The Economics Case for the Consumer Welfare Standard in Antitrust

The consumer welfare standard in antitrust has strong economic underpinnings, and revisiting them demonstrates how that standard can be applied with simplicity and clarity. This illustrates its superiority over the non-­economic neo-Brandeisian factors that the Federal Trade Commission (“FTC”) and U.S. Department of Justice Antitrust Division (“DOJ”) currently advocate.

The Debate Over the Consumer Welfare Standard in Antitrust

Sherman Act monopolization, Robinson-Patman price-­discrimination, and merger enforcement all require some version of proving harm to competition. Some academics have argued that the goals of antitrust should go beyond harm to competition, taking into account other considerations for which normative objectives are debatable, such as political power, protection of small firms, income disparity, supporting labor, and other social goals.

Professor Hovenkamp has observed that “Proponents, some of whom are referred to as ‘neo-Brandeisians’ (after Supreme Court Justice Louis Brandeis), often regarded low prices as an undesirable outcome, at least when they come from large firms at the expense of higher cost, smaller rivals. Overall, the movement is not enthusiastic about the use of economics in antitrust and appears to believe that economics should either be subordinated to political priorities or abandoned entirely.”

The current antitrust enforcement authorities are on a mission to have courts vindicate social goals through antitrust statutes. The FTC 2022 Policy Statement declared that the “legislative record demonstrates that Congress enacted Section 5 to protect against various types of unfair or oppressive conduct in the marketplace” and that “Congress evinced a clear aim that ‘unfair methods of competition’ need not require a showing of current anticompetitive harm or anticompetitive intent in every case.” Gregory Werden described this approach as having been “intended to knock down any walls that might cabin the FTC’s enforcement, rather than to map its boundaries.”

The difficulty with these non-economic alternatives is their lack of guidance for assessing practices that point in different directions. A good example is the approach taken by the antitrust enforcement agencies on labor. President Biden has characterized himself as the most pro-union President in history. Supporting employees over employers is a social goal not necessarily consistent with economic efficiency. Indeed, forming a monopoly of an input is explicitly identified as a negative in the 2023 Merger Guidelines (“2023 MGs”): “if a merger may substantially lessen competition or tend to create a monopoly in upstream markets, that loss of competition is not offset by purported benefits in a separate downstream product market.” Favoring a monopoly of an input undermines economic efficiency. Outside of the statutory and nonstatutory exemptions from the antitrust laws for the formation and operation of labor unions, it also contradicts traditional antitrust doctrine.

Seemingly in synch with the social objective of siding with labor, President Biden’s antitrust appointees at DOJ and the FTC announced, for the first time, that an increase in employers’ relative bargaining power vis-à-vis workers would be a negative factor in evaluating a merger, explicitly downplaying the fact that if the final product market is competitive, lowering labor costs will benefit ultimate consumers.

This tension was recently illustrated in the FTC’s complaint against the proposed merger of two stylish handbag manufacturers, based in part on concern that salespersons and other employees might see their wages drop. As an economic matter, it is highly implausible that employees selling Coach, Kate Spade, and Michael Kors handbags would suffer lower wages because those brands merged. There are hundreds of other handbag outlets and department stores for whom these employees could work. Hence, though couched in terms of the risk that the merger would enhance employer monopsony power, the FTC’s inclusion of this count in the complaint is more plausibly explained by a non-economic factor—a desire to show a governmental concern for employees.

How much this preference for labor should influence merger enforcement decisions is impossible to measure. For example, should America anticipate more agency opposition to a unionized automotive plant being acquired by a nonunionized automobile manufacturer than the reverse, even when market shares and all other economic factors are identical?

In this debate, clarity and ease of administration disfavor a set of neo-Brandeisian factors that might point in different directions. By contrast, the consumer welfare standard is clear and easy to apply.

Total Welfare Standard or Consumer Welfare Standard?

Economics defines social welfare as the value of a good or service in excess of what it costs to produce that good or service. This is the familiar “welfare triangle.” Social welfare is the sum of consumers’ surplus (the value consumers place on a good over the price they must pay for the good) and suppliers’ surplus (profit).

