A Primer in Antitrust Law and Policy
Version 1.3 (1/2009)
Hanno F. Kaiser*

This work is licensed under the Creative Commons Attribution 3.0 United
States License. To view a copy of this license, visit http://creativecommons.org/
licenses/by/3.0/us/ or send a letter to Creative Commons, 171 Second Street,
Suite 300, San Francisco, California, 94105, USA.
Contact me at: hanno [at] wobie.com

*.

For questions, comments, suggestions, etc. please email me at hanno [at] wobie.com or visit my website at
www.hannokaiser.com. As always, the views expressed herein are mine alone and do not contain legal advice.

1

Table of Contents
Building Blocks of Antitrust Law and Policy ................................................................3
A Stylized Economy ......................................................................................................3
Competition....................................................................................................................4
Perfect Competition and Monopoly ...............................................................................6
Profits... ........................................................................................................................10
A Simple Model ...........................................................................................................10
Exploitation: Limiting Competition Among the Participants ......................................12
Exclusion: Limiting Competition from Others ............................................................12
Upstream Foreclosure ................................................................................................14
Downstream Foreclosure ...........................................................................................14
The Antitrust Laws Protect “Competition, not Competitors” ......................................16
Taxonomy of Antitrust Offenses ...................................................................................18
Section 2 of the Sherman Act ......................................................................................18
Section 1 of the Sherman Act ......................................................................................20
Section 7 of the Clayton Act ........................................................................................21
Application of the Federal Antitrust Laws...................................................................23
Price Fixing and Competitor Collaborations..............................................................23
Exclusive Dealing, Tying, and other Vertical Restraints ...........................................24
Interbrand Restraints: “Don’t sell my rival’s products” ...........................................24
Interbrand Restraints: “Don’t sell my widget for less than $10.” ............................25
Vertical Integration ....................................................................................................27
Predatory Pricing ........................................................................................................27
Taxonomy Chart ..........................................................................................................28
Market Power Revisited ................................................................................................30
Relevant Product Market Definition ............................................................................32
Relevant Geographic Market Definition ......................................................................34
Market Participants and Market Shares .......................................................................34
Market Concentration Measures ..................................................................................35
Putting it All Together: An Example ...........................................................................38
Theory and Practice .....................................................................................................39
Where to Go From Here? ..............................................................................................40

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I. Building Blocks of Antitrust Law and Policy
1. A Stylized Economy
In economic terms, the “wealth of a nation” consists of the goods and services (“goods”) that
fulfill the consumer’s immediate and future wants. Increasing wealth means expanding the
quantity, quality, and variety of consumer goods. As most goods do not exist in usable form (for
example, bauxite or iron ore), they have to be transformed from raw materials to consumer goods
in order to be usable. The basic purpose of economic activity is just that, turning unfinished, unusable goods into finished, usable goods.
The actors performing that transformation are firms, defined as arrangements of production
factors, land, labor, and capital, organized for the purpose of bringing finished goods (one step
closer) to the consumer. The production factors derive their value from the value of the ultimate
consumer good; therefore, ownership of production factors is also wealth, because land, labor,
and capital contribute to fulfill future wants. Most goods move through various stages of production before they reach the consumer, for example, prospecting, drilling, refining, manufacturing,
wholesale, and retail. At each stage of production, the value of the good increases, measured in
units of currency (for example, dollars or euro), as it moves closer to a usable state. Once the
good reaches the consumer, its value is quite literally consumed in the satisfaction of the consumer’s wants, either immediately, for example, a slice of pizza, or over time, for example, a
movie ticket or a car. Note that, while goods travel downstream, money travels upstream – and
back to the consumer at every stage of the process in the form of wages.
The multi-layered economic transformation process requires both cooperation and competition among the participating firms. Broadly speaking, firms cooperate vertically across stages of
production and compete horizontally within stages of production. For example, manufacturers
enter into distribution agreements with wholesalers (cooperation) and compete with other manufacturers. Competition and coordination are thus not unrelated as competition is often competition for cooperation. For example, manufacturers compete for the contracts with the best wholesalers, and retailers compete for sales to consumers.

3

Figure 1: Aggregate Production Structure
(1)

Time
S1

ey

Sn

ds

oo

G

Land
Labor
Capital

(2)

M
on

M1

M2

Mn

D1

D2

D3

Consumption

Dn
Value ($)

(1) Competition; (2) Cooperation
Based on M. Skousen, Economic Logic, 2000

At each stage of the process, firms seek to maximize profits. Profits, in this simplified model,
are the best indication that a firm is supplying something that consumers want more of. As profits are revenues minus costs, firms have incentives to maximize revenues (that is, increase the
quantity, quality, and variety of those products that consumers want) and decrease costs (that is,
increase efficiency by making more with less). Successful firms will earn above-average profits,
which investors will reward with additional capital for expansion and innovation; by the same
logic, unsuccessful firms will ultimately exit the marketplace, as profits dwindle and investors
will transfer their capital to more promising ventures, that is, ventures that better serve the customer's wants.1

2. Competition
A functioning market economy requires at a minimum (i) private property in rivalrous goods,
(ii) freedom of contract, including the freedom to organize firms, and (iii) competition. Competition creates the incentives for firms to increase (a) productive efficiency, i.e., to produce more
with less, (b) allocative efficiency, i.e., to deploy resources where the value placed on a good by
the consumer is greater than the cost of making it, and (c) dynamic efficiency, i.e., to invest in
innovation. Moreover, competition (d) disperses private power and thus protects the democratic
process and (e) smaller but efficient firms in the marketplace from being deprived of their freedom to compete by more powerful firms. As a result, competition ensures that, by and large, individual profit seeking is at least directionally aligned with the public interest, including the promotion of societal wealth, efficiency, and the democratic process. The Supreme Court described
the varied benefits of competition as follows:

1.

This sketch of the economic transformation process is based on Skousen, Economic Logic (2000).

4

The Sherman Act was designed to be a comprehensive charter of economic liberty
aimed at preserving free and unfettered competition as the rule of trade. It rests on the
premise that the unrestrained competitive forces will yield the best allocation of our
economic resources, the lowest prices, the highest quality and the greatest material
progress, while at the same time providing an environment conductive to the preservation of our democratic political and social institutions.2
The rules of competition are among the most basic marketplace design choices a society can
make.3 The antitrust laws reflect and protect those choices.
Figure 1a: The role of antitrust in promoting welfare

Welfare
Productivity,
Growth
Promotes allocative,
productive,
and dynamic efficiency

Ideological
commitment

Free market
system
Property

Contract

Competition

IP

Threatened
exploitative and
exclusionary
conduct by market
participants, rentseeking

Antitrust

The above chart locates the place of antitrust policy in this broader framework. The goal of
economic policy is maximizing welfare. For most goods, we believe that a free market system is
the best means to achieve that goal – better certainly than the alternatives to large scale coordination of production that have been tried and in large part failed: tradition and command and control.4 Antitrust protects a key element of free markets, competition, from being undermined by
2.
3.

4.

Northern Pacific Railway Comp., v. U.S., 356 U.S. 1, 4 (1958).
Here is not the place to discuss the various flavors of competition, e.g., perfect competition, workable competition, fair competition, rivalry, etc., which to a large extent follow from the emphasis placed on the goals of
competition.
This is not to say that social norms and command and control regulation do not have a place in an economic

5

market participants. In addition, antitrust protects the the moral legitimacy of the economic system by promoting competition as a condition of contractual fairness. The ultimate subject of
antitrust regulation is not individual transactions but markets, and the goal is to keep (or, more
ambitiously, to make) markets competitive. Buyer competition ensures seller choice, and under
conditions of meaningful seller choice, buyer—seller agreements can plausibly be presumed to
be not only efficient but also fair.5 Antitrust also protects the integrity of the legal system. The
operation of the legal system critically depends on its ability not to deal with certain problems.
For example, the legal system refuses to decide political questions. It refuses to settle scientific
or religious disputes. And it fights tooth and nail to stay out of the price setting business. In fact,
when it comes to the latter, the display of humility by the judiciary is quite remarkable. Why
such (self-) restraint? Because the legal system would quite literally overload and collapse if it
had to deal with price setting in all but the rarest of circumstances. The operation of the legal
system depends on prices being inputs, not outputs. Because the legal system is structurally coupled to the economic system through the institution of the contract, the law must insist on certain
minimal conditions of justice in the economic system’s price setting mechanism. The maintenance of competitive markets through antitrust regulation is one of those important self-restraint-enabling interventions of the legal system in the operations of the economic system. Only
as long as markets can plausibly be trusted to produce just results can the law simply transform
market results (prices) into enforceable obligations without fear of undermining its own legitimacy. The almost complete disengagement from substantive review at the transaction level requires
certain procedural oversight of the market process. Antitrust performs that supervisory role.

