The Economics Behind the Cellophane Fallacy

The Cellophane Fallacy reveals how measuring competition at inflated monopoly prices can disguise true market power. Rooted in the DuPont case, it underscores the importance of defining markets using competitive price baselines to avoid misleading conclusions in antitrust analysis.

The Cellophane Fallacy—also known as the Cellophane Paradox or Cellophane Trap—illustrates a key pitfall that can occur when defining relevant product markets and assessing monopoly power. The fallacy arises when substitution between products is assessed at prices already elevated above the competitive level. It is named after the product at issue in the landmark 1956 Supreme Court case United States v. E. I. du Pont de Nemours & Co.

This essay explores the economics behind the Cellophane Fallacy: its origins in case law and economic thought, its implications for antitrust enforcement and policy, modern refinements like the “reverse Cellophane fallacy,” and the broader methodological lessons for market-power analysis.

Key Takeaways

The Cellophane Fallacy occurs when economists or courts define a market at monopoly prices rather than competitive prices, making it appear that significant substitution exists when, in fact, the monopolist has already inflated prices. This error leads to overly broad market definitions and underestimation of monopoly power.
The fallacy stems from the 1956 Supreme Court case, United States v. DuPont, where the Court wrongly concluded that DuPont lacked monopoly power in cellophane. The Court assessed substitution among wrapping materials after DuPont had already raised prices, creating an illusion of competition.
Modern market definition uses the SSNIP (Small but Significant Non-Transitory Increase in Price) test to determine relevant markets. The Cellophane Fallacy shows that using a supracompetitive base price invalidates this test, as it overstates elasticity and market breadth. Analysts must use competitive baselines for reliable market delineation.
The fallacy has deep implications for antitrust enforcement and merger review. Its inverse—the Reverse Cellophane Fallacy—occurs when regulated (below-competitive) prices make markets appear narrower than they are, overstating market power. Both distort true competition and misguide policy.
Market definition must be based on competitive conditions, not distorted prices. Economists should use profit margin analysis, cost benchmarks, and natural experiments to infer competitive baselines. The principle also extends to digital markets and “free” platforms, where defining a competitive baseline is especially challenging.

Historical Origins: The DuPont Cellophane Case

The Cellophane Fallacy is named after the product at issue in the antitrust case: United States v. E. I. du Pont de Nemours & Co. The Defendant, du Pont (“DuPont”), was a major chemical corporation that manufactured almost all cellophane (a transparent wrapping material) in the U.S. at the time. A lawsuit was filed in 1947 against DuPont under Section 4 of the Sherman Act, alleging DuPont held monopoly power over cellophane.[1] DuPont responded by arguing its product was merely one of many “flexible wrapping materials” alongside aluminum foil, wax paper, and others, and therefore, its market share—and thus its market power—was modest.

The District Court of Delaware and the Supreme Court ultimately agreed with DuPont,[2] but the reasoning became the focus of enduring critique. A central issue is that the courts measured cross-elasticity of demand (how much sales of one product change in response to the price changes of another) at the prevailing market price, which turned out to be an already-inflated, monopolistic price. At such a high price it is unsurprising consumers would turn to substitutes. But this resulted in the Court defining the relevant market too broadly and understating DuPont’s true market power. This mistake is the essence of the Cellophane Fallacy.

Summary of the Cellophane Fallacy

The problem, in essence, is that the inquiry began after monopoly pricing had already been enacted, rather than considering whether such pricing is even possible under effective competition. This leads to the illusion of a competitive market, when in fact, the market is already distorted by monopolistic pricing. As noted by the Supreme Court in Eastman Kodak: “The existence of significant substitution in the event of further price increases or even at the current price does not tell us whether the defendant already exercises significant market power” (cleaned up).[3]

The Cellophane Fallacy occurs when market definition relies on cross-price elasticities measured at monopoly prices. Because the monopolist has already set a high price, consumer demand becomes more elastic there. But this is not because there is a lack of market power. Instead, it is a result of the inflation in price having already pushed consumers toward substitutes. Assessing substitutability at such prices expands the market scope artificially, obscuring existing monopoly power