If social welfare is the correct concept to apply to “harm to competition” in the antitrust context, then antitrust courts would have a clear test to apply. The government, or private plaintiff, would have to show that a practice has caused (or in the case of mergers, is likely to cause) a drop in output or an increase in price. Depending on burden of proof, this test could also be expressed as an affirmative defense by a business or individual accused of an antitrust violation. If the defendant could show that the challenged practices have led to output growing and price dropping, that would be sufficient to show social welfare had increased.

Suppose a practice increases profit but diminishes consumers’ surplus. If the measurement of the former exceeds the measurement of the latter, total societal welfare would have grown. The DOJ/FTC’s 1992 Merger Guidelines originally recognized this, permitting a possible defense upon showing cost savings from a merger, without requiring that consumers benefited. The 1997 Guidelines even more explicitly recognized that “efficiencies may result in benefits even when price is not immediately and directly affected.” The 2023 Guidelines, however, have now changed: cost savings that only increase profit, rather than reduce prices, are not sufficient as procompetitive efficiencies. “To the extent efficiencies merely benefit the merging firms, they are not cognizable.”

Distinguishing between business practices that increase total economic welfare and those that increase consumers’ surplus might seem to present a complexity in applying the “consumer welfare standard.” Indeed, the very phrase “consumer welfare standard” confuses total economic welfare with consumers’ surplus. Robert Bork appears to have made that error. Hovenkamp has observed that for Bork, “‘consumer welfare’ referred to the sum of the welfare, or surplus, enjoyed by both consumers and producers, or perhaps even by all of society.”

Hovenkamp proposed simply using “consumers’ surplus.” As he explains:

‘Consumer welfare’ as it is properly used today refers to the welfare of consumers-as-consumers, pure and simple. Speaking objectively, consumer welfare is improved by high output and low prices, as well as high quality. . . . But misunderstandings about definition–often the result of confusing the consumers’ and general welfare standards—have complicated the debate about how to improve antitrust policy and have affected even Supreme Court usage of the term. The Supreme Court has never categorically embraced any particular definition of consumer welfare, even though it has used the term several times.

Professors Joseph Farrell and Michael Katz, by contrast, after exhaustive analysis, favored total welfare. According to these authors, “We believe that there is a strong case for using total surplus, together with appropriate non-welfarist process criteria, as the overall objective of antitrust policy—and arguably even the process element earns its place through the view that competition promotes total surplus.”

Richard Schmalensee and Hal Varian also used total welfare, as have other economists. In contrast, Simon Cowan has argued: “There are several reasons to consider the effect on consumers’ surplus on its own. Anti-trust agencies sometimes use consumer surplus, rather than total welfare, as the standard. The monopolist might be owned by foreigners, so its profits would normally be excluded from the measure of domestic welfare.”

A review of the economic origins of the total economic welfare measure shows that the Supreme Court does not have to choose between these two standards. (In fact, it never has done so.) As will be shown below, there are strong conditions sufficient to show an increase in total economic welfare will also yield an increase in consumers’ surplus.

Price discrimination

If a practice increases total output and lowers price, consumers are benefited. So the case that needs exploration is where a challenged practice increases total output but also increases price, at least for some consumers. This circumstance arises in the case of price discrimination.

Price discrimination is not exclusive to Robinson-Patman Act cases. Price discrimination is often effectuated by tying one product or service to another, where the tied product serves as a measure of use, or as a means of separating elasticities of demand by consumers, thus effectuating second- or third-degree price discrimination. “Tying arrangements may be challenged under Section 1 of the Sherman Act, Section 3 of the Clayton Act, and Section 5 of the FTC Act, and they may constitute conduct supporting a monopolization claim under Section 2 of the Sherman Act.” Whatever the statute, it can be shown that price discrimination increases total economic welfare when output grows and consumers’ surplus grows.

The seminal works of Robinson, Varian, and Schmalensee set forth the conditions sufficient for total economic welfare to increase. Building on Robinson’s path-breaking work, Schmalensee and Varian proved the sufficient conditions for a rise in total welfare in the context of price increases to a subset of consumers, where the firm with market power exercises third-degree price discrimination (i.e., where consumers are separated into groups depending on their differing elasticities of demand). Increase in output is a necessary but not a sufficient condition, contrary to Bork’s assertion that output increase alone is sufficient. (Output increase alone is sufficient for first and second-degree price discrimination to be proved as total welfare enhancing.)

