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The Circle Bastiat

The different angles of market competition for consumer goods

By S.M. OlivaGuest blogger / April 19, 2010



I highly recommend today’s Mises Daily by Daniel Krawisz on the meaning of “competition.” But in the interests of equal time, let’s also consider how our poor, beleaguered antitrust regulators define competition in response to Krawisz’s free-market approach.

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Krawisz insists “all consumer goods can substitute for one another”; the antitrust folks don’t see it that way. They only consider “close” substitutes when defining a market for antitrust purposes. The narrower the market the better, since it’s easier to prove the existence of “monopolists.” Here’s the official definition from the federal government’s Horizontal Merger Guidelines:

A market is defined as a product or group of products and a geographic area in which it is produced or sold such that a hypothetical profit-maximizing firm, not subject to price regulation, that was the only present and future producer or seller of those products in that area likely would impose at least a “small but significant and nontransitory” increase in price, assuming the terms of sale of all other products are held constant. A relevant market is a group of products and a geographic area that is no bigger than necessary to satisfy this test. The “small but significant and nontransitory” increase in price is employed solely as a methodological tool for the analysis of mergers: it is not a tolerance level for price increases.

And what is a “small but significant and nontransitory” price increase?

[The DOJ or Federal Trade Commission] in most contexts, will use a price increase of five percent lasting for the foreseeable future. However, what constitutes a “small but significant and nontransitory” increase in price will depend on the nature of the industry, and the Agency at times may use a price increase that is larger or smaller than five percent.

This raises two questions: Why 5 percent–as opposed to 4, 6, or 8 percent–and exactly how long is the “foreseeable future”? This isn’t economics; astrology or numerology, maybe, but not economics.

Krawisz also suggests that “market share” may not be a “meaningful measure” of economic power. Now he’s trampling on a sacred antitrust cow. Market share is everything in anti-merger cases. The DOJ and FTC even have an impressive-sounding formula to express its importance:

Market concentration is a function of the number of firms in a market and their respective market shares. As an aid to the interpretation of market data, the Agency will use the Herfindahl-Hirschman Index (“HHI”) of market concentration. The HHI is calculated by summing the squares of the individual market shares of all the participants. Unlike the four-firm concentration ratio, the HHI reflects both the distribution of the market shares of the top four firms and the composition of the market outside the four firms. It also gives proportionately greater weight to the market shares of the larger firms, in accord with their relative importance in competitive interactions.

The Agency divides the spectrum of market concentration as measured by the HHI into three regions that can be broadly characterized as unconcentrated (HHI below 1000), moderately concentrated (HHI between 1000 and 1800), and highly concentrated (HHI above 1800). Although the resulting regions provide a useful framework for merger analysis, the numerical divisions suggest greater precision than is possible with the available economic tools and information. Other things being equal, cases falling just above and just below a threshold present comparable competitive issues.

The important number here is 1,800. That’s the level at which a further increase (of 100 or more) in the HHI creates a presumption, in the DOJ and FTC’s mind, that a merger is illegal; the firms then have to demonstrate to the government’s satisfaction that the merger won’t adversely impact competition.

Let’s take a simple hypothetical. Suppose there are five companies that make widgets and each has a market share of about 20 percent. That means the HHI is 2,000, which is “highly concentrated” according to the DOJ-FTC scale. If two of the five companies merge, the HHI increases to 2800. That’s more than a 100-point increase, so the government would presume the merger violates antitrust law, even though there are four remaining firms producing widgets, and the “market share” of the two merging firms is only 40%. Again, this is numerology, not economics.

Now let’s briefly return to the 5 percent issue. In a “highly concentrated” market, antitrust lore tells us, customers won’t instantly respond to a 5 percent increase by switching to a close substitute (assuming one is available). Thus, antitrust intervention is necessary to protect these customers from their own decision to pay the higher price.

The problem, as Krawisz astutely notes, is that “[p]eople are misled into believing that competition primarily operates between firms rather than between individual people.” That’s certainly the antitrust view as expressed in the 5 percent rule. In order for their theories to make any sense, the DOJ and FTC have to treat “consumers” as a faceless, homogenized collective that all have the same preferences and values. They all have to respond–instantly–as a group to a price increase by switching to an identical product. If an individual customer responds to a 5 percent increase in the price of pizza by, say, buying a hamburger, that’s the wrong decision; the switch must be to an identical product in the same geographic area. Similarly, if a customer decided the pizza is worth buying even at 5 percent more, that’s also the wrong decision.

The implication, of course, is that the antitrust agencies know the correct price for any good or service. Well, okay, it’s more than implied; the DOJ-FTC Merger Guidelines come right out and say it:

[T]he Agency will use prevailing prices of the products of the merging firms and possible substitutes for such products, unless premerger circumstances are strongly suggestive of coordinated interaction, in which case the Agency will use a price more reflective of the competitive price. However, the Agency may use likely future prices, absent the merger, when changes in the prevailing prices can be predicted with reasonable reliability. Changes in price may be predicted on the basis of, for example, changes in regulation which affect price either directly or indirectly by affecting costs or demand. (Italics added)

So the DOJ knows when current prices aren’t “competitive,” and it can predict–”with reasonable reliability”–what future prices can and should be. If it walks like a central planner and acts like a central planner…

The basic error here is that antitrust reduces the market to the level of laboratory experiments–and experiments performed by an elementary school science teacher at that: “Here Billy, use this HHI wand to measure concentration levels in the superpremium ice cream market! Very good!” Antitrust somehow grossly oversimplifies market processes while simultaneously producing complicated-sounding jargon to make the whole thing sound highly educated. Which I suppose describes most government regulation.

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