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`Exhibit
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`GEORGE MASON LAW REVIEW
`
`
`
` VOLUME 7 SPRING 1999 Number 3
`
`
`
`ARTICLES
`
`CONTENTS
`
`EFFICIENCIES IN DEFENSE OF MERGERS: TWO YEARS AFTER o....cscecceeee Robert Pitofsky 485
`
`PROMOTING INNOVATION COMPETITION THROUGH THE
`ASPEN/KODAK RULE wiccscssssececvsesssccssvsnsseevssseceusecceeeseverasees Jonathan B. Baker 495
`
`NETWORKS AND EXCLUSIVITY: ANTITRUST ANALYSIS TO
`PROMOTE NETWORK COMPETITION voccsssissessecsscesesescveceveereeseevcnes David A, Balto 523
`
`Nerwork EFFECTS: A CONTRARIAN VIEW c.ccsecccnseseenreeseserseerssees William J. Kolasky 577
`
`PRESERVING MoNoPoLy: Economic ANALYSIS, LEGAL
`STANDARDS, AND MICROSOFT saiteiisininioinnnncnencrinrinniiiandss Steven C. Salop
`R. Craig Romaine 617
`
`EXCLUSIVITY IN NETWORK INDUSTRIES \.cccccceccseseseevseseeeretsessucneesssasnaneas Carl Shapiro 673
`
`EFFICIENCY CLAIMS IN MERGER ANALYSIS:
`HOSTILITY OR HUMILITY? vo. ceesteeeereretererstersneereeere reese Craig W. Conrath
`Nicholas A. Widnell
`
`685
`
`EFFICIENCIES FROM THE CONSUMER VIEWPOINT......-:ssessseesseeseeeseerens Jerry A. Hausman
`Gregory K, Leonard 707
`
`THE GOVERNMENT AND MERGER EFFICIENCIES:
`STILL HostILe AFTER ALL THESE YEARS vos.ssscestececevseeenererenes Timothy J. Muris 729
`
`COMMENTS
`
`ERISA PREEMPTION OF “ANY WILLING PROVIDER”:
`WHYTHE EIGHTH CirCurr GOT IT RIGHT ....ccceccceeeeenesseeens Alice T. Armstrong 753
`
`APPLYING THE FAUse DEFENSE IN TRADITIONAL
`TRADEMARK INFRINGEMENT AND DILUTION CASES
`TO INTERNET META TAGGING OR LINKING CASES .....0.45 Katherine E. Gasparek 787
`
`RECEIVED
`paws Pagar
`
`{
`
`JUL Qe ey
`
`Hieater
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`og *
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`

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`old and the new addresses and should be mailed at least forty-five days before the
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`© 1999 by The George Mason Law Journal Association. All Rights Reserved,
`
`

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`1999]
`
`107
`
`EFFICIENCIES FROM THE CONSUMER VIEWPOINT
`
`Jerry A. Hausman®
`Gregory K. Leonard™
`
`INTRODUCTION
`
`Section 4 of the Federal Trade Commission (FTC) and Department of
`Justice (DOJ) Merger Guidelines (MG) considers the treatment of effi-
`ciencies used in the agencies’ mergerevaluations.' Theefficiencies section
`of the MG,as revised in 1997, discusses various special considerations
`regarding the specific details of the proposed merger.” We proposeadif-
`ferent approach to efficiency evaluation within the scope of the MG. Be-
`cause the antitrust laws are most often interpreted from a consumer wel-
`fare viewpoint, we propose to evaluate mergerefficiencies using Section 2
`of the MG, “Competitive Effects,”? Mergers that lead to lowerprices for
`consumersafter efficiencies are taken into account(i.e., mergers that will
`be pro-competitive) will increase consumer welfare and therefore should
`not be opposed by the agencies, regardless of the special considerations
`contained in Section 4 of the MG,
`to merger analysis
`Wealso developresults that should be useful
`where significant efficiencies exist. We demonstrate that so Jong as de-
`mand curves have the expected shape, the minimum amount of marginal
`cost savings passed on by a monopolist in terms of lowerprice is one-half
`of the cost savings. Competition will lead to a higher proportion of cost
`savings being passed on, and we demonstrate how to calculate the effect
`on prices in the two leading models ofunilateral effects, the Nash-Bertrand
`differentiated products model and the dominant firm model. We demon-
`strate that if significant efficiencies exist, post-merger prices may well be
`lowerthan those prior to the merger,
`However, even if post-merger prices are predicted to increase by a
`relatively smal] amount, merger policy perhaps should take accountof the
`efficiency gains to the economy from the merger. Afterall, the efficiency
`
`* MacDonald Professor of Economics, Massachusetts Institute of Technology,
`OK
`Director, Cambridge Economics, Inc. This Article was presented at the George Mason Law
`Review Antitrust Symposium (October 1998), The authors thank Dennis Carlton for a helpful conver-
`sation,
`! U.S. Dep’T oF Justice & Fep, TRADB COMM'N, HoRIZONTAL MERGER GUIDELINES§ 4 (rev.
