Section 2 of the Sherman Act

Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other persons to monopolize… shall be deemed guilty” (Section 2 of the Sherman Act)

  • Section 2 of the Sherman Act does not necessarily forbid monopolies, but rather the process of becoming a monopoly
    • Monopolization: obtain exclusive possession or control of a trade, commodity, or service
    • Attempts to monopolize
    • Conspiracies to monopolize

Natural monopoly

  • Section 2 of the Sherman Act only condemns those who attempt to become a monopoly

  • There exist certain situations where breaking up the monopoly lowers welfare

  • Economic model

    • Consider this cost structure for a hypothetical market
    • Natural monopolies are typically associated with large fixed costs and high economies of scale
    • Suppose we start off with several firms at (\(P_C, q_c\))
    • At this point, average cost exceeds price –> negative profit
    • In fact, at any competitive outcome (\(P = MC\)), firms will earn negative profit because marginal cost is less than average cost for all \(q\)

  • Superior efficiency
    • Suppose multiple firms operate in an industry and one firm is much more efficient than the rest
    • While profit maximizing, the efficient firm sets a price that makes it unprofitable for the other firms to enter
    • The efficient firm sets the price not as a result of a price war or predatory pricing, but based on it having lower costs of production
    • This leads to a lower price faced by consumers
    • The efficient firm is the only firm left in the industry and no other firm will have incentive to enter
  • Graphical representation
    • Consider the following market where firm 1 faces a lower average cost curve than all other firms in the market (whose average cost is given by \(AC_2\))
    • Any competitive outcome where the efficient firm prices according to marginal cost will lead to losses for all the other firms.
    • The profit-maximizing price and output for the efficient firm will be the monopoly outcome
    • All other firms will exit due to negative profits
    • Firm 1 can act as a monopolist if no other efficient firm enters the market