3. Perfect Competition and Monopoly
Under perfect competition every customer has an unlimited number of suppliers to satisfy
their demand. From a producer’s (P) viewpoint, demand is thus infinitely elastic. If P1 raises
price by just a cent above the market price, all of its customers will switch all of their purchases
to P2...Pn. Any price increase above the competitive price will therefore result in zero sales, zero
revenues, and zero profits. As a result, producers maximize profits by making all the units for
which there is a buyer who is willing to pay more than the costs of making the unit. Firms

5.

system. They most certainly do as unregulated markets have a tendency to undermine their own foundations
and self-destruct. The point is that as a default choice, free markets have proven to be far superior to tradition
and command and control in creating societal wealth. One of the primary advantages of free markets is that
the actors do not have to pay attention to much information beyond the cost of their inputs and the price of
their products. The market processes information in a distributed fashion, which dramatically reduces the internal complexity required by each individual node while enabling the system as a whole to quickly absorb
and react to changes. To what extent vastly improved central information processing at petabyte scale and beyond will make a partially planned economy viable again is open to debate. Moreover, alternative forms of
large scale productive coordination have emerged that fall neither into the market nor in the command and
control categories, for example the collaborative peer production that created the operating system, the word
processor, and the graphics tools used to write this document.
Here is an important, under-explored link between antitrust policy and social justice.

6

produce until price (or marginal revenue) equals marginal cost (P = MR = MC).6 In a perfectly
competitive market, the individual profit motive is aligned with the social welfare goal such that
maximizing individual profit has the effect of maximizing social welfare as well.7 Under perfect
competition, the only way to get rich is by serving others, not by exploiting them. The close
alignment of the individual profit motive with the promotion of social welfare is at the heart of
the hopeful creed of laissez-faire capitalism. Under perfect competition individual greed is indeed good for all.
Not so under monopoly conditions. Monopoly is the absence of competition, because a true
monopolist is the only seller of a good. Unlike a firm in a competitive market, the monopolist is
able to raise prices above the competitive level without losing all of its customers. The mechanism by which a monopolist raises price is by reducing output below the competitive level. The
resulting artificial shortage induces some customers, who would otherwise walk away emptyhanded, to bid up the price. The welfare effects from monopoly lend themselves to a simple
graphic representation.

6.

7.

If each and every customer has an unlimited number of suppliers to satisfy his or her demand for widgets, demand is infinitely elastic from a widget-supplier’s (S) point of view, because if S1 raises its price just a tiny
little bit above the market price, all of its customers will switch their entire purchases to widget makers S2..n.
In other words, any price increase above the competitive price will result in zero sales, zero revenues, and
zero profits.
Assuming for simplicity’s sake that all externalities are being fully internalized. In reality, that is not the case.
So even under perfect competition, individual profit and social welfare maximization are never perfectly
aligned.

7

Figure 2: Deadweight loss from foregone trades

p

A
pM
Effect

B

C

pC

MC

E

D
qM

qC

q

Cause

Under perfect competition, qC units are being produced at price pC. Assuming for simplicity’s sake that each customer purchases one unit, qC is also the number of buyers who get to buy
the goods. With the exception of the one buyer at the intersection of MC and qC, who values the
good exactly at price pC and is thus indifferent between buying the good or keeping her money,
all other buyers value the good more highly than the money that have to pay to get it. They are
all richer after they leave the store with their purchase than they were before. The areas C, B, and
A represent that consumer surplus, i.e., the difference between what the customers was willing to
pay (the subjective value of the good for the consumer) and what he or she had to pay to get the
good (the sales price, pC).
The monopolist, in contrast, reduces output from qC to qM. As a result, prices rise from pC
to pM. (Note that in economic diagrams, the cause is commonly drawn on the x-axis and the effect on the y-axis.) Now the customers located between qM and qC walk away empty handed,
they have been priced out of the market. Only those customers to the left of qM value the good
higher than pM and thus willing to pay pM or more. The first effect of monopoly pricing is
therefore a wealth transfer from consumers to producers. Under perfect competition, the consumers realize 100% of the profits from trade (areas A, B, C). The producers have zero profits,
and thus no area in the diagram.8 Under monopoly conditions, the producer gains area B as

8.

Zero profits include, by way of assumption, a normal rate of return on capital. In normal times that would
probably be somewhere around 5%.

8

producer surplus.9 Consumer surplus is reduced from areas A, B, and C to area A. Monopoly
pricing thus slices the pieces of the economic pie differently, with a larger slice for the producer
(B, instead of “nothing”) and a smaller slice for the consumer (A, instead of A, B, and C). But
that is not all, because area C disappears entirely under monopoly conditions.10 The cake, in other words, is not only sliced differently, but it also loses in absolute size, from A, B, and C to A
and B. Area C represents the “deadweight loss” of monopoly, that is, lost opportunities for welfare enhancing trades. Those customers between qM and qC are all willing to pay more than it
costs to make the goods (MC), they are just not willing to pay pM or more. In order to protect its
higher profits (B), the monopolist thus refuses to make efficient trades. The disconnect between
the individual profit incentive and social welfare is obvious.
Another effect of monopoly pricing is a reduction in cost from D + E to D. However, far
from mitigating the negative effects of monopoly, not using the inputs represented by E makes
the welfare loss worse, because now the inputs in area E will have to be put to less valued uses.
It gets worse once we take the effects of monopoly on innovation into account. Monopoly on
balance retards the incentives to innovate and thus reduces dynamic efficiency. On the one hand,
large firm monopolies are arguably better able to innovate. They can self-finance, spread the risk
across scale and scope, may have learning curve advantages and, maybe most importantly, have
no disclosure problem. Unlike small firms, large monopolies do not have to shop and disclose
their ideas to investors and venture capitalists whose compliance with non-disclosure agreements
may be less than absolute, in particular if they have already invested in similar firms. On the other hand, if a monopolist introduces a new invention in a related market, it replaces some of its
pre-invention monopoly sales. This replacement effect has time and time again cost successful
firms their edge. Firms without an installed base have much greater incentives to radically innovate. Lastly, monopolies tend to seek government protection (“rent seeking”) for their supracompetitive returns, for example by extending copyright retroactively. Lobbying is expensive, and
the money spent on influencing the political process is not available for productive investment.
Some economists have estimated that the cost to society from rent seeking is greater than the monopoly deadweight loss.11
Most real–world market structures fall in between the extremes of perfect competition and
monopoly and thus between zero and (near) infinite market power. The greater the market power, the more pronounced the negative distributive, allocative, and dynamic welfare effects. Be-

9.
10.
11.

At pM, the monopolist sells qM units, so its revenues are areas B and D. Area D, however, also represents the
costs of making the goods, i.e., MC times qM, which must be subtracted from revenues.
Assuming that the monopolist cannot engage in perfect price discrimination.
The issue of rent seeking is related to the concerns that an undue concentration of economic power undermines the democratic process. Rent seeking identifies the welfare losses from the corruption of the political
process from the vantage point of economic theory. The democratic theory of antitrust, in contrast, focuses on
the damage done to the value of democratic participation.

9

cause market power is at the root of these varied distortions of the ideal market process, courts
and commentators have identified market power as the core concern of the antitrust laws.

4. Profits
A firm’s profits are determined by revenues minus costs, where revenues are a function of
price times number of units sold. That leaves a firm with two basic strategies for increasing its
profits. The firm can (i) lower its costs or (ii) increase its revenues. Lowering costs is never an
antitrust problem, because it is a profitable strategy irrespective of whether a firm has market
power. Increasing revenues, on the other hand, may be an antitrust issue if the increase is the
result of an unreasonable exercise of market power. The chart below provides an overview of the
basic strategy choices faced by any firm. Antitrust only comes into play in the lower right hand
corner.
Figure 3: Profit maximizing strategies
Profit
maximization
Lower costs
No antitrust
problem

Increase
Revenues

Increase output,
lower price
No antitrust
problem

Increase price
(decrease output)
Implies market
power, therefore
potential antitrust
problem.

5. A Simple Model
In what follows, we will analyze the most common ways in which firms increase, use, and
abuse market power within a toy economy with only six players: two suppliers of raw materials
(S1, S2), two manufacturers or retailers (M1, M2), and two consumers (C1, C2). In a state of
competition, M1 and M2 compete for the business of C1 and C2, and S1 and S2 compete for the
business of M1 and M2. The straight arrows indicate the flow of goods. The model further assumes (unless explicitly stated otherwise) that there is no new entry, no alternative products, and
no additional suppliers, manufacturers, or consumers.12 Virtually every antitrust problem can
usefully be analyzed within this relatively simple framework. Figure 4 below shows the default

12.

Note that these assumptions are different from the traditional model of perfect competition, which is characterized by homogenous products and prices, free and costless entry and exit, perfect information, and an infinite number of firms.

10

position of “unfettered competition.”13
Figure 4: Competition
= M1 and M2 bid against each other
S1

S2

M1

M2

C1

C2

A monopoly at the manufacturer level, as shown in Figure 5, results in fewer choices for C1
and C2 and for S1 and S2. The customers are now facing a single seller (monopoly) and the suppliers are facing a single buyer (monopsony).
Figure 5: Monopoly
= M is the only seller/buyer
S1

S2

M

C1

C2

In our model, Figures 4 and 5 are the end-points of what is in reality a continuum of market
structures between competition and monopoly. Thus, every strategy that in the real world increases market power tips the market structure in the model from competition (Figure 4) to monopoly (Figure 5).

