 You're watching FJTN, the Federal Judicial Television Network. The Federal Judicial Center presents The Architecture of Antitrust, an FJTN program for judges, staff attorneys, and law clerks. This broadcast is a videotaped and edited version of a lecture presented at the Center's National Workshop for District Judges in Baltimore, Maryland. The lecture was given on August 10, 1999 by John Shepard Wiley Jr., Professor of Law at UCLA School of Law in Los Angeles, California. This is an area of law that I love dearly and I love to talk about it to an audience that really shapes this area of law. I want to make a number of points today, but I want to start off with the key idea that antitrust, it's a common law field. The Congress has really given you, the Federal Judiciary, an area of crucial national economic policy to invent, and really that's what federal judges have done during the century that we've had the Sherman Act. I'll elaborate on that, then go on to make a second basic point that these days antitrust law is all about antitrust economics. Points have got to understand some basic economics to apply modern antitrust doctrine, and really there's three key economic points that I'd like to make. In the time available it's impossible to cover all of antitrust. We've had 100 years of it, I've got 90 minutes to talk, I'm not going to try to divide the number of years by the number of minutes and shape the talk accordingly. Points I'm going to make are basic points, are fundamental points, and the first is the simple but crucial point that competitive pricing is fundamentally different from monopoly pricing, and we'll talk about exactly how that is. The second economic point I want to make is that cartels are the central evil that the Sherman Act tries to forestall or prevent. They aim to mimic monopoly conduct, and their aim is the target of the per se rule against price fixing. That's really the core rule of the Sherman Act. It's a simple rule, the Supreme Court has made it a simple rule, and it's a powerful rule. I'll try to explain exactly what that rule is about in a straightforward way. Third, related to the first two points, is something that I'm going to refer to as the market concentration supposition. This is an idea that's crucial to a lot of antitrust analysis, having to do with inferences that we draw from market concentration. It's a controversial idea, and it's varied over time, but the basic point I want to drive home is that the notion is that the more concentrated the market, the fewer the number of players, the more likely is cartel conduct. We'll talk about the application of that third principle. And then finally, all of this economic analysis is important, but as always, economics serves some larger policy goal, and it's been up to judges really to define what those policy goals are in antitrust, and they've changed over time. They've changed over time in a way that's fundamentally important to appreciate because you have, for your use, Supreme Court opinions that have never been overruled, never even been questioned by the Supreme Court, and yet they are literally from a different era. They're from an era when goals where I think it's fair to say quite different than antitrust goals are recognized by the Supreme Court to be today. So I want to give you a sense of how these underlying policy goals have changed over time. So let's start at the top here. I've got three basic points to make. My first one is that we're talking about a common law field. Now, Peter and Mark just gave you an overview, a spectacular overview of a highly statutory set of subjects, patent, copyright, and trademark. Those are doctrines that are numbingly filled with statutes. The patent code in particular is very long. The code is as well, heavily statutory topics. Now the Sherman Act also is an act of Congress, of course. That's our fundamental antitrust statute. But the first place to start with the Sherman Act is its brevity, its breathtaking brevity. It's very short. In fact, there's really only four words that are important in section one of the Sherman Act. Every contract, combination, or conspiracy, okay, those are agreements. Those are all synonyms. Those aren't helpful. That's not helpful detail. That's just repetition. So contracts, combinations, conspiracy, and criminal law, you'd say that all collapses into a meeting of the minds, a conspiracy, and agreement, okay. So agreement in restraint of trade. There's your four words. Agreements in restraint of trade are illegal. In fact, they're a felony. Wow. Now it was just as Brandeis who made the fundamental observation that this can't possibly mean what it says. Why is that? Because every contract is in restraint of trade. That's the whole idea of a contract is to restrain trade. If I take my 1965 Carmen Gia, one owner, and offer to sell it to you next week for $5,000 today, I wish, you give me the $5,000, we have a deal, and then I try and go sell the Carmen Gia to somebody else before I deliver