A Critical Analysis of Critical Loss Analysis

FTC Bureau of Economics Working Paper No. 254

24 Pages Posted: 21 Aug 2003

See all articles by Daniel P. O'Brien

Daniel P. O'Brien

Compass Lexecon

Abraham L. Wickelgren

University of Texas at Austin - School of Law; University of Texas at Austin - Center for Law, Business, and Economics

Date Written: January 2003

Abstract

Critical loss analysis is often used to argue that firms with large margins have more to lose from a reduction in sales and hence are less likely to increase prices. This argument ignores the fact that profit-maximizing competitors who do not coordinate their pricing only have large margins if their customers are not very price sensitive. In this paper, we explore the implications of critical loss analysis using an internally consistent model of oligopoly. We show that, under the assumptions made in the standard critical loss analysis, firms with larger pre-merger margins are more likely to raise prices than are firms with smaller margins, other things equal. This reinforces the traditional view that mergers are more likely to harm consumers when the merging firms have greater market power, as measured by their margins. We also derive internally consistent formulas for evaluating the profitability of price increases when defining markets and evaluating unilateral effects.

Keywords: Critical Loss Analysis

JEL Classification: K21, L40

Suggested Citation

O'Brien, Daniel P. and Wickelgren, Abraham L., A Critical Analysis of Critical Loss Analysis (January 2003). FTC Bureau of Economics Working Paper No. 254. Available at SSRN: https://ssrn.com/abstract=402100 or http://dx.doi.org/10.2139/ssrn.402100

Daniel P. O'Brien (Contact Author)

Compass Lexecon ( email )

555 12th Street NW
Washington, DC 20004
United States

Abraham L. Wickelgren

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States

University of Texas at Austin - Center for Law, Business, and Economics

Austin, TX 78712
United States

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