`ed,997), reprinted in 4 Trade Reg. Rep. (CCH) J 13,104, at 20,573-11 lo -13 (Apr. 8, 1997) [herein-
`after 1997 REVISED MERGER GUIDELINES].
`2 See id.
`3 See id. § 2, reprinted in 4 Trade Reg. Rep. (CCH) at 20,573-6 to -9.
`
`

`

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`708
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`GEO. MASON L. REV,
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`(VOL. 7:3
`
`gains to the economy maybe quite large if the cost savings that arise from
`the efficiencies are significant.
`
`I,
`
`PRICES AND COSTS IN ECONOMIC THEORY
`
`Productive efficiencies lead to a reduction in cost for the mergedfirm,
`Suppose that initially no change in competition occurs with the merger.
`What would be theeffect on prices to consumers fromthe cost reduction?
`Economic theory makesa straightforward prediction: The decrease in cost
`will lead to a decrease in price, with the relationship betweenthe decreases
`in cost and price depending on the shape of the demandcurve. Later in this
`Article, we will demonstrate how economic theory places bounds onthe
`relationship between cost and price decreases, given the usual expectation
`aboutthe shape of a demand curve.’
`
`A.
`
`The Effect of a Cost Reduction on the Price to Consumers
`
`To begin with the extreme case of a monopolist, price will decrease
`when marginal cost decreases, This claim is unexceptional to any student
`of intermediate microeconomics.” However, we have been continually
`surprised over the years that many lawyers at the antitrust agencies refuse
`to accept this proposition and instead claim that a monopolist will “pocket
`the cost savings” and not pass any of them on to consumers. This claimis
`based onthe incorrect assertion that only competition forces afirm to pass
`along cost savings.
`In fact, however, profit maximization by the firm
`causes it to pass along at least some of the cost savings in terms of a lower
`price, evenif the firm is a monopolist.
`to pass
`Why does profit maximizing behavior cause a monopolist
`along to consumers some of the cost savings? A: monopolistsets its price
`so that marginal revenue equals marginalcost. If the monopolist lowers its
`price (by a small amount),
`three effects result. First,
`the monopolist
`achieves lower revenue on its existing unit sales; second,
`it sells more
`units because of the lowerprice; and third, its total costs increase because
`of the extra production.® At the profit maximizing optimum,the neteffect
`of these three terms is zero—they cancel each other out.’? However, if the
`last term, whichis the cost of the extra production, becomes smaller due to
`efficiencies, the total net effect becomes positive because the added reve-
`nue from the price decrease exceeds the added productioncost.® Thus, the
`
`
`4 See infra Part TV,
`5
`See, ¢.g., ANDREW MAS-COLELL ET AL., MICROECONOMIC THEORY 429 (1995).
`6 A price increase can be analyzed ina similar way ifthe signs of each lerm are changed,
`7 A small price increase leads to the same resuli—the three terms cancel each otherout,
`8 This result requires that the price elasticity exceeds 1.0 (in magnitude) al the initial optimum,
`whichit does as a consequence ofprofil maximization, See, ¢.g., DENNIS W, CARLTON & JEFEREY M.,
`
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`EFFICIENCIES FROM THE CONSUMER VIEWPOINT
`
`709
`
`monopolist can increase its profits by reducing its price, causing marginal
`revenue and marginal cost to be equal once again.
`The mathematical formula for the solution to the monopolist’s price
`setting problem is found in most microeconomic textbooks:”
`
`p-c_|l
`poo”
`
`(1)
`
`wherep is the price, c is the marginal cost, and 1) is the price elasticity (i.e.
`the magnitude of the percentage change in quantity divided by the percent-
`age change in price). Rearranging the terms makes the relationship be-
`tween price and marginal cost more explicit:
`
`(2)
`
`=cd
`‘
`
` 1
`
`7
`pee n-!