13.

Of course, for simplicity’s sake, competition in this model is limited to only two players at each level of
production. The results will thus be binary: two players (= competition) or one (= monopoly). This is a feature, not a bug.

11

6. Exploitation: Limiting Competition Among the Participants
If M1 and M2 enter into an agreement not to compete on price, quantity, and variety, then
they effectively create a monopoly, the profits of which they share. The immediate effect of the
joint reduction of output is consumer exploitation and deadweight loss as shown in Figure 6.14
Figure 6: Cartel
= M1+M2 act as a monopolist
S1

S2

M1 + M2

C1

C2

7. Exclusion: Limiting Competition from Others
The goal of a successful exclusionary strategy is to isolate a competitor from its suppliers
and/or its customers. Where a collusive agreement aimed directly at consumer exploitation limits
competition among the participants, exclusion limits competition from others. The result, as
shown in Figure 7, is an industry structure similar to that in Figure 6.
Figure 7: Successful exclusion
= M1 is now a monopolist

14.

S1

S2

M1

M2

C1

C2

From a welfare economics standpoint, effective cartels are worse than monopolies, because one huge firm
(monopoly) is more likely to realize efficiencies of scale than two large firms that merely agree not to compete (cartel). The potential for creating efficiencies is also the key rationale for the “merger privilege,” that is,
the rationale for the more lenient treatment of mergers, even though the result of a horizontal merger is the
elimination of a competitor.

12

In contrast to collusive exploitation (Figure 6), there is no shared monopoly here; the winner
M1 takes all. In this sense, exclusion may lead to a more stable form of monopoly than a cartel,
because there is no partner with an incentive to cheat. In most markets, however, successful exclusion is much harder to achieve than a cartel agreement, because a competitor under attack has
every incentive to fight back. Exclusionary strategies generally take the form of indirect attacks,
aimed at the competitor’s supply lines or its customer base. Collusion harms the customers directly, it is a “one punch” offense, resulting in consumer exploitation. Exclusion harms consumers indirectly, it is a “one–two punch” offense. The first punch takes out the competitor, and
the second punch is the exploitation of the newfound monopoly position.
Figure 8: Harm to Competition
Conduct in question
Limits competition
between the parties

Limits competition
from others

Direct, collusive effect
("one punch")

Indirect, exclusionary effect
("one-two punch")

Competitor
exclusion

Consumer
exploitation
Derivative offense,
if eliminating
competitors is a
concern only if it
results in consumer
exploitation

Independent offense
if market structure
and rivalry are
protected as such

The relationship between exploitation and exclusion is subject to debate.15 The key issue is
whether exclusion is an independent or a derivative offense. If exclusion is a derivative offense,
then the only harm to competition recognized by the antitrust laws is consumer exploitation. We
care about competitor exclusion if and only to the extent that it enables consumer exploitation. If
exclusion is an independent offense, then the freedom of a business to compete on the merits is
protected as an end in itself, not merely as a means to promote consumer welfare. Consequently,
a competitor could bring an antitrust claim for exclusion even in the absence of consumer harm.16
In any case, there is no successful exclusion without foreclosure, either from essential sup-

15.
16.

Fox, What is Harm to Competition, 70 Antitrust L.J. 371 (2002).
See p. 16 below for the related controversy over protecting competition or competitors.

13

plies (upstream foreclosure) or from access to customers (downstream foreclosure). The tactics
of foreclosure are discussed below.

a. Upstream Foreclosure
Suppose that M1 enters into exclusive supply contracts with S1 and S2, that is, S1 and S2
agree to only sell to M1. As a result, M2 is denied access to essential inputs and will exit the
market once its inventories are depleted (Figure 9). Once M2 has left the picture, M1 enjoys monopoly power (Figure 7).
Figure 9: Upstream foreclosure

S1

e
lusiv
Exc ing
l
dea

S2

M1

M2

C1

C2

It is important to recall the assumptions made at the outset, in particular the absence of other
firms at the supplier and the manufacturer level and the lack of entry. If any of these conditions
fails, exclusion doesn’t work – or at least not as well. Specifically, in order for the exclusive supply arrangements to harm M2, there must be no other present or potential suppliers (S3...Sn); in
order to harm the consumers, there must be no other present or potential manufacturers of the
same or a close substitute good (M3...Mn). Thus, harm to competitors and harm to competition
both depend on the existence of barriers to entry.

b. Downstream Foreclosure
Downstream foreclosure follows the same logic as upstream foreclosure. Suppose that M1
enters into exclusive distribution agreements with the only two available distributors D1 and D2,
that is, D1 and D2 agree to only sell M1’s goods. Here, M2 continues to have access to supplies
and can still produce its goods, however, it has lost access to its customer base (Figure 10). Unable to generate revenues, M2 will exit the market and M1 will remain as a monopolist (Figure
7).

14

Figure 10: Downstream foreclosure
S1

S2

M1

M2

D1

excl
u
distr sive
ibut
ion

C1

D2

C2

Of course, in the real world there will often be alternative channels of distribution, substitute
supplies, and an abundance of caution on the part of the suppliers and the distributors, who have
few incentives to support M1 in its quest for monopoly power. However, in a directional sense,
the model is valid. Foreclosure does not have to be absolute in order to slow the growth of a
competitor, and to allow the market share leader to enjoy significant (yet not absolute) monopoly
profits. In many instances, exclusionary conduct is not aimed at destroying competitors outright
but rather at raising a rival’s costs, for example, by forcing the rival to resort to more expensive
or less efficient means of distribution. Raising a rival’s cost is often sufficient to substantially increase a company’s market power or to defend a market leadership position.
Note that as a matter of convention we follow the flow of goods, not services, in identifying
upstream and downstream markets. Goods travel from the upstream manufacturer to the downstream retailer. If we were to focus on the provision of services instead, the retailer would be an
upstream supplier of distribution services to the downstream manufacturer.

15

8. The Antitrust Laws Protect “Competition, not Competitors”
No discussion of antitrust law is complete without a brief discussion of the oft-quoted yet
confusing meme that antitrust “protects competition, not competitors.”17 The confusion arises because “competition, not competitors” is a false dichotomy – without competitors, there is no
competition. At some point, one has to start protecting competitors if one wants competition. The
real question is not whether antitrust protects competitors or not but at what point competitors
must be protected in order to maintain competitive markets. The question is quantitative, not
qualitative. It is not an “if” but a “how much” question.
As a practical matter, the differences between those who want to “protect competition” (i.e.,
antitrust conservatives) and those who want to “protect competitors” (i.e., antitrust progressives)
are smaller than one would think. In a market of 10 equally situated firms with equal market
shares, no one would suggest that a merger between two of the firms be challenged, because going from 10 to 9 firms will have no effect on the intensity of competition in any appreciable way.
Similarly, virtually everyone agrees that, absent extraordinary circumstances, a merger from 2 to
1 is a non-starter and that, as a result, the target of the acquisition, a competitor, must be protected in order to maintain a (somewhat) competitive marketplace. The real battle is over markets in
which there are 3 to 5 competitors. Today, antitrust progressives draw the line at about 4 or 5
firms in a given market. Anything less, they fear, will diminish (i) rivalry as an evolutionary
principle, (ii) the freedom to compete (i.e., “open markets”) as a normative principle of keeping
open the entrepreneurial possibilities space, and (iii) consumer choice below acceptable levels.
Thus, a “4 to 5 firm or more” market structure should be protected, even at the expense of possible static efficiency gains. In other words (and with appropriate caveats against the false dichotomy), this means protecting “competitors, not competition.”
Antitrust conservatives, in contrast, do not place any independent value on open markets and
consumer choice per se. What counts is efficiency. If a merger from 3 to 2 is efficient because it
is likely to decrease costs and not lead to higher prices, then there is no reason to stand in the
way of increasing overall welfare. One can put this even more simply. Antitrust progressives

17.

The vexing history of the “competition, not competitors” meme begins with its appearance in Brown Shoe v.
US, 370 US 294 (1962). The court uses the phrase twice. The first time, the discussion supports a “derivative
offense” meaning. “Taken as a whole, the legislative history illuminates congressional concern with the protection of competition, not competitors, and its desire to restrain mergers only to the extent that such combinations may tend to lessen competition.” The second time, however, the court leaves no doubt that the right to
compete on the merits is independent of short run consumer welfare. “[S]ome of the results of large integrated
or chain operations are beneficial to consumers. Their expansion is not rendered unlawful by the mere fact
that small independent stores may be adversely affected. It is competition, not competitors, which the Act protects. But we cannot fail to recognize Congress’ desire to promote competition through the protection of
small, locally owned business. Congress appreciated that occasional higher costs and prices might result from
the maintenance of fragmented industries and markets. It resolved these competing considerations in favor of
decentralization. We must give effect to that decision.”

16

want to protect the weak from the strong, whereas antitrust conservatives want to protect the
strong from the (government protecting the) weak.

17

II. Taxonomy of Antitrust Offenses
The distinction between unilateral and coordinated conduct is antitrust’s most fundamental
conceptual divide. Section 1 of the Sherman Act (§1) and Section 7 of the Clayton Act (§7) both
require an agreement, that is, coordination. In contrast, Section 2 of the Sherman Act (§2) merely
requires unilateral conduct by a firm with “monopoly power.”