The additional sufficient condition for total welfare to grow under third-degree price discrimination, in addition to an increase in output, does not require complicated calculations. It requires only estimates of marginal cost and elasticities of demand. These measurements are commonplace in antitrust courtrooms today, however daunting they might have appeared when Robinson first suggested the concept of measuring the curvature of demand curves.

The reason why increased output alone is not a sufficient condition for total economic welfare to improve from third-degree price discrimination stems from the fact that the delta between price and marginal cost differs between the two (or more) groups of consumers. Economic welfare can be increased, therefore, by shifting sales between the groups until the delta between the economic value of one more unit for one group (as given by the price on the demand curve) and its marginal cost (which is unrelated to what consumers are willing to pay) has become equal to that delta for every other group. That is to say, the contribution to total economic welfare is the same at the margin of each group.

In third-degree price discrimination, one group of consumers (called “strong” consumers) pays a higher price than what would have been charged if the monopolist did not price-discriminate, and another group of consumers (called “weak” consumers) pays a lower price. The group of strong consumers has its consumers’ surplus diminished by the higher price, and there is no guarantee that the increase in consumers’ surplus enjoyed by the group of weak consumers, who pay a lower price, will offset that. If the sum is negative, it might be sufficiently negative to offset the growth in total economic welfare from the increase in output. Robinson concluded, “Before it is possible to say whether discrimination is desirable or not, it is therefore necessary to weigh up the benefit from the increase in output against this disadvantage.”

Schmalensee and Varian tests for efficiency of third-­degree price discrimination

Varian proved that a strong sufficient condition for total economic welfare to increase is for the growth in consumers’ surplus in the weak market to exceed the loss in consumers’ surplus in the strong market. He estimated this difference as the weighted sum of the changes in output between the strong and the weak markets, where the weights are the marginal cost of production divided by (the absolute value of demand elasticity minus one).

Schmalensee had previously studied the case of constant marginal costs, and he similarly developed the equation that the total economic welfare change was the sum of the gain in consumers’ surplus in the weak market and the loss of consumers’ surplus in the strong market, as the supplier diverged from a uniform price.

Both tests required a measure of total consumers’ surplus to grow, in order to find a strong sufficient condition for total welfare to grow. If courts apply the strong sufficient condition of either test, then consumer welfare and total welfare will both grow, and a court does not need to choose between them.

Aggregate Consumer Surplus

Of course, as is common in all calculations of consumers’ surplus, measures of consumers’ surplus are assumed to be additive: namely, that one consumer’s welfare is entitled to be considered no more or less important than any other consumer’s welfare. Varian noted the difference between individual and aggregate interests: “For this class of preferences it is well known that not only does consumers’ surplus serve as a legitimate measure of individual welfare, but also that the individual consumers’ utility functions can be added up to form a social utility function, that aggregate consumers’ surplus is also meaningful.”

Courts might find it more comfortable to deal with measured effects on output and estimates of demand elasticities rather than estimates of consumers’ surplus. As Varian showed, one can use the former to estimate the latter. Measuring output and estimating elasticity of demand are the business of expert accountant and economic witnesses in modern antitrust cases. This should impose no unusual burden on a court today.

Simplification: Does output increase? Nevertheless, two possible simplifications would make practical sense if measurements of elasticity are not available

First, if there is a large growth in output after the supplier institutes the price discrimination, then a court might grant an affirmative defense under the assumption that only a massive decline in consumers’ surplus would be enough to offset the welfare-­enhancing effects of greater output. Second, requiring a bit more detail (but still useful as a rule of thumb), a court could look at the components of the Varian and Schmalensee formulations and more readily conclude that total economic welfare was enhanced by the price discrimination the greater the growth of output in the weak market and the smaller the drop in output in the strong market, as compared with the outputs if the monopolist charged the same price in each market.