`
`where 6 = 1/(n - 1) > | since 7 > |. Thus, price is set as a markup over
`marginal cost where the markup depends on the parameter 6.
`In general, 6
`depends on price. For the special case where 5 is constant for small
`changes in price (e.g., a constant elasticity demand curve), a percentage
`reduction in marginal cost c of a certain size will lead to an equal sized
`percentage decrease in price. On a dollar and cents basis,
`the price de-
`creases by more than the cost.
`For example, suppose that the price equals $1.00 per unit and the
`marginal cost is $0.50 per unit so that n = 6 = 2. If an efficiency improve-
`ment causes the marginal cost to decrease to $0.40 perunit, a decrease of
`20 percent, the price drops to $0.80 per unit, which is also a decrease of 20
`percent. While the change in cost is $0.10 per unit, however, the changein
`price is $0.20 per unit. Thus, for this example of a constantprice elasticity,
`the monopolist has passed on twice the cost savings caused by the effi-
`ciency to consumersin the form of lowerprices. The monopolist passes on
`twice the cost savings becauseits profits increase by 25 percent due to the
`fact that it sells more at the lowerprice.
`To demonstrate this outcome using a numerical example, suppose the
`monopolist sold 100 units at the original price of $1.00 for an overall profit
`of $50. When it decreases its price to $0.80, it sells 156.25 units, Even
`
`PERLOFF, MODERN INDUSTRIAL ORGANIZATION 103 (1990) (Therefore, a commonobservationis that
`monopolists never operate on the inelastic portion of their demand curve. That is, monopolists always
`profit more by changing prices until (hey reach the elastic portion of their demand curve.”). The elastic
`portion of the demand curve occurs when the demandelasticity equals or exceeds 1.0 in magnitude,
`Aceording to George Stigler, “It follows immediately that since no monopolist will willingly operate
`where marginal revenue is negative, he will never willingly operale where demand is inelastic.”
`GEORGE STIGLER, THE THEORY OF PRICE 197 (4th ed. 1987).
`9 See, ¢.g., CARLTON & PERLOFF, stipra note 8, al 102,
`
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`710
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`GEO, MASONL,Rev.
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`(VOL, 7:3
`
`though the per unit profit decreases from $0.50 per unit to $0.40 per unit,
`overall profits increase from $50 to $62.50 because of the additional units
`sold. If the monopolist had maintained the price at $1.00 when cost de-
`creased from $0.50 per unit to $0.40 per unit, however,
`its profit would
`have only increased from $50 to $60. Therefore, the monopolist can in-
`crease its profits by passing along more than the changein cost, The exact
`proportion depends on equation (2) and the shape of the demand curve."
`Thus, economic analysis reaches a straightforward conclusion that some of
`the cost change will be passed on to consumers, even in the case of a mo-
`nopoly. (Wefindit difficult to understand why so many lawyers have dif-
`ficulty accepting this result.)
`|
`
`B.
`
`The Overall Effect of a Cost Reduction on the Econonty
`
`Evenif only part of the cost savings is passed on to consumers, efficiency
`gains still benefit consumers and the economy. As Professor Paul Samuel-
`son States in his well-known economics textbook:
`
`. Productive effi-
`,
`.
`Efficiency is a central (perhaps fhe central) concern in economics .
`ciency occurs when society cannot increase the output of one good without cutting back on
`another, An efficient economyis on its production-possibility frontier, !!
`
`A gain in productive efficiency increases the amount of output the econ-
`omy can produce. Indeed, deviations from productive efficiency cause a
`“first order” welfare loss to the economy while deviations from allocative
`efficiency caused by monopoly cause “second order” welfare losses to the
`economy, which are typically smaller welfare losses.'* This observation
`forms the basis for Professor Oliver Williamson’s classicarticle discussing
`the tradeoff between productive andallocative efficiency in antitrust.'?
`The MGneverdirectly address this basic economic point. Presuma-
`bly, an objection to recognition of the overall gain in economic efficiency
`created by a transactional efficiency arising from a merger is based on
`distribution considerations. That is,
`if the price increases to consumers
`while the stockholders of the firm receive most of the gains of increased
`
`
`10 Wewill consider how muchofthe cost change will be passed on subsequently, See infra Part
`
`IV.
`
`11 PauL A. SAUMELSON & WILLIAMD, NORDHAUS, ECONOMICS 28-29 (12th ed. 1985).
