The Williamson tradeoff model is a theoretical model in the

economics Economics () is the social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behaviour and intera ...

industrial organization In economics, industrial organization is a field that builds on the theory of the firm by examining the structure of (and, therefore, the boundaries between) firms and market (economics), markets. Industrial organization adds real-world complic ...

which emphasizes the tradeoff associated with horizontal mergers between gains resulting from lower

costs of production In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which ...

and the losses associated with higher

price A price is the (usually not negative) quantity of payment or compensation given by one party to another in return for goods or services. In some situations, the price of production has a different name. If the product is a "good" in the c ...

s due to greater degree of

monopoly power A monopoly (from Greek el, μόνος, mónos, single, alone, label=none and el, πωλεῖν, pōleîn, to sell, label=none), as described by Irving Fisher, is a market with the "absence of competition", creating a situation where a spec ...

. The model was first presented by

Oliver Williamson Oliver Eaton Williamson (September 27, 1932 – May 21, 2020) was an American economist, a professor at the University of California, Berkeley, and recipient of the 2009 Nobel Memorial Prize in Economic Sciences, which he shared with Elinor Ostro ...

in his 1968 paper "Economies as an Antitrust Defense: The welfare tradeoffs" in the ''

American Economic Review The ''American Economic Review'' is a monthly peer-reviewed academic journal published by the American Economic Association. First published in 1911, it is considered one of the most prestigious and highly distinguished journals in the field of ec ...

''. Williamson argued that ignoring efficiencies that may result from proposed mergers in antitrust law "fail dto meet the basic test of economic rationality".

Basic idea of the model

Suppose that a given industry is initially characterized by

perfect competition In economics, specifically general equilibrium theory, a perfect market, also known as an atomistic market, is defined by several idealizing conditions, collectively called perfect competition, or atomistic competition. In Economic model, theoret ...

and has a constant unit cost of production equal to ''c1'' (assumed the same across all firms in the industry). Because of competition, the market price of the good produced will be equal to this unit cost, which means that firms in the industry earn

normal profit In economics, profit is the difference between the revenue that an economic entity has received from its outputs and the total cost of its inputs. It is equal to total revenue minus total cost, including both explicit and implicit costs. It i ...

s, as captured by the

producer surplus In mainstream economics, economic surplus, also known as total welfare or total social welfare or Marshallian surplus (after Alfred Marshall), is either of two related quantities: * Consumer surplus, or consumers' surplus, is the monetary gain ...

(the area below the market price, but above the supply/unit cost curve). Suppose further that after a merger between firms in the industry takes place, unit costs fall to ''c2economies of scale In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced per unit of time. A decrease in cost per unit of output enables ...

Applications in antitrust policy

This is because the welfare losses associated with the latter tend to be "second-order" (graphically, they are triangles), while the gains tend to be "first-order" (rectangles). What this means is that the gains from the merger would have to be very small, or alternatively, the demand for the good in question would have to be relatively quite

inelastic In economics, elasticity measures the percentage change of one economic variable in response to a percentage change in another. If the price elasticity of the demand of something is -2, a 10% increase in price causes the demand quantity to fall b ...

for social surplus to decrease. A broader conclusion of the model is that

antitrust Competition law is the field of law that promotes or seeks to maintain market competition by regulating anti-competitive conduct by companies. Competition law is implemented through public and private enforcement. It is also known as antitrust l ...

, or competition, policy should be "discretionary".C. L. Pass, Bryan Lowes
"Business and microeconomics: an introduction to the market economy"
Routledge, 1994, p. 175-178 That is, government regulators who are faced with a proposed merger need to examine each proposal on a case-by-case basis. In some instances, the cost savings might make it worth the loss of competition, while in others they will not. This is in contrast to a "non-discretionary" policy where regulators set certain standards that any industry must meet - for example, that no firm has more than 20% market share. Then, they do not actually examine the potential gains or losses to consumer or producer surplus from a proposed merger, but only its impact on meeting the set standard - for example, whether or not the merger will increase a single firm's market share above 20%. The model has been applied to the study of mergers in the US rail freight industry and the US food industry, among others. It has also been used in evaluation of actual antitrust laws by American legal scholar and judge

Robert Bork Robert Heron Bork (March 1, 1927 – December 19, 2012) was an American jurist who served as the solicitor general of the United States from 1973 to 1977. A professor at Yale Law School by occupation, he later served as a judge on the U.S. Court ...

.Richard Fink
"General and partial equilibruim theory in Bork's antitrust analysis"
paper delivered at the Annual Western Economic Association International Conference, Las Vegas, Nevada, June 24–28, 1984 A regulatory approach based on the model was popular in the United States in the 1980s and influenced much antitrust legislation.Patrick A McNutt, "Signalling, Strategy and Management Type
Chapter 7, Antitrust & Public Policy
/ref>

Criticisms and limitations

#The "tradeoff" in the Williamson model involves a gain in producers' (firms') surplus and a loss in consumers' surplus. Thus, in focusing the analysis on total surplus, it neglects distributional issues and treats changes in both consumers' and producers' welfare symmetrically. However, anti-trust policy as actually practiced in many countries (

Europe Europe is a large peninsula conventionally considered a continent in its own right because of its great physical size and the weight of its history and traditions. Europe is also considered a Continent#Subcontinents, subcontinent of Eurasia ...

Canada Canada is a country in North America. Its ten provinces and three territories extend from the Atlantic Ocean to the Pacific Ocean and northward into the Arctic Ocean, covering over , making it the world's second-largest country by tot ...

and US) appears to have the goal of maximizing consumer surplus (or this goal is stated explicitly).S. Zulfi Sadeque, Competition Bureau, Industry Canada, Government of Canada
"Some Aspects of Competition Policy: the View from Canada"
APEC Workshop on Competition Policy and Deregulation, August 17–18, 1996 In that sense, as long as the post-merger market price is higher than pre-merger, the fact that producer surplus and firm profits rise is immaterial from the point of view of the regulators. In that case, only those mergers in which the fall in unit cost is sufficiently large to ensure a lower price after the merger should be permitted.Michael Whinston in Mark Armstrong, Robert Porter, eds
"Handbook of industrial organization, Volume 3"
Elsevier, 2007, p. 2373-2375 For this reason, the Williamson model is not applicable in

European Community competition law European competition law is the competition law in use within the European Union. It promotes the maintenance of competition within the European Single Market by regulating anti-competitive conduct by companies to ensure that they do not crea ...

and is controversial in Canada.Giorgio Monti
"EC competition law"
Cambridge University Press, 2007, p. 292 #The simplest version of the model compares a situation where initially the market is competitive to a situation where the post-merger market is not. However, if initially price exceeds marginal cost (i.e. the market is not competitive), further increases in price have a "first order" effect on consumer surplus (graphically, they are trapezoids). #The model is limited in that it only considers the effect of the merger on price charged by the firm(s). However, in most real life situations, firms compete on many other aspects other than price, for example product quality, capacity, research and development, and product differentiation. These variables are also likely to be affected by a merger and the basic model does not capture these effects. However, the model can and has been extended in these directions by more recent work. #The model ignores the possibilities that the same cost reductions and efficiency gains (once technologically feasible) may arise on their own due without any need for a merger,Paddy McNutt
"Law, economics and antitrust: towards a new perspective"
Edward Elgar Publishing, 2005, p. 221 for example via own-firm investment.

References

{{reflist, 2 Industrial organization Competition law Mergers and acquisitions Market (economics)