Antitrust Policy and Regulation Or What to do about Monopoly Please listen to the audio as you work through the slides.

Applying the economics of product markets, resources markets, to selected microeconomic issues and policies. Learning Objectives: 1.How the effectiveness of antitrust laws changes through time. 2.Industrial Regulation and Social Regulation

Purpose of Antitrust Policy 1.Prevent monopoly, 2.Promote competition 3.Promote allocative efficiency The effectiveness and appropriateness is not clear.

The Antitrust Laws Historical Background Trusts (late 1800”s after the civil war the national economy expanded) – business combinations that assign control to a single decision group. Petroleum, meatpacking, railroads, sugar, lead, coal, tobacco. Oligopolies, near monopolies, and monopolies P=MC Pricing of pure competition vs. MR-MC pricing of monopoly leading to under allocation of resources to monopolized product. P=MC represents an efficient allocation of resources because Price measures the marginal benefit to society of an extra unit of output, while MC reflects the cost of an extra unit. In the 1800’s and early 1900’s, Government concluded that market forces in monopolized industries did not protect consumers, achieve fair competition, or achieve allocative efficiency.

The Antitrust Laws Historical Background Government instituted alternative approaches to supplement the market. Government intervened in the market 1.Regulatory Agencies to control economic behavior of natural monopolies. 2.Antitrust laws to prevent / inhibit monopolies

The antitrust laws – the result of public displeasure with trusts (4 key pieces of Federal legislation) Sherman Act of 1890 – direct and to the point Section 1 - Restraint of Trade illegal Section 2 – Monopolization illegal Courts can issue injunctions, break up monopolies, levy fines, allow Treble Damages More explicit language was needed. Clayton Act of 1914 strengthened and made more explicit Section 2 - Price Discrimination illegal when not based on cost differences and when it reduced competition. Section 3 - Tying Contracts illegal – producer requires buyer to purchase additional products. Kodak require customers to use their processing when you buy film Movie distributors force theaters to buy package of films to get a big movie Section 7 – Prohibits Stock Ownership of competing companies when result would reduce competition. Section 8 – Prohibits Interlocking Directorates that lead to reduced competition. Also sought to outlaw the techniques firms might use to develop monopoly power

The Antitrust Laws Federal Trade Commission Act of 1914 Established FTC - has joint federal responsibility for enforcing antitrust laws with the DOJ Power to investigate Holds Hearings on Complaints Seeks Cease-and-Desist Orders when unfair methods of competition are found. Wheeler-Lea Act of 1938 Gave FTC additional responsibility Made it an independent antitrust agency Made unfair and deceptive sales practices illegal. Policing Deceptive Practices Protect public from false advertising, and Misleading Representation of Products

The Antitrust Laws Celler-Kefauver Act of 1950 Strengthened Clayton Act Regarding Asset Ownership in Competing Firms where it would reduce competition. Anticompetitive Mergers Illegal No Matter How Accomplished

The antitrust policy Issues of Interpretation 1.Should the firm be judged by its Monopoly Behavior or its Structure? 2.How broadly should markets be defined in antitrust cases? Standard Oil Case and American Tobacco Trust – 1911 (abusive, anticompetitive) – both found fuilty Is every monopoly guilty or just those involved in anticompetitive actions. U.S. Steel Case – 1920 (no violation) a good trust! Courts established a “Rule of Reason” – not every monopoly is illegal. Only those that unreasonably restrain trade. Size not an offense. Courts have been inconsistent in interpreting the antitrust laws

The antitrust policy Issues of Interpretation Alcoa Case – mere possession of monopoly power made them guilty, even though behavior was legal. (90% of aluminum ingot market) Structurists – if a firm is big (large market share) it will behave like a monopolist. Behaviorists – relationship between structure, behavior, and performance is tenuous and unclear. The Relevant Market Issue Courts often decide whether or not market power exists based on market share held by the dominant firm. Courts must determine how broadly to define the relevant market. DuPont Cellophane Case 1956 – controlled 100% of cellophane market but only 20% of the flexible packaging market. No monopoly Market for cellophane vs. flexible packaging materials Courts have been inconsistent in interpreting the antitrust laws