`12
`Byfirst and second order welfare losses we mean the corresponding term in a Taylor's expan-
`sion around a Parelo efficient point, The allocative efticiency loss from monopoly arises because the
`monopoly price exceeds the competilive price and leads to a “deadweight loss.” For a further discus-
`sion of deadweight loss and its neasurement, see, e.g., Alan J, Auerbach, The Theory of Excess Burden
`and Optimal Taxation,
`in ALAN J, AUBRBACH & MARTIN FELDSTEIN, HANDBOOK OF PUBLIC
`ECONOMICS (1985); Jerry A. Hausman, Exact Consumer's Surplus and Deadweight Loss, 71 AM.
`ECON, REV. 662 (1981).
`13° Qliver E. Williamson, Economics as an Antitrust Defense: The Welfare Trade-offs, 58 AM,
`ECON. REV. 18, 36 (1968),
`
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`1999]
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`EFFICIENCIES FROM THE CONSUMER VIEWPOINT
`
`TKI
`
`efficiency through increased profits, social welfare may well decrease de-
`pending onthe relative weights used for consumer welfare and for firms’
`profits." We would expect the antitrust agencies to exercise discretion
`here since a very small increase in price could be outweighed by a large
`increase in productive efficiency. Section 4 of the MG seemsto recognize
`the scope of such discretion, and the agencies often weigh expected effi-
`ciencies in their decisions.'*
`If consumer welfare increases because of lowerprices arising from a
`merger and the firms’ profits also increase, however, we see no good eco-
`nomic reason for federal antitrust agencies to challenge the merger. Be-
`cause both consumer welfare and producer welfare (profits) increase, no
`weighting of consumer and producer welfare exists under which total wel-
`fare would decline. Yet the MG doesnot accept this approach, for reasons
`that we turn to subsequently.'® First, however, we consider the case of two
`firms merging where a reduction in competition as well as an increase in
`efficiency are both present. In such cases the antitrust authorities can de-
`termine whetherthe price to consumers will decrease in that situation.
`
`Il.
`
`PRICE AND COST WHEN COMPETITION CHANGES BECAUSE OF A
`MERGER
`
`In the usual case of a merger that causes concern for the antitrust
`agencies a reduction in competition (holding other factors constant) may
`occur because the merging firms were competing prior to the merger. Here
`we considerthe situation of unilateral effects discussed in Section 2.2 of
`the MG.'’ We will consider both situations discussed in Section 2.2, be-
`ginning with differentiated products (Section 2.2!) and then analyzing the
`relatively undifferentiated situation (Section 2.22) where the supply re-
`sponseis limited by capacity constraints.
`
`
`
`
`
`!4 Overall economic efficiency can be expressed (approximately) as the sum of consumer wel-
`fare (consumer surplus) plus producer surplus (firms' profits), However,
`in a given social welfare
`function the terms may be weighted differently depending on distributional preferences. See, e.g.,
`Auerbach, supre note 12,
`'5 For instance, IMC acquired, from Western Ag, the only other mine in North America that
`produced a certain type of polash. The acquisition generated substantial operational efficiencies, how-
`ever, and (he DOJ did not oppose the merger,
`16 See infra Part II.
`.!7
`1997 REVISED MERGER GUIDELINES § 2.2, supranote 1, at 20,573-8 to -9,
`
`

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`712
`
`GEO, MASONL, REV,
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`[VOL. 7:3
`
`A. Differentiated Products'*
`
`A merger between two firms selling differentiated products has two
`potential competitive effects. First,
`to the extent that the products of the
`merging firms constrain each other’s pricing prior to the merger,
`the
`merger will remove this competitive constraint, giving the merged firm an
`incentive to raise its prices. If prices are “strategic complements,” the other
`firms will also raise their prices in an equilibrium.'? The size of this com-
`petitive effect will depend upon the extent of competition between the
`products in the industry.
`Second, the merger couldresult in production efficiencies (reductions
`in marginal cost) for the merging firms. The lower marginal costs will
`generally create an incentive for the merged firm to lowerits prices, hold-
`ing constant the pre-merger equilibrium prices of the other firms. Again, if
`prices are strategic complements, the equilibrium prices of the other firms
`will also generally decrease. The size of this competitive effect is directly
`related to the size of the reductions in marginalcost.
