Price Theory and Vertical Restraints: A Misunderstood Relation

Abstract:     
Beginning in the 1970s, the "Chicago School" of antitrust has exercised significant influence over antitrust policy governing vertical restraints. Some scholars have decried Chicago's influence, claiming that Chicago's policy prescriptions rest upon over-simplified and unrealistic economic models. These "Populist" scholars have urged courts to ban such restraints or at least presume them unlawful absent a very strong justification.

This essays rebuts many of the charges Populists have leveled against Chicagoans. To be sure, Chicagoans often claim that their prescriptions with regard to vertical restraints rest upon "price theory." However, close analysis reveals that the Chicago approach to vertical restraints articulated by Lester Telser and Robert Bork during the 1960s is founded upon the so-called New Institutional Economics, which recognizes and depends upon several departures from the perfect competition model that is the foundation of price theory. For instance, Chicagoans argue that vertical restraints such as minimum resale price maintenance and exclusive territories can encourage dealers to promote the manufacturer's product, thereby enhancing consumer demand for it. This argument depends expressly or implicitly upon several departures from perfect competition. For one thing, the argument assumes the existence of product differentiation and advertising, both of which have no place in perfect competition. The argument also assumes that at least some dealers will behave in an opportunistic fashion; such opportunism is also inconsistent with the perfect competition model. Finally, the argument assumes that bargaining and information costs - also departures from perfect competition - prevent manufacturers from contracting directly with dealers regarding the sort of promotional services that dealers should provide.

Ironically, the Populist critics of Chicago themselves adhere to several tenets of outmoded economic theory. For instance, while Populists purport to assert a "normative" approach, divorced from economic theory, their approach in fact rests upon economic assumptions. For example, while Populists claim that vertical restraints interfere with the "freedom" of dealers to sell how and where they please, they have offered no normative theory of freedom that would not ban all contracts which, by their nature, restrain the autonomy of the parties to them. Instead, Populists distinguish vertical restraints on the purely economic ground that manufacturers supposedly employ market power to "impose" such restraints on unwilling dealers. Moreover, Populists assert that manufacturers can achieve the benefits of vertical restraints by contracting with dealers on an individual basis for desired promotional services. Both of these arguments rest upon (false) price theoretic premises.

Keywords: Vertical Restraints, Price Theory, Chicago School, New Institutional Economics

JEL Classifications: D23, K21, L14, L22, L42

Accepted Paper Series