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Antitrust Economics on Trial
A Dialogue on the New Laissez-Faire
By Walter Adams, James W. Brock PRINCETON UNIVERSITY PRESS
Copyright © 1991 Princeton University Press
All rights reserved.
ISBN: 978-0-691-04291-6
CHAPTER 1
DAY 1 – The Trial Begins; The Witness Defines Price Theory
Judge: We shall now proceed with the voir dire requested by the Government.
Attorney: Thank you, Your Honor. [To the witness] Please state for the record your current occupation and title.
Expert: I am currently professor of economics at the University of Chicago, a fellow at the Cato Institute, and a consultant to the Heritage Foundation.
Attorney: The Cato Institute and the Heritage Foundation are self-styled libertarian think tanks?
Expert: They are research organizations inspired by the laissez-faire philosophy and dedicated to the preservation of free enterprise institutions.
Attorney: What other professional experience have you had?
Expert: After receiving my doctorate from the University of Chicago, I served as an assistant professor of economics at the University of Rochester and an associate professor at UCLA. During my sabbatical year, I was chief economist in the Justice Department's antitrust division; at the time, Professor William Baxter of the Stanford Law School was assistant attorney general in charge of the division. In addition I have served as an economic consultant to the governments of Chile and Poland.
Attorney: I assume you have published widely in your field?
Expert: Yes. I have published numerous books and articles on such topics as game theory, Cournot duopoly, contestability, dynamic Nash equilibria, optimal two-part tariffs, opportunism and self-disbelieved behavior, as well as public choice models of antitrust and other forms of government intervention. My articles have appeared in the Journal of Economic Theory, the Journal of Political Economy, the Journal of Law and Economics, the Journal of Business, and the University of Chicago Law Review.
Attorney: With the exception of the Journal of Economic Theory, would I be correct in assuming that the other journals you mentioned are all published by the University of Chicago?
Expert: That is correct.
Attorney: Would you tell us, Professor, what you consider to be your special field of expertise.
The Testimony on the Scope of Price Theory
Expert: Price theory.
Attorney: Could you define that, please?
Expert: It is the science explaining rational economic behavior and the operation of markets.
Attorney: And what is its relevance to law?
Expert: Its relevance is much broader.
Attorney: What do you mean?
Expert: In recent years, economists have used price theory more boldly in an effort to explain behavior beyond the narrow confines of the business world, and many noneconomists have followed their example. We have developed economic theories to explain racial discrimination, human fertility, crime, marriage and the family, divorce, suicide, drug addiction, politics, education, etc. Indeed, economic theory is singularly useful in providing a unified framework for understanding all behavior involving scarce resources, both market and non-market, both monetary and nonmonetary.
Attorney: Could you give us some examples?
Expert: Take crime, for example. As Professor Gary Becker argued in a seminal article, criminals are about like anyone else. They rationally maximize their own self-interest (utility), subject to the constraints (prices, incomes) that they face in the marketplace and elsewhere. Thus the decision to become a criminal is in principle no different from the decision to become a bricklayer or a carpenter, or, indeed, an economist.
Attorney: It is all a very rational process?
Expert: That is correct. Price theory demonstrates that punishment will deter crime.
Attorney: Could you explain?
Expert: The reason is perfectly simple: Demand curves slope downward. If you increase the cost of an article, less of it will be consumed. Similarly, if you increase the cost of committing a crime, fewer crimes will be committed. The elasticity of the demand curve, of course, has to be taken into consideration. If the elasticity is low, the quantitative effect of raising the cost of engaging in delinquency will be relatively small. If the elasticity is high, the effect will be great.
Attorney: Can you furnish some other examples?
Expert: Like other human behavior, marriage and divorce can be explained in terms of price theory: A person decides to marry when the utility expected from marriage exceeds that expected from remaining single or from additional search for a more suitable mate. Similarly, a married person terminates his or her marriage when the utility anticipated from becoming single or marrying someone else exceeds the loss in utility from separation, including losses due to physical separation from one's children, division of joint assets, legal fees, and so forth. Since many persons are looking for mates, there is a marriage market: Each person tries to do the best he or she can, given that everyone else in the market is trying to do the best they can. A sorting of persons into different marriages is said to be in equilibrium if persons not married to each other in this sorting could not marry and make each better off.
Attorney: It's all a matter of simple, rational calculation?