1. Section 2 of the Sherman Act
Every person who shall monopolize, or attempt to monopolize, or combine or conspire
with any other person or persons, to monopolize any part of the trade or commerce
among the several States, or with foreign nations, shall be deemed guilty of a felony.
(§2)18
A violation of §2 requires (i) monopoly power, (ii) some form of exclusionary conduct, and
(iii) a causal connection between (ii) and (i).19 “Monopoly” means significant but not absolute
market power, in practice a market share of 60% or more. A firm must thus be both “big and
bad” to trigger §2 liability – bigness as such is not actionable. In Verizon Communications, Inc.
v. Law Offices of Curtis V. Trinko, the Supreme Court held that:
[t]he mere possession of monopoly power, and the concomitant charging of monopoly
prices, is ... an important element of the free-market system. The opportunity to charge
monopoly prices – at least for a short period – ... induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession
of monopoly power will not be found unlawful unless it is accompanied by an element
of anticompetitive conduct.20
This definition deviates significantly from the perfect competition ideal of welfare economics. Far from viewing monopoly as an evil, Justice Scalia embraces it as “an important element
of the free-market system.” The stated reason is that “[t]he opportunity to charge monopoly
prices ... induces risk taking that produces innovation and economic growth.” The intuition is
presumably that while every firm wants to be a monopolist, as long as everyone is trying to
achieve that goal, usually no one will. In the unlikely event that one player reaches the pot of
gold at the end of the rainbow, that firm is then free to enjoy the welfare-diminishing benefits of
18.
19.

20.

Full text at http://assembler.law.cornell.edu/uscode/html/uscode15/usc_sec_15_00000002----000-.html
Section 2 also covers (i) the attempt to monopolize and (ii) the conspiracy to monopolize. The elements of
each Section 2 offense vary slightly. An attempt to monopolize requires less market power (50% market
share) but proof of specific intent. A conspiracy to monopolize requires (a) an agreement, (b) an act in furtherance of the agreement and (c) specific intent. Notably, the conspiracy does not require any proof of market power. It is thus the only “monopolization” offense without any market power requirement.
Verizon Communications, Inc. v. Law Offices of Curtis V. Trinko, 540 U.S. 398 (2004)

18

monopoly for however long they last. The welfare loss from monopoly is the price that society
pays for greater incentives to compete along the way. There is indeed significant empirical evidence connecting the rate of innovation to GDP growth. However, there is little evidence
connecting monopoly with positive effects on the rate of innovation. Moreover, the “monopoly
as incentive” theory faces some basic plausibility hurdles as countless firms enter and innovate at
a rapid pace in markets where they cannot reasonably expect to ever become monopolists (fashion, cars, bikes, text editors, furniture, economics, law, etc.). And even if the dream of monopoly
were to create some incremental incentives in markets where monopolization is indeed in the
cards, it remains an open question whether the possible welfare gains from the added inducement
outweigh the certain static efficiency losses.
Historically, the question of whether and to what extent society is willing to tolerate monopolies has been negotiated in the context of the conduct element. Not surprisingly, what qualifies as
exclusionary conduct (i.e., “bad”) has been a subject of intense dispute since the passage of the
Sherman Act. That said, most courts and commentators agree that in order to be exclusionary,
conduct must be (a) harmful to a rival and (b) without benefit to consumers. As indicated above,
the conduct must further (c) create or help to maintain the monopoly position, which amounts to
a causation feedback requirement between the conduct and the monopoly element. But for this
causation requirement, any business tort by a dominant firm could easily be converted into an
antitrust offense. The harm from monopolization is always exclusionary in nature.
Figure 11: Monopolization
Monopolization,
§2 (e)

Monopoly power
(direct evidence or >
60% of relevant
market)

Harms rivals

Exclusionary
conduct

Doesn't benefit
consumers

Increases
monopoly power

Violations of §2 may be prosecuted civilly by the government or by injured parties for treble
damages. Violations may also be prosecuted criminally by the Department of Justice, even
though criminal monopolization cases are exceedingly rare. As a practical matter, the bar for
proving a §2 violation is high, which is sensible because most business conduct is unilateral and
almost all of it is competitively benign – price setting, introducing new products, marketing, etc.

19

2. Section 1 of the Sherman Act
Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal. (§1)21
Section 1 requires (i) an agreement (express or implied), resulting in (ii) a net restraint on
trade such that the anticompetitive effects from the agreement (AE) outweigh the procompetitive
effects (PE). For the agreement prong, conscious parallelism is not sufficient. Two gas stations
across the street from each other do not “agree” in a manner relevant to §1 if all they do is observe and react to the other station’s price changes. Section 1 covers both horizontal and vertical
restraints. Horizontal restraints are between competitors, and vertical restraints between companies in a buyer-seller relationship. Potential harm from horizontal restraints is exploitative, and
harm from vertical agreements is (mostly) exclusionary.
Over time, two standards have emerged to determine whether an agreement in restraint of
trade is unreasonable: per se illegality and rule of reason. For certain categories of hardcore restraints, the law conclusively presumes that AE > PE. Such per se illegal restraints are price fixing, market division (territory, customer, time22), naked output reduction, and group boycotts to
defend a cartel. Those agreements, “because of their pernicious effect on competition and lack of
any redeeming virtue, are conclusively presumed to be unreasonable and therefore illegal without elaborate inquiry as to the precise harm they have caused or the business excuse for their
use.”23 In other words, the courts will consider neither PE nor whether there are, in fact, any AE.
The latter is particularly important. For per se illegal conduct, the agreement completes the offense. Thus, if two hot dog vendors in Central Park agree to charge §4/dog, they engage in a per
se illegal price fixing conspiracy, even though the agreement has virtually no effect. Per se violations are routinely prosecuted criminally by the Department of Justice.
The default standard for §1 analysis – and, arguably, for antitrust generally – is the rule of
reason. While theoretically straightforward (AE > PE = illegal), the practical obstacles to determining and then balancing the anticompetitive and procompetitive effects of an agreement are
daunting. The courts have thus transformed the substantive rule of reason (AE > PE) into a procedural sequence of conceptual and empirical inquiries, shifting the burden of persuasion back
and forth between plaintiff and defendant. Only as a measure of last resort will the courts actually engage in a balancing of the restraint’s effects. The modern, structured or procedural rule of
reason proceeds as follows:

21.
22.
23.

Full text at http://assembler.law.cornell.edu/uscode/html/uscode15/usc_sec_15_00000001----000-.html
A common example of market division by time is bid rigging, where the conspirators “take turns.”
Northern Pacific Railway Comp., v. U.S., 356 U.S. 1, 5 (1958)

20

Figure 12: Rule of Reason
Structured
Rule of Reason

Proof of
AE/PE

Theory of
AE/PE

!: Plausible
theory of AE

Balancing
of AE/PE

!: Proof
of AE

": Plausible PE
for which the
restraint is
reasonably
necessary

AE>PE
= illegal
": Proof of PE
for which the
restraint is
reasonably
necessary

The first step, usually at the motion to dismiss stage, is a conceptual inquiry into whether
there is a plausible theory of harm to competition. The plaintiff must present a plausible theory
of harm, including market power on the part of the defendant. The burden then shifts to the defendant to show plausible PE for which the restraint is reasonably necessary. If the plaintiff fails,
the case should be dismissed. The second step, which usually corresponds to the summary judgment stage, involves empirical proof of harm. The plaintiff must present evidence of AE, either
directly or circumstantial, i.e., through a showing of actual harm or market shares and entry barriers respectively. The burden then shifts to the defendant to produce proof of PE and that the restraint is reasonably necessary to achieve them. If the plaintiff fails, summary judgment should
be granted to the defendant. The third and final step, often requiring a full trial, includes the actual balancing (AE > PE) by the court in addition to any proof of contested facts.24

3. Section 7 of the Clayton Act
No person … shall acquire … any part of the stock … or any part of the assets of
another person … where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially
to lessen competition, or to tend to create a monopoly. (§7)25
A violation of §7 requires (i) the acquisition of stock or assets of a firm; resulting in (ii) a
likelihood of a substantial lessening of competition (”SLC”).
Violations of §7 may be prosecuted civilly by the government or by injured parties for treble
damages. The SLC test is structurally similar to a ROR inquiry. If AE(merger) > PE(merger),
24.
25.

