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Comment on “Punished for Being Too Small?”

Almost one year after this analysis was done, it is possible to update it with additional information regarding the outcome of the case, as well as discussing other underlying economic concepts that are at stake here. In fact, in July 2013, Apple was found liable, under the scope of the Sherman act, of the concerted practices to maintain high prices (the publishers had previously reached a settlement). More recently, Apple appealed the decision, so we cannot be certain on what the final outcome of this case will be.

To start, it is important to discuss why the wholesalers accepted to engage in a most favored nation clause with Apple: since they can, in principle, benefit from competition in the downstream market, this strategy has to be justified. For any given wholesale price they set, producers in general benefit from competition at the retail market: more competition will imply higher sales and larger demand for them, at that wholesale price. This means that they would have to gain from the low price set by Amazon. Apart from the possible exclusionary effects that would affect competition in the long-run, discussed by my colleague, there are two possible reasons that may explain why they accepted the agreement with Apple. First, Apple’s proposal of high prices might have worked as a coordination mechanism that was missing, allowing them to start a concerted practice in the wholesale market, since most favored nation clauses tend to enhance collusive behavior. Secondly, they may fear that the low prices for e-books may lead consumers to substitute hardcover books for e-books. Since the publishers are also present in the hardcover book market, this could decrease their profits.

One of Apple’s arguments against the ruling is that they did, in fact, increase competition, since before they entered Amazon had a market share of about 90% in the e-book market. The fact that a firm with a market share this high is setting such low prices may seem, at first, an indication of predatory behavior. However, it is important to notice that this is a two-sided market: Amazon may want to set low prices for the e-books and compensate this by charging a higher price for Kindle, its e-book reader. In this case, the low prices by Amazon can be the optimal behavior of the firm in this market, even without implying that they want to deter entry or exclude rivals. This brings an additional point to the analysis, since authorities may want to weight the effects of their decision on two markets. If they keep the decision against Apple and the publishers, they may be increasing competition in the e-books market, while strengthening Amazon’s position in the e-book readers’ market. On the other hand, if they let the companies keep the “most favored nation” kind of agreement, this will favor collusion in the e-books market, but may allow other companies (like Apple), to effectively compete with Amazon in the e-book readers’ market.

Given all of the above, it will be of interest to follow the outcome of this case, due to its complexity, since there are many economic effects involved, pointing in different directions.

João Araújo no.638


Author: studentnovasbe

Master student in Nova Sbe

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