Expert: Yes. For example, the physical and emotional involvement called love has an important economic component. The calculation may be conscious or unconscious, explicit or implicit, but it has to be made in order to arrive at a utility-maximizing decision.
Attorney: What does that mean?
Expert: By sharing the same household, persons in love can reduce the cost of frequent contact and of resource transfers between each other.
Attorney: Any other examples?
Expert: Yes, take decisions with respect to family size, for instance. Children are much like cars, houses, and machinery. They can be considered consumer durables, which provide utility to their parents. Via a utility function or a set of indifference curves, the utility from children can be compared with that derived from other goods. The net cost of children can easily be computed.
Attorney: How do you make such a computation?
Expert: In principle, the net cost of children equals the present value of expected outlays plus the imputed value of the parents' services, minus the present value of the expected money return plus the imputed value of the child's services. If net costs are positive, children constitute a consumer durable yielding psychic income or utility. If net costs are negative, children would constitute a producer good yielding pecuniary income. The family can select children of many different qualities—its selection being determined by family tastes, family income, and each child's price. Most families in recent years have made very large net expenditures on children.
Attorney: Are you saying that decisions on family size are determined by strictly economic decisions?
Expert: By no means. Sociological considerations—factors such as race, religion, and cultural heritage—are subsumed in the "tastes" category in our formula. They are part of the framework. The point is that by using economic theory we are able to analyze fertility trends scientifically.
Attorney: Do you have other such esoteric examples of how economic theory explains human behavior?
Expert: YOU may find these examples esoteric—and even amusing—but they do demonstrate the explanatory power and ubiquitous relevance of economic theory. Take extramarital affairs. Price theorists have developed a model that explains how a married person allocates his or her time among work, spouse, and paramour. The philanderer sees the value (or cost) of time spent with the paramour as a function of his/her own wage rate and non-labor income, the time spent by the spouse in the marriage, the value of goods supplied by the spouse to the marriage, the time spent by the paramour in the affair, the value of goods supplied by the paramour to the affair, etc. These are the kinds of considerations that impact on the utility received from the marriage and the utility received from the affair.
Attorney: Let me see if I understand you correctly. Does the rational choice model, which you have articulated and which you believe applies to the most diverse types of human behavior, imply that individual economic decisionmakers never make mistakes?
Expert: Stated more accurately, the model implies that if, ex post, a decision appears to have been mistaken, either at the individual level (in the sense of having failed to maximize expected utility or profit or some other maximand) or at the social level (in the sense of being Pareto inefficient), either type of mistake is attributable to well-known market imperfections. In the case of individual mistakes, the conventional explanation is that the decisionmaker lacked the appropriate information and that had he or she had that information, he or she would have behaved differently, in a clearly utility-maximizing way.
Attorney: Is there not an alternative explanation for errors in decisionmaking? Does not recent work in cognitive psychology provide a mounting body of evidence suggesting that the rational choice model routinely used by economists—including the subjective expected utility model of decisionmaking under uncertainty—is not complete and therefore may neither accurately describe nor predict actual decisionmaking?
Expert: Could you clarify that question?
Attorney: The thrust of this evidence seems to indicate that many, perhaps most, individuals routinely make errors in the processing of routine information. The implication of this finding is that individuals may make many more errors in their attempts to maximize their utility or profit than the rational choice model assumes. Actions like smoking a cigarette, having a drink, or eating a candy bar all lead to immediate and certain gratification, whereas their bad consequences are remote in time, only probabilistic, and still avoidable now. It is no contest: certain and immediate rewards win out over probabilistic and remote costs, even though the rewards are slight and the possible costs lethal.
Expert: Unlike economics, cognitive psychology is not an exact science. The conclusions you have advanced are entirely hypothetical and speculative.
Attorney: Isn't it true that not only psychologists but some very distinguished economists would raise questions about your rational choice model and its applications? For example, hasn't Professor James Buchanan, a Nobel laureate—and, incidentally, your classmate at Chicago—pointed out that "the theory of choice presents a paradox. If the utility function of the choosing agent is fully defined in advance, choice becomes purely mechanical. No 'decision,' as such is required; there is no weighing of alternatives. On the other hand, if the utility function is not wholly defined, choice becomes real, and decisions become unpredictable mental events. If I know what I want, a computer can make all of my choices for me. If I do not know what I want, no possible computer can derive my utility function since it does not really exist."
