Slide 1  2005 South-Western Publishing Corporations are legal entities which exist only because governments allow them to exist. Governments impose many restrictions on firms: mergers, patents, licensing, or subsidies. The stated intention of governments is set restrictions that promote social welfare, but they sometimes benefit particular groups or individuals. Government Regulation Chapter 17

Slide 2 Market Structure, Conduct, and Performance Fundamental Market and Environmental Conditions MARKET STRUCTURE MARKET CONDUCT MARKET PERFORMANCE Feedback Effects Feedback Effects

Slide 3 Good Market Performance Depends on: 1.Efficient resource allocation 2.Technologically progressive 3.Promote full employment 4.Equitable distribution of income 5.Resource conservation 6.Satisfactory product performance and safety characteristics.

Slide 4 Market Conduct 1.Pricing behavior 2.Product policy 3.Sales promotion and advertising strategies 4.R&D and innovation strategies 5.Legal tactics with regard to entry

Slide 5 Market Structure 1.Seller and buyer concentration 2.Actual or imagined Product differentiation. 3.Entry conditions. 4.Vertical Integration 5.Diversification or conglomeration 6.Contestability

Slide 6 Types of Barriers to Entry 1.Product differentiation Advertising, patent control, distributional control 2.Absolute cost advantages Superior techniques, control of inputs, superior access to financing 3.Scale Economies Capital intensive technology, high start-up costs 4.Limited access to distribution channels open closed

Slide 7 Fundamental Market and Environmental Conditions SUPPLY 1.Location of ownership of raw materials 2.Product durability 3.Technology 4.Labor organization DEMAND 1.Price elasticity 2.Cross price elasticity 3.Growth prospects 4.Type of product 5.Method of purchase

Slide 8 A market is a group of economic agents that interact in a buyer-seller relationship. The nature of that relationship is affected by the number and size distribution of the buyers and sellers. A popular measure of seller concentration is the percentage of an industry comprised of the top 4 firms. Similarly, the top 4 buyers is a popular measure of buyer concentration. Determining Industry Structure

Slide 9 Market Concentration Ratios The size distribution of firms is measured by the percentage of the top four firms (or buyers) ».22 ».18 ».10 ».08 »… shares of market listed in descending order Similar concentration of occur for 8-firm, 20- firm, and 50-firm ratios The Bureau of Census provides data on industries by SIC (Standard Industrial Classification) or its equivalent 58% of market is controlled by top 4 firms

Slide 10 Industry Classifications 2-digit sectors: 32 Manufacturing sector 3-digit sub-sectors: »322 Paper Manufacturing Sub-sector 4-digit industry groups: »3221 »3221 Pulp, Paper, and Paperboard Mills 5-digit industry in North America: »32212 Paper Mills 6-digit industry in US, Canada, or Mexico: » Paper Mills in the US except newsprint u Industrial and firm classifications »North American Industrial Classification System (NAICS) of the US Department of Commerce replaced SIC’s in To compare NAICS to SIC see:

Slide 11 Incomplete Measures of Concentration Providing all the market shares can reveal too much »Partial measures use only some of the market shares 4, 8, 20 & 50 firm Concentration Ratios »Share of top 4 firms, as in 4CR = 60 »Problem of two industries A has shares of 60, 10, 5 & 5 B has shares of 20, 20, 20 & 20 The knowledge of each share is hidden in partial measures of concentration in an industry Both are 4CR=80

Slide 12 Other Market Concentration Measures Complete Measures »Know the market shares of all firms »Herfindahl-Hirschman Index : HHI =  s i 2 Example: Baby Food »70% for Gerber »16% for Beech-Nut »14% for Heinz So the 4CR = 100% And the HHI = (70) 2 + (16) 2 + (14) 2 = 5352 The maximum HHI is (100) 2 = 10,000 for a pure monopoly With 100 firms, each with 1% of the market, HHI=100

Slide 13 Antitrust : Government Regulation of Market Conduct and Structure In trusts, the voting rights to the several firms are conveyed to a legal trust to manage the group of firms as if it were one firm. This tends to create monopolization of an industry. The Sherman Antitrust Act (1890) outlawed monopolies per se and attempted monopolization.

Slide 14 The Clayton Act The Clayton Act (1914) extended the list of conduct that was anti-competitive: a.price discrimination. (section 2) b.tying contracts force customers to buy added products with one product. (section 3) c.purchasing shares of competing firms as an anti-merger section. (section 7) d.corporate directorship interlocks occur when the same people are in directorships of competing firms. (section 8) The Federal Trade Commission was established in 1914 to prohibit unfair methods of competition.

Slide 15 Robinson-Patman Act of 1936 Section 2(a) prohibits price discrimination which "substantially lessen competition". Section (2b) provides a cost justification for price discrimination. Section (2c) prohibits some kinds of brokerage commissions. Sections (2d-2e) prohibits discounts to buyers not afforded to other customers. The Hart-Scott-Rodino Antitrust Improvement Act (1976) requires notification by large firms to the Justice Department of impending mergers.

Slide 16 Antitrust Prohibitions of Selected Business Decisions Collusion to fix prices (airlines and grocery stores have been penalized) Mergers that substantially lessen competition (mergers raise 4CR and the HHI) »If HHI > 1,800, mergers are usually challenged »If 1,000 < HHI < 1,8000, mergers challenged if raise the HHI by more than 100 points »If HHI < 1,000, most mergers are not challenged Monopolization (attempted monopolization is a violation of the Sherman Antitrust Act) Wholesale Price Discrimination (forms of price discrimination that injured other competitors, not necessarily customers) »Penguin Books sold books at lower prices to Barnes & Noble than to other bookstores Refusals to Deal (when not based on legitimate business justifications)

Slide 17 Palladium Metal-Casting Industry The Palladium Metal-Casting numerical example uses a simple monopoly model (pages ) »P = 15, Q and TC = 100,000,000 +6Q +.05Q 2 »Solution: P=$8,574 & ROI = 7.2% Adding an additional fixed cost ($150 million to reduce smoke) lowers profit and ROI (return on investment) without changing the price. »Solution: same price and ROI = 5.4% If the operating controls raise variable costs, then the output and price changes in the directions you would expect: higher prices and lower output. »Solution: P = $9,378 & ROI = 3%

Slide 18 The Deregulation Movement Airline and trucking have been deregulated. They are no longer "infant industries". Deregulation of long-distance occurred due in large part to technological changes in transmitting phone messages by microwave.

Slide 19 Government Protection of Business Governments historically have helped some companies by restricting or eliminating competition. Examples »Licensing of professions (or businesses) »Patents of ideas or processes restricts use of the idea »Import quotas

Slide 20 Trade Restrictions on US Sugar Markets Ignoring tariffs, lets look only at quotas. D & S are domestic demand and supply At world price P w, the US grows 6.14 and imports the rest to (imports of 13.04) With a quota on of imports, price rises to P quota, and quantity consumed declines and local production grows Quantity in billions of pounds S D PwPw P quota imports imports before quota A B C D E F G H

Slide 21 Welfare Impacts of Quotas Consumers »Pay more after quotas. »Consumer surplus declines by areas A+B+C+D Domestic Producers of Sugar »Receive more after quotas »Producer surplus rises by area A Foreign Producers of Sugar »Receive more after quotas »Foreign producer surplus is area C No one gets areas B + D, this is called excess burden or deadweight social loss