Public Policy in Private Markets

Public Policy in Private Markets Collusion

Announcements • HW: • HW 2, due 2/28 (posted); HW 3 due 3/6 (day of 1st debate) • Reading assignments: • K&W 10 & 11 for next week (2/21, 2/23) • K&W 9 (4th edition) for the following week (2/28, 3/1) - posted

What does this mean from an economics/public policy angle? • Size of the company and nature of business • Large amount of time connected to the network • Revelation of individual preferences • Revelation of connections • Business opportunities: • On-line advertising, games, dating, etc. • Sales: music, video, clothing, etc. • Search engine? • Antitrust concerns: • Dominance of company = abuses? • US (2011), EU (2012): privacy concerns

Overview of Antitrust Laws

Sherman Act, Section 1 • Collusive restraints of trade “Every contract, combination, … or conspiracy in restraint of trade or commerce among the several states, or with foreign nations is hereby declared illegal. Every person who shall make any such contract … shall be deemed guilty of a misdemeanor and … shall be punished by fine … or by imprisonment … in the discretion of the court”

Sherman Act, Section 1 • “Every contract” - PER SE RULE, no room for “but…” • Key question: Did you collude? • Caveat: if there is absence of explicit contract (or agreement) – per se rule can’t be applied

Recap of Chapters WJ Ch 9 & 10 • Why is the prisoner’s dilemma game a useful way to think about incentives to collude? • How do factors such as cost structures, product differentiation, elasticity of demand, and frequency of sales affect the likely success of collusive agreements?

Prisoner’s Dilemma Action by Westinghouse • (C,C) highest joint profits • Incentive to deviate (Collusion is unstable) • (D,D) is the equilibrium (it is a safer location too) Action by GE

Factors Facilitating Collusion • Identical costs across firms (e.g. sugar vs. cars) • Different costs = different prices • No product differentiation (e.g. vitamins) • Different products = different prices • Few firms / high concentration • Fewer firms = easier to coordinate and monitor

Factors Facilitating Collusion • Slow rate of technological advance • Little change in products = easier coordination • Steady rate of demand growth • Unstable demand = harder price coordination • Low elasticity of demand • This means less substitutes, more price control, more market power • Low frequency of sales • Prices of frequent sales (e.g. daily) are more difficult to monitor & are more disruptive to cartel

Interpretation of Section 1 • Judicial interpretation of section 1 takes its shape from three key decisions: • U.S. v. Addyston Pipe & Steel (1899) • U.S. v. Trenton Potteries, et al (1927) • U.S. v. Socony-Vacuum Oil, et al (1940)

U.S. v. Addyston Pipe & Steel (1899) • 6 pipe makers: coordinated who would get each municipality contract. • Avoid “cutthroat” price competition. • Defense: essential to avoid destructive price wars + prices were “reasonable” • Judge Taft: • Naked and ancillary price fixing. • Per se rule applied only to naked price fixing

U.S. v. Addyston Pipe & Steel (1899) • Ancillary price fixing: agreement not to engage in head-to-head competition • Naked price fixing: Main purpose is to fix prices, divide the market, or generally eliminate competition • What does this mean? RULE OF REASON

U.S. v. Trenton Potteries, et al (1927) • 23 suppliers of bathroom fixtures admitted to a price-fixing agreement • Tried to convince jury of reasonable prices • Jury returned a guilty verdict (held after appeal) • “The aim and result of every price-fixing agreement is . . . the elimination of one form of competition. The power to fix prices, whether exercised reasonably or not, involves the power to control the market.” • PER SE RULE, regardless of type of price fixing

U.S. v. Socony-Vacuum Oil, et al (1940) • 27 corporations + 56 individuals charged with fixing price of gasoline. • 16 companies and 30 individuals convicted • Federal judge instructs jury to apply a per se rule. • Conviction was overturned on appeal but reversed again by the Supreme Court • Justice Douglas: “Under the Sherman Act any combination formed for the purpose and with the effect of raising, fixing, pegging, or stabilizing the price of a commodity in interstate or foreign commerce is illegal per se.” • Per se rule confirmed (standard for 60+ years)

Collusive Restraints of Trade • Practices covered by Section 1: • Direct Agreements • To fix price • To Allocate markets • Geographically • By type of customer • Other Collusive restraints • Gray area (circumstantial evidence) • Conscious parallelism, trade associations, patent holders

Direct Agreements: price fixing • Conspirators agree on price • PER SE illegal since Trenton Potteries • But price fixing can also be achieved indirectly EXAMPLE 1: • Socony-Vacuum case: large firms had agreement with small refiners to buy excess supply • The price was thus kept (artificially) high in times of excess supply • Why was this illegal?

Example: indirect price fixing EXAMPLE 2 • Coupon case (1984) • 4 supermarkets in CT and MA • Conspiring to drop double coupons • Is this price fixing? • 4 firms pleaded Nolo contendere • Fines: Waldbaum ($400,000), Supermarkets General ($350,000). Total $830,000 • Court gave this out to consumers in coupons

Direct Agreements: price fixing

Direct Agreements • Market allocation • Geographic allocation is rare (easier to detect) • Bidders agree on who takes what: • Subcontract bid-rigging: unsuccessful bidders subcontract with successful one • Bid suppression: some conspirators agree not to submit a bid so that another conspirator can successfully win the contract. • Complementary bidding: some of the bidders bid an amount knowing that it is too high • Bid rotation: bidders take turns being the designated successful bidder

Direct Agreements • Market allocation • Types of bidding are not mutually exclusive Example 1: Electrical equipment industry (1950’s) • Combination of bid rotation and complementary bidding and geographic allocation • Based on the phases of the moon and regions: who occupies low bid (and where) during which weeks or phase of the moon • Government case first (criminal case), $2 mill. in fines, 7 executives in jail (30 days) • Private cases followed: $400 mill. in total treble damages

Direct Agreements • Market allocation Example 2: Insurance (Late 2004) • NY state cases (brought by NY attorney general) • Insurers: AIG, ACE, Hartford • Broker: Marsh & McLennan • Companies give insurance needs to broker • Broker gets bids but asks insurers for special commission (kick backs) to secure business • Broker asks for artificial bids to certain insurers so as to award bid to targeted insurer • Broker makes sure he gets largest kick back (not necessarily lowest price for customer)

Public Policy in Private Markets