Price Elasticity of Demand and Why It Is Relevant to Your Case

Elasticity of demand is a hot topic in the legal world. It is cited in a variety of cases when it comes to damages, and specifically in antitrust cases when it comes to market definition and market power.

What is Elasticity?

In the field of economics, elasticity is a term that refers to the change in one economic variable that results from a change in some other economic variable. The term price elasticity of demand is used to describe the responsiveness of consumer demand to a change in price.

The formula for the price elasticity of demand is often described as having three components: (1) the quantity demanded of the product, (2) price of the product, (3) the ratio of the change in demand to the change in price.

What are the Types of Price Elasticity?

Price elasticity can be divided into two broad types. This is related to whether the price at issue is the product’s own price or the price of another product:

• The responsiveness of demand for a product to change in its own price is called the own-price elasticity of demand.
• The responsiveness of demand for a product to change in another product’s price is called the cross-price elasticity of demand.

Why is Elasticity of Demand Evaluated?

The elasticity of demand is evaluated to: (1) define the relevant antitrust market, (2) analyze market power, and (3) calculate any change in quantity needed as part of a damage calculation.

         (1) Defining the Relevant Antitrust Market

A relevant market is defined as a set of products or services that consumers consider to be reasonably close alternatives. This can be evaluated by looking at substitution patterns in response to price changes. As described above, one measure of responsiveness to price changes is the elasticity of demand.

If the price of a consumer’s most-preferred product goes up they may choose to shift to other products. Economists often use historical price changes as an opportunity to observe these shifts and identify which products consumers view as the closest alternatives. Various tests based on this principle exist, such as the Hypothetical Monopolist Test (“HMT”) and the Small but Significant Non-transitory Increase in Price (“SSNIP”) test.

(2) Analyzing Market Power

One way in which firms use market power is to raise prices above the competitive level. A plaintiff typically must show that a defendant has or could obtain market power to prevail in an antitrust case.

Market power is frequently evaluated by determining if the elasticity of demand for the consumer is high or low. If the elasticity of demand is high, this indicates there are close substitutes that customers would readily switch to if prices were to increase. Alternatively, if the elasticity of demand is low then there are few close substitutes. Therefore, evidence showing a low elasticity of demand can be indicative of market power.

(3) Quantifying Damage

One form of economic damage is price erosion. Price erosion damage occurs if one firm takes an illegal action that forces another firm to lower its prices. The firm whose prices were lowered due to this conduct might sue for damages on the basis that lower prices resulted in lower profits.

However, lower prices may also lead to a greater quantity of sales. This can be evaluated using the elasticity of demand, which measures responsiveness of quantity to price.

When Might Elasticity of Demand Be Evaluated?

Elasticity of demand can be relevant for market definition, market power, and damages. Courts have used evidence on elasticity of demand in situations such as the following cases:

• Brown Shoe v. U.S.: Antitrust case in which elasticity of demand was relevant to market definition.
• Crystal Semiconductor v. Tritech: Patent infringement case in which elasticity of demand was relevant to showing but-for price erosion.
• ICTSI Oregon v. ILWU: Labor case involving a boycott in which elasticity of demand was relevant to showing price erosion damages.

How is Elasticity Evaluated?

Elasticity can be evaluated using a variety of evidence:

• Evidence of historical prices and quantities, and how they have fluctuated in the past.
• Evidence of a company raising relative prices or maintaining prices above the competitive level.
• Testimony from firms, customers, and industry commentators about how products are priced and who is viewed as competitors.

Having addressed the what, why, when, and how of elasticity, we now turn to five examples of it being referenced in federal courts.

Recent and/or Noteworthy Case References to Elasticity of Demand

The elasticity of demand has been cited in hundreds of court cases, including by U.S. District Courts, Circuit Courts, and the Supreme Court.

(1) Brown Shoe Co. v. United States

Brown Shoe is an antitrust merger case decided by the U.S. Supreme Court in 1962. This was a case about the planned merger between two shoe companies. The question arose as to how to define the market for shoes, specifically whether there was a “price/quality” and “age/sex” distinction within the larger categories of men’s, women’s, and children’s shoes.[1]

In the U.S. Supreme Court ruling, “The outer boundaries of a product market are determined by the reasonable interchangeability of use or the cross-elasticity of demand between the product itself and substitutes for it.”[2] While this case acknowledged the potential importance of elasticity of the demand, it also relied on “practical indicia” of market definition.[3]

(2) Queen City Pizza v. Domino’s

Queen City Pizza is an antitrust case decided by the 3^rd Circuit in 1997. The case involved a dispute over pizza franchisees’ contractual commitment to purchase supplies from Dominos.[4]

In the 3^rd Circuit’s decision, “Where the plaintiff fails to define its proposed relevant market with reference to the rule of reasonable interchangeability and cross-elasticity of demand…the relevant market is legally insufficient and a motion to dismiss may be granted.”[5]  From an economics standpoint, care should be taken when interpreting this because own-elasticity of demand can be informative about cross-elasticity of demand.