Economic Mechanics and SSNIP Test

Modern antitrust policy often uses the Small but Significant Non-transitory Increase in Price (“SSNIP”) test for defining a relevant product market. This test starts from a base price and evaluates whether a hypothetical small but significant (e.g., 5–10%) price increase would be unprofitable because it would drive customers to substitute to alternative products. If so, the next-closest alternatives are included in the relevant market. Through an iterative process, the SSNIP test is performed until a market is found where a hypothetical monopolist of all products in the market could profitably raise prices of at least one (but possibly more) by 5-10%.[4]

Where the Cellophane Fallacy comes into play is in the selection of the base price used in the SSNIP test. As the Cellophane Fallacy highlights, using a base price that is already supracompetitive undermines the validity of this test.

Institutional frameworks, such as the U.S. DOJ and FTC’s Merger Guidelines, explicitly warn that defining markets using prices reflective of monopolistic behavior leads to the Cellophane Fallacy. To avoid this, economists should employ competitive prices as the baseline in their SSNIP analysis. Failing to do so can cause market definitions to be overly broad and underestimate anticompetitive risks.

Illustrative Example of the Fallacy

Suppose a competitive price is $1, but the alleged monopolist currently charges $5 (its profit-maximizing rate). If we evaluate substitutability at a price of $5, demand may appear elastic, and a 5% rise might provoke sufficient consumer switching to suggest that additional products should be included in the relevant market. Yet at $1, demand may be relatively inelastic demonstrating that a price increase by a hypothetical monopolist would be profitable. Thus, starting from $5 misleads market definition

Broader Implications for Antitrust Analysis

Use of prevailing monopoly prices conflates consumer behavior in the face of existing distortions with consumer behavior in a competitive market, leading courts and regulators to systematically understate market power. The Cellophane Fallacy can thus enable firms to avoid scrutiny in enforcement and merger cases, as their high-price ecosystems mask dominance.

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To avoid the fallacy, economists must identify or estimate the competitive price baseline. This may involve cost-based analysis (e.g., profit margin analysis, Lerner index), analyzing pre-monopoly conditions, analyzing conditions in yardstick/benchmark competitive markets, or evaluating responses to exogenous shocks/natural experiments.

Reverse Cellophane Fallacy and Merger Review

In merger reviews, regulators often ask whether combining firms will lead to significantly increased prices or other worsening of terms for consumers. This often involves a question of how much the merged firm could increase prices over the prevailing level. One potential pitfall is that markets delineated based on prevailing demand elasticities may be too small relative to those that would exist post-merger, and therefore overstate the true potential for the merged firm to exercise additional market power.[5]

Unlike a monopolization case, a typical merger case is not focused on whether the merging firms are currently exercising market power but whether the merger will lead to an incremental increase in the exercise of market power. In terms of pricing, this would mean that the focus is not on whether current prices are inflated above the competitive level but whether the merger would lead to the inflation of prices.

Extension: Reverse Cellophane Fallacy in Government-Regulated Industries

In regulated industries where prices are set below competitive levels (for example, by rate regulation), economists may also run afoul of the Reverse Cellophane Fallacy. If government regulation pushes prices below the competitive level, this may lead to incorrectly defining narrow markets because low prices suppress substitution.

With artificially low prices, different products appear insufficiently substitutable, leading to overestimates of market power and justification for regulation. This inverse error creates a policy trap: regulators insist that firms lack market power before deregulating, but low regulated prices bias analysis toward detecting power, creating a “self-perpetuating nature of regulation.”[6]

Theoretical and Policy Lessons

Effective antitrust analysis requires methods that capture true competitive baselines rather than relying on already-inflated prices. Whether in monopolistic or regulated frameworks, misuse of the SSNIP or elasticity tests at distorted prices undermines market definition.

