Price Theory, Competition, and the Rule of Reason
94 Pages Posted: 19 Jun 2006
This article offers a critique of the standards that courts and the enforcement agencies employ when evaluating partial contractual integration under the Rule of Reason. The article demonstrates that the current structure of Rule of Reason analysis rests upon neoclassical price theory's partial equilibrium trade-off model so fruitfully applied in the merger context. Price theory, it is shown, assumes that legitimate competition consists of technological rivalry, unconstrained by non-standard contracts. This "competition on the merits" produces a "competitive" equilibrium of price and output, data that serve as a baseline against which courts can measure the impact of partial contractual integration. The model therefore bolsters current law, under which a plaintiff may make out a prima facie case by showing that a restraint produces higher prices for the defendants' own products compared to the status quo ante. The model also supports current law's requirement that any cognizable efficiencies produced by such restraints manifest themselves in lower prices, other things being equal. Finally, the model also implies that, once a plaintiff makes out a prima facie case, any beneficial effects of a restraint necessarily coexist with harmful effects, thereby making sense of the law's requirement that courts "balance" a restraint's harms against benefits as well as the rule condemning restraints whenever a less restrictive alternative will achieve the same benefits.
Neoclassical price theory does not supply the only methodology for evaluating the causes and consequences of partial integration. A rival paradigm, Transaction Cost Economics ("TCE") holds that much beneficial rivalry is contractual in nature, requiring restraints on commercial autonomy that prevent or mitigate market failure. Under current law, many restraints avoid per se condemnation in the first place precisely because they may plausibly overcome the sort of market failures emphasized by TCE.
The article argues that application of TCE undermines current law's method for evaluating such restraints under the Rule of Reason. If a restraint avoids per se condemnation because it may overcome a market failure, there is no reason to assume that the prices and output that existed before the restraint are "competitive" in any meaningful sense. As a result, proof that such a restraint resulted in prices higher than the status quo ante can be entirely consistent with the defendant's assertion that the restraint overcomes a market failure by, for instance, eliminating free riding and causing additional promotional expenditures and greater demand for the defendants' product. Thus, proof that such a restraint produces higher prices is at least equally consistent with a procompetitive explanation for the agreement and thus should not by itself give rise to a prima facie case. Moreover, once the plaintiff makes out a prima facie case, there is no rationale for requiring a defendant who shows that a restraint produces benefits also to show that those benefits manifest themselves as lower prices. Finally, absent any showing that the defendants possess market power, TCE undermines the assumption that such benefits necessarily coexist with harms and thereby invalidates the assumption that underlies the requirement that courts balance such effects against each other and apply a "less restrictive alternative test."
Keywords: Price Theory, Transaction Cost Economics, Contractual Integration, Rule of Reason, Antitrust
JEL Classification: B25,D23,K21,L14,L22,L41,L42
Suggested Citation: Suggested Citation