Chapter: Which of the following is a violation of the Sherman Antitrust Act? (EN)

Chapter: Which of the following is a violation of the Sherman Antitrust Act? (EN)

Section 1: Understanding the Sherman Antitrust Act

The Sherman Antitrust Act, enacted in 1890, is a landmark U.S. federal law that prohibits anti-competitive agreements and unilateral conduct that harms competition. The primary goals are to protect consumers by promoting a competitive marketplace and preventing monopolies or cartels from dominating industries. The Act comprises two main sections: Section 1 and Section 2. Understanding these sections is crucial to identifying violations.

• Section 1: Contracts, Combinations, and Conspiracies in Restraint of Trade: Prohibits agreements, conspiracies, or combinations that unreasonably restrain trade. This section focuses on agreements between two or more entities.
• Section 2: Monopolization, Attempted Monopolization, and Conspiracy to Monopolize: Prohibits monopolization, attempts to monopolize, and conspiracies to monopolize any part of trade or commerce. This section can apply to the conduct of a single firm with significant market power or agreements between firms aiming to achieve monopoly power.

Section 2: Section 1 Violations: Agreements in Restraint of Trade

Section 1 violations require proof of an agreement that unreasonably restrains trade. Courts have developed analytical frameworks for assessing whether an agreement violates Section 1.

• Per Se Violations: Certain agreements are considered so inherently anticompetitive that they are automatically illegal, without requiring a detailed analysis of their market effects.

  • Price Fixing: Agreements among competitors to set prices, raise prices, lower prices, or stabilize prices are per se illegal. Even agreements to fix minimum or maximum prices are per se violations.

  P_fixed = (P_competitor1 + P_competitor2 + ... + P_competitorN) / N (Simple Average)

  Where P_fixed is the fixed price, and P_competitorN is the price charged by the Nth competitor. The agreement to set a fixed price, regardless of its specific value, is illegal.
  * Bid Rigging: Agreements among competitors to coordinate bids on contracts, to decide who will win a bid, or to divide up bidding opportunities are per se illegal. Common bid-rigging schemes include:
  * Complementary Bidding (Cover Bidding): One or more competitors submit bids that are intentionally higher than the bid of the designated winner.
  * Bid Suppression: One or more competitors agree not to bid, allowing the designated winner to secure the contract.
  * Bid Rotation: Competitors take turns being the winning bidder.
  * Market Allocation: Agreements among competitors to divide territories, customers, or product lines are per se illegal. This can include explicit agreements not to compete in certain geographic areas or agreements to serve only specific customer groups.
  * Group Boycotts (in some instances): Agreements among competitors to refuse to deal with a particular supplier, customer, or competitor can be per se illegal if they are designed to eliminate competition.

• Rule of Reason Analysis: Agreements that are not per se illegal are analyzed under the “rule of reason.” This involves a fact-specific inquiry into the agreement’s competitive effects, considering factors such as:

  • Market Definition: Defining the relevant product and geographic markets affected by the agreement.

  • Market Power: Assessing the market power of the parties involved in the agreement.

  • Herfindahl-Hirschman Index (HHI): A common measure of market concentration.

    HHI = Σ (S_i)^2

    Where S_i is the market share of the ith firm in the market, expressed as a percentage.
    * Anticompetitive Effects: Determining whether the agreement has anticompetitive effects, such as reduced output, higher prices, or reduced innovation.
    * Procompetitive Benefits: Evaluating whether the agreement has any procompetitive benefits, such as increased efficiency or enhanced product quality.
    * Overall Balance: Weighing the anticompetitive effects against the procompetitive benefits to determine whether the agreement unreasonably restrains trade.

Section 3: Section 2 Violations: Monopolization

Section 2 addresses unilateral conduct by firms with monopoly power. A violation of Section 2 requires proof of:

• Possession of Monopoly Power in a Relevant Market: Monopoly power is the ability to control prices or exclude competition in a relevant market. Market share is often used as evidence of market power, but it is not the sole determinant.

  • Relevant Market Definition: Defining the relevant product and geographic markets is critical in assessing monopoly power. The “hypothetical monopolist test” is often used.