it to you, you can restrain me from trading away the thing that I have contracted to you for because we have a deal. So how can it be that a contract which has the very purpose of restraining trade is a felony if it does indeed restrain trade? Well, those words can't mean what they say, said Justice Brandeis in the Chicago Board of Trade case. And so it's a judicial gloss that comprises all of the law on contracts in restraint of trade. The same thing is true in an even more spectacular way of Section 2 of the Sherman Act. And there's really only two sections of the Sherman Act that make much difference. Sections one and two. So this is it. Section one has got those four keywords, contract and restraint of trade. Section two says every person who shall monopolize shall be deemed guilty of a felony. That's only one keyword to monopolize. Now that word also can't literally mean what it says. I mean, to monopolize means to gain a monopoly, a single firm in possession of an entire market. Well, of course, we're literally to insist that monopolizing require a firm to get 100% of the market. Nearly no firm gets 100% of the market. And so to insist on the literal language here would instead of making the section apply everywhere would make the section apply nowhere. So that's the simple point. This is a common law subject because Congress left all the key words undefined, didn't go into any detail in the statute, and as Judge Frank Easterbrook, formerly Professor Easterbrook, who taught antitrust law before he became a member of the 7th Circuit, put it, when Congress wrote the Sherman Act, it wrote a blank check. It gave to federal judges the responsibility for engineering our national competition policy. Now you might say, that's a crazy way to run a country. We want judges, people who have no necessary economic training at all, to be the authors of our oldest industrial policy. Well it's worked out pretty well. Judges after all have a good reputation for being very smart, very diligent, and very properly motivated. You have integrity, and nobody doubts it. And over the course of 100 years of common law development, judges have indeed created our national competition policy, but it's been judicial and not legislative in character. Okay, so that's my first point. Second point, some economics. Now I want to illustrate the point that competitive pricing is fundamentally different from monopoly pricing. Now I want to do this with a commodity with which you're familiar, gasoline. Everybody buys gasoline, at least everybody who doesn't live in New York City. Now there may be some exceptions, but even there people have been known to at least keep a casual interest in what the gasoline market is. So let's take a competitive price setting mechanism to start out with. How are gasoline prices set if the market is truly competitive? Well an econ one course teaches that the beauty of a competitive market is that it drives prices down to cost, so that competitive prices are cost based prices. Now why is that? Well because competition forces prices to be at that level. If we have a truly competitive market, if there are a large number of firms producing petroleum, refining it and selling gasoline to motorists, then prices can't be above costs because otherwise competitive pressure will drive the price down. Why is that? Well if it's truly a competitive market and my price is $2 a gallon and everybody's price on the other corners in town is $1 a gallon, obviously nobody's going to buy from me. Why? Because consumers have an option, that's the beauty of competition. Consumers have the power to say no. Consumers have the power to walk out of the room, they have the power to exit an incredibly powerful power that consumers have when the market is truly competitive. So consumers can walk when they see a deal they don't like and they can go to a better competitive alternative. So prices are forced down to a cost based level. Now they're not going to go below a cost based level because the market won't sustain that in the long run. If prices are forced below the cost of production in the long run, firms will go bankrupt and that good won't be produced at a below cost price. So firms will drop out of the market and the price will come up. So the simple insight of the Econ 1 course is that competitive pricing is cost based pricing. So good so far. Let's just ask, what are competitive prices in gasoline right now? If we assume, let's assume that the gas market presently is competitive, I went online here and found out in California as of earlier this month that the price of gas in California is about a dollar and a half for regular. Now that's expensive because California is a weirdo market. We've got our own air pollution requirements and various other things that makes us sort of an island within the national petroleum market. But it's about a dollar and a half a gallon, about a dollar and seventy for a premium. And it turns out that those prices have been pretty stable