Market Definition: Use and Abuse

Dennis Carlton, Apr 19, 2007

Market definition is a crude though sometimes useful tool for identifying market power. The ambiguity in what analysts mean by market power (price above marginal cost, or excess profits) cannot be resolved by market share. When used to analyze a merger or U.S. Sherman Act Section 2 case, it is not just the level of market shares, but also the changes in market shares that are relevant to calculate whether any increase in market power occurs. Despite this, in Section 2 cases courts often use market definition to figure out whether market power exists, a question that can be especially problematic to answer by using market definition. In Section 2 cases, the full antitrust analysis is difficult because any increase in market power typically has to be weighed against any benefits of the alleged bad act.

The procedure for defining a market in a merger case or Section 2 case can be rigorously described, but the information required to implement the procedure is typically unavailable. Few analysts (or courts) follow the rigorous procedure in either merger or Section 2 cases. Instead, most markets are defined with some guidance from theory and some qualitative knowledge. Econometric studies using market definition may be helpful both in testing various definitions and in understanding the economic consequences of either the merger or the bad act. My view is that the definition of a market and the use of market shares and changes in market shares are at best crude first steps to begin an analysis. I would use them to eliminate frivolous antitrust cases when shares are low, but would use them cautiously for anything else. Their usefulness in Section 2 cases is especially weak. Despite their limitations, when they can be used to eliminate frivolous antitrust cases, that use can contribute enormous value to society.

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