For details see Elhauge & Geradin, Global Antitrust Law and Economics (2007), p.190-91.
Full text at http://assembler.law.cornell.edu/uscode/html/uscode15/usc_sec_15_00000018----000-.html

21

then the acquisition is unlawful. Similar to the transformation of the substantive rule of reason
into a sequence of procedural events, the courts have developed a burden-shifting approach to
§7.
By showing that a transaction will lead to undue concentration [i.e., a market share
measure] ... the government establishes a presumption that the transaction will substantially lessen competition. The burden of producing evidence to rebut this presumption
then shifts to the defendant. If the defendant successfully rebuts the presumption, the
burden of producing additional evidence of anticompetitive effect shifts to the government, and merges with the ultimate burden of persuasion, which remains with the government at all times.26
The use of presumptions and inferences from market shares is more prominent in merger cases than in §1 cases because the SLC test is forward looking and requires a showing that future
anticompetitive effects are likely.27 In contrast, most §1 cases address past injury and are thus
backward looking.
Similar to the classification of agreements under §1, mergers are either horizontal (i.e., a
merger between competitors) or vertical (e.g., a manufacturer buying one of its suppliers). The
harm to competition from horizontal mergers is exploitative, that from vertical mergers exclusionary. For horizontal mergers, the theory of exploitative competitive harm is either based on coordinated or on unilateral effects.
A coordinated effects theory is based on the concern that after the merger, collusion among
the remaining competitors is more likely than before. Suppose that past efforts to forge a cartel
among firms A, B, C, and D have failed because B, the lowest cost producer refused to join or
kept cheating on the cartel. An acquisition of D by A may not change the likelihood of postmerger collusion at all, because B is still around as a disruptive force. In contrast, an acquisition
of B by A would make post-merger coordination more likely, because the acquisition eliminated
the cartel-disruptor.
A unilateral effects theory reflects the concern that after the merger the combined company
will be able to profitably raise prices all by itself – for example because firm A acquires the next
best substitute to its product by merging with B. Before the merger, A could not profitably raise
prices because customers defected overwhelmingly from A’s product to B’s product. After the
merger, A can profitably raise prices for its product, because it recaptures the defectors to product B, which it now owns.

26.
27.

U.S. v. Baker Hughes, 908 F.2d 981 (D.C.C. 1990).
Of course, there are also post-consummation challenges to mergers where direct evidence of past effects from
the merger is available. In such cases, there is no need to fall back on inferences.

22

4. Application of the Federal Antitrust Laws
To illustrate some applications of the legal principles outlined above, we will take another
look at some examples of collusion (Figure 6) and foreclosure (Figures 9, 10).

a. Price Fixing and Competitor Collaborations
The agreement between M1 and M2 in Figure 6 to fix prices is per se illegal under §1. Note
that it doesn’t take much to “fix” a price in a horizontal conspiracy. It is not required that the parties determine price as a fixed dollar amount (for example, M1 and M2 agree to both sell for $10/
unit). Rather, any (naked) agreement that influences price comes under the per se ban. Moreover,
“price” in a horizontal setting is an extremely broad concept that encompasses virtually every
factor contributing to the economic value of the trade, including terms of sale, discounts, advertising, and credit.
The problem with a categorical per se ban on price fixing, market allocation and similar
agreements is overdeterrence. The per se rule captures agreements that are demonstrably efficient and welfare enhancing. Easy labels, as the Supreme Court observed, do not always produce
ready answers.
Consider the facts in BMI v. CBS,28 where thousands of composers granted non-exclusive licenses for playing their songs to ASCAP (75%) and BMI (25%). ASCAP sold blanket licenses to
all of the songs in its library to radio stations and TV networks (“stations”), among them CBS.
Most stations paid a “fixed” flat fee for the right to play any song in the inventory as often as
they wanted. The stations also provided ASCAP with usage metrics, i.e., how often they played
what song. Since the stations paid a flat fee, they had no incentive to shade the numbers (e.g.,
over-report the playing of cheap songs and under-report the playing of hits). On the basis of
those metrics, ASCAP then paid the composers a share of the flat fee profits. CBS sued ASCAP/
BMI for price fixing, alleging a conspiracy among the composers. Instead of competing individually for the licensing of their compositions, the composers – through ASCAP/BMI – agreed to
charge CBS one uniform price for access to all of their works.
There is no question that the blanket license involved price fixing in a literal sense.29 There is
also no question that the blanket license arrangement was highly efficient and that without the restraint the ASCAP/BMI venture could not have worked. Where there are hundreds of stations
and thousands of composers, individually negotiated agreements would have been prohibitively
28.
29.

BMI v. CBS, 441 U.S. 1 (1979). The “easy labels” phrase above is from BMI.
Note that the composers were free to license songs on an individual basis, bypassing ASCAP/BMI. Such nonexclusivity is another reason for why the agreement was unlikely to harm competition. However, the composers were barred from licensing songs to competing collection societies, which explains why there are only
ASCAP and BMI. Interestingly, this latter restraint did not play a major role in deciding the case, even though
it is not apparent why it would be reasonably necessary to make the venture work.

23

expensive. It is too hard for an individual composer to monitor every radio station for infringement. And it is too hard for every radio station to go out and negotiate a “per song” license with
hundreds of composers each. The blanket license thus minimized transaction costs, created the
correct incentives for both stations and composers, and dramatically increased the “output” of
legally performed compositions.
In these and similar situations, the key question is whether the restraint is “naked,” that is, an
end in itself to exploit consumers or “ancillary,” that is, a means to a procompetitive end. The
clearest statement of the rule is from Rothery Storage & Van Co. v. Atlas Van Lines, 792 F.2d
210, 224 (D.C.Cir. 1986):
To be ancillary … an agreement eliminating competition must be subordinate and collateral to a separate, legitimate transaction. The ancillary restraint is subordinate and
collateral in the sense that it serves to make the main transaction more effective in accomplishing its purpose.
In BMI, the underlying “legitimate transaction” is the agreement to set up and maintain the
collecting society. The blanket license is “is subordinate and collateral in the sense that it serves
to make the main transaction more effective in accomplishing its purpose.” If the restraint is ancillary, then the ROR applies. If the restraint is naked, then the per se rule applies. The ancillary
restraints doctrine is thus the ultimate arbiter of whether a prima facie per se illegal agreement is
really per se illegal.30

b. Exclusive Dealing, Tying, and other Vertical Restraints
All vertical agreements of antitrust relevance are conditional transactions, where the problem
is with the condition, not the underlying transaction.31
Interbrand Restraints: “Don’t sell my rival’s products”
Some vertical restraints imposed by the upstream manufacturer limit the ability of a distributor to deal in products of the manufacturer’s rivals. For example, McDonald’s has agreed to only
sell Coke, not Pepsi. In this “interbrand” restraint setting the manufacturer says to the distributor:
“I will sell you my widgets under the condition that (i) you don’t sell any competing products
(exclusive dealing as in the McDonalds/Coke example), or (ii) you also purchase another product
from me (tying).” There are less absolute variants of exclusive dealing and tying, where the contractual obligation (“you shall/not”) is replaced by economic incentives (“it sure would pay if
you did/didn’t”). For example, a manufacturer might say to the distributor: “I will sell you my
widgets at a much lower price if you buy 100%, 80%, etc., of your requirements from me (loyal30.
31.

See also the Competitor Collaboration Guidelines: www.ftc.gov/os/2000/04/ftcdojguidelines.pdf
That pattern alone strongly suggests rule of reason treatment across the board, as long as the restraint is ancillary to the underlying transaction.

24

ty rebate / exclusive dealing light).” Similarly, the manufacturer might say to the distributor: “I
will sell you a bundle of my products A and B at a much lower price than A and B separately
(bundling / tying light).”
The problem with interbrand restraints is the foreclosure of a rival’s access to upstream suppliers or downstream customers. In Figure 9, for example, M2 is foreclosed from access to all of
its suppliers, which is unlawful under the rule of reason as the exclusionary effects outweigh the
benefits. As a practical matter, foreclosure of less than 30% of a relevant market is generally
lawful, 30-60% is a gray area, and foreclosure of more than 60% tends to be unlawful, barring
exceptional circumstances. In addition to the immediate effects of denying a rival access to effective distribution or supplies, foreclosure may also prevent the rival from achieving minimum
efficient scale or scope. Vertical restraints are common because most of the time they are (also)
imposed by firms without market power and thus presumably efficient. For instance, exclusive
dealing better aligns the incentives of the retailer with the manufacturer – irrespective of the
manufacturer’s market power. If the retailer cannot sell anyone else’s product, he or she has
every incentive to promote the manufacturer’s product line. Exclusive dealing also enables relationship-specific investments that would otherwise be too risky. For example, if Ford asks an
auto body maker to relocate its plant right next to the Ford plant, the auto body maker is likely to
insist on an exclusivity or minimum volume commitment from Ford to ensure sufficient demand.32 But for some such guarantee, Ford could opportunistically renegotiate the agreement after the auto body maker made irreversible investments. In other words, Ford could say: “Now
that you’ve spent $10 million on a plant that can only be used for my cars, let’s revisit that price
we’re going to pay you.” Similarly, tying and bundling have clear procompetitive effects across a
wide range of business practices. It is cheaper to distribute cars with tires, printers with toners,
and razors with blades (i.e., transaction cost savings and distribution efficiencies). In addition, tying is a useful metering device to make heavy users pay more for a product than light users. Suppose that Xerox were to require users of its copiers to only purchase Xerox paper. The copiers
could be sold at a rock-bottom prices, because all the money would be made from the sale of paper. Heavy users pay more and effectively subsidize light users – all without any cumbersome
hardware requirements such as page counters, inspections, and complex long-term contracts. As
long as the supplier of both products has no appreciable market power in the tying and the tied
product market, this arrangement enables more users to buy copiers and is thus efficient. As a
practical matter, the ubiquity of tying in competitive markets proves that it is generally net
beneficial.
Interbrand Restraints: “Don’t sell my widget for less than $10.”
Another type of vertical agreements limit what a distributor can do with the manufacturer’s
own products. Those “intrabrand” agreements do not limit the distributors right to sell products
of rival manufacturers. Rather, the manufacturer says to the distributor: “I will sell you my wid32.