for the last period of time except since around March. Prices for regular were about a dollar and twenty down to a dollar and ten even. And then there was a price spike around March. The price went up, it's tailored off a little bit. But in general that's been a fairly stable price. Take a look at another measure. This is a national measure. This is Chicago, Houston and Dallas, unleaded prices. What we see is since 1994, they've been within a pretty narrow range. Okay, so those are gasoline prices as of the present. There's been a recent price spike but it's tailoring off. Now if that's a competitive market, what I want to find out from you consumers is what you'd be willing to pay if John Wiley owned all the gas. Now this depends on your willingness to pay. The very first point to make about monopoly price setting is it's not a cost based price at all. Costs aren't crucial, costs may not even be relevant. What's important is how bad do you want it? Because I will price at what the traffic will bear. And you're the ones who will decide what the traffic will bear. Why? Because each consumer decides for her or himself, what's my next best alternative to gasoline? So let's make this real. Think about your life. Think about how important petroleum is to your life. So let's quantify this. Now you might say, how can we possibly quantify such intangible things? And the point of a market is you do quantify it. You quantify it down to the penny. You have to. Your credit card company forces you to do that. So gas is a dollar and a half, maybe dollar 70 a gallon. How much can I raise this price of gas and still have you buy? Because you're the ones who are going to walk on me. You're going to go to my next best alternative to your next best alternative. You're going to limit my power. But let's see how much power I've got. I'm going to double the price of gas, $3 a gallon. How many people are going to drop out of the market if I double the price again? OK, we've got one person who's going to drop out. I'm assuming everybody else is still in the market. I just doubled the 100% price increase. No problem. Well, it's a problem. It's a problem. I know it's a problem. I'm sympathetic. I feel your pain. But let's see the three bucks. You know, I've got a good PR department for my monopoly. I don't want to look hard-hearted. I just want to collect a lot of money. So how about doubling it again? $6 a gallon. Let's reverse it. How many people are still with me with $6 a gallon? Please raise your hand high. Don't be bashful. Now, your honor, OK, OK, you're good. Got the $6. OK, look at this. Look at this. It's $1.5 a gallon now. I'm just going to $6. I've got the majority of the room still with me. Let me double it again to $12 a gallon. How many people are still with me at $12 a gallon? Now, those of you who've got your hand down, ask yourself honestly, if you went home tomorrow and found gas, $12 a gallon, you'd be mad. But would you really get out of your car? Let me... OK, your usage would go down. OK. All right. So now we see there's some marginal issues that come up, some trade-offs. Your usage would go way down. I'm trying to illustrate a simple point here. And before we get into the, rather in lieu of getting into the marginal trade-offs of using the gas less, in fact, over time buying a car that gets better mileage and so on and so forth, my point is simple. As a monopolist, I have a very large amount of power. I have the power to double, triple, fourple. Who knows how much raised the price of gas? And in fact, if we look at how much power oil producers have used in the past, take a look at this chart. This is taking gas prices back over time. This is the glorious 1970 period when US gas prices were at an all-time low, US production was at an all-time high. Right here we had the Arab oil embargo in 73, 74, and here the Iranian Revolution. Look what happened to oil prices. When OPEC got serious about flexing its cartel muscles, prices shot up, shot up dramatically. Now that, that is the evil that the Sherman Act is centrally aimed at preventing. Don't have jurisdiction over OPEC. That is a collection of sovereign nations. Sometimes they're at war with each other. Sometimes they have a hard time cooperating on price setting. But where we do have jurisdiction over monopolists, or at least competitors who are trying to mimic monopolists, we don't want them to raise price just because they have the power to do so. Why? Well, first and foremost because it's a tremendous wealth transfer from consumers to producers. It's very painful. It makes consumers worse off. It does a lot of other bad things. It distorts efficient pricing decisions and so on. But the main thing is it's a simple idea that we don't want to pay $12 a gallon when the price of gas, when the cost of gas is only a dollar and a half. So point one, competitive price setting is cost based. Monopolistic price setting is what the traffic will bear. And that is a huge flexing of economic power of cartel might