    • Hypothetical Monopolist Test: Asks whether a hypothetical monopolist controlling all sales of a product in a given geographic area could profitably impose a “small but significant and nontransitory increase in price” (SSNIP). If so, the market definition is too narrow and must be expanded.

  • Market Share as Evidence:

    • Market share ≥ 70%: Often considered indicative of monopoly power, but not conclusive.
    • Market share < 50%: Generally insufficient to establish monopoly power.

• Willful Acquisition or Maintenance of Monopoly Power (as opposed to growth or development as a consequence of a superior product, business acumen, or historic accident). This means that the firm must have engaged in exclusionary or predatory conduct designed to acquire or maintain its monopoly power.

  • Exclusionary Conduct: Conduct that harms competition by excluding rivals or impeding their ability to compete. Examples include:

    • Predatory Pricing: Pricing products below cost to drive competitors out of the market. A common test is the Areeda-Turner Rule.

    P < AVC (Predatory Pricing)

    Where P is the price, and AVC is the average variable cost. If the price is below average variable cost, it may be considered predatory.
    * Exclusive Dealing Agreements: Agreements that prevent customers from purchasing products from the firm’s competitors. These are analyzed under the rule of reason.
    * Tying Arrangements: Conditioning the sale of one product (the tying product) on the purchase of another product (the tied product). These can be per se illegal if the firm has market power in the tying product market and a substantial amount of commerce is affected in the tied product market.
    * Refusals to Deal: A monopolist’s refusal to deal with a competitor may be illegal if it is designed to exclude competition.

• Causal Antitrust Injury: The plaintiff must demonstrate that it has suffered an injury as a direct result of the defendant’s anticompetitive conduct.

Section 4: Examples and Applications

• Example 1: Price Fixing: Several gasoline companies are accused of colluding to raise gasoline prices in a particular city. This would be a per se violation of Section 1.

• Example 2: Market Allocation: Two major soft drink companies agree that one will only sell its products east of the Mississippi River, and the other will only sell its products west of the Mississippi River. This is a per se violation of Section 1.

• Example 3: Predatory Pricing: A dominant airline reduces its fares on routes served by a smaller competitor to below its average variable cost, intending to drive the competitor out of business. If the dominant airline possesses monopoly power in the relevant market, this could be a violation of Section 2.

• Example 4: Exclusive Dealing: A major manufacturer of computer chips requires its customers to purchase all of their chips exclusively from it, preventing them from purchasing chips from rival manufacturers. This could be a violation of Section 2 if the manufacturer has monopoly power and the exclusive dealing agreements have a significant anticompetitive effect.

Section 5: Important Discoveries and Breakthroughs

• The Development of Economic Theory of Antitrust: Chicago school of economics emphasizes economic efficiency in antitrust analysis. Its influence led to a shift away from focusing solely on market structure and towards a more rigorous analysis of market effects.

• The Evolution of Legal Standards: The legal standards for analyzing antitrust violations have evolved significantly over time. The courts have refined the per se rule and the rule of reason analysis, taking into account new economic insights and changing market conditions.

Section 6: Experiments and Simulations

• Game Theory Modeling of Collusion: Game theory can be used to model the incentives for firms to collude and the factors that affect the stability of collusive agreements.

  • Prisoner’s Dilemma: A classic game theory model that illustrates the challenges of maintaining cooperation, even when it is in the best interest of all players.

• Simulation of Market Competition: Computer simulations can be used to model the effects of different types of anticompetitive conduct on market outcomes, such as prices, output, and innovation. These simulations can help to identify potentially harmful business practices and to evaluate the effectiveness of antitrust enforcement actions.

Section 7: Conclusion

Identifying a violation of the Sherman Antitrust Act requires a thorough understanding of Section 1 (agreements in restraint of trade) and Section 2 (monopolization). A firm grasp of per se rules, the rule of reason analysis, market definition, and the elements of monopolization is crucial for determining whether specific conduct constitutes an antitrust violation. Furthermore, appreciating the evolution of legal standards and the application of economic principles enhances the ability to assess the competitive effects of business practices.