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17 Antitrust 49 (2002-2003)
Critical Loss: Let's Tell the Whole Story

handle is hein.journals/antitruma17 and id is 143 raw text is: 

Critical Loss: Let's Tell the Whole Story


     proposed or consunmnatcd horizontal merger, the gov-
     ernment typically attempts to establish a presumption
     that the challenged merger would likely harm competi-
     tion based on a showing that the merger would signifi-
cantly increase concentration in one or more defined relevant
antitrust markets. Because the delineation of the relevant
market determines the market shares of the merging firms
and the impact of the merger on concentration, market def-
inition can he critically important in merger litigatiun.
   Market definition alsn plays a role in governmental deci-
sinns whether in challenge mergers. Although many econo-
mists think that market definition and market shares tend to
get too much attention in the analysis of horizonta mergers,
in practice market definition is often a central topic in agency
investigations of mergers. The Antitrust Division of the U.S.
Department of Justice, the Federal Trade Commission, and
at least one other federal agency that examines mergers, the
Federal Communications Commission, all conduct market
definition exercises.
   The now-standard procedure for defining relevant prod-
uct markets in horizontal merger cases asks whether a hypo-
thetical monopolist controlling a group of products would
find it profitable to raise the price ofat least one product sig-
nificantly above the prevailing level.' According to the DOJ
and FTC 1 Iorizuttal Merger Guidelines, a relevant product
market is:
   a product or group of products such that a hypothetical
   profit-maximizing firm that was the only present and future
   seller of rhose products (monopolist) likely would impose
   at east a  ma l but significant and nontransitory increase
   in price ....

 Michael L. Kali Is Edward J. and Moille Arnold Professor of Business
 Administraiion. Hoes Schoo of Business, University of California at
 Berkeley. This article was written while Katz was the Deputy Assistant
 Altorney General for Economic Analysis ot the U.S. Department of Justice.
 The arlicle (toes not draw on any confidential materials or Information,
 and the views erpressed do nol necessarily represent the views of tIhe
 U.S. Detvattment of justlce. Carl Siapiro Is rransameriea Professor of
 Business Strategy, lions School of Business, Universliy of California at
 Berkeley, and Senior Consultant, Charles River Associates. The authors
 thank Joseph Ferell, Sloven Salop. Grog Vistnes. and Gregory Werden far
 helpful comments an earlier draffs of this paper.

   Specifically, the Agency will begin with each product (nar-
   rowly defined) protduced or sold by each merging firm and
   ask what would happen if a hypothetical motmplist of dita
   product imposed at least a snall but significant and nnn-
   transitory incra.C'S in price. but the terms tEfSaIe Ofall other
   products remained constant. If, in response to the price
   increase, the reduction in sales of the product would be large
   enough that a hypothetical monopolist would not find it
   profitable to impose such an increase in price, then the
   Agency will add to the product group the product that is the
   next-best substitute for the merging firm's product. (footnote
   The price increase question is then asked for a hlthlstical
   monopolist controlling tie expanded product group. It per-
   forming successive iterations of the price increase test, the
   hypothetical monopolist will be assumed to pursue maxi-
   mum profits in deciding whether to raise the prices of any o
   all of the additional products under its control. This process
   will continue until a group of products is identified such that
   a hypothetical monopolist over that group of products would
   profitably impose at least a small but significant and non-
   transitory increase, including the price ofa product of one
   of the merging firm%. The Agency generally will consider the
   relevant product market to he the smallest group nfproducts
   that satisfies this test.2
   To illustrate, consider a proposed merger between two
colipanies manufacturing prescription sleeping pills. If a
single firm controlling all brands of prescription sleeping
pills would find it profitable to impose a small but significant
and nontransitory increase in price (5SNIP) for at least one
of the brands sold by the merging parties, then prescription
sleeping pills constitute a relevant product market. If not,
then the next-best substitute, e.g., non-prescription sleeping
pills, is added to the candidate relevant market and the test
is repeated.
   As a matter of arithmetic, the effect of a SSNIP on the
hypothetical monopolist's profits depends upon the prevail-
ing profit margin earned on each unit sold and  ill the per-
centage of unit sales that would be lost as a result of the
price increase. We call the latter the actual hoss. 'lhe maxi-
trial percentage of unit sales that can be lost for the price
increase to be profitable is known as the critical loss. ' If the
actual loss from a price increase would be greater than the
critical loss, the price increase Would be unprofitable.
   A critical loss calculation can thus usefully frame the
empirical estimation of demand responsiveness for the put-

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