Class 15 Whiteboard Antitrust, Fall, 2012 Horizontal Mergers Randal C. Picker Leffmann Professor of...

Class 15 WhiteboardAntitrust, Fall, 2012

Horizontal MergersRandal C. PickerLeffmann Professor of Commercial Law

The Law School

The University of Chicago773.702.0864/[email protected] © 2000-12 Randal C. Picker. All Rights Reserved.

April 18, 2023 Copyright © 2000-12 Randal C. Picker 2

Decisions According to an Economist

Maximize Utility Subject to Constraints U(x1,x2,x3, … xn) Subject to p1x1 + p2x2 + p3x3 + … + pnxn

= B Xi’s are amounts of each good in the market

place Pi’s are prices B is amount of money to spend


Buying Diet Cola

Assume Two relevant goods: Diet Coke and Diet

Pepsi General Form of Utility Function

U(x1,x2) = s(a1x1 + a2x2) Consumer will spend B on the two products

Budget constraint given by p1x1 + p2x2 = B B = $10 (set arbitrarily)


Buying Diet Cola

Three Versions of the Demand Function The Diet Coke Lover

a1 = 1, a2 = 0• Will never buy Diet Pepsi at any price

The Diet Pepsi Lover a1 = 0, a2 = 1

• Will never buy Diet Coke at any price


Buying Diet Cola

Brand Doesn’t Matter a1 = 1, a2 = 1

• Either one works and will just buy the cheapest


Demand: DC by DC Lover

Demand Curve

10

10

P

Q

Independent of pDP


Demand: DP by DP Lover

Demand Curve

10

10

P

Q

Independent of pDC


Demand: DC by Indifferent

Demand Curve

10

10

P

Q

When pDP = 2



Demand Curve

10

10

P

Q

When pDP = 5


Substitutes

Definition Goods for which demand curve of the first

depends on the price of the second Here

DC and DP aren’t substitutes (at all) for two of our consumers

Perfect substitutes for the third


Cost Conditions and Extent of Competition

Introduce Costs Assume no fixed costs Marginal cost of making DC = 2 Marginal cost of making DP = 5

Competitive Structure Assume both produced competitively so P =

MC


Demand: DC by DC Lover

Demand Curve

10

10

Marginal Cost2

P

Q

Independent of pDP


Demand: DP by DP Lover

Demand Curve

10

10

Marginal Cost5

P

Q

Independent of pDC



Demand Curve

10

10

P

Q

When pDP = 5

Marginal Cost2


Results

10 units of DC at $2, 2 units of DP at $5 DC lover buys 5 units at market price of $2 DP lover buys 2 units at market price of $5 Brand indifferent compares price of DC ($2)

with price of DP ($5); buys no DP and buys 5 units of DC at $2


Results

Social Welfare Add utilities of the the three types,

assuming that utilities are measured in dollars

Subtract cost of production Here

5s + 2s + 5s – (10 x 2) – (2 x 5) 12s - 30


The Mission

What We Can’t See Utility functions

What We Can See Behavior changes in response to price

changes


Try It

Assume MC of Making DP Drops from $5 to $4: What Happens?


Results

DC Lover No change

DP Lover Buys more DP; buys 2.5 units rather than 2

Brand Indifferent Price of DP above price of DC still No change


Results

Social Welfare 5s + 5s + 2.5s – (10 x 2) – (2.5 x 4) 12.5s – 30

Cross-Elasticity and Markets The price of DP dropped: what happened to

sales of DC?


Results

No change in DC sales No substitution Not in same market?


Next Change

Unilateral Cost-Unrelated Price Increase in DC Price of Diet Coke rises from $2 to $5 Price of Diet Pepsi still at $4

What happens?


Results

DC Lover Reduces consumption of DC from 5 units to

2 units; buys no DP DP Lover

Still buys 2.5 units of DP; 0 units of DC Brand Indifferent

Price of DC 5 exceeds price of DP 4 Stops buying 5 units DC, buys 2.5 units DP


What Does this Mean?

We have seen substitution We can calculate a cross-elasticity of

demand DP sales increased 2.5 units with an

increase in the price of DC from $2 to $5 Are DP and DC in the same market? What

can we say about “market power”?


Calculating Market Shares

Volume of Diet Pepsi (2.5 x Number of Diet Pepsi Lovers + 2.5 x

Number of Brand Indifferent) x Price of Diet Pepsi

Volume of Diet Coke 5 x Number of Diet Coke Lovers x Price of Diet

Coke Market Share of Diet Coke: Vol DC / (Vol DC +

Vol DP)


Evaluating Substitution

Are DC and DP Substitutes? Depends on prices of related products Not when one product has a cost-

advantage over the other (first example) But exercise of pricing power as to DC

induces substitution between DC and DP


The Cellophane Fallacy

Price Determines Scope of Substitution Whether products are perceived as

substitutes is a function of price. High prices—monopoly power—expand the number of goods that will serve as substitutes.

Actual behavior, given monopoly power, would suggest a broader definition of the market than might be appropriate.


The Harm of Monopoly Again

Substitution may mitigate reduction in output Need to focus not only on reduction in DC

output but increase in consumption of substitutes

If MC of DC = 2 and MC of DP = 2 and no market power in DP market, Brand Indifferent could switch over completely and drop in DC sales would overstate harm

Class 15 Whiteboard Antitrust, Fall, 2012 Horizontal Mergers Randal C. Picker Leffmann Professor of...

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