that we want to avoid. OK, so that's our first point, number one. Now, the second point is that. Excuse me, when you say cost based, does that cost based allow a reasonable price? Yes. The question is, what do I mean, what's included in the cost that I say is the cost basis for competitive price setting? And in particular, does that include a rate of return? Absolutely. A reasonable rate of return to investment, to investors, to management, that's a necessary cost to production. That's a cost to capital. You need to have a rate of return to attract capital into a market and to keep it there. So yes, there's got to be a reasonable rate of return or else the capital flees the market. Is that responsive, Your Honor? OK, important point that can be a very tricky point if we follow that very far. Well, what do you mean by reasonable? How do we find that out? But the core notion is we're not just talking about physical tangible costs. We're talking about the costs that are the economic costs to operating any business. So in a competitive market, those are compensated. OK, now, we know that a single firm can exercise monopoly power where a competitive market has no such power. The consumers have the power in the competitive market. We also know that where there is a competitive market, the producers could have monopoly power if they'd just cooperate with each other. This is my second point. Competitors can mimic the monopoly result if they can just get along. Competitors could agree with each other, you know, this dollar and a half. This is way too low for gas, don't you think? I mean, just imagine that we're a meeting of the oil producers of Baltimore. The gas station owner's association. Wouldn't it be better for all of us and fair to, in a sense that we can all identify with, to sell gas at, well, we don't have to go to 12. Let's go to 10. Nice round number. Won't you agree with me that that would be good? Won't you agree not to sell gas unless it's $10 or above? If we can agree to do that successfully. My second key point is that competitors have just mimic the monopoly result. We've just replaced competitive price setting with a monopolistic method of setting prices. Even though there's many of us, we can act as a cartel as OPEC has tried to. Now that produces exactly the same kind of injury to consumers and for that reason, the core rule, the central rule of antitrust law is the per se rule against price fixing where producers get together and use whatever mechanism it is that they try to replace a competitive price with a monopolistic price. That could be an agreement on minimum price setting. Don't go below 12 or 10. A second method would be to divide markets. You take your neighborhood, I'll take mine. We'll turn each neighborhood into a little monopoly. It could be a third method. It could be an output quota. Hold your production down. Hold your sales down to some level that our accountants will specify for us. These are all synonyms. They're all equivalent methods. Minimum prices, maximum quotas, market divisions. We can use any of these or all of these to try to mimic the monopoly result. All of those agreements, all of those price setting agreements are illegal per se under section one. Those are all classic agreements, conspiracies and restraint of trade. Now, not only are these agreements illegal in a civil law sense under the recent activities of the Department of Justice, increasingly these actions have been prosecuted in criminal court. Let me give you an example of a typical cartel prosecution here. This is a case that arose in San Francisco. Well, it was prosecuted in San Francisco. This is a change of plea. You all have seen these way more of these change of plea hearings than you care to, probably. This is before Judge Smith and the plaintiff is the Antitrust Division. It is a criminal case prosecuting Harmon and Reimer Corporation in the Citric Acid Cartel. This was just last year, actually 1997. And the Assistant United States Attorney or the lawyer from the Justice Department says, had this case gone to trial, Your Honor, we would approve that you and other conspirators did enter and engage into a conspiracy to suppress and eliminate competition in the citric acid industry. We would approve the following facts. Let's skip over to the second page here. Defendants Harmon and Reimer through several of its employees conspired with other major citric acid producing firms to fix the price of citric acid and to allocate among the major citric acid producing firms the volumes produced in the US and elsewhere. This is a detail I like. The broad terms of the conspiracy were agreed to by a high level group of executives known as the masters. The details were left to the Sherpas. So the masters formulated strategies. The Sherpas made it work. And the whole thing got caught when competitors policed each other, had an elaborate agreement to make sure that the whole thing worked. And the Department of Justice found out about it and brought