Expert: That's correct. As I remember it, Buchanan never did consider the theory of choice central to the study of economic theory.
Attorney: And hasn't F. A. Hayek, another Nobel laureate in economics, criticized your profession for what he calls its "abuse of reason," its penchant for engaging in "scientism," and its failure to recognize that imperfect knowledge is endemic to the human condition? Hasn't he derided economists for aping the methods of the physical sciences, mindlessly misapplying them to socioeconomic phenomena, and reaching absurd conclusions as a result?
Expert: So he has.
Attorney: And hasn't the illustrious Frank Knight—your teacher at Chicago—warned economists against trying to ape the methodology of the natural sciences? Hasn't he pointed out that "the fundamental revolution and outlook which represents the real beginning of modern natural science was the discovery that the inert objects of nature are not like men, that is, subject to persuasion, exhortation, coercion, deception, etc., but are 'inexorable'"? Hasn't he admonished economists to combat the inference "that since natural objects are not like men, men must be like natural objects"?
Expert: I am quite cognizant of Knight's cautionary counsel.
Attorney: In your reliance on the rational choice model, aren't you underestimating the substantial role of nonpurposive, nonrational behavior? Everyone would agree that there is an element of Homo economicus in every individual, but how do you explain the behavior of the romantic fool, the person who enjoys the fray, the prejudiced ignoramus? Conceding the fact that some individuals are rational maximizers of economic interest, aren't there other types—the Malthusian consumer, the martyr, the patriot, the ideologue, the addict, the fanatic, etc.?
Expert: Be that as it may, the heart of the economic approach is to rely, relentlessly and unflinchingly, on the combined assumptions of maximizing behavior, market equilibrium, and stable preferences.
Attorney: I guess it's futile to pursue this point. But I cannot resist reminding you of Alexander Pope's poetic advice: "Be sure yourself and your own reach to know/How far your genius, taste, and learning go/ Laimch not beyond your depth; but be discreet/And mark that point where sense and dullness meet."
Expert: Pope has never been one of my favorites. I much prefer the nineteenth-century British romantics—Byron, Keats, Shelley, etc.
Attorney: I trust you will spare us an economic interpretation of their poetry.
The Testimony on the Application of Price Theory to Antitrust
Expert: To be serious again, I will agree that much of economics is vague. When applied to antitrust, however, microeconomics is not vague. It is quite powerful.
Attorney: All right, then, let us turn to antitrust. What is the relevance of price theory to antitrust?
Expert: Antitrust is about the effects of business behavior on consumers. To understand the impact of business behavior on consumer well-being we are forced to rely on basic economic theory. This should not be worrisome, because the economic models essential to antitrust analysis are simple and don't require any previous training in economics.
Attorney: And price theory is robust enough to measure up to this task?
Expert: Basic price theory is an intensely logical subject. It is such a powerful explanatory tool that we can be certain, or virtually certain, of its reliability.
Attorney: Does it not make you uneasy to rely entirely upon a theory to infer the nature of a reality that is not directly observed?
Expert: I am convinced that the theory is good enough to make the task doable. I am also convinced that there is no other possible way to get the job done. Indeed, unless we rely on economic theory, we cannot possibly have a rational antitrust law.
Attorney: What do you consider a rational antitrust law?
Expert: Professor Bork has said it best: "The law's mission is to preserve, improve, and reinforce the powerful economic mechanisms that compel businesses to respond to consumers." The main—indeed, the exclusive—concern of antitrust is the maximization of consumer welfare.
Attorney: Are you using the term "consumer welfare" in the vernacular sense—in Ralph Nader's sense?
Expert: No, in the scientific sense—in the Pareto optimally sense.
Attorney: Would you tell us what that means, please?
Expert: General welfare is at a maximum when no one can be made better off without making someone else worse off.
Attorney: By that standard, how is consumer welfare maximized?
Expert: Consumer welfare is maximized when society's economic resources are allocated so that consumer wants are satisfied as fully as technological constraints permit. Simply put, consumer welfare is the measure of a nation's wealth.
Attorney: IS this what economists call allocative efficiency?
Expert: Yes. It is to be distinguished from productive efficiency, which consists of the effective use of resources by individual firms.
(Continues...)
Excerpted from Antitrust Economics on Trial by Walter Adams, James W. Brock. Copyright © 1991 Princeton University Press. Excerpted by permission of PRINCETON UNIVERSITY PRESS.
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