Issues of Enforcement: Two perspectives on antitrust policy Active Antitrust Perspective Competition is insufficient in some cases to achieve allocative efficiency and ensure fairness to consumers and competing firms. Laissez-faire Perspective Antitrust intervention is largely unnecessary relative to monopoly Creative Destruction Innovation can push prices down toward MC and reduce / eliminate monopoly. Government does nothing. Behavior of a Presidential Administration can influence the enforcement of antitrust law depending on their perspective. The antitrust policy

Effectiveness of Antitrust laws AT&T – anti-competitive practices to maintain monopoly – 1982 structural remedy Microsoft Case 2000 – behavioral remedy prohibited from engaging in anticompetitive behaviors Mergers – treatment varies with type and effect on competition. Horizontal Merger – between two competitors that sell similar products in same geographic market. Chase and chemical bank Boeing and McDonald Douglas (merger allowed) MD was loosing money Office depot and staples – blocked WorldCom and sprint - blocked The antitrust policy

Effectiveness of Antitrust laws Vertical Merger – between firms at different stages of the production process. PepsiCo and taco bell, KFC, Pizza Hut, WingStreet 1999 FTC threatened action on: Barnes and Noble and Ingram Books (largest book wholesaler) because Barnes and Noble would be able to set wholesale prices to its competitors. Blocked Conglomerate Merger – firms in different industries or geographic areas to extend product lines, territory, or combine unrelated companies. Walt Disney and ABC - okay AOL and Time Warner – okay The antitrust policy

Business Level ABCDEF TUVWXYZ Raw Materials Finished Goods TYPES OF MERGERS AUTOS GLASS BLUE JEANS DENIM FABRIC

ABCDEF TUVWXYZ Raw Materials Finished Goods TYPES OF MERGERS AUTOS GLASS BLUE JEANS DENIM FABRIC The merger of suppliers T and U represent a HORIZONTAL MERGER

ABCDEF TUVWXYZ Raw Materials Finished Goods TYPES OF MERGERS AUTOS GLASS BLUE JEANS DENIM FABRIC The merger of suppliers F and Z represent a VERTICAL MERGER

ABCDEF TUVWXYZ Raw Materials Finished Goods TYPES OF MERGERS AUTOS GLASS BLUE JEANS DENIM FABRIC Merging unrelated firms represents a CONGLOMERATE MERGER

Industrial Regulation Government regulation of an entire industry Natural Monopoly – economies of scale so extensive that single firm can supply entire market. Example - Public Utilities (electric, water, natural gas, telephone Two possible alternatives for promoting better economic results when natural monopolies exist. 1.Public Ownership – TVA, postal service, Amtrak, or local water systems or mass transit 2.Public Regulation (aka industrial regulation) – regulate rates Public Interest Theory of Regulation Necessary to keep a natural monopoly from charging monopoly prices and harming consumers and society. Goal to set price to ATC so regulated firm receives a normal profit.

Industrial Regulation Problems with Industrial Regulation Costs and Inefficiency Unregulated firm has incentive to reduce costs to increase profit Regulated firms have much less incentive due to “fair rate of return” Perpetuating Monopoly long after conditions of natural monopoly have ended. Trucks competing with rail. Satellite TV competing with cable Cell phones competing with land line service Protection of regulated firms discourages entry and efficiency. The Interstate Commerce Commission case (trucking, railroads) Outdated in the 1930’s not dismantled until 1996

Industrial Regulation Problems with Industrial Regulation Deregulation in the 1970’s Outcomes of Deregulation Airlines, trucking, banking, railroads, natural gas, television, electricity, Telco Lower prices, lower costs, increased output, increased efficiency, technical advance – cell phones fiber optics, Internet

Social Regulation Concerned with the conditions under which goods and services are produced, the impact of production on society, and the physical qualities of the goods themselves. Applies to Far More Firms More Intrusive into Daily Activities FDA (1906) – Food and Drug Administration EEOC (1964) – Equal Employment Opportunity commission OSHA (1971) – occupational Safety and Health Administration EPA (1972) CPSC (1972) – Consumer Product Safety Commission regulating design of unsafe products Optimal Level of Social Regulation MB of Social Regulation = MC of Social Regulation

Social Regulation Pros – Addresses big problems – Costly but alternative is serious – Specific benefits Lower highway fatalities National air quality Food safety Patients rights Cons – Business says laws poorly written – Politicians ignore costs to business – Rules are based on inadequate information – Costly side effects