`Whether a merger has an overall positive or negative effect on prices
`depends on whetherthe first effect is larger than the second effect. We
`analyze the tradeoff using a static Nash-Bertrand price-setting model for
`differentiated products,’? where we compare the pre-mergerequilibriumto
`the post-merger equilibrium. We make two additional assumptions. First,
`we assume no entry will occur even if prices rise.“ Second, we assume
`that the firms’ marginal costs are constant over the relevant range of out-
`put,
`
`Suppose there are N firms, with each firm producing and selling one
`brand so that there are N brands. We discuss the case where firms | and 2
`merge to forma single firm that controls two products post-merger,”
`Pre-merger, the producer of each brand i seeks to maximize its prof-
`its, which are equal to the difference between price and marginal cost
`multiplied by the quantity of brand i demanded (we ignore fixed costs
`here):
`
`
`Forfurther discussion and analysis of this point, see Jerry A. Hausman and Gregory K, Leon-
`18
`ard, Economic Analysis of Differentiated Products Mergers Using Real World Data, 5 GEO, MASONL.,
`REV, 321 (1997),
`19 Prices are slralegic complementsif the price best response function ofone firmis an increas-
`ing function ofthe prices of the other firms. In a price setling game, this condition is related (o the
`products being demand substitutes.
`20 See, e.g., Jerry A, Hausmanet al., Competitive Aualysis with Differentiated Products, 34
`ANNALES, D'ECONOMIE ET DE STATISTIQUE [59 (1994).
`21 Of course, if entry would occur when existing producers allempled (o increase price, the eco-
`nomic analysis would need to change to take account of the entry. Forinstance, if no barriers to entry
`existed for similar products, any concerns regarding post-mergerunilateral effects may be alleviated.
`22° The case where (he firms have more than one brand is a straightforward extension, which is
`given in our previous papers, See, ¢.g., Hausmanetal., supra note 20.
`
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`EFFICIENCIES FROM THE CONSUMER VIEWPOINT
`
`(p, ~¢,)Q,(p)
`
`713
`
`(3)
`
`In this equation, p; is the price of brandi, c; is the marginal cost ofbrand /,
`p (with no subscript) is a vector containing the pricesof all N brandsin the
`industry, and Q((p) is the quantity demanded for brand i given prices p.
`The producerof brand i choosesits price to maximizeits profits, taking the
`prices of the other brands as given, The first order condition for this
`maximization problem sets the derivative of profit with respect to p; equal
`to zero:
`
`d0,(p)_
`O,(p)+ (py,a =0
`
`This equation can be re-arranged to take on the following form:
`
`Ppaey _ tI-_-
`Pp;
`. ei (; )
`
`(4)
`
`(9)
`
`wheree,(p) is the absolute value of the ownprice elasticity for brand i,
`which is in general a function ofthe pricesofall the brands.”3 Equation (5)
`says that each producerof i sets its price so thatits price-cost markup is
`equalto the inverseof its own elasticity of demand.
`The pre-merger industry equilibrium is defined as the vector of N
`prices that simultaneously satisfy the first order conditions (5) for all N
`brands. In other words, the equilibrium vector of industry prices simulta-
`neously solves the system ofN first order conditions.
`After the merger, a single producercontrols both brand | and brand 2
`and the marginal costs of producing these products are reduced, In general,
`the pre-mergerequilibrium prices will no longer constitute an equilibrium
`in the post-merger world.
`To see why, considerfirst the merged producer, holding the prices of
`the other firms at their pre-merger (equilibrium) levels, The merged pro-
`ducerrecognizes thatifit raises the price ofeither ofits brands, some of
`the lost demand will go to its other brand, whichit also controls, Thus, the
`pre-merger, price-constraining effect of brand 2 on brand 1 (when it was
`under separate control) will be eliminated, as will the price-constraining
`
`23 Weuse the convention that an own-priceelasticity is taken to be positive, so that its magni-
`tude is used,
`‘
`
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`
`GEO, MASONL,REV.
