Does Big Business Need Taming?
Neely, Michelle Clark, Regional Economist
The Role of Economics in Antitrust Law
Antitrust authorities in Washington and the states have been busy in the past several years scrutinizing megamergers in the banking, communications and defense industries, among others. As the number of competitors in certain markets dwindles, the potential combination of former rivals raises concerns about market concentration and the consequent implications for consumers and other firms.
But mergers aren't the only business activities that have drawn regulators' attention of late. Antitrust authorities are also examining allegations of exclusionary actions-like predatory pricing, exclusive dealing and tying arrangements-in a host of industries and firms. This stepped-up action by regulators has put them on the hot seat because they're taking on some of the nation's best known and widely respected companies. Indeed, the recent antitrust suits filed against Microsoft by the Department of Justice and 20 state attorneys general promise to generate renewed debate about the role government has in ensuring a competitive marketplace. Because the application of antitrust law relies heavily on economic principles and analyses of potential outcomes, it's worthwhile to take a look at what economists have to say about the structure and operation of American business.
Antitrust economics is part of a branch of economics known as industrial organization, which attempts to explain the structure and competitive behavior of firms and industries. When economists talk about the structure of any industry, they are generally referring to the number of firms that provide products or services to a given market; the barriers to entry for new firms; and the degree of product differentiation.
The structure of an industry selling a homogeneous, or similar, product or service can be described in one of three ways: 1) perfectly competitive (no barriers to entry, many sellers with no pricing power); 2) oligopolistic (barriers to entry, a few sellers with some pricing power); or 3) a pure monopoly (barriers to entry, one seller with complete pricing power).1 More recently, economists have also defined a structure called the dominant firm with a competitive fringe, which consists of a single firm with a large market share and some pricesetting power that competes with smaller, price-taking firms.2 Examples of dominant firms are IBM in the market for mainframe computers and Kodak in the photographic film market.
Since it is the exercise of monopoly or market power that is problematic, economists and policymakers are more concerned about the way firms in an industry behave than the structure of the industry per se. Indeed, in some circumstances, a monopoly structure yields the most efficient, socially desirable outcome. Natural monopolies are one example. They occur in markets in which additional output can be produced at a lower per-unit cost, such as the public utility industries. Monopolies are even encouraged in other types of markets.3
According to the nation's antitrust laws, a monopoly is not-strictly speaking-illegal. Rather, the laws are used primarily by federal authoritiesthe Department of Justice and the Federal Trade Commission (FTC)both to rein in firms that exercise excessive market power and to limit the way in which firms compete with one another.
Antitrust officials are guided by three major federal statutes: the Sherman Act of 1890, the Clayton Act of 1914 and the Federal Trade Commission Act of 1914. Section 1 of the Sherman Act prohibits restraint of trade. On its surface, the more widely invoked Section 2 of the act appears to outlaw monopoly outright ("every person who shall monopolize or attempt to monopolize.... shall be deemed guilty of a felony"). The courts, however, have interpreted the act less literally, saying that it merely forbids monopolistic behavior.
The Clayton Act is more specific than the Sherman Act; it describes the type of conduct and practices that will get a firm (or group of firms) into trouble. …