felony charges. Now this kind of a prosecution, a felony charge with a large, actually these days, a whopping criminal fine has become more and more typical. Take a look at the antitrust divisions. Total criminal fines in antitrust cases on a yearly basis. You can see that antitrust prosecutions have become a profit center for the federal government. It's not yet rivaling forfeiture. I'm not sure it ever will. But this is a kind of case that may well appear in your courtroom. Typically in the form of an arranged police since once a corporation is caught red-handed, typically other executives besides the ones directly involved will conclude we need to settle this case. We need to settle this as quickly as possible. $100 million, sure. We'll write that check. So the maximum fines that the antitrust division has been getting for cartel prosecutions, criminal cartel prosecutions have been accelerating. Okay, so monopoly price setting differs fundamentally from competitive price setting. Second point, when competitors try to mimic monopoly price setting, it's a felony. It can also be prosecuted civilly for trouble damages and so forth. Now, before I leave this point, I'd like to stress its relationship to the third point, the market concentration supposition. This is the notion that the more concentrated the market, the more likely it is that the producers in that market will be able to fix prices with each other. Why is that? The smaller the group, the easier the coordination problem. That's what cartel management is all about. It's achieving and enforcing coordination. Now, a fundamental point to understand from an economic perspective is that coordination is difficult. Price fixing is harder than it looks. I'd like to drive this home with a little game that I play with my antitrust classes, and I've played this before with federal judges. This is a game. You can't get hurt. You can only win in this game. I need two volunteers. Can I get two volunteers to help play this game? I've got Judge Buckwalter. I've got one. Okay, and Judge Schwartz. Now, I want the rest of the audience to keep an eye on these two judges to make sure they do not communicate with each other. So I must inform you two judges that you're now under the scrutiny of all of your colleagues, and I'm going to now ask you to make independent decisions in a little pricing game. Now, imagine that you are service station owners in some small town. I like to pick my favorite small town in California, Copperopolis. It's by the freeway. There's two gas stations. Each one has a 70-foot-tall sign. And every morning, your problem is to pick a price. And just to simplify things, we're going to get all the marginal decision-making out of here. We're just going to give you a high and a low price to choose from. Now, if you both choose a high price, tacitly, you've cartilized that market. If you both choose a high price, consumers in Copperopolis will face a duopoly that's effectively coordinated its price to a monopoly level, whatever that level is. Let's just say $10 or $12 high. However, you might choose a low price, a low cost-based price. Here's the rules that will govern this game. Oh, I should mention, I play this game with real money. So I will pay you. It's very far, very far. Next gas station, 200 miles. And so you have a lot of power in Copperopolis. Now, if you both pick high, each station splits the monopoly profit. Each gets $30. If you each pick low, then you split a competitive profit. And I'll say that's $10. Just to pick some arbitrary figures to get the point across. What happens if one picks high and the other picks low? Then the rule is, low gets the 60 and high gets zero. So, is that clear? Now, I'm going to ask you each to write down on a piece of paper in front of you your decision in this pricing game. Now, observers, make sure there's no conspiratorial conversations. No, no, none of this, no embraces, no whispering in the ear. You make your decision. No emails. That's right. So you're about to crawl up that, climb up that sign, put up that notice to the world and you know that communicating with your competitor is a felony. So you don't want to do that. You have an independent decision to make. There's a question or comment? Two questions. First of all, is there a range? And second, is there a minimum low wherein, if they go below it, they lose? They came back in profit. So it's like $1.20, which is their minimum bid before they lose? Yes. In the real world, we have a lot of complexities. I want to abstract from those and just have a high and a low. So there's no range. There's a binary choice. It's an either or choice. So either got to pick high or low. Have you written down which you're going to pick? I'm going to ask you now, high or low? Just high or low? Okay. Don't look? Don't look? Didn't look. I heard what he said. Judge Schwartz, high or low? Low. Judge Buckwalder? High. High. Okay. So one went high. Judge Buckwalder gets zero. Judge Schwartz gets $60. Let's play