1. Chapter 15 Professor Yuna Chen
Economic Regulation
and
Antitrust Policy

2. 1. Types of Government Regulation
Three types of government regulation
1.1 Social regulations
Aimed at improving health and safety
Control over
Unsafe working conditions, dangerous products
Health care reform

3. 1. Types of Government Regulation
1.2 Economic regulations
Control: price, output, entry of new firms, quality of service
Control over natural monopolies
Local electricity transmission, local phone service

4. 1. Types of Government Regulation
1.3 Antitrust policy
Preventing monopoly
Fostering competition
Outlaws monopolies and cartels

5. 2. Regulating a Natural Monopoly
Case study: Subway system: a natural monopoly
Average production cost is lowest when a single firm supplies the market

6. Exhibit 1 Regulating a Natural Monopoly $40 25 15 12.50 5
Dollars per trip a
Demand MR c b
LRAC
Profit h g
Long-run MC f
Loss e
105 90 50
Trips per month
(millions)

7. Regulating a Natural Monopoly
(1) Unregulated monopoly
Qm = 50 Pm = $40 TR = $200 TC = $
Profit =
Consumer surplus =
Result: inefficient in terms of social welfare

8. Regulating a Natural Monopoly
(2) Setting P (marginal benefit)=MC
Q* = P* = TR = TC =
Profit =
Consumer surplus =
Result: a. social welfare is maximized.
b. monopolist: economic loss
c. In long-run: monopolist exits the market

9. Regulating a Natural Monopoly
(3) Possible solutions
a) Government-owned monopolies; use tax revenue to cover the loss

10. Regulating a Natural Monopoly
b) Subsidizing the natural monopolist
Monopolist: produce where P=MC
Government covers the loss
Firm: earn normal profit
Drawback: government either raise taxes, or forgo public spending

11. Regulating a Natural Monopoly
c) Setting P = average cost
Breaking even
normal profit
Stay in business without a subsidy
Higher social welfare than unregulated

12. Regulating a Natural Monopoly
(4) The regulatory dilemma
If P=MC
Socially optimal allocation of resources
Marginal benefit=MC
Monopolists: loss
Requires government subsidy
If P=average cost
Monopolist: normal profit
Not a socially optimal allocation

13. Alternative Theories Views of government regulation
Economic regulation is in the public interest
Promotes social welfare by keeping prices down
Economic regulation is in the special interest of producers

14. Alternative Theories Producers’ special interest
Well-organized producer groups
Expect to gain from economic regulation
Persuade public officials to impose restrictions
Reduce competition
Increase prices

15. Alternative Theories Capture theory of regulation Producers have
Political power
Strong stake in the regulatory outcome
Leads them to “capture” the regulating agency
Prevail on it to serve producer interests

16. Antitrust Law and Enforcement
Antitrust policy
Reduce anticompetitive behavior
Promote competition
Attempts to promote socially desirable market performance

17. Origins of Antitrust Policy
sharp economic decline
Competing firms formed a trust
Sugar, tobacco, oil industries
Widespread criticism

18. Origins of Antitrust Policy
Sherman Antitrust Act of 1890
First national legislation in the world against monopoly
Prohibited trusts, restraint of trade, monopolization
Vague and ineffective
Allowed room for much anticompetitive activity

19. Origins of Antitrust Policy
Clayton Act of 1914
Improved the Sherman Act
Outlawed certain anticompetitive practices not prohibited by the Sherman Act
Price discrimination
Tying contracts
Exclusive dealing
Interlocking directorates
Buying the corporate stock of a competitor

20. Origins of Antitrust Policy
Tying contract
A seller of one good requires a buyer to purchase other goods as part of the deal
Exclusive dealing
A supplier prohibits its customers from buying from other suppliers
Interlocking directorate
A person serves on the boards of directors of two or more competing firms

21. Origins of Antitrust Policy
Federal Trade Commission Act of 1914
Federal trade commission (FTC)
Enforce antitrust laws
Cellar-Kefauver Anti-Merger Act
Prevents one firm from buying physical assets of another firm
If the effect is to reduce competition

22. Origins of Antitrust Policy
Horizontal merger
One firm combines with another firm
That produces the same type of product
Vertical merger
From which it had purchased inputs or to which it had sold output

23. Antitrust Enforcement
Antitrust Division of the US Justice Department or the FTC
Charges a firm/group of firms with breaking the law
Acting on a complaint by a customer or a competitor
Accused
Sign a consent decree
Contest the charges: Court trial
Judge decides

24. Antitrust Enforcement
Consent decree
Accused party
Without admitting guilt
Agrees not to do whatever it was charged with
If the government drops the charges

25. Per Se Illegality Per se illegal Business practices deemed illegal
Regardless of their economic rationale or their consequences

26. Rule of Reason Rule of reason
Reasons of the offending practice and its effect on competition
Focus on
Firm’s behavior
Market structure resulting from that behavior
Predatory pricing
Pricing tactics employed by a dominant firm to drive competitors out of business

27. Mergers and Public Policy
Antitrust Division and FTC
Approve/deny mergers and acquisitions
Herfindahl-Hirschman Index, HHI
Sales concentration
Square the sales of each firm, then sum them
Perfect competition: HHI closes to 0
Monopoly: HHI = 10,000

28. Mergers and Public Policy
Antitrust Division and FTC
Challenges any merger in an industry that meets two conditions
(1) the HHI exceeds 2,500
(2) the merger increases the index by more than 200 points

29. Exhibit 2
Herfindahl-Hirschman Index (HHI) Based on Market Share in Three Industries
Each of the three industries shown has 44 firms. The HHI is found by squaring each firm’s market share then summing the squares. Under each industry, each firm’s market share is shown in the left column and the square of the market share is shown in the right column. For ease of exposition, only the market share of the top four firms differs across industries. The remaining 40 firms have 1 percent market share each. The HHI for Industry III is nearly triple that for each of the other two industries.

30. Exhibit 3
U.S. Merger Waves in the Past Century

31. Exhibit 4
Competitive Trends in the U.S. Economy: 1939 to 2000