Questions 1-3 refer to the court's opinion from Northeastern Telephone Company vs. American Telephone & Telegraph Co. (1981) in Breit and Elzinga, pg. 305. Note that the concept of fully distributed costs is discussed on page 443 in the VHV textbook.
1. SNET is a multi-product firm. Therefore, it can fund a predatory pricing effort in one product by drawing on profits from another. Why does the court think this is unimportant?
A) Division managers at SNET are unlikely to allow profits from their division to be devoted to another division.
B) Being able to survive below-cost pricing does not make it profitable.
C) Firms never have a reason to price below marginal cost in any market.
D) SNET is regulated and therefore cannot earn profits.
2. From reading the opinion, it seems that Northeastern presented evidence that AT&T priced below fully distributed cost. Judging from the opinion, fully distributed cost conforms most closely to which concept that we discussed in class:
A) Average total cost
B) Average variable cost
C) Marginal cost
D) Average variable cost of added units
3. Why didn't the court take Northeastern's presentation about pricing and fully distributed costs as evidence of predatory pricing?
A) Pricing below fully distributed costs forces exit of an equally efficient rival only in the long run, in which case the recoupment period is too far away to be profitable.
B) Pricing below fully distributed costs can be a profitable strategy without being predatory.
C) Pricing below fully distributed costs is predatory but if courts punish firms for pricing below fully distributed costs, they may punish firms that are pricing above marginal cost which would be a mistake.
D) Defining predatory pricing in terms of fully distributed costs advantages small firms, which have fewer products and therefore less costs to be distributed over products.
4. In Jefferson Parish Hospital vs. Hyde (1984), the majority of the court voted to use a per se approach towards tying. Here is an excerpt of the minority's opinion:
The Court has on occasion applied a per se rule of illegality in actions alleging tying. ... However, this declaration was not taken literally even by the cases that purported to rely upon it. In practice, a tie has been illegal only if the seller is shown to have "sufficient economic power with respect to the tying product to appreciably restrain free competition in the market for the tied product". ... The Court has never been willing to say of tying arrangements, as it has of price fixing, division of markets, and other agreements subject to the per se analysis, that they are always illegal without market power or anticompetitive effect.
The per se doctrine of tying cases has thus always required an elaborate inquiry into the economic effects of the tying arrangement. As a result, tying doctrine incurs the costs of a rule-of-reason approach without achieving its benefits: the doctrine calls for the extensive and time-consuming economic analysis characteristic of the rule of reason, but then may be interpreted to prohibit arrangements that economic analysis may show to be beneficial.
Near the end of the quotation, there is a comparison of the costs and benefits of the Rule of Reason. What do you think these costs and benefits refer to?
A) The costs are production costs of the firms and the benefits are consumer benefits in consumption.
B) The costs are the legal fees and costs of running a court room, and the benefits are the benefits of making the correct decision.
C) The costs are the costs to a consumer of purchasing the goods, and the benefits are the benefits of tying.
D) The costs are the mental costs of having to do complex analysis, and the benefits are the benefits of having a simple clear rule that businesses can follow.
5) According to the quotation in (4):
A) It is almost impossible to determine whether a firm has market power.
B) It is almost impossible to determine whether an action is beneficial to the economy.
C) Knowing whether a firm has market power is not very helpful in learning whether a firm's action is beneficial to the economy.
D) If you knew whether a firm had market power, it is relatively easy to determine whether its actions are anticompetitive.
6. Areeda and Turner suggest that predatory pricing should be defined as price being less than average variable cost. They reject average total cost because it is difficult to observe in practice. What is another good reason to favor the AVC standard over the ATC standard?
A) Big firms have already paid their fixed cost.
B) Setting price less than ATC drives out an equally efficient competitor only in the long- run. Because firms discount future cash flow, recoupment cannot be too far off in the future.
C) Entrants can get financing from banks in order to pay their fixed costs but must cover their variable costs themselves.
D) Fixed costs are not important in many industries.
7. Suppose two firms produce a homogenous good for which there is inverse demand curve P = 101-Q, where Q = Q1+Q2.
Each firm as the total cost curve TCi = 9 + Qi + Qi2 where i=1 or i=2.
Each firm picks quantity simultaneously. That is, we have a Cournot game.
a) What is the function for average total cost for firm 1? What is the function for average variable cost?
b) Suppose firm 2 picks a quantity of Q2=20. If firm 1 picks a quantity of Q1=33, is firm 1 pricing above or below marginal cost? What about average total cost and average variable cost? Is the firm predatory pricing under the Areeda Turner rule?
c) If firm 1 sets Q1=48, what is firm 2's best response? At the resulting price, is firm 1 predatory pricing under the Areeda-Turner rule?
d) In (c), would we expect Firm 2 to exit in the short-run, the long-run or not at all?
e) What does this model say about the relationship between the Areeda-Turner definition of predatory pricing and the likelihood of an equally efficient competitor exiting?
8. Justice Antonin Scalia, in his dissent to the 1992 decision Eastman Kodak Co. v. Image Technical Services, Inc., made the observation that if Kodak had required consumers to purchase a lifetime parts and service contract with each machine, the tie-in between service and parts would not have been a violation of Section 2 of the Sherman Act. What is the argument behind this claim?
9. Assume that the maximum values to theater owners for movies A and B are as follows. The Fox Theater values A at $100 and B at $70. The York Theater values A at $60 and B at $50. Is block booking more profitable than charging a single price for each movie? Explain.