bargaining position to negotiate discriminatory rail freight rates.
• Engaging in business espionage.

Court (1911): Crime of monopolization requires two elements: (1) Monopoly position (market structure), and (2)

Evidence of intent to acquire that monopoly position (through anticompetitive actions).

U.S. Steel (1920): Formed in 1901 through mergers giving the firm a 65 percent market share. Chairman of the Board of U.S. Steel, Judge E. H. Gary, used to host dinner meetings called the "Gary Dinners" with the CEO/CB of major rival firms. These dinners were designed to stabilize prices and create good will among the "rivals." Rivals never sued U.S. Steel, which provided industry price leadership (which ultimately eroded their market share to 52 percent by 1915). Court found U.S. Steel not guilty. Even if the firm had (1) a monopoly position, evidence did not suggest that (2) it had not exercised that position through market power.

This position was later reversed by a different court reversed the U.S. Steel interpretation in the Alcoa case. Judge Learned Hand found Alcoa guilty based only on (1).

After its patents on the electrolytic process of smelting aluminum from alumina (chemically extracted from bauxite ore) ran out in 1909, Alcoa was somewhat protected from entry by new firms because of high tariffs on imported bauxite, because Alcoa bought up most of the U.S. bauxite ore bodies and hydroelectric power sites. They may have also engaged in limit pricing, which also had the effect of leading to large output volumes and the rapid development of scrap supply rivals.

In the 1940s, Alcoa had 33 percent of the aluminum production market when that market included both primary and secondary and imported supplies. They had a 64 percent share of that market if their own purchases of aluminum (for fabrication) was added to their own production, and they had a 90 percent market share if their output + purchases were relative to a market defined solely on primary aluminum (and imports)

The judge picked the last definition, in part because he recognized that through its near-monopoly on primary production it indirectly controlled the secondary supplies.

The judge further asserted that illegal monopolization should be found unless the firm "cannot avoid" the control of the market (its monopoly position is compelled upon it, perhaps in war-time?), which is a very difficult test to pass.

Remedy: WW-II government-owned plants (potlines) sold to create Kaiser and Reynolds.

United Shoe Machinery Case (1953): USM had between 75 and 85 percent of the shoe fabrication machinery market in the U.S. USM would not sell its machinery to shoe manufacturers-it leased them on 10-year leases. Lessees had to agree to use USM if additional equipment was needed, and USM provided free maintenance, which the court saw as being a type of entry barrier. Remedy: removal of restrictive elements of the lease agreement.

More Modern Cases

IBM: Justice Dept stopped prosecuting in 1982.

Berkey-Kodak 1979: Did Kodak have a duty to reveal its new 110 Pocket Instamatic photograpic system (which required a new type of film) to rival film and photofinishing suppliers? Court said no. There is no duty for a firm to reveal strategically valuable information on a superior new product to its rivals, since doing so reduces the incentive for innovation that drives our economic system.

Breakfast Cereals (1981): Novel approach of "shared monopoly." C-3 was 81 percent. FTC argued that the firms engaged in certain interdependent acts and practices in order to achieve a highly concentrated, noncompetitive market structure and shared monopoly power.

Brand proliferation: The big three created 150 brands between 1950 and 1970, and FTC argued that that "left no room" in product space for new entrants. Like limit-entry pricing, the idea behind a brand proliferation strategy is that insufficient "product type space" is left to make entry profitable, given that entry involves a set amount of sunk promotional costs.

FTC administrative law judge argued that brand proliferation is a legitimate business practice. Case dismissed.

Predatory Pricing: Pricing below AC (total or variable) with the intent of driving out rivals (presumably with shallower pockets), thence raising price above AC to recoup losses and enjoy market power.

Legal/economic tests for predatory pricing….

Areeda-Turner Rule (1975):

a. A price at or above AVC should be presumed lawful

b. A price below AVC should be presumed unlawful

Explain the economic logic behind the Areeda-Turner rule? Why do you think Justice Breyer argued in favor of the rule?

Joskow-Klevorick Two-Stage Rule (1979):

Stage 1: Examine the market structure to determine if predation is likely to be successful. Focus on entry/exit costs.

Stage 2: Do one or more of the following tests: P < AVC; determine whether the following scenario occurred: price cut, exit by rival, price rise (within 2 years of exit) unaccounted for by a rise in cost or demand; See Matsushita case…

Compare J-K rule v. A-T rule.

ATC Two-Step Rule (Greer):

Step 1: Establish whether P < ATC

Step 2: Establish substantial evidence of predatory intent, such as

• P < AVC
• Documents revealing intent
• Dixit-style excess capacity

What is your sense of the ATC rule? Is it more or less favorable to defendants relative to the A-T or the J-K rule?

Output-Restriction Rule (Williamson, 1977): Predatory pricing should be evaluated as a long-run strategy. Williamson evaluates predation from the perspective of a dominant firm's response to entry.

Output Restriction Rule: After entry, the dominant firm cannot increase output above the preentry level. Why? Think of Cournot-in a normal rivalry, entry results in a reduction in Q. If instead an incumbent firm were to expand Q, that indicates predatory intent a la Dixit.

Price Discrimination and the Robinson-Patman Act (1936):

Standard 3^rd degree PD (market segmentation) reduces total surplus for the case of linear demand.

PD that has the effect of substantially lessening competition or creating a monopoly is illegal under section 2 of the Clayton Act. Thus most forms of PD are not illegal themselves, though the market power required to exercise PD is illegal under section 1 of the Sherman Act. The original Clayton Act exempted PD in the form of quantity or volume discounts.

In 1936, under pressure from "mom & pop" grocery stores, Congress passed the Robinson-Patman Act (RPA), which amended section 2 of the Clayton Act.

• The RPA extended antitrust to indirect PD such as credit terms, delivery times, quality, etc.
• The RPA included PD in the form of volume discounts.

1. Primary Line Injury: Seller practicing discrimination harms its rivals in a predatory manner. Key case: Utah Pie (1967). Charged that Continental Baking, Pet, and Carnation, all producing pies in California, were charging less for their pies in Utah than in markets closer to their California plants, once Utah pie entered the market in Utah. Court found for Utah Pie, though Justice Stewart dissented, arguing that the consumer benefited from lower prices and increased competition in Utah.

2. Secondary Line Injury: Seller gives preferential treatment to select buyers, who then use this cost advantage to harm its rivals. Key case: Morton Salt (1948). Morton gave volume discounts to buyers. Thus big chain grocery stores got the lowest wholesale prices. Court found against Morton based on the RPA.

RPA has been characterized as protecting (small) competitors rather than the competitive process. FTC and DoJ do not currently enforce the RPA.