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`[VOL, 7:3
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`effect of brand 1 on brand 2. Consequently, the merged producer has an
`incentiveto raise its prices,4
`%
`The merged producer will also take into account the lower marginal
`costs as a result of the merger-related efficiencies. For the reasons dis-
`cussed above in the case of a monopolist, the reduced levels of marginal
`cost give the merged produceran incentive to lowerits prices, holding the
`prices of the otherfirms at their pre-mergerlevels,
`These two effects give the merged firm incentives to changeits prices
`from their pre-merger equilibrium levels. When its prices change, how-
`ever, the pre-merger equilibrium prices of the other firms are no longer
`optimal for those firms. Thus, their prices will also change and the pre-
`merger equilibrium prices no longer define an equilibrium in the post-
`merger world,
`Wenowformalize the previous discussion. After the merger, with the
`two brands 1 and 2 underits control, the profits of the merged producerare
`the sum ofthe profits of the two brands:
`
`(p, ~e )Q,(p)+ (p, —€,)Q,
`
`(p)
`
`(6)
`
`When the merged producersets its two prices optimally, the prices solve
`the first order equations for the two brands, Thesefirst order conditions are
`the two partial derivatives of (4) with respect to py and p, After re-
`arranging, these twofirst order conditions can be expressedas:
`
`
`
`- 5,(p)-e,(p)- An + 5,(p):e,,(p): Pro= -s,(p)
`Py
`Py
`
`NX
`—X.
`s) (p): en(p): Pea s,(p): en {p): Paw —s,(p)
`Pr
`P2
`
`(7)
`
`the s,s are revenue
`where the e's denote the elasticities of demand,
`shares, and x; and x2 denote the post-merger levels of marginal cost for
`brands | and 2 respectively. These post-merger marginal costs incorporate
`the production efficiencies that result from the merger. Note that both the
`elasticities and revenue shares are functions of the prices of all N brands
`and thus in general change as these prices change.
`Post-merger, the N-2 producers not involved in the mergerstill have
`profit functions taking the form of equation (3). Accordingly, the first or-
`der conditions for the prices of the other N-2 brands in the post-merger
`
`
`
`24 Wediscuss these effects as though they played out in a dynamic setting. Strictly speaking,
`however, our analysis comparestwostatic equilibria.
`
`

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`1999]
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`EFFICIENCIES FROM THE CONSUMER VIEWPOINT
`
`71S
`
`situation continue to have a form similarto the first order conditions in the
`pre-mergersituation;”°
`
`-_ 3
`i
`!
`Py — Cc; _
`oy TI
`3)
`Pp,—e(p)’
`
`In the post-merger equilibrium, the prices of the N brands simultane-
`ously solve the twofirst order conditions (7) and the N-2 first order condi-
`tions (8). Together, the first order conditions (7) and (8) represent a system
`of N nonlinear equations in N unknownprices, This system of nonlinear
`equations can besolved to find the post-merger equilibrium prices.
`As an example, consider an industry with five firms. One firm is
`“large” relative to the others, holding a 50 percent share. This firm seeks to
`merge with a secondfirm that holds only a 5 percent share. The remaining
`three firms have shares of 15 percent each.?® Margins in the industry are
`low as the firms are highly competitive. Firm 1 has a 23 percent margin
`and Firm 2 has an 18 percent margin. Pre-merger, all firms charge the
`same price of $1. The following table summarizes the pre-mergersituation
`for Firms | and 2:
`
`Pre-MergerPrices
`Shares
`% Margin
`OwnElasticity
`Cross Elasticity w.r.t. other
`
`Brand |
`$1
`50%
`23%
`4,3
`0.33
`
`Brand 2
`$1
`5%
`18%
`5.5
`3.3
`
`Supposethat the mergerwill result in no efficiencies. Then, the post-
`merger price changes would be as follows:
`
`Post-Merger
`Price
`
`$ Price
`% Price
`
`Change
`Change
`
`Firm |
`Firm 2
`Firm 3
`Firm 4
`Firm 5
`
`$1.024
`$1,124
`$1,009
`$1.009
`$1.009
`
`$0,024
`$0,124
`$0.009
`$0.009
`$0.009
`
`2%
`12%
`1%
`1%
`1%
`
`
`_—_—__oor:.:.:_
`25 Note that the own priceelasticities in the following equationwill, in general, change when
`prices for the merging goods change.
`26 Firms 3 through 5 are assumed to be symmetric with respect to each other and Firms | and 2.
`
`

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`
`GEO. MASON L. REV.