See Elhauge & Geradin, p.501 for a more detailed example.

25

gets under the condition that (i) you do not resell them for less than $10/unit (resale price maintenance), or (ii) you only sell them to academic buyers (customer restraint) or in a specific territory (territorial restraint).”
Interbrand and intrabrand restraints are not of equal concern to the antitrust laws. “Interbrand
competition ... is the primary concern of antitrust law.”33 Focusing on the interbrand restraints
makes good legal and economic sense. The point of intrabrand restraints is to give distributors a
reliable profit margin – to induce loyalty and effort, ensure better service, break into otherwise
locked up distribution channels, etc.34 It is hard to imagine how a manufacturer could use such
restraints to exploit consumers, because giving downstream distributors a greater margin for
one’s own product does not increase the manufacturer’s market power. The manufacturer is simply paying more for presumably better distribution services. Moreover, as intrabrand restraints
do not limit the distributors’ ability to carry competing brands, there are no plausible foreclosure
effects.
A commonly cited concern with intrabrand restraints that has some theoretical credibility is
that downstream distributors X, Y, and Z may want to form a cartel for the sale of manufacturer
M’s product. Collectively, they go to M and say: “We will boycott your product unless you grant
each of us exclusive territories (or set a minimum price of $10/unit) in order to set up, facilitate,
and police our cartel.”35 But in this case the real concern is the horizontal conspiracy between X,
Y, and Z, not the fact that they draft M to organize and provide cover for the cartel through a series of phenotypically vertical agreements.36
Vertical agreements – including tying – are analyzed under the rule of reason. The “per se”
rule against tying only kicks in if the defendant has a share of 30% or more of the tying product
33.
34.

35.

36.

Continental TV Inc. v. GTE Sylvania Inc., 433 U.S. 36 FN. 19 (1977).
Another commonly cited reason is to deter free riding. For example, a computer equipment retailer specializes
in excellent in-store service. (Please email me if you find this mystical store in the real world.) Shoppers take
advantage of the in-store service to choose their equipment and then order it from Newegg or Amazon. Here,
Newegg and Amazon are free riding off of the retailer’s investment in superior service. While theoretically
appealing, the real world significance of free riding is likely very limited.
Other concerns include “first sale” and “restraints on alienation”–type arguments, which may ultimately be far
more significant than the (rare) downstream cartel. As a normative matter, one could argue that once goods
have been released into the flow of commerce, upstream control over those goods or the economic agents involved in their distribution should end. Recall that antitrust laws reflect basic marketplace design choices, and
trade in goods with no strings attached (and thus no uncertainty about their legal status) may be preferable
from a policy standpoint.
Note that the same economic effect – elimination of competition between X, Y, and Z in the sale of M’s products – is per se illegal if brought about by X, Y, and Z and perfectly lawful under the rule of reason if imposed
by M. This, too, makes both legal and economic sense. As long as M imposes the restraints, chances are that
M’s interests are aligned with those of the consumers. Paying X, Y, and Z a healthy margin must, from M’s
point of view, be worth it in terms of increased sales through better placement, in-store service, etc. In contrast, a cartel among X, Y, and Z is exploitative both vis-a-vis the consumers and M.

26

market. And even then, courts usually neither (strictly) presume anticompetitive effects nor do
they deny defendants the opportunity to introduce (some) procompetitive business justifications.
The ill-fitting per se label for tying illustrates the real practical difficulty with vertical restraints.
Nowhere in antitrust jurisprudence have courts and agencies changed their minds more often
than with respect to vertical agreements. Layers of incompatible precedent make vertical restraints law especially crufty. The bad code situation is made worse by the fact that vertical
agreements are captured by virtually every antitrust statute, including §1, §2, §3 Clayton Act (for
downstream restraints on goods only), and §5 FTC Act, all of which have slightly different
standards. Careful analysis of the economic effects and the intent behind a vertical restraint and
judicious selection of precedent is of paramount importance for crafting a persuasive argument in
this area.

c. Vertical Integration
Vertical integration may also result in foreclosure and exclusion. In Figure 10, for example,
M1 entered into exclusive distribution agreements with D1 and D2. Alternatively, M1 could
have acquired control over D1 and D2 by purchasing their stock and subsequently directed D1’s
and D2’s management to terminate any agreements with M2. The effect on M2 (foreclosure of
access to C1 and C2) would be the same in both instances. As discussed above, exclusive distribution agreements are analyzed under the rule of reason, and given that M2 would be entirely
foreclosed from access to customers, the agreement would be in violation of §1. If M1 chooses to
acquire D1 and D2 instead, the acquisition would be subject to §7. (Section 1 remains applicable,
however, in an acquisition context, §7 is normally lex specialis). The effect of the acquisition
would be to “substantially lessen competition,” because M1 would control 100% of the relevant
market and M2 would be excluded from access to C1 and C2.

d. Predatory Pricing
One of the more clearly defined monopolization offenses is predatory pricing. Monopolist
M1, the predator, consistently underprices M2, the prey. As a result, C1 and C2 will purchase
from M1, and M2 will go out of business. Once M2 has been driven from the market, M1 remains as the only seller of the product and and will raise prices to the monopoly level.

27

Figure 13: Predatory Pricing
(de facto downstream foreclosure)
S1

S2

M1

M2

C1

bel
cos ow
pric t
ing

C2

Structurally, predatory pricing is a form of incentive-driven downstream foreclosure.
Through lower prices, M1 “monopolizes” the business of C1 and C2. The problem is to distinguish bona fide low prices (which are good for C1 and C2) from predatorily low prices (which
are good for C1 and C2 in the short run, but bad in the long run). The line is drawn where M1
sells its goods below a reasonable measure of marginal or avoidable cost, because such sales diminish M1’s short run profits and are thus irrational unless offset by the expectation of future
monopoly profits.37 Predatory pricing has traditionally been of significance in high fixed costs
and low margin industries, such as the airline industry, where incumbent carriers have constrained new entry on profitable routes by underpricing the new entrant, subsidizing their losses
on the competitive city pairs with supracompetitive profits from non-competitive city pairs.

5. Taxonomy Chart
The chart below summarizes and concludes the taxonomy of the antitrust laws. Exploitative
or collusive effects are indicated by (c) and exclusionary harm by (e).

37.

If the cost of the marginal unit is $6 and M1 sells the unit for $5, M1 loses money no matter what. Because it
is difficult to observe marginal costs, courts have accepted average variable cost as a proxy.

28

Figure 14: Antitrust Taxonomy
Antitrust Taxonomy
Monopolization,
§2 (see separate

Coordinated
conduct, §1

chart)

Agreement

Horizontal (c)

Mergers and
acquisitions §7
(SLC)
Unreasonable
restraint of trade
(standard)

Horizontal (c)

Vertical (e)

Vertical
Per se for naked
"hardcore"
horizontal
restraints

Interbrand (e)
Intrabrand (c)

ROR for all other
horizontal
restraints

29

ROR for all
vertical
agreements

Semi-exception
for tying

Coordinated
Unilateral

III. Market Power Revisited
The stylized examples above assume that there is a defined market with no alternative distribution channels, no new entry, and stagnant technology. Since there are only two players at each
level, M1 and M2 both have significant market power, and after M2 exits the market, M1 is a
true monopolist. In reality, questions of market power are rarely ever that simple and defining
the relevant antitrust market and assessing the degree of actual or likely power in that market is
often the most critical issue for any rule of reason analysis under §1, the finding of monopoly
power under §2, and the SLC test under §7. In practice, most antitrust cases turn on market
definition.
Before we discuss the algorithm for defining a relevant antitrust market, it is helpful to put
the market definition exercise in context.

effect

effec
t

Figure 15: Circumstantial proof, twice removed
Consumer
Welfare
(end)

Free market:
Competition
(primary means)
Evidence
Anticompetitive
conduct/effect?
(AE)

Evidence of AE:
actual welfare
loss (= effect)

Inference 1: MP!AE
Market power
(circumstantial
evidence of AE)

Evidence of MP:
e.g., demand
elasticity

Inference 2: MC!MP
Market
concentration
(circumstantial
evidence of MP)

