What is Antitrust Law Really About?

Antitrust law has been around for over a century in the United States. On a broad level, everyone seems to know the purpose of antitrust law: to stop big companies from being too powerful.

However, on a more specific level, no one seems to know how to enforce it. Well, that’s not quite correct either. Everyone seems to think they know how to enforce it, but none of these people agree with one another. Let’s see if we can work ourselves through it.

Let’s start with the big picture stuff. If you ask people what antitrust law is really all about, you will likely get an answer about how it is really just a policy to deal with monopolies. This is plausible, and possibly even correct, on some level. If antitrust law is about the problem created by monopolies, we need to go a step deeper to understand what problem that monopolies create and how we might counteract that problem with policy.

The textbook problem with monopoly is that if the firm sets a uniform price, its profit-maximizing quantity of production is less than what would be produced in a competitive market. The reason this creates an inefficiency is as follows. A profit-maximizing firm will produce until its marginal revenue is equal to its marginal cost. Since a monopolist faces a downward-sloping demand curve, its marginal revenue will always be below the price that the marginal buyer is willing to pay. Taken together, this implies that the uniform monopoly price is associated with some mark-up over marginal cost. In a competitive market, price is equal to marginal cost. Thus, when it comes to monopolies, there are potential gains from trade to be had that are foregone. For example, some consumers will have a willingness to pay that is between the uniform price and the marginal cost of production. Thus, they would be willing to pay an amount greater than what it costs to produce the good — a mutually beneficial trade. Nonetheless, the monopolist that charges a uniform price rationally chooses to forgo this trade because doing so would require lowering the price for everyone and reducing its profit.

To some extent, this is really just a problem of uniform pricing, not monopoly. As Brian pointed out in a previous post, price discrimination (or perhaps more appropriately, marginal revenue equalization) can improve the market output. By charging different prices to different people, more trade can take place than under uniform pricing. But let’s ignore price discrimination for now and focus just on the problem of monopolies using uniform pricing.

What we have established is that the textbook problem with monopolies is that they do not produce enough. If antitrust law is really about the monopoly problem, then one would expect that the law would aim to fix this specific problem. An optimal policy against a uniform-price monopoly would be for the government to outlaw price discrimination, subsidize the identified monopoly to induce it to produce the efficient quantity of output, and then collect a lump sum tax approximately equal to the monopoly profits.

If that is the problem antitrust is solving, antitrust would be easy.

But does that sound like antitrust law to you? No?

In reality, antitrust law seems to be about something else. The Sherman Antitrust Act, passed in 1890, forbids, “every contract, combination, or conspiracy in restraint of trade” and “monopolization, attempted monopolization, or conspiracy or combination to monopolize.”

In 1914, two additional acts were passed. The Federal Trade Commission Act and the Clayton Act. In addition to creating the Federal Trade Commission, the Federal Trade Commission Act banned “unfair methods of competition” and “unfair or deceptive acts or practices.” The Clayton Act prohibits mergers and acquisitions that “may be substantially to lessen competition, or tend to create a monopoly.”

On the one hand, it seems clear that the law has something to do with monopolies and their business practices, but does this have anything to do with the textbook model? It doesn’t really seem like it. Also, enforcement of this legislation would seem like a lot of work to deal with the problem of monopoly when the government could just implement the subsidy-and-lump-sum-tax scheme that I already described.

Would we really want to forbid “every contract … in restraint of trade”? I think a reasonable person would say the answer is no. Virtually all contracts could be thought of in some way as restraining trade. “Unfair methods of competition” and “unfair or deceptive acts or practices” are similarly vague. What is fair? Fair for whom? And who gets to decide? Apparently, the courts get to decide. At least that is how things have worked for the past century in the United States.

Before getting to the courts, let me speculate on why there seems to be this difference between the textbook model and the language of the law.

I think it is important to note that the law is referred to as “antitrust” law and not “antimonopoly” law. It seems important that Teddy Roosevelt ran a campaign that promised “trust-busting” rather than “monopoly-busting.” To me, this suggests that antitrust law was really about limiting predatory and collusive behavior of the infamous trusts during the period. In some cases, this might involve going after firms for out-of-equilibrium behavior. However, it certainly requires defining the sorts of behavior that need to be discouraged.

The trouble for the courts is the vague nature of the law and the fact that the sorts of behavior that are prohibited do not always have harmful effects. For example, it is not hard to think of circumstances in which exclusive dealing between firms could be harmful. However, as Brian discussed in his post on exclusive dealing and as Kevin Murphy discusses, there are reasons to believe that exclusive dealing can actually be beneficial. This should give one pause about the way in which these laws are enforced.

If you read antitrust law (who doesn’t?!), a lot of the rulings — especially the early ones — appear to be all over the place in terms of the criteria for evaluating violations and interpreting the law. Not only does the textbook model not make sense of these rules, no one seems to be able to make sense of these rules.

What seems to have emerged, with the help of economists and legal scholars, as a way to determine whether or not a firm has violated the law is the consumer welfare standard. According to this view, the actions of a particular firm should be judged based on the influence that their actions have on consumers, rather than some evergreen problem with big companies.

The consumer welfare standard seems to have arisen out of a desire to rationalize and articulate a coherent interpretation of the law. As I said, the law is vague and seems to have been aimed at the particular harmful practices of the trusts.

If there is only one unifying theme that seems to connect the law to economic concepts, it is that the law seems to want to discourage costly commitments to actions that are socially wasteful.

But how can we determine what is wasteful? Is it wasteful for Coca-Cola to pay Walmart for a prominent display in their stores? After all, doesn’t that just help Coca-Cola at the expense of, say, Pepsi? Or does the ability of firms to pay for these prominent displays actually produce more competition among firms? The common theme that has emerged is to determine whether consumers benefit or are harmed by this type of action. The logic is that if the consumer is harmed, then this is a wasteful action since it only benefits the firm at the expense of others.

Costly battles over the distribution are wasteful because they are negative sum games. If on the other hand, the consumer and the firm benefit, then it is hard to argue that the firm’s actions are wasteful. In fact, since the textbook problem of monopoly is the foregone gains from trade, actions that benefit both the firm and the consumer are a step toward eliminating the inefficiency. These sorts of actions do not seem like the sorts of things that were intended to be punished by the law and that seems to be why the consumer welfare standard emerged as the rationale for enforcement. It is a coherent framework for interpreting and enforcing the law.