`
`[VOL, 7:3
`
`However, now supposethat the merger leads to a marginal cost reduction
`of 10 percent for both Firms | and 2. Thus, Firm 1’s cost is reduced by
`$0,077 and Firm 2’s cost is reduced by $0.082. Then,
`the post-merger
`prices are as follows:
`
`% Price
`$ Price
`Post-Merger
`
`Price
`Change
`_ Change
`
`Firm 1
`Firm 2
`Firm 3
`Firm 4
`Firm 5
`
`$0,956
`$1.050
`$0,986
`$0.986
`$0,986
`
`-$0.044
`$0.050
`-$0.014
`-$0.014 ,
`-$0.014
`
`-4%
`5%
`-1%
`-1%
`-1%
`
`For Firm 1, the efficiencies offset the reduction in competition, leading to
`an overall price decline. Indeed, the $0,077 in cost reduction leads to a
`$0.068 price reduction. Thus, the pass-through for Firm |
`is 88 percent.
`For Firm 2, however,
`the efficiencies do not overcome the reduction in
`competition andpricestill increases, by $0.05. Nevertheless, 90 percent of
`the cost reduction is passed through to consumers.
`The pro-competitive effect from Firm 2 causes the remaining firms’
`prices to fall, although by a lesser amount than Firm 1’s price. Note that on
`a weighted average basis, the industry price falls by 2.2 percent. Thus,
`overall, the merger would be pro-competitive, leading to an increase in
`consumerwelfare,
`Equation (7) and the example demonstrate the two counteracting ef-
`fects from a merger with differentiated products, The terms (p; — xj) / p
`have a similar form to equation (5) where price is determined as a markup
`over marginal cost. When the marginal cost x; decreases due to a produc-
`tion efficiency, the price also decreases (holding other factors constant),
`The other effect from the merger arises from the cross-price elasticities
`e;(p). The higher the cross price elasticities are, the more closely competi-
`tive the merging products are and the greaterthe price increase, for a given
`share sp). The merged firm will have an economic incentive to lower
`prices due to its lower marginal costs, similar to the monopolist, but it will
`also have an economic incentive to raise prices due to the removal of the
`competitive constraint of the merged brand. If the efficiency effect
`is
`greater than the competitive constraint effect, post-mergerprice for one or
`both of the brands could be lowerthan in the pre-mergersituation.”’
`
`If one price is predicted to increase and the other price is predicted to decrease, we recom-
`27
`mend taking a revenue weighted average of the two merging brands. Price changes of non-merging
`
`

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`EFFICIENCIES FROM THE CONSUMER VIEWPOINT
`
`717
`
`B. Relatively Non-Differentiated Products
`
`The MGalso considerthe situation of possible unilateral effects when
`the goods are relatively non-differentiated.> We analyze this situation
`under a dominant firm-price taking fringe model.” The industry demand
`for the productis Q(p). Prior to the merger, the price-taking fringe is char-
`acterized by a supply curve S(p), The dominantfirm has constant marginal
`cost of productionc.
`Priorto the merger, the dominantfirm maximizes its profits subject to
`the behavior of the fringe (ic.,
`the fringe supplies S(p) given price p),
`Thus, its maximization problem ts
`
`max (p ~ ec@(v)- S(v))
`
`Thefirst order condition for the dominantfirm is
`
`O(p)-S(p)+(p-cfa'(p)-S'(p)]=0
`
`(9)
`
`(10)
`
`The pre-merger equilibrium price is the solution ofthis first order condi-
`tion.
`
`We assume a merger in which the dominant firm acquires capacity
`from the fringe. We assumethat the acquired capacity is “low” on the sup-
`ply curve, ie.,
`it
`is low-cost capacity.” Then,
`in the relevant range of
`prices the post-merger fringe supply curve is H(p) = S(p) - A, whereAis
`the amount of acquired capacity. Note that H'(p) = S'(p). We also assume
`that as a result of the merger, the dominant firm’s marginal cost is reduced
`from c to x, Underthese assumptions, the post-mergerfirst order condition
`for the dominant firmis
`
`Q(p)~ 8(p)+ A+ (p - xJQ'(p)- S'(p)]=0
`
`(1)
`
`
`
`
`
`brands can also be taken into account, However,these predicted price changes are typically small in
`relation to the merging brands, and if both merging brandsprices are predicted to decrease, then prices
`of competing non-merging brands will also be predicted to decrease in the typical situation,
`28
`(997 REVISED MERGER GUIDELINES § 2.22, supra note 1, at 20,573-9.
`29
`See, e.g,, CARLTON & PERLOFF, supra note 8, at 172-74,
`30 This assumption avoids a situation where the fringe supply curve would have a discontinuity
`in the vicinity of the optimum.
`
`

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`718
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`Gro, MAS