As critiques note, the current price behavior may already be at supracompetitive levels and therefore current substitution patterns may not fully reflect a competitive baseline. A holistic assessment including profit margin and cost data may be useful. Measuring margins—difficult though it may be—provides another basis for identifying market power. So to can before/after comparisons, analysis of yardstick/benchmark markets, or evidence on reactions to exogenous shocks/natural experiments.

The Cellophane Fallacy serves as a cautionary tale. Both courts and regulators must avoid simplistic reliance on cross-elasticities at prevailing prices and instead strive for internally consistent frameworks (e.g., markets defined by hypothetical monopolists at competitive prices).

Application to digital markets and “free” goods

Though originating in traditional goods markets, the Cellophane Fallacy applies equally to digital platforms, subscription services, and “free” offerings, where pricing structures are complex. Economists must identify what constitutes a competitive baseline—even when explicit prices are absent or zero—to avoid misleading inferences about substitutability or dominance.

Conclusion

The Cellophane Fallacy embodies a crucial economic insight: that using distorted current prices—be they supracompetitive or regulated—as baselines for assessing substitutability misleads analysis of market power. Rooted in the 1956 DuPont decision and refined by economic research since then, the fallacy highlights the essential role of baseline realism in antitrust economics. Avoiding it requires more than a mechanical application of the SSNIP test: it calls for nuanced modeling of competitive price environments, margins analysis, and attention to both economic structure and performance. Its sibling—the Reverse Cellophane Fallacy—reminds us that distortion in either direction (high or low prices) undermines market clarity. As markets evolve, especially in digital and multi-sided contexts, the core lesson remains: accurate market definition hinges on measuring substitution at prices that reflect competitive conditions, not those shaped by monopoly power or regulatory distortion.

Frequently Asked Questions

Q: What is the Cellophane Fallacy?

A: The Cellophane Fallacy is a well-known concept in antitrust economics that arises when courts or regulators mistakenly define the relevant product market too broadly because they evaluate substitution at a monopoly (or supracompetitive) price rather than at the competitive price.

Q: When does the Cellophane Fallacy occur?

A: The Cellophane Fallacy occurs when product substitutability is evaluated at prevailing (potentially inflated) prices, instead of competitive prices.

Q: What problems does the Cellophane Fallacy cause?

A: The Cellophane Fallacy may cause (1) too many products to be included in the relevant market definition, (2) competitive elasticity of demand to be over-estimated, and (3) market power and potential for anticompetitive conduct to be underestimated.

Q: How does the Cellophane Fallacy affect market definition?

A: If economists define the market based on consumer switching at inflated monopoly prices, they may incorrectly include too many substitutes, making the market appear more competitive than it actually is.

Q: How do economists avoid the Cellophane Fallacy?

A: They analyze pricing and substitution at or near competitive price levels, use historical data from before price increases, and/or apply advanced econometric methods to estimate demand at lower, non-monopoly prices.

References

[1] United States v. E. I. du Pont de Nemours & Co., 118 F. Supp. 41, 47-48 (D.Del. 1953) (“This is a civil suit by the United States of America under § 4 of the Sherman Act[.]” “This case was instituted originally in the District Court of the United States for the District of Columbia on December 13, 1947. On April 28, 1949, the case was transferred to the District of Delaware.”).

[2] United States v. E. I. du Pont de Nemours & Co., 118 F. Supp. 41 (D.Del. 1953); United States v. E. I. du Pont de Nemours & Co., 351 U.S. 377 (1956)

[3] Eastman Kodak Co. v. Image Technical Services, Inc., 504 US 451, 471 (1992), quoting from P. Areeda & L Kaplow, Antitrust Analysis ¶ 340(b) (4^th ed. 1988).

[4] U.S. DOJ & FTC, 2023 Merger Guidelines.

[5] Luke M. Froeb and Gergory J. Werden, The Reverse Cellophane Fallacy in Market Delineation, 7(2) Review of Industrial Organization 241-247 (1992).

[6] Debra J. Aron and David E. Burnstein, Regulatory Policy and the Reverse Cellophane Fallacy, 6(4) Journal of Competition Law & Economics 973-994 (2010).

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