SLIDES FOR CLASS
1. Introduction to Price Fixing:
Legal and Economic Foundations
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
Demand Curve
Price
Demand curve
Quantity
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
www.appliedantitrust.com
2
Revenues
Price
Demand curve
p
Revenues
q
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
Quantity
www.appliedantitrust.com
3
Profits and Costs
Price
Demand curve
p
Marginal cost curve
Profits
Costs
q
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
Quantity
www.appliedantitrust.com
4
Profits and Costs
Price
Firm can make more
profits by increasing
q, since incremental
revenue gains
exceed incremental
costs
Firm can make more
profits by decreasing
q, since incremental
costs exceed
incremental revenue
gains
MR = MC
Profits
 *
Demand curve
p
Marginal cost curve
Profits
MR > MC
Costs
q
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
q*
Quantity
MR < MC
q*
Quantity
www.appliedantitrust.com
5
Competitive Firms

Competitive firms take prices as given

→ Individual output decisions do not affect the market-clearing price
Price
When price does not change as the firm expands
output, the firm will produce every unit for which p  MC
Demand curve
Marginal cost curve
pc
(Perceived) marginal revenue
curve (MR = p)
Profits
Costs
Quantity
p  MC
q
Increasing q
increases profits
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
c
p  MC
Increasing q
decreases profits
www.appliedantitrust.com
6
Monopolist Firm

A monopolist choice of output q affects the market-clearing price p
Price
When price decreases as the firm expands output, MR
is less than p since in order to sell an additional unit the
firm has to decrease the price for all units.
Demand curve
pm
Marginal cost curve
Profits
Marginal revenue curve
Costs
qm
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
Quantity
www.appliedantitrust.com
7
Moving to the Competitive Outcome

Why a monopoly does not want to price at the competitive price
Price
Incremental
losses from
lower prices
on old sales
Demand curve
Incremental
profits from
new sales
pm
Marginal cost curve
pc
Incremental
costs of
new sales
qm
qc
Quantity
Incremental profit = Incremental revenues from new sales at lower price
– incremental losses on old sales at lower price
– incremental costs of new sales at lower price
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
www.appliedantitrust.com
8
Gains from Cartelization

Why firms in a competitive market have an incentive to form a cartel
Price
Demand curve
Profits gained
from old sales
at higher
prices
pm
Marginal cost curve
pc
Foregone
profits from
reduced sales
Avoided costs
from reduced
sales
qm
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
Any q in this region yields
higher aggregate profits
than the competitive
equilibrium qc
qc
Quantity
www.appliedantitrust.com
9
Obstacles to Cartel Formation

The law



Lack of sufficient market dominance



Too few competitors join the cartel
Too easy for new competitors to enter the market
Too much cheating on the cartel rule (incentive incompatibility)


Cartel agreements are unenforceable (contract law)
Cartel agreements are illegal (antitrust law)
Not enough market transparency to tell if there is cheating
Failure to agree on distribution of monopoly rents
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
www.appliedantitrust.com
10
Too Much Cheating

Single-period cartel game
Firm 2
Monopoly Competitive
45, 45
0, 50
Competitive
50, 0
25, 25
Firm 1
Monopoly
Firms split monopoly
profits of 90
Competitive firm takes
total competitive profits of
50 against firm charging
monopoly price
Firms split competitive
profits of 50
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
www.appliedantitrust.com
11
Failure to Agree on Distribution of Rents

Infinitely repeated games
Price
Demand curve
Incremental
Profits
Folk theorem: Any q in
this region is an
equilibrium in an
infinitely repeated game
pm
Marginal cost curve
pc
Incremental
Costs
qm
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
qc
Quantity
www.appliedantitrust.com
12
Public Policy of Price Fixing
1. Shift in wealth from consumers to producers
2. 2. Deadweight loss
3. May retard innovation
Price
Price
Consumer surplus
Producer
surplus
(monopoly
rents)
p
c
p
Dead-weight
loss
m
MC
MC
Aggregate
demand curve
q
c
Quantity
Perfectly Competitive Market
Antitrust Law
Fall 2014 Yale Law School
Dale Collins
MR
q
m
Aggregate
demand curve
Quantity
Perfect Monopoly Market
www.appliedantitrust.com
13