Critical Loss: Modeling and Application Issues

Abstract

Critical Loss analysis is an empirical implementation of the hypothetical monopolist test for market definition contained in the Department of Justice and Federal Trade Commission Horizontal Merger Guidelines. As usually applied, the test accepts the proposed market definition as relevant for antitrust analysis whenever the predicted loss in volume (Actual Loss) from a small, but significant and non-transitory price increase is less than the computed break-even loss in volume (Critical Loss). Critics complain that the predicted Actual Loss must be linked to the Critical Loss, claiming both calculations depend heavily upon the firm/industry margin. We note that the critics derive their result from a particular modeling structure useful only in markets where product differentiation leads to a simple form of price-based competition. Moreover, no clear link between Critical Loss and Actual Loss is likely when the markets are best defined with either homogeneous goods or dynamic differentiation assumptions. Thus, the critics have only introduced a special case generalization of the standard Critical Loss methodology.

Keywords: market definition, merger analysis, critical loss

JEL Classification: K21, l40