Controversies Over Antitrust Policy

Over time, much controversy has centered on the question of what kinds of behavior the antitrust laws should prohibit. Most commentators agree that price-fixing agreements among competing firms should be illegal. Yet the antitrust laws have been used to condemn some business practices whose effects are not obvious. Here we consider three examples.

Resale Price Maintenance One example of a controversial business practice is resale price maintenance, also called fair trade. Imagine that Superduper Electronics sells VCRs to retail stores for $300. If Superduper requires the retailers to charge customers $350, it is said to engage in resale price maintenance. Any retailer that charged less than $350 would have violated its contract with Superduper.

At first, resale price maintenance might seem anticompetitive and, therefore, detrimental to society. Like an agreement among members of a cartel, it prevents the retailers from competing on price. For this reason, the courts have often viewed resale price maintenance as a violation of the antitrust laws.

Yet some economists defend resale price maintenance on two grounds. First, they deny that it is aimed at reducing competition. To the extent that Superduper Electronics has any market power, it can exert that power through the wholesale price, rather than through resale price maintenance. Moreover, Superduper has no incentive to discourage competition among its retailers. Indeed, because a cartel of retailers sells less than a group of competitive retailers, Superduper would be worse off if its retailers were a cartel.

Second, economists believe that resale price maintenance has a legitimate goal. Superduper may want its retailers to provide customers a pleasant showroom and a knowledgeable sales force. Yet, without resale price maintenance, some customers would take advantage of one store's service to learn about the VCR's special features and then buy the VCR at a discount retailer that does not provide this service. To some extent, good service is a public good among the retailers that sell Superduper VCRs. As we discussed in Chapter 11, when one person provides a public good, others are able to enjoy it without paying for it. In this case, discount retailers would free ride on the service provided by other retailers, leading to less service than is desirable. Resale price maintenance is one way for Superduper to solve this free-rider problem.

The example of resale price maintenance illustrates an important principle: Business practices that appear to reduce competition may in fact have legitimate purposes. This principle makes the application of the antitrust laws all the more difficult. The economists, lawyers, and judges in charge of enforcing these laws must determine what kinds of behavior public policy should prohibit as impeding competition and reducing economic well-being. Often that job is not easy.

Predatory Pricing Firms with market power normally use that power to raise prices above the competitive level. But should policymakers ever be concerned that firms with market power might charge prices that are too low? This question is at the heart of a second debate over antitrust policy.

Imagine that a large airline, call it Coyote Air, has a monopoly on some route. Then Roadrunner Express enters and takes 20 percent of the market, leaving Coyote with 80 percent. In response to this competition, Coyote starts slashing its fares. Some antitrust analysts argue that Coyote's move could be anticompetitive: The price cuts may be intended to drive Roadrunner out of the market so Coyote can recapture its monopoly and raise prices again. Such behavior is called predatory pricing.

Although predatory pricing is a common claim in antitrust suits, some economists are skeptical of this argument and believe that predatory pricing is rarely, and perhaps never, a profitable business strategy. Why? For a price war to drive out a rival, prices have to be driven below cost. Yet if Coyote starts selling cheap tickets at a loss, it had better be ready to fly more planes, because low fares will attract more customers. Roadrunner, meanwhile, can respond to Coyote's predatory move by cutting back on flights. As a result, Coyote ends up bearing more than 80 percent of the losses, putting Roadrunner in a good position to survive the price war. As in the old Roadrunner-Coyote cartoons, the predator suffers more than the prey.

Economists continue to debate whether predatory pricing should be a concern for antitrust policymakers. Various questions remain unresolved. Is predatory pricing ever a profitable business strategy? If so, when? Are the courts capable of telling which price cuts are competitive and thus good for consumers and which are predatory? There are no easy answers.

Tying A third example of a controversial business practice is tying. Suppose that Makemoney Movies produces two new films—Star Wars and Hamlet. If Makemoney offers theaters the two films together at a single price, rather than separately, the studio is said to be tying its two products.

When the practice of tying movies was challenged in the courts, the U.S. Supreme Court banned the practice. The Court reasoned as follows: Imagine that Star Wars is a blockbuster, whereas Hamlet is an unprofitable art film. Then the studio could use the high demand for Star Wars to force theaters to buy Hamlet. It seemed that the studio could use tying as a mechanism for expanding its market power.

Many economists, however, are skeptical of this argument. Imagine that theaters are willing to pay $20,000 for Star Wars and nothing for Hamlet. Then the most that a theater would pay for the two movies together is $20,000—the same as it would pay for Star Wars by itself. Forcing the theater to accept a worthless movie as part of the deal does not increase the theater's willingness to pay. Makemoney cannot increase its market power simply by bundling the two movies together.

Why, then, does tying exist? One possibility is that it is a form of price discrimination. Suppose there are two theaters. City Theater is willing to pay $15,000 for Star Wars and $5,000 for Hamlet. Country Theater is just the opposite: It is willing to pay $5,000 for Star Wars and $15,000 for Hamlet. If Makemoney charges separate prices for the two films, its best strategy is to charge $15,000 for each film, and each theater chooses to show only one film. Yet if Makemoney offers the two movies as a bundle, it can charge each theater $20,000 for the movies. Thus, if different theaters value the films differently, tying may allow the studio to increase profit by charging a combined price closer to the buyers' total willingness to pay.

Tying remains a controversial business practice. The Supreme Court's argument that tying allows a firm to extend its market power to other goods is not well founded, at least in its simplest form. Yet economists have proposed more elaborate theories for how tying can impede competition. Given our current economic knowledge, it is unclear whether tying has adverse effects for society as a whole.

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