again. Please make that decision another time. Don't look? Introspect? Think about after the sunset and the sunrise. It is tomorrow. It's next day. What's your decision today? Have you reached a decision? Don't tell me yet. Have you reached a decision? Judge Buckwalder? Judge Schwartz? No discussion now. No discussion. Okay. Sunsets. Sun rises. Let's play again. Please make your choice. Don't communicate. Tell me when you have decided and you're ready to go. Ready? Judge Schwartz? Okay. Two lows. Each gets 10. Sunsets. Sun rises. Let's play again. Make your decision, high or low? Tell me when you've decided. You've decided? Judge Buckwalder? Judge Buckwalder? Judge Schwartz? Low. Let's play again. Make a decision, high or low? Tell me when you're ready. Can't conspire. Judge Buckwalder? Judge Buckwalder, your decision? Judge Schwartz? No. Okay. We have five rounds of our game. Now let's take a look at what happened here. This is a very interesting result we've got. Now we've tried in a crude way to mimic the problem that every cartel faces. Do you cheat or do you cooperate? There's always a cheating incentive because you know if you go low you can get a bigger share of the business. Now look what happened to every round. Low, high, low, high, low, low, low, low, low, low, high. In every single round this cartel failed to produce a high cartel price. Because of the cheating incentive consumers in Copperopolis got a competitive price alternative in every single day that the game operated. Now this is an artificial game. It abstracts from reality in many ways. On the other hand, it also represents reality in some crucial ways too. What we've seen is that even though it's in both players' mutual self-interest to cooperate, they can't do it. Or they fail to do it. Why? Because there's always a payoff to uncooperative behavior. Now this is the same result that has occurred actually every time I've played this game. When I played this game in San Francisco, the FJC there, look at the result we got. We got low, high, low, high, low, high. Took three rounds for the high player to get the message. And then low, low. Now this was interesting. On the last round this player went high as Judge Buckwalder went high. Now why did you go high on the last round? Because I know where Murray's from. I happen to have Judge Schwartz. And I thought for sure he'd go up to high by the time around. So that's why I went high. Why did you go high? Even in the example, he's close by so we supposedly know each other. And I went high because I wanted to make some more money. And I thought he'd be going up too. Now why did you go high the second round? Basically, I wanted to give it a shot. I thought I'd do another try at a high. OK. And then I decided third round I had to cut my losses. OK. Would it be fair to call your high price an offer to him? An invitation? OK. We see out by just using pricing signals and no other form of communication. Competitors who know each other in a small market can send messages just by pricing. Now we see airlines do this. And in fact, the Department of Justice says engaged in some litigation about this right now. So firms can try to collude just via their pricing signals. But there's some problems because the other firm may decide, OK, fine. You go high. I'll get all the business. I'll go low. So we got the same sort of results in San Francisco. These are class results. I've done this with students. I must say I pay them somewhat less. But I get the same result. These results are highly suggestive to me. Again, I don't want to make too much of them. We haven't proved that cooperation never works. A match with two highs? So far playing in these little classroom settings, no. Never have. So somebody doesn't get the word? Somebody doesn't get the word. Or else is to put it in the student's term, they get outsmarted. They think they've got the right strategy. And the other person moves one step ahead. The basic point I want to make here is that although cooperation, although cartelization is in the producer's own best interest, it's harder than it looks. It's tough, it turns out, successfully to pull off a cartel. And that is why that OPEC price spike was just that, was just a spike and not a high plateau. It turned out that moment of effective petroleum cartelization was a fleeting moment. It didn't help that Iran and Iraq were at war in a very, very bloody war and that in between the battles where they're trying their best to kill the other side, their oil ministers would meet in Geneva and say, okay, well, hostilities aside. Now don't you think a $60 price is the right one for a barrel of oil? So there's many real world barriers to the cooperation problem in real life. But what I want you to understand in a visceral sense is just because it's a good thing to cooperate from the producer's point of view. Doesn't mean it's going to happen. The cheating perspective is an overwhelmingly practical problem that faces everybody who would cartelize a market.