Antitrust, Regulation, and Deregulation

The Government’s Role in Promoting Efficiency Studied the effects of the various market structures and government policy (taxes, price controls) on economy efficiency (deadweight loss). Now: role of government in promoting economic efficiency when there is market failure (the unregulated market is inefficient). Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-2

Why the Government Might Intervene Three main reasons why the government would intervene in a market: To promote productive efficiency Resources are employed at the lowest cost. To promote innovation Creation and application of new technology To promote allocative efficiency Resources are distributed in the way that society values most. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-3

Why the Government Might Intervene (cont’d) Most economists agree that the best way to achieve efficiency and promote innovation is through competition. However, competitive markets do not always arise naturally, and may even be undesirable in some cases. (market failure) Too few competitors / barriers to entry Externalities (costs/benefits not price in market) Assymetric information Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-4

Natural and Optimal Market Structures The natural structure of a market is the degree of competition that would occur in the absence of government intervention. The optimal structure of a market is the degree of competition that maximizes allocative efficiency. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-5

Natural and Optimal Market Structures (cont’d) The government will tend to intervene if the natural structure differs significantly from the optimal structure. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-6

The Sherman Antitrust Act of 1890 The basis of much of U.S. antitrust policy, the Sherman Act outlaws: Monopolies or attempts to monopolize an industry Standard Oil: Predatory Pricing Dropping price < ATC to drive out competitors McGee: found SO offered P = P(monopoly) (higher than competitive value) Mergers that are anti-competive Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-7

Sherman Anti-Trust Act Divided into three sections. Sec 1 delineates and prohibits specific means of anticompetitive conduct, (e.g., contracts/agreements) Sec 2 deals with end results that are anticompetitive in nature. (actual pricing tactics, or non-compete) Sec 3 simply extends the provisions of Section 1 to U.S. territories and the District of Columbia. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-8

The Sherman Antitrust Act of 1890 (cont’d) Under the Sherman Act, courts may: Break monopolies up into smaller firms Divestiture – divest the company of its smaller firms 1980 – AT&T break-up Prohibit certain business practices Predatory pricing: P < min ATC to drive competitors out Supposedly Standard Oil in the 30’s Price fixing: setting P > MC and agreeing not to compete Eastern/American Airlines Not compete: geographic/product lines Impose fines on firms Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-9

The Federal Trade Commission Act of 1914 Created the Federal Trade Commission (FTC), the agency that identifies and pursues antitrust cases Department of Justice (DOJ), agency for attorneys that prosecute the cases Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-10

Enforcement of Antitrust Policy The Department of Justice (DOJ) and the Federal Trade Commission (FTC) have the power to sue firms in order to: Force violators to stop anticompetitive practices Break up existing firms into smaller ones Prevent the formation of very large firms Impose fines on firms that violate antitrust legislation Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-11

Changes in Enforcement Since the Sherman Act of 1890, enforcement of antitrust legislation has become less stringent. Technological change and globalization have lead to increased competition. (contestable markets) Telecomm – wireless and landlines Music – record manufacturers and ITunes Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-12

Mergers In addition to enforcing antitrust laws, the FTC may try to block or alter a merger. A merger occurs when two firms combine to form a single firm. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-13

Types of Mergers Conglomerate Merger Firms in unrelated industries merge. Vertical Merger A firm buys another firm that is either above it or below it in the supply chain. Horizontal Merger A combination of two firms that are in the same industry Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-14

The Government’s Position on Mergers The government’s position on mergers has changed over the years, from preventing the merger of relatively small firms to allowing the merger of large companies. Bush(43) – focused only on horizontal mergers Obama – returned to review both horizontal and vertical mergers (Ticketmaster) In general, a merger that results in a Herfindahl-Hirschman Index of less than 1800 will not be challenged. Copyright © 2006 Pearson Addison-Wesley. All rights reserved.13-15

16 Reviewing Mergers Primarily aimed at preventing mergers or acquisitions that reduce competition FCC regulates communications media (newspapers, tv, telecomm, radio) FTC and DOJ regulate the rest

17 Where We’re Going How do we tell if a merger is anti-competitive? Market Concentration CR4: market share for the 4 largest firms Herfindahl Index (HHI): computed from the squares of the market shares Strategic behavior (how do they behave in the market place) Collusive: act together Non-collusive: act separately and/or stratgeicially

18 How do we tell? Market concentration refers to the size and distribution of firm market shares and the number of firms in the market. Economists use two measures of industry concentration: Four-firm Concentration Ratio The Herfindahl-Hirschman Index

19 Four-Firm Concentration Ratio The four-firm concentration ratio (CR4) measures market concentration by adding the market shares of the four largest firms in an industry. If CR4 > 60, then the market is likely to be oligopolistic.

20 Example FirmMarket Share Nike62% New Balance15.5% Asics10% Adidas4.3%

21 The Herfindahl-Hirschman Index The Herfindahl-Hirschman index (HHI) is found by summing the squares of the market shares of all firms in an industry. Advantages over the CR4 measure: Captures changes in market shares Uses data on all firms HHI > 1800

22 Example FirmMarket Share Nike62% New Balance15.5% Asics10% Adidas4.3%

23 Example (cont’d) FirmMarket Share Nike22.95% New Balance22.95% Asics22.95% Adidas22.95% What happens if market shares are evenly distributed?

24 How do they determine whether a merger reduces competition? Herfindahl-Hirschman Index or HHI, measure of the size of firms in relationship to the industryfirms industry Meant to be an indicator of the amount of competition sum of the squares of the market shares of each individual firm. decreases in the Herfindahl index generally indicate a loss of pricing power and an increase in competition, whereas increases imply the opposite DOJ guidelines Mergers resulting in HHI > 1800 can be challenged

25 Figure Four-Firm Concentration Ratio (CR4) for Selected Industries in 1997

26 Are All Mergers Equal? Conglomerate Merger of firms in unrelated industries Vertical Merger Merger of firms upstream/downstream from each other in production stream FCC: ownership of more than 1 media type Microsoft Horizontal Mergers Firms in the same industry Telecomm industry AT&T divestiture Verizon/GTE merger; RBOC mergers Would the HHI be a valid measure of competitiveness?