21.2: Clayton Act

Learning Objectives

• What other major antitrust legislation exists in the United States?
• What is predatory pricing and why is it illegal?
• Is price discrimination illegal?

Critics of the Sherman Act, including famous trust-buster President Teddy Roosevelt, felt the ambiguity of the Sherman Act was an impediment to its use and that the United States needed a more detailed law setting out a list of illegal activities. The Clayton Act, 15 U.S.C. §§ 12–27, was passed in 1914 and it adds detail to the Sherman Act. The same year, the FTC Act was passed, creating the Federal Trade Commission (FTC), which has authority to enforce the Clayton Act as well as to engage in other consumer protection activities.

The Clayton Act does not have criminal penalties, but it does allow for monetary penalties that are three times as large as the damage created by the illegal behavior. Consequently, a firm, motivated by the possibility of obtaining a large damage award, may sue another firm for infringement of the Clayton Act. A plaintiff must be directly harmed to bring such a suit. Thus, customers who paid higher prices or firms that were driven out of business by exclusionary practices are permitted to sue under the Clayton Act. When Archer Daniels Midland raised the price of lysine, pork producers who bought lysine would have standing to sue, but final pork consumers who paid higher prices for pork, but who didn’t directly buy lysine, would not.

Highlights of the Clayton Act include:

• Section 2, which prohibits price discrimination that would lessen competition
• Section 3, which prohibits exclusionary practices, such as tying, exclusive dealing, and predatory pricing, that lessen competition
• Section 7, which prohibits share acquisition or merger that would lessen competition or create a monopoly

The language lessen competition is generally understood to mean that a significant price increase becomes possible; that is, competition has been harmed if the firms in the industry can successfully increase prices.

Section 2 is also known as Robinson-Patman because of a 1936 amendment by that name. It prohibits price discrimination that lessens competition. Thus, price discrimination to final consumers is legal under the Clayton Act; the only way price discrimination can lessen competition is if one charges different prices to different businesses. The logic of the law was articulated in the 1948 Morton Salt decision, which concluded that lower prices to large chain stores gave an advantage to those stores, thus injuring competition in the grocery store market. The discounts in that case were not cost-based, and it is permissible to charge different prices based on costs.

Section 3 rules out practices that lessen competition. A manufacturer who also offers service for the goods it sells may be prohibited from favoring its own service organization. Generally manufacturers may not require the use of the manufacturer’s own service. For example, an automobile manufacturer can’t require the use of replacement parts made by the manufacturer, and many car manufacturers have lost lawsuits on this basis. In an entertaining example, Mercedes prohibited Mercedes dealers from buying Bosch parts directly from Bosch, even though Mercedes itself was selling Bosch parts to the dealers. This practice was ruled illegal because the quality of the parts was the same as Mercedes’s (indeed, identical), so Mercedes’s action lessened competition.

Predatory pricing involves pricing below cost in order to drive a rival out of business. It is relatively difficult for a firm to engage in predation simply because it only makes sense if, once the rival is eliminated, the predatory firm can then increase its prices and recoup the losses incurred. The problem is that once the prices go up, entry becomes attractive; so what keeps other potential entrants away? One answer is reputation: a reputation for a willingness to lose money in order to dominate the market could deter potential entrants. Like various rare diseases that happen more often on television shows than in the real world (e.g., Tourette’s syndrome), predatory pricing probably happens more often in textbooks than in the real world.Economists have argued that American Tobacco, Standard Oil, and AT&T each engaged in predation in their respective industries.

The FTC also has authority to regulate mergers that would lessen competition. As a practical matter, the DOJ and the FTC divide responsibility for evaluating mergers. In addition, other agencies may also have jurisdiction over mergers and business tactics. The Department of Defense has oversight of defense contractors, using a threat of “we’re your only customer.” The Federal Communications Commission has statutory authority over telephone and television companies. The Federal Reserve Bank has authority over national and most other banks.

Most states have antitrust laws as well, and they can challenge mergers that would affect commerce in the respective state. In addition, attorneys general of many states may join the DOJ or the FTC in suing to block a merger or in other antitrust actions, or they can sue independently. For example, many states joined the Department of Justice in its lawsuit against Microsoft. Forty-two states jointly sued the major record companies over their “minimum advertised prices (MAP)” policies, which the states argued resulted in higher compact disc prices. The MAP case settlement resulted in a modest payment to compact disc purchasers. The FTC had earlier extracted an agreement to stop the practice.

Key Takeaways

• The Clayton Act was passed in 1914 and adds detail to the Sherman Act. The FTC, which has authority to enforce the Clayton Act, as well as engage in other consumer protection activities, was created the same year.
• The Clayton Act does not have criminal penalties, but it does allow for monetary penalties that are three times as large as the damage created by the illegal behavior.
• Highlights of the Clayton Act include:
  • Section 2, which prohibits price discrimination that would lessen competition
  • Section 3, which prohibits exclusionary practices, such as tying, exclusive dealing, and predatory pricing, that lessen competition
  • Section 7, which prohibits share acquisition or merger that would lessen competition or create a monopoly
• The language lessen competition is generally understood to mean that a significant price increase becomes possible; that is, competition has been harmed if the firms in the industry can successfully increase prices.
• Predatory pricing involves pricing below cost in order to drive a rival out of business.
• The DOJ and the FTC divide responsibility for evaluating mergers.
• Most states have antitrust laws as well, and they can challenge mergers that would affect commerce in the respective state.