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However, government regulation might be justified in

order to:

Correct externalities
Protect other rights
Ensure fairness
Support caring

But the advantages of free market Capitalism depend
on competition
Criteria include:

Numerous small buyers & sellers
Freedom of buyers & sellers to enter or leave the market
Perfect information of all relevant facts about the
product or service

Result: Buyers & sellers are protected by competition
from exploiting each other
Monopoly
Oligopoly
Anti-competitive practices
2 Key Characteristics:
Only one seller: 100% market share
Extremely high barriers to entry:
High capitalization costs
Example: electric power?
Patents
Example: pharmaceutical drugs

Example: Does Microsoft have a monopoly with
Windows?
Control over
prices:
Higher prices
than would
occur with
competition
Higher profits
for the
monopolist
Quantity
Price
Demand
Pc
Qc
Pm
Qm
Supply =
Marginal Cost
Marginal Revenue
Violates
utilitarianism
Deadweight loss
to society from
higher prices
Inefficiency?
Violates rights:
restricted
choices
Violates justice:
unfair to
consumers
Quantity
Price
Demand
Pc
Qc
Pm
Qm
Supply =
Marginal Cost
Marginal Revenue
Natural monopoly: regulate prices
Example: electric power?

Government-granted monopoly through patents: limit
length of patent protection
Example: pharmaceutical drugs

Earned monopoly: regulate ability to use earned
monopoly power to extend monopoly to new markets
Example: Microsoft?

Microsoft Corporation is an American public multinational
corporation headquartered in Redmond, Washington, USA that
develops, manufactures, licenses, and supports a wide range of
products and services predominantly related to computing through
its various product divisions. Established on April 4, 1975 to develop
and sell BASIC interpreters for the Altair 8800, Microsoft rose to
dominate the home computer operating system market with MS-
DOS in the mid-1980s, followed by the Microsoft Windows line of
operating systems. Microsoft would also come to dominate the office
suite market with Microsoft Office.
Background

Microsoft sells DOS to IBM for use on PCs. IBM allows
Microsoft to sell MSDOS to third party computer manufacturers.

PCs quickly eclipse Apple as leading computer platform.

Microsoft and IBM jointly begin work on graphical interface
(OS/2) which has very ambitious specifications and is not based
on DOS. IBMs attempt to recapture PC market by having special
version that only runs on its PCs.

Microsoft develops Windows as a temporary graphical interface
that runs on top of DOS. Tells IBM that it doesnt compete with
OS/2.
Background:

Windows 1.0 and 2.0 are flops, but Windows 3.0 takes off in
1990.

PC manufacturers quickly adopt Windows on the machines
they sell. Windows is much cheaper than OS/2.

Microsoft and IBM have a falling out and IBM takes over
OS/2 development.

Microsoft develops Windows NT as a more advanced OS to
compete with high end workstations such as Sun. Since
Microsoft now dominates PCs, workstations are a new
market opportunity.
In May of 1998, the US Department of Justice, twenty
individual states, and DC filed suit against Microsoft

Claimed Microsoft had monopolized the market for PC
OSs
Also that it had used its monopoly to engage in a wide
range of antitrust violations
The Government claimed that Microsoft had engaged
in multiple anticompetitive acts to protect its OS
monopoly
Consumers were being harmed by higher prices
Microsofts actions had reduced innovation
Microsoft argued it was not a monopoly
Highly dynamic industry
Microsoft also claimed to be procompetitive since
consumers benefited
Access to high quality, innovative software
Claim #1
Did the Microsoft Corporation possess monopoly
power in the market for personal computer operating
systems?

Claim #2
Did Microsoft maintain its monopoly power by a series
of anticompetitive actions that unreasonably
restrained trade?

Government's View:

Microsoft did possess monopoly power in the market for

operating systems for Intel-compatible desktop personal
computers
Microsoft's View:

The relevant market for antitrust purposes is substantially

broader than Intel-based PC OSs; it includes hand-held
computer operated systems and servers

Also, it faces threats from other non-OS platforms that can

support applications and threats from yet unknown innovations

The very fact that Microsoft found it necessary to take action

against Netscape and Java shows that those companies and their
products are in the market. Thus, Microsoft does not have
monopoly power.

Government's View:

They claimed Microsoft foresaw the possibility that the

dominant position of its Windows OS would be eroded by
Internet browsers and by cross-platform Java.

Microsoft engaged in a series of anticompetitive practices in

order to protect the monopoly power of its Windows OS
Microsoft's View:

It did perceive a competitive threat from Java and responded in a

number of ways to combat that competitive threat

However, those responses were the reasonable and appropriate

responses of a competitor and cannot be appropriately
characterized as an attempt by Microsoft to maintain its OS
monopoly.

Did Microsoft have monopoly power?

