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In 1956 the Supreme Court concluded that DuPont, accused by the government of having monopolized the market for cellophane, did not have sufficient market power, because, in a properly defined product market, it was unable to raise prices profitably, that is, so many customers would have stopped buying the firm’s products (or would have bought less) that the higher prices extracted from the loyal customers would not have made up for the loss. The discussion was subject to almost immediate criticism, as lawyers and economists discovered an error that became known as the “Cellophane fallacy.” Here is the court’s central premise, stated positively: “Only a firm with market power can raise prices profitably.” Nothing wrong with that. But the negative implication, on which much of the opinion rests, does not follow: “If a firm cannot raise prices profitably, it doesn’t have market power.” The reason for the disconnect is that even a monopolist has no control over the reservation price of its buyers. At some point every customer is fed up and walks. So inability to raise prices any further only shows that the firm is already pricing optimally, irrespective of whether the firm is one of many competitors or a monopolist. The “raising prices profitably” test tells us something about whether the firm can exercise additional market power. It tells us nothing about whether the starting point for the exercise of additional market power is no market power or monopoly.

There might be a similar mistake with respect to consumer choice. Consumer choice is one of the bedrock principles of modern economics. In fact, the entire economic process has been portrayed as a transformation of relatively few raw materials into an ever expanding universe of goods that are ready for consumption. At each step along the way from planting trees in the nursery to buying a pencil in the store, value is added. And every supplier along the way coordinates its activities based on the consumer’s willingness to pay. The consumer is the source of all original price signals. Everything else is, in some fashion, derived demand. And price signals depend on the consumer’s subjective preferences. Thus, the idea of consumer sovereignty. The “wealth of a nation,” as we understand it today, lies not in the value of the gold stored in Fort Knox but in the quality, quantity, and variety of goods that consumers who happen to live here are able to enjoy.

But what about the universe of the consumer preferences? Consumers seek to maximize their utility, that is, they choose (by and large) reasonable means to achieve their ends. Thus, looking at me, economic theory would assume that I am, in fact, maximizing my utility. There is a not-so-subtle, legitimizing aspect to this theory, as I am, presently, in a maximalist state. Using the present state as a starting point, antitrust law would ask whether a merger between two competitors would significantly reduce my universe of choices, and if so (and if there are others that are similarly affected) chances are the the government would not permit the merger to proceed. But what about the starting point? In what way do my choices truly express my preferences, or the degree to which they are satisfied, rather than merely reveal which of the options available to me I choose to exercise? Put differently, I can only express my preferences within a pre-defined set of choices, and I have little to no opportunity to help define that set. For example, I have read that the average, specialized record store (apparently a dying species) has about 60,000 titles in stock. A typical big box retailer, in comparison, has 5,000, all purchased centrally. Big box retailers command by far the largest share of record sales. Similarly, local radio stations used to play different kinds of music, today’s near-monoculture pushes the exact same mix everywhere. Unless I seek out speciality stores, download what I need, or fork over $120 for satellite radio, I can only express my preferences from within a set of overall unappealing choices. Rational actor that I am, I settle for the least unappealing. A similar case could be made for the auto industry, where it requires significant effort to find low consumption, low emission cars. Here, too, my choices will be made and my utility maximized, within a set of rather unappealing options. And the list goes on. Of course, I understand and can anticipate the reply that my plight merely exemplifies that, after things went awry in the Garden of Eden, goods are limited and wants are not. Everybody has to choose from within the set of available options, and at no point in time have options been more varied and, significantly, available to a greater number of consumers than they are today. Moreover, my choices of the least unappealing alternatives will, if others share my preferences, provide incentives for producers to supply more of what I want, and to expand or shift the set of available options in a direction that will provide greater value to me, given my set of preferences.

Which brings me to an important point about the goals of antitrust policy. Which industry structure is more likely to be responsive to expand or shift the available sets of choices in response to diversified consumer demand? A concentrated industry or a collection of small firms in open markets? While I am not at all certain of the answer, it seems at least plausible that in markets for differentiated products that are not characterized by high fixed costs (in comparison to other markets, not to variable cost) or other significant scale economies, smaller entities have greater incentives to respond quickly to diverse customer preferences. The welfare gains from the expansion of the set of available choices may well be greater than achieving lower costs for more or less standardized and therefore incomplete substitute products. So maybe antitrust policy should embrace different standards: an efficiency standard for some markets, and a policy aimed at maintaining low concentration levels for others. As always, axiomatic reasoning only goes so far in these matters, and empirical evidence rules. That said, there is certainly nothing in the law or in the legislative history of the antitrust statutes to confine antitrust policy to operating within existing sets of options or markets. Rather, it may be an even more critical role of antitrust policy to ensure that conditions prevail on a broader scale, within which sets of options and markets can evolve more freely. Protecting the conditions of the possibility of market evolution is no call to return to the days of U.S. v. Alcoa, Brown Show v. U.S., U.S. v. Philadelphia National Bank, or U.S. v. Von’s Grocery. Rather, it is a call for a re-examination of the efficiency paradigm as the sole justification of the antirust laws. Sometimes, (productive) inefficiencies may be a price worth paying for significantly increased total welfare. But is it then still correct to speak of inefficiencies?

Technorati Tags: economics, rational choice, welfare

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