1 Eco 100 Lecture 7-2 Feb18, 2009 Intro to Regulation: Overview, Goals, History

2 Government Regulation Major categories –Anti-competitive behavior Price Discrimination Collusion Mergers/acquisitions –Deregulation –Natural Monopolies Regulatory solutions Deregulating where economies of scale no longer exist Managed competition –Externalities Pollution Fishing, forestry, mining, oil drilling

3 Government Regulation Tools available –Statutory Prohibitive –E.g. Price fixing/restricting output, cartels, collusive behavior Fines, breakup (divestiture) –Deregulation Removing regulation –Airlines, Banking Incentive mechanisms –Managed competition –Incentive design –Taxes, subsidies and tradable permits (property rights)

4 Promoting Efficiency Goals of regulation –Efficiency in Production Produce at least cost –Efficiency in Allocation Value consumers place on goods = opportunity costs of resources used –Promote Technological Innovation Regulatory incentives should promote, or at least not discourage, development and adoption of new cost saving technology

5 Efficiency in Production Produce Goods at Least Cost –Firms to operate at the minimum of their Long Run Average Cost Curve

6 Efficiency in Allocation Marginal value consumers place on last (marginal unit) produced to equal the resource “opportunity” costs –MV = MC at the marginal unit

7 Promote Technological Innovation Ensure regulatory design promotes rate of technical change similar to perfect competition –Technologically neutral, e.g. wireless, landline, cable Doesn’t inhibit technological change

8 Government Regulatory Agencies Administrative Agencies Federal Trade Commission (1914) Act –“empowered to pursue abuses of trade that could lessen competition” Department of Justice (DOJ) –Jointly charged with FTC for overseeing and enforcing antitrust policy –Established by the Judiciary Act of 1789 –1870 Act: handle the legal business of the United States. –control over all criminal prosecutions and civil suits in which the United States had an interest Federal Communications Commission (FCC) –established by the Communications Act of 1934Communications Act of 1934 –charged with regulating all non-Federal Government use of the radio spectrum (including radio and television broadcasting), and all interstate telecommunications (wire, satellite and cable) as well as all international communications that originate or terminate in the United States.regulating spectrumradiotelevision telecommunicationswiresatellitecable communications

9 What Happens in Different Markets? Monopoly –Single-price monopolist (price fixing) –Price Discrimination Multi-part tariffs Oligopoly –Cartels –Passive collusion: Stackleberg leader, Sticky prices Monopolistic Competition –Limited price competition (brand name loyalty) Limited market power –Product differentiation Greater variety Perfect Competition –No efficiency loss, incentive to innovate, extensive price competition –No product differentiation

10 Perfect Competition Standard of comparison for all market models (optimal) –Productive efficient Firms operate at min of LRAC or exit –Technological innovate Innovate or die –Allocative efficient Consumers value marginal unit at MV –Equals firm’s cost of producing marginal unit No deadweight loss

11 Monopoly/Cartels Not Efficient in Production –Never operate at min of LRAC –Underutilized capacity and resources Not Technologically Innovative –No incentive to invest in/develop new technology when you’re the only firm Not Efficient in Allocation –P (=MV) > MR = MC –Deadweight loss

12 Monopolistic Competition Not Efficient in Production –Never operate at min of LRAC –Underutilized capacity and resources Technologically Innovative –Competition with other firms provides incentive Not Efficient in Allocation –P (=MV) > MR = MC –Deadweight loss (but not as great as Monopoly)

13 How Has the Government Sought to Regulate Markets? Punishing Anti-Competitive Behavior –Pricing/market tactics Collusion –Price-fixing, restricting output Price Discrimination Predatory Pricing –Impose fines for AC tactics Preventing Anti-competitive Behavior –Mergers and Acquisitions Review by appropriate administrative agency –Divestiture/breakups Regulating Natural Monopolies Deregulation(sic) of Selected Industries

14 Punishing AC Behavior Punishing firms for behaving like a monopoly –Sherman anti-trust Act (1890) “conspiring to fix prices or restrict output” –Clayton Act (1914) More sophisticated price discrimination Tie-in sales – requiring the purchase of 2 nd good Stock purchases/acquisitions –Robinson-Patman(1936) 3 rd degree price discrimination Amendment to Clayton Act

15 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

16 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

17 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?