Evidence of MC:
e.g., HHI

Example: Structural
presumption and
Merger Guidelines

Assuming that the ultimate goal of economic policy is to maximize consumer welfare (top
box), the primary means of achieving it is the free market system, of which competition is a nec30

essary component. Antitrust protects and promotes competition and, thus, indirectly consumer
welfare by providing agencies and private plaintiffs with the legal foundations to prosecute conduct having net anticompetitive effects (AE). Ideally, there is direct evidence of AE, for example, the overcharges by the Vitamins cartel or the elimination of Netscape through Microsoft’s
exclusionary practices. However, proof of AE is not limited to direct evidence. AE may be
proven circumstantially by “motive and ability,” i.e., incentive and market power (MP). For
example, a showing of inelastic demand is evidence of market power. Combined with the incentive to exercise that power, which is usually safe to presume, a plaintiff in a merger case, for
example, can prove that the merger is likely to substantially lessen competition. This circumstantial proof relies on the MP–AE inference. Again, in most cases, direct proof of market power will
not be available. Few firms keep demand elasticity studies on file.38 Thus, in most cases antitrust
plaintiffs have to rely on a double inference, first from market concentration (MC) to market
power, and then from market power to anticompetitive effects, i.e., MC–MP–AE. This inference
is sometimes called a “structural presumption.” In practice, the structural presumption means that
a showing of few competitors and high market shares permits the (rebuttable) double inference
of anticompetitive effects from a merger or exclusionary conduct.39
It is only in the context of establishing the market concentration predicate, the launching pad
for the double inference, that the market definition exercise becomes significant.40 The motivation for using proxies and inferences is that the most relevant information, i.e., direct evidence of
anticompetitive effects, is also usually the least accessible. Market concentration measures, e.g.,
the number of firms in a market and market shares, in contrast, are less relevant but (seemingly)
easy to observe. The exercise is thus about identifying the number of competing sellers and assigning market shares to them. Competing sellers, in turn, are identified on the basis of whether
their products are substitutes in the eyes of the consumers.

38.

39.

40.

Even though this is changing. Many firms now regularly estimate the own demand elasticity for their products
and with the help of third party market observers (e.g., Gartner/Dataquest, Nielsen, etc.) attempt to estimate
cross-elasticity of demand as well.
Economically, the structural presumption is based on the structure–conduct–performance (SCP) paradigm,
where few competitors (structure) leads to oligopolistic behavior (conduct), which in turn results in consumer
overcharges (performance) compared to benchmark of perfect or near-perfect, atomistic competition. In the
1970s the Chicago School began to challenge the conduct–performance inference, i.e., that oligopolistic competition leads to higher prices compared to atomistic competition.
Market definition is thus an evidence-driven, legal concept, even though it uses an economic algorithm aimed
at approximating demand elasticity. This is why economics textbooks usually do not discuss market definition
at all.

31

1. Relevant Product Market Definition
Frequently, the market definition inquiry is based on a variant of the “hypothetical monopolist plus price increase thought-experiment.” (HM+SSNIP).41 Suppose that M sells small batch,
high-end bourbon. What is the relevant product market? Is it “small batch, high-end bourbon,” in
which case M would command a significant market share? Or is it “all spirits, excluding wine,”
in which case M’s share of the market would be a tiny drop in a huge bucket, as the denominator
increases? For antitrust purposes, a relevant product market is defined as that set of products for
which a hypothetical monopolist could profitably raise prices for a non–trivial period of time.
Figure 16: HM + SSNIP Test; own elasticity ("How many customers did we lose?")
Not profitable
Not a market

Not profitable
Not a market

Not profitable
Not a market

Profitable
= Market

10% price
increase
30% drop in
quantity

10% price
increase
20% drop in
quantity

10% price
increase
15% drop in
quantity

10% price
increase
8% drop in
quantity

P1

P1
P2

P1
P2
P3

P1
P2
P3
P4

Step 1: The
hypothetical monopolist
(HM) raises prices by
10% and loses 30% of
its customers. The price
increase is not
profitable. (Price
elasticity of demand =
3). P1 is not a relevant
product market.

Step 2: We add another
product, P2. The HM
increases price for P1
and P2. Still not
profitable.

Step 3: Yet another
product, P3. The HM
increases price for P1,
P2, and P3. Still not
profitable.

Step 4: Finally, after
adding P4, a price
increase over P1, P2,
P3, and P4 would be
profitable. (Price
elasticity of demand =
0.8). The relevant
product market consists
of P1, P2, P3, and P4.

First, assume that M is the only seller of small batch, high-end bourbon (= P1) in the entire
world. (Or assume that M owns every other seller of P1, which amounts to the same thing.) This
step of the thought experiment transforms M into the hypothetical monopolist (“HM”). Second,
assume that M raises the price for P1 by 10% for a non-trivial period of time, say one year. This
second step is the SSNIP test, where SSNIP stands for “small, significant, non-transitory price
increase.” Would M’s price increase be profitable? Not in the above example. In response to a

41.

See in particular the influential 1992 DOJ/FTC Horizontal Merger Guidelines. www.ftc.gov/bc/docs/
horizmer.htm

32

10% price increase M sells 30% less of P1. As revenues = price * quantity, the price increase is
not profitable. What’s next? We add another product, “all other bourbon” (= P2), and repeat the
process. What if M was the only seller of small batch, high-end bourbon (= P1) and all other
bourbon (= P2) and were to raise prices for P1 and P2 by 10%? Would that price increase be
profitable? Again, it wouldn’t. We add “Canadian Whiskey” (= P3) and repeat. Again, the price
increase would be defeated by a relatively greater decline in quantity demanded. Finally, after
adding “Scotch Whiskey” (= P4) the customers are cornered. They can no longer avoid a 10%
price increase over P1–P4 because there are no viable substitutes. We now have an antitrust
market.42
An obvious question at this point is how we know which products to add at each step? It is
one thing for M to know how many sales were lost in response to a price increase (i.e., own price
elasticity of demand). It is quite another to know where all those lost sales went (i.e., cross price
elasticity of demand). That is a question that M alone cannot answer. It requires a broader study
of the candidate market and the interaction of the various products in that space. Consider the
example below.
Figure 17: Cross-elasticity ("Where did they all go?")

25 additional
customers (+25%)
10% price
increase
30 out of 100
customers leave
(-30%)

Bourbon

Scotch

many

few

5 additional
customers (+5%)

Own price elasticity of
demand for bourbon = 3. Price
increase is not profitable so
bourbon is not a relevant product
market. Which product should be
added to the candidate market
for the next HM + SSNIP
iteration?

Grappa

If price for bourbon goes up by
10%, quantity demanded of
scotch goes up by 25%. Crossprice elasticity of demand for
scotch = 2.5. Scotch should be
included in the next candidate
market, consisting of bourbon
and scotch.
If price for bourbon goes up by
10%, quantity demanded of
grappa goes up by only 5%.
Cross-price elasticity of
demand for grappa = 0.5.
Grappa should thus not (yet!) be
included in the candidate
market.

M is the only seller of bourbon (= P1) and raises price by 10%. He loses 30% of sales. For
simplicity’s sake, assume that 30% are represented by 30 customers, each of whom accounts for
1% of bourbon purchases. Looking at the candidate market broadly, we learn that of the 30

42.

The example is hypothetical. In reality, substitution patterns for high-end spirits are much less clearly delineated. For example, there is surprisingly strong substitution between high-end bourbon and vodka.

33

bourbon defectors, 25 resort to buying scotch and 5 to buying grappa. We thus add scotch (= P2)
for the next round of SSNIP. Ideally, one would always seek to add the product with the next
highest cross-elasticity to the candidate market. In practice, however, due to incomplete information, this step is more art than exact science. As a result, many antitrust cases are tried on the basis of a range of candidate markets, e.g., “no smaller than high-end bourbon and no broader than
all bourbon.”

2. Relevant Geographic Market Definition
The algorithm for determining the product market is similarly applied to determine the geographic boundaries of the relevant antitrust market. Suppose that M is the only seller of the set of
products that make up the relevant product market (P1…Pn), as defined above, in the smallest
possible territory T1 (for example, a city block), and that M raises prices for P1…Pn by 10%;
would that price increase be profitable? If not, expand T1 by adding T2 (the entire city)…Tn (the
county, the region, the state, the nation, the world) and repeat the 10% price increase until the
price increase becomes profitable. The sum of the territories (T1…Tn) for which the price increase would be profitable constitutes the geographic market.

3. Market Participants and Market Shares
Once the antitrust market is properly defined both in terms of products and geographies, we
can determine how many firms participate in that market. Market participants include firms that
are presently manufacturing products and firms that could enter the market quickly, without having to incur significant capital costs upon exit.43

43.

These firms are called “uncommitted entrants.” Uncommitted, because they don’t have to invest in specilalized assets, and are therefore likely to be “hit and run” players in the relevant market, should prices go up.

34

Figure 18: Market participants ("Who is in the relevant market?")

Relevant antitrust market
P1+P2+P3+P4 in T1+T2
10% price increase
8% drop in quantity
P1
P2
P3
P4

A, B, and C are firms that currently
make or sell P1, P2, P3, or P4 in
T1+T2 (= actual competitors)

A, B, C
D, E
F, G, H

D and E are firms that don't currently
make or sell but could start making or
selling P1, P2, P3, or P4 in T1+T2 in
less than one year without having to
incur significant sunk costs in response
to a SSNIP (= uncommitted "hit &
run" entrants)

F, G, and H are firms that don't currently make or sell but could start making or selling P1,
P2, P3, or P4 in T1+T2 in response to a SSNIP, but not within one year or without incurring
significant sunk costs. (= potentially committed entrants) Note: Committed entrants are
considered in the entry analysis (§3)

Finally, we can now calculate the market shares of the participating firms on the basis of revenues (that is, dollars/year), capacity (that is, maximum output of units/year), or units sold and
plug those numbers into one of formulas for determining market concentration indices, which
will be discussed below.
As a rule of thumb, if a firm controls < 30% of a relevant market, it has usually no significant
market power for antitrust purposes, 30%-60% are a gray area, and anything > 60% is considered
an indication of significant market power. Monopoly power in the context of §2 usually requires
a > 60% market share. Note that this sketch provides by no means a complete picture. The possibility of entry, the ease of supply-side substitution, and changes in technology may significantly
alter the share-based estimate of market power.