The Governments Perspective
Yes, according to market share data Microsofts share of PC operating
systems was very high and had remained stable over time.
During the 1990s, Microsofts worldwide share of shipments of Intel-
based operating systems had been approx. 90 percent or more

Microsofts Response
Microsoft denied it had market power, claiming that the governments
market definition was invalid
It argued that it competed vigorously to remain a provider of the
leading software platform. Any market power it enjoyed was temporary,
thus could not be characterized as monopoly power

The Courts Perspective
The court supported the Governments position on the market
definition and monopoly power issues
They also affirmed that there were significant barriers to entry in the
market


The Governments Case
The government stressed that by bundling its free
browser with its OS, Microsoft prevented browser
companies from entering the browser market unless
they entered the OS market as well
Market Allocation
Microsoft took part in a number of market allocation
efforts with Netscape, Apple, and Intel in an effort to
minimize the competitive threat to its OS monopoly
Netscape-Microsoft attempted to limit Netscape to the server
market, so Microsoft could dominate the PC browser market
Intel- Microsoft threatened to deny support for Intels new
generation of processors
Apple-Microsoft required Apple to make Internet Explorer
the default browser on all Macintosh operating systems
Predatory Pricing
Microsoft devoted $100 million per year to develop
Internet Explorer which it distributed at a negative price
Predatory Pricing Strategy
Definition: A strategy in which the predator forgoes current
profits in order to eliminate or cripple the competition, with
the expectation of recouping those forgone profits at some
point in the future.
Bundling and OEM Restrictions
Microsoft bundled IE with Windows 95 and with
Windows 98
The Government stated that there was separate demand
for browsers and for operating systems
1996: Microsoft imposed screen and start-up
restrictions on OEMs
The Government argued that Microsoft viewed
Netscape as a platform to support substitute OSs

Exclusionary Agreements with ISPs
Microsoft drew up contracts with ISPs to limit the
number of customers to whom ISPs could distribute
other browsers

Microsoft created a desktop folder for favored ISPs
Government stated that Microsoft extracted promises from
those ISPs
ISP restrictive provisions:
75% or more ISP shipments must only have IE and only
include a competing browser when requested
Restricted total shipments of non-Microsoft browsers
Government saw provisions as anticompetitive

Market Allocation
Browser battle was really part of larger effort to be leading
PC provider of Microsoft Windows
Actions were not predatory
improving its own browser and OS
not eliminating Netscape
Efficiencies in integrating browser into OS

Predatory pricing
Discussions with Netscape, Apple, and Intel did not alter
their behavior
Offering free browser was natural step toward integrating
the browser into Windows 95 and 98
Government did not provide evidence that integrating the
browser into its OS was not profit-maximizing apart from
any predatory motives

Bundling and OEM Restriction
OEM restrictions justified in order to preserve the quality
and speed of the start-up process
Bundling is not anticompetitive if firm does not have market
power
In fact, efficiencies would be lost if Microsoft had to separate
its browser from the OS
Exclusionary agreement with ISPs
Justified in competing aggressively for the distribution of its
browser
Hence, ISP agreements were necessary
OEM and ISP agreements = no harm, no foul
Netscape could distribute its browser through the mail or
encourage downloads from the web

Judge Jackson supported the Governments claims of
anticompetitive acts
Sided with the Government on:
Market allocation
Predatory pricing
Bundling
Exclusionary agreement
The U.S. v. Microsoft case has now been resolved, and
a remedy chosen
Path to remedy circuitous
The appellate court made clear its dislike of a structural
remedy
Easier to enforce than behavioral remedies, but also riskier as
far as creating inefficiency
Proposed settlement contained 3 components
First, attempted to prohibit Microsoft from foreclosing
the OEM channel by eliminating restrictive licensing
agreements and outlawing retaliatory measures.
Second, it attempted to keep the ISP distribution
channel open by placing limits on Microsofts ability to
discourage companies from promotion of other
middleware.
Third, the settlement offered a series of compliance
measures whose goal is to enforce the terms of the
settlement agreement.
9 States Opposed the Initial Proposal
The proposal didnt prohibit Microsoft from illegally
bundling its middleware with its OS
Claimed that the proposal wouldnt effectively prohibit
retaliatory conduct or open the ISP channel of
distribution
Were worried Microsoft could still withhold vital
technical information from developers of rival
middleware
Enforcement mechanism wont be effective


Judge Kollar Kelly was generally supportive of the
initial settlement between the DOJ and Microsoft
The court did offer more aggressive compliance
procedures sympathetic to the issues raised by the
litigating states
The price of the OS went down. Hence, consumers
were benefited.
It was asserted that IE was not really free because its
development and marketing cost kept the price of the
Windows higher than they were.

Almost a decade later, the governments predictions
about browser competition have turned out to be
correct.
IEs share of the market grew to over 90%
Microsofts OS monopoly continues today
New challenges for Microsoft
A rise in browser competition from Firefox, etc.
Power has shifted to web based companies
Linux based operating systems gaining traction