(3) Crystal Semiconductor Corporation v. Tritech Microelectronics International, Inc. et al.

Crystal Semiconductor is a case decided by the U.S. Court of Appeals, Federal Circuit (“CAFC”) in 2001. This was a patent infringement case including a claim of lost profit on a theory of price erosion.[6]  Plaintiffs claimed that they would have been able to increase their profits by raising prices but for the infringement.

The CAFC ruled that Plaintiffs “presented no evidence of the elasticity of demand,” nor did they “make any estimates as to the number of sales it would have lost or kept had it increased its prices…. Thus, Crystal did not make a showing of ‘but for’ causation of price erosion.”[7] The Plaintiffs argument was found to be flawed because they failed to account for a potential reduction in quantity that might have corresponded to the price increase they allegedly would have made.

(4) FTC v. AbbVie Inc.

FTC v. AbbVie is a case decided by the 3^rd Circuit in 2020. It was alleged that certain Defendants entered into anticompetitive reverse-payment agreements to monopolize and restrain trade over the testosterone-replacement drug AndroGel.[8] A key issue in the case was whether AndroGel, a gel, belonged in the same relevant antitrust market as other testosterone replacement therapies that were injections.[9]

The 3^rd Circuit described evidence that the District Court relied on to find “little cross-elasticity of demand” between injectables and AndroGel:

• • Injectables are much cheaper than AndroGel, yet [Defendant] AbbVie has “consistently raised AndroGel’s wholesale acquisition cost.”
  • AbbVie executive James Hynd testified that AbbVie does not price AndroGel against injectables and did not offer rebates to match the price of injectables.
  • AndroGel’s Director of Marketing Frank Jaeger testified that AbbVie did not consider injectables to be competition.[10]

Based on this evidence, the “District Court defined the product market as ‘the market for all TTRTs [Topical/transdermal Testosterone Replacement Therapies]’” which did not include injectables in the relevant antitrust market.[11]  The 3^rd Circuit upheld the lower court’s market definition and the conclusion that Defendants “AbbVie and Besins had monopoly power in the relevant market.”[12]

(5) ICTSI Oregon v. International Longshore and Warehouse Union

ICTSI Oregon v. International Longshore and Warehouse Union is a case decided by a District Court for Oregon in 2020. The case arose out of a dispute at a container terminal in the Port of Portland. The International Longshore and Warehouse Union (“ILWU”) was found to have “engaged in work stoppages, slowdowns, ‘safety gimmicks,’ and other coercive actions” to get Plaintiff ICTSI to pressure the port to switch work from the International Brotherhood of Electrical Workers (“IBEW”) to the ILWU.[13] 

Defendants “raised serious reliability questions about [Plaintiff’s damages] model because it included increases of both pricing and volume.”[14] The Court pointed to evidence that “these ports compete in a market with a relatively elastic demand curve” to support its finding that “the jury awarded excessive lost profit damages, and a new trial on damages is warranted.”[15]

Conclusion

Elasticity of demand is an economic measurement which frequently appears in litigation at all levels. Courts have found evidence regarding the elasticity of demand to be informative when evaluating market definition, market power, and damages. Economic experts are essential for unravelling the complex issues which can arise when applying this measurement to cases.

From the examples above,

• In Brown Shoe, FTC v AbbVie, and in Queen City Pizza, the Court relied on evidence of cross-elasticity of demand to define the market. In both, the decisive factor in the outcome of the case was the Court’s evaluation of market definition.
• In Crystal Semiconductor and in ICTSI Oregon, the Courts denied or significantly reduced damages which did not account for elasticity of demand.

These provide examples of the wide variety of cases in which the elasticity of demand can be used. This complex topic can decisively change the outcome of liability or damage phases of a case. Given the importance of this topic, it would be most beneficial to work with an expert who has intricate knowledge and experience of elasticity of demand.