1. Economic Regulation and Antitrust Policy

2. Types of Government Regulation
Firms with market power
Raise the price without losing all its customers to rival firms
Downward-sloping demand curve
Produce less of the good than would be socially optimal
Monopoly – insulated from competition
Not too innovative
May influence public choice

3. Types of Government Regulation
Government policies - firm behavior
Social regulation
Economic regulation
Antitrust policy
Social regulations
Aimed at improving health and safety
Control over
Unsafe working conditions, dangerous products
Health care reform

4. Types of Government Regulation
Economic regulations
Control: price, output, entry of new firms, quality of service
In industries in which monopoly appears inevitable or even desirable
Control over natural monopolies
Local electricity transmission, local phone service, and a subway system
Land and air transportation

5. Types of Government Regulation
Antitrust policy
Preventing monopoly
Fostering competition in markets where competition is desirable
Outlaws monopolies and cartels

6. Regulating a Natural Monopoly
Downward-sloping LRAC curve
Economies of scale
Average production cost is lowest when a single firm supplies the market

7. Regulating a Natural Monopoly
Unregulated profit maximization
Produce where MR=MC
Economic profit
Some consumer surplus
Inefficient in terms of social welfare
Price far exceeds marginal cost
Higher social welfare if output expanded

8. Regulating a Natural Monopoly
Government
Can increase social welfare
Force the monopolist to lower the price and expand output
Public utilities
Government-owned monopolies
Government regulated monopolies

9. Regulating a Natural Monopoly
Setting P (marginal benefit)=MC
Where D intersects MC
Higher consumer surplus
Monopolist: economic loss
In long-run: monopolist exits the market

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

11. Regulating a Natural Monopoly
Setting P=average cost
‘Fair return’: normal profit
Stay in business without a subsidy
Higher social welfare (than unregulated)
Marginal benefit exceeds marginal cost
Expanding output would increase social welfare

12. Regulating a Natural Monopoly
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
No socially optimal allocation

13. Exhibit 1 Regulating a Natural Monopoly $4.00 2.50 1.50 1.25 0.50
Dollars per trip a
With a natural monopoly, the long-run average cost curve slopes downward where it intersects the market demand curve. The unregulated firm maximizes profit by producing where marginal revenue equals marginal cost, in this case, 50 million trips per month at a price of $4.00 per trip. This outcome is inefficient because price, or marginal benefit, exceeds marginal cost. To achieve the efficient output rate, regulators could set the price at $0.50 per trip. The subway would sell 105 million trips per month, which would be an efficient outcome. But at that price, the subway would lose money and would require a subsidy to keep going. As an alternative, regulators could set the price at $1.50 per trip.
Demand MR c b
LRAC
Profit h g
Long-run MC f
Loss e
105 90 50
Trips per month
(millions)
The subway would sell 90 million trips per month and would just break even (because price equals average cost). Social welfare could still be increased by expanding output as long as the price, or marginal benefit, exceeds marginal cost, but that would result in an economic loss

14. 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

15. Alternative Theories Producers’ special interest
Well-organized producer groups
Expect to gain from economic regulation
Persuade public officials to impose restrictions
Consumers have no special interest
Reduce competition
Increase prices

16. 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

17. Airline regulation and deregulation
1938 Civil Aeronautics Board
Regulated interstate airlines
40 years: No new interstate airline
Created a cartel
Fixed prices among the 10 major airlines
Blocked new entry
Capture theory of regulation

18. Airline regulation and deregulation
1938 Civil Aeronautics Board
Labor unions
Higher wages
Pilots worked 2 weeks/month
High price
No regulatory power over airlines that flew only intrastate routes
Fares on intrastate airlines were only half those on identical routes flown by regulated airlines

19. Airline regulation and deregulation
Price competition
New entry
Price: one quarter below regulated price
More efficient airlines
FAA regulates quality and safety
Accident rates declines by 10-45%
More people fly (passenger miles tripled)

20. Airline regulation and deregulation
Fierce competition
Mergers
Disappeared
Bankrupt
Lower wages
Lower fares
More flights
Saving lives (less driving)

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

22. Origins of Antitrust Policy
Economic developments
Bigger forms serving wider markets
Technology: economies of scale
Railroad: reduced transport costs
sharp economic decline
Competing firms formed a trust
Sugar, tobacco, oil industries
Widespread criticism

23. 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

24. 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

25. 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

26. Origins of Antitrust Policy
Federal Trade Commission Act of 1914
Federal trade commission (FTC)
Enforce antitrust laws
Commissioners, economists and lawyers
Cellar-Kefauver Anti-Merger Act
Prevents one firm from buying physical assets of another firm
If the effect is to reduce competition
Horizontal and vertical mergers

27. 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

28. 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

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

30. Per Se Illegality Per se illegal Business practices deemed illegal
Regardless of their economic rationale or their consequences
Government – examine firm’s behavior

31. Rule of Reason Rule of reason Predatory pricing
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

32. Mergers and Public Policy
Antitrust Division and FTC
Approve/deny mergers and acquisitions
Herfindahl-Hirschman Index, HHI
Sales concentration
Horizontal mergers
Firms in the same market
Nonhorizontal mergers

33. 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

34. 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.

35. Merger Waves First wave Second wave Third wave Fourth 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

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

37. Competition Over Time U.S. industries: Pure monopoly Dominant firm
One firm controls the market
Blocks entry
Dominant firm
One firm: more than half market share
No close rival

38. Competition Over Time U.S. industries: Tight oligopoly
Top 4 firms: more than 60% of market output
Evidence of cooperation
Effective competition
Low concentration
Low barriers to entry
Little or no collusion

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

40. Competition Over Time Growth in competition (1958-2000)
Competition from imports
One-sixth of the overall increase in competition
Deregulation
One-fifth of the overall increase in competition
Antitrust policy
Two-fifths of the overall increase in competition

41. Charges Protect Windows monopoly (90%)
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

42. Ruling Microsoft maintained a monopoly in operating-system software
Microsoft on trial
Ruling
Microsoft maintained a monopