Chapter 15 Economic Regulation and Antitrust Policy © 2009 South-Western/ Cengage Learning

Government Regulation Market power –the ability to affect the market price downward-sloping demand curve prices are too high output too low inefficient (P ≠ MC) 2

How can firms grow? Mergers –Horizontal merger merger of 2 or more firms competing in the same market –Vertical merger merger of 2 or more firms at different stages of the production process –Conglomerate merger merger of 2 or more firms in unrelated markets 3

Types of Government Regulation Government regulations –Social regulation Regulation aimed at improving health and safety –Economic regulation Regulation aimed at natural monopolies 4

Natural Monopoly Natural monopoly –Barrier to entry is economies of scale Unregulated profit maximization –Choose Q where MR=MC –Economic profit –Consumer surplus –P > MC higher social welfare if output expanded 5

Regulating a Natural Monopoly AC Pricing –regulatory agency allows the firm to charge a price high enough to cover costs but no above normal profit P=AC Increase social welfare Lower P, expand Q –P > MC inefficient 6

Regulating a Natural Monopoly Setting P = MC –Where D intersects MC –Higher consumer surplus –Monopolist: economic loss (P < AC) –In long-run: monopolist exits the market –Needs subsidizing 7

Regulating a Natural Monopoly Setting P = MC or P = AC –Reduce P –Increase output –Erase economic profit –Increase consumer surplus –Increase social welfare 8

Regulating a Natural Monopoly The regulatory dilemma –If P = MC Socially optimal allocation of resources –Marginal benefit = MC P < AC –Economic loss Requires government subsidy –If P = AC Monopolist: normal profit Not socially optimal allocation 9

Alternative Theories: Economic Regulation Economic regulation –Public interest, promotes social welfare –Special interest of producers ‘Capture theory of regulation’ Producer groups –Expect to gain –Persuade public officials to impose restrictions Consumers have no special interest Reduces competition Increases prices 10

Antitrust Legislation and Enforcement Antitrust policy –Reduce anticompetitive behavior –Promote more efficient market structure Origins of antitrust policy –Developments Technology improvements: economies of scale Railroad: reduced transport costs Bigger firms, wider markets 11

Origins of Antitrust Policy sharp economic decline –Competing firms formed a trust Sugar, tobacco, oil industries Widespread criticism Sherman Antitrust Act of 1890 –Outlaws many behaviors whose ultimate goal is “restraint of trade” 12

Origins of Antitrust Policy Clayton Act of 1914 –Outlaws specific behaviors whose purpose is to “lessen competition” Price discrimination, tying contracts, exclusive dealing Federal Trade Commission Act of 1914 –established Federal Trade Commission –Enforce antitrust laws 13

Objectionable Behaviors Price Fixing –Any action by 2 or more firms to set price Collusion Outlawed by Sherman Antitrust Act Vertical Restraints –involves an agreement between producer and retailer Price Discrimination –outlawed by Clayton Act where purpose is to reduce competition (rule of reason) Mergers 14

Per Se Illegality and Rule of Reason Per se illegal –Illegal regardless of the economic rationale or consequences Rule of reason –Reasons and its effect on competition 15

Mergers and Public Policy Antitrust division and FTC –Approve/deny mergers and acquisitions Concentration Ratio –Sales of 4 or 8 largest firms as a percentage of total industry sales Higher concentration –More potential monopoly power Lower concentration –More competition 16

Mergers and Public Policy Herfindahl-Hirschman Index HHI Sum of squared % market shares of all firms in the industry HHI = p p p … + p n 2 where p i is the % market share of the ith firm –Challenged mergers if Post-merger HHI>1800 Merger increases HHI by >100 points Mergers with HHI < 1000 rarely challenged 17

Exhibit 3 U.S. merger waves in the past century 18 WaveYears Dominant type of mergerExamplesStimulus First Second Third Fourth present Horizontal Vertical Conglomerate Horizontal and vertical U.S. Steel, Standard Oil Copper refiner with fabricator Litton Industries Banking, tele- communications, health services, insurance Span national markets Stock market boom Diversification Span national and global markets, stock market boom

Merger Waves First wave –Technological progress in transportation, communication, and manufacturing Second wave –Stock market boom of 1920s Third wave –After WWII Fourth wave –One-third: hostile takeovers 19

Competitive Trends in the US Economy 1.Pure monopoly –One firm controls the market –Block entry 2.Dominant firm –One firm: more than half market share –No close rival 20

Competitive Trends in the US Economy 3.Tight oligopoly –Top 4 firms: more than 60% of market output –Evidence of cooperation 4.Effective competition –Low concentration –Low barriers to entry –Little or no collusion 21

Exhibit 4 Competitive trends in the US economy: 1939 to

Competitive Trends in the US Economy Growth in competition ( ) –Competition from imports –Deregulation –Antitrust policy 23

Recent Competitive Trends Increased competition in US Growing world trade Three major automakers –80% of US market in 1970; only 54% by 2006 Deregulation International phone service –$0.88 a minute in 1997; under $0.10 by 2007 Technological change Three major TV networks –90% in 1980; under 40% by

Microsoft on trial Charges –Protect Windows monopoly (90%) –Extend monopoly into Internet Explorer –Internet Explorer’s integration into Windows 98 Microsoft: to make life easier for customers Government: boost IE’s market share –Predatory practices –Anticompetitive behavior 25

Problems with Antitrust Policy Competition may not require that many firms Abuse of antitrust Growth of international markets 26

Antitrust Enforcement Antitrust division of the US Justice Department and FTC –Fines Treble damages –Jail –Injunctions Court order to cease behavior –Break up firm into smaller firms AT&T Standard Oil 27