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71 Antitrust L.J. 161 (2003-2004)
A Critical Analysis of Critical Loss Analysis

handle is hein.journals/antil71 and id is 171 raw text is: A CRITICAL ANALYSIS OF CRITICAL LOSS ANALYSIS DANIEL P. O'BRIEN ABRAHAM L. WICKELGREN* I. INTRODUCTION Critical loss analysis is a widely-used technique in antitrust practice.1 The basic idea is simple. One asks: given a price increase of X percent,2 what would the percentage loss in unit sales have to be to make the price increase unprofitable? This loss is referred to as the critical loss for an X percent price increase. If the actual loss is less than the critical loss, the price increase would pay. Otherwise it would not. The most common uses of critical loss analysis are to define relevant markets and assess the competitive effects of mergers. For example, experts representing merging parties often use this technique to argue that where margins are high, the product market must be broader than the government contends. The argument is that the larger the margins, the greater the reduction in profits from sales lost after a price increase. Therefore, it takes a smaller critical loss to make a given price increase by a hypothetical monopolist unprofitable. The experts then argue that the actual loss from a 5 percent price increase would surely exceed the critical loss, implying that the relevant market must include substitutes that are not included in the government's alleged market.3 * The authors are economists at the U.S. Federal Trade Commission. Patrick DeGraba, Alan Frankel, Ezra Friedman,Jerry Hausman, Stephen Holland, Dan Hosken, David Scheff- man, David Schmidt, Carl Shapiro, Mike Vita, and Charlotte Wojcik provided many useful comments and suggestions. The views in this article are those of the authors and do not necessarily reflect those of the Federal Trade Commission or any individual Commissioner. I The use of critical loss analysis was first suggested by Barry C. Harris & Joseph J. Simons, Focusing Market Definition: How Much Substitution Is Necessary? RESEARCH L. & ECON. 12, 207-26 (1989). Since it was proposed, it has appeared in numerous White Papers presented to the antitrust agencies, numerous pre-trial affidavits, and expert testi- mony offered on behalf of antitrust defendants. 2 The analysis applies equally well for any potential price increase. 3 The FTC/DOJ Merger Guidelines define a product market as the narrowest set of products such that a hypothetical profit-maximizing monopolist would raise price a small but significant amount. U.S. Dep't of Justice and Federal Trade Comm'n, Horizontal Merger Guidelines § 1.1 (1992, rev. 1997). For a discussion of the use of demand elasticities

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