Price discrimination is the most difficult case for applying the consumer welfare standard because prices can rise for some consumers, and yet total consumers’ surplus and economic welfare might still increase. The Schmalensee and Varian tests, however, provide a workable solution for courts to apply.

Judging Business Practices

Having dealt with price discrimination, we can return to the more general case for judging business practices. Here, a simple and powerful test is whether a business practice leads to an increase in total output. (If there is no price discrimination, then an increase in output will always be accompanied by a drop in price, as compared with the situation before the growth in output.) If output increases as a result of a business practice, then consumers’ surplus and overall economic welfare both improve from the business practice, and antitrust law should not condemn it.

In predatory pricing, short-term output might grow as consumers buy more of the monopolist’s goods at lower prices. Nevertheless, the test advanced here would not exonerate predatory pricing when a long-run perspective is adopted, whatever one’s view of the plausibility of predatory pricing. The essence of a predatory pricing claim is that, in the long-run, prices will rise and output will decline. Increased output is a necessary condition of increasing total economic welfare, so a long-run predatory pricing strategy would not fit that condition.

Conclusion

The consumer welfare standard is met in most cases where a business practice leads to an increase in total output. In the case of third-degree price discrimination, however, output might increase but consumer welfare diminish. Nevertheless, there are strong sufficient conditions developed by Schmalensee and Varian for identifying when overall consumer welfare increases even in this situation. Applying those sufficient conditions requires only estimates of demand elasticities of differing groups of consumers and the marginal cost of production. When those conditions are present, the consumer welfare standard is an accurate surrogate for total economic welfare. This degree of precision and ease of application illustrate the superiority of the consumer welfare standard over non-economic, neo-Brandeisian factors in analyzing business practices under the lens of antitrust law.

Appendix

In the last 50 years, the Supreme Court has embraced the consumer welfare standard in its antitrust jurisprudence. Supplementing prior research by Keyte and Hovenkamp, a fresh review of Court opinions confirms that no decision supports antitrust liability based on a reduction of consumers’ surplus when output actually increased. For reference, the cases are as follows.

1. United States v. Citizens & Southern Nat’l Bank, 422 U.S. 86, 130 n. 1 (1975) (Brennan, J., dissenting).

2. Brunswick Corp. v. Pueblo Bowl-O-Mat, Inc., 429 U.S. 477, 486 n. 10 (1977).

3. Illinois Brick Co. v. Illinois, 431 U.S. 720, 754–55 (1977).

4. Continental TV, Inc. v. GTE Sylvania, Inc., 433 U.S. 36, 56 (1977).

5. Pfizer, Inc. v. Gov’t of India, 434 U.S. 308, 314-15 (1978).

6. Reiter v. Sonotone Corp., 442 U.S. 330, 343 (1979).

7. Arizona v. Maricopa County Medical Soc’y, 457 U.S. 332, 367 (1982) (Powell, J., dissenting).

8. Jefferson Parish Hosp. Dist. Number 2 v. Hyde, 466 U.S. 2, 15 (1984).

9. NCAA v. Board of Regents of the Univ. of Oklahoma, 468 U.S. 85, 107 (1984).

10. Atlantic Richfield v. USA Petroleum, 495 U.S. 328, 360 (1990).

11. Eastman Kodak Co. v. Image Technical Services, Inc., 504 U.S. 451, 487 (1992) (Scalia, J., dissenting).

12. Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 244 n.2 (Stevens, J., dissenting) (1993).

13. Illinois Tool Works, Inc. v. Independent Ink, Inc., 547 U.S. 28, 36-37 (2006).

14. Weyerhauser Co. v. Ross-Simmons Hardwood Lumber Co., 549 U.S. 312, 324 (2007).

15. Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S. 877, 889-90 (2007).

16. Kirtsaeng v. John Wiley & Sons, Inc., 568 U.S. 519, 539 (2013).

17. FTC v. Actavis, Inc., 570 U.S. 136, 161 (2013) (Roberts, C.J., dissenting).

18. Ohio v. American Express Co., 585 U.S. 529, 551 (2018).

19. NCAA v. Alston, 594 U.S. 69, 106 (2021).