4. Market Concentration Measures
A simple market concentration measure is to add the market shares of the top four firms,
sometimes referred to as the “C4” index. The maximum C4 score is 100, the minimum is 4. A
market with a C4 score of 75 is highly concentrated, whereas a market with a C4 score of 25 is
not. The problem with the C4 measure is that it fails to capture relative differences among the top
four firms. Consider the following example.

35

Figure 19: C4 Index
A

B

C

D

C4

M1

25%

25%

25%

25%

100

M2

97%

1%

1%

1%

100

M1 and M2 both have a C4 index of 100. However, the structure of M2 is vastly less competitive than that of M1. M2, for all intends and purposes, is a monopoly, because firm A controls
97% of the market and B, C, and D are fringe players without sufficient capacity to constrain A
in any meaningful way. In contrast, M1 may well be a highly competitive (if concentrated) market. Simply adding the shares of the top 4 firm fails to capture this critically important difference.
The Herfindahl-Hirschmann Index (HHI) first squares and then adds the market shares of all
firms in the relevant market. As a result the HHI emphasizes the relative significance of high
market shares and thus captures the difference between M1 and M2. (Squaring the market share
increases the significance of high market shares relative to smaller shares.)
Figure 20: Same market structure, different C4 and HHI
A

B

C

D

C4/HHI

M1

25%

25%

25%

25%

100

M1
(HHI)

625

625

625

625

2,500

M2

97%

1%

1%

1%

100

M2
(HHI)

9,409

1

1

1

9,412

M1

M2

The higher the HHI, the more concentrated the market. HHIs range from 10,000 (100² * 1) to
100 (1² * 100). In the table above, the HHI reflects the difference in the relative size of the firms
that the C4 index fails to capture.
For the same reasons, the C4 index does not properly distinguish between competitively relevant and competitively irrelevant changes in the market structure. Consider the following two
mergers, one between the market leaders A and B and another between A and a fringe player E.

36

Figure 21: A acquires B; A acquires E. Same change in C4.
Firm

pre

post

A

40%

B

!C4

Firm

pre

post

70%

A

40%

41%

30%

-

B

30%

30%

C

20%

20%

C

20%

20%

D

9%

9%

D

9%

9%

E

1%

1%

E

1%

-

C4

99

100

C4

99

100

1

!C4

1

In both cases, the change in the C4 index (i.e., ∆C4) is 1. However, the merger between #1
(A) and #2 (B) completely changes the industry by creating a dominant firm with a market share
more than three times that of the next closest competitor (C), whereas the merger between A and
E essentially leaves the market structure unaffected. Once again, the C4 index fails to reflect this
important difference.
The HHI index, in contrast, properly reflects that the anticompetitive potential of the A–B
transaction far outweighs that of the A–E transaction.
Figure 21: A acquires B; A acquires E. Different change in HHI
Firm

pre

post

A

40%

B

!HHI

Firm

pre

post

70%

A

40%

41%

30%

-

B

30%

30%

C

20%

20%

C

20%

20%

D

9%

9%

D

9%

9%

E

1%

1%

E

1%

-

HHI

2,982

5,382

HHI

2,982

3,062

2,400

!HHI

80

The ∆HHI (A–B) is 30 times greater than ∆HHI (A–E), which appropriately reflects the
much greater likelihood of the merger between A and B to substantially lessen competition.
The 1992 Merger Guidelines use a combination of (i) post merger HHI and (ii) increase in
HHI (i.e., ∆HHI) to determine whether a merger is presumably lawful, warrants significant
scrutiny, or should be presumed unlawful.

37

Figure 22: The 1992 Guidelines Grid
!HHI /
post HHI

< 50

50 - 100

> 100

< 1,000
low

no
challenge

no
challenge

no
challenge

1,0001,800
moderate

no
challenge

no
challenge

high
scrutiny

> 1,800
high

no
challenge

high
scrutiny

presumed
unlawful

In this grid, the rows list the three post-merger HHI ranges: low, moderate, and high concentration and the columns the increase in HHI.44 The HHI grid as contemplated by the guidelines is
far more sensitive than real-world practice. Mergers in the 2,000–3,000 range routinely get approved by both the FTC and the DOJ. That said, the methodology makes sense, and for purposes
of triggering the double inference, some measure of post-merger HHI combined with the HHI increase from the acquisition is a useful proxy for anticompetitive effects.

5. Putting it All Together: An Example
Here is an example to illustrate the three conceptual steps from market definition to market
concentration.45 Suppose that A, B, C and D make copper wires, which customers use for underground wiring. E, F, G, and H make aluminum wires, which customers use for above-ground
wiring. Each firm sells 25 units/year, and there are no other makers of copper or aluminum
wires. A proposes to acquire B. If prices for copper went up after the merger, customers would
not switch from copper to aluminum. But E, F, and G would shift capacity from aluminum to
copper (15, 10, and 5 units/year, respectively). The capacity switch would be quick and costless.
Step 1: What’s the relevant market? Copper wires, because aluminum wires are no substitutes (focus on the demand side).
Step 2: Who are the market participants? A, B, C, D as actual producers of copper wire
and E, F, G as uncommitted entrants (focus on the supply side).
Step 3: What’s the market concentration? The total size of the copper wire market is 130
units/year (A=25, B=25, C=25, D=25, E=15, F=10, G=5). The combined share of A and
44.
45.

I’ve seen this grid first in Randy Picker’s (University of Chicago) lecture slides.
The example is based on Baker, Market Definition: An Analytical Overview (2006). Another excellent article
on market definition is Fisher, Market Definition: A User’s Guide, in: Finnish Competition Authority, Workshop on Market Definition: Compilation of Papers, Helsinki 2002, pp. 38-54.

38

B is 38%. The post-merger HHI is 2,426 (∆740).

6. Theory and Practice
While theoretically appealing, it is at best difficult and usually impossible to apply the
HM+SSNIP test to real world products in any rigorous fashion. Imagine a proposed merger between the only two cable networks with dedicated SF subscription movie channels. Is there a
market for “SF subscription movie channels?” For some viewers, romantic comedies or action
films are unlikely to be acceptable substitutes for Battlestar Galactica, Farscape, and the like.
These viewers would be willing to pay a higher post-merger price. Applying the SSNIP + HM
test to them would result in a narrow market definition and a likely challenge to the merger. The
problem is that the market to be proved is assumed implicitly in one of the premises of the argument, because there will almost always be customers with strong brand loyalties or narrow bands
of preferences. But what if 95% of the viewer population doesn’t care? What if these 95% are
perfectly content to catch the occasional Star Wars rerun on any of the other channels? Which
viewer group should serve as the benchmark to establish patterns of substitution or the lack
thereof – the loyalists or the average customer? There is no principled way to answer this question, but there is a legal mandate. Section 7 of the Clayton Act requires a “substantial” lessening
of competition, which strongly suggests that the unavoidable disappointment of brand loyalists
should, as a legal matter, not be sufficient. The hypothetical monopolist test works best with homogenous products, such as sugar, corn syrup, aluminum, oil, gas, coal, etc., where there are established patterns of industrial consumption and “natural experiments” that provide evidence for
real-world substitution behavior (for example, a steep increase in the price of oil).

39

IV. Where to Go From Here?
This little primer is intended to add the “missing first chapter” to the many excellent antitrust
textbooks. My pick for “best textbook” is Gavil, Kovavic, Baker, Antitrust Law in Perspective:
Cases, Concepts and Problems in Competition Policy, 2d. Ed. (2008). For those interested in an
integrated U.S. and EU perspective, I recommend Elhauge & Geradin, Antitrust Law and Economics (2007). The Gavil, Kovacic, Baker book is more theoretical, using case excerpts primarily to illustrate concepts, whereas the Elhauge & Geradin text is more of a traditional casebook.
That said, Elhauge’s and Geradin’s (mostly brief) commentary is among the most insightful of
all textbooks that I have used. As to basic microeconomics, my favorite text is Cabral, Introduction to Industrial Organization (2000). It is impressive how much ground Cabral covers in less
than 300 pages of crisp, lucid prose. Another excellent choice is Landsburg, Price Theory, 7th ed
(2007). Helpful internet resources are the ABA’s antitrust online journal “Antitrust Source”
(www.antitrustsource.com), the Federal Trade Commission’s website at www.ftc.gov, the
Antitrust Review (www.antitrustreview.com), and the Antitrust Institute (www.antitrustinstitute.org), which maintains a useful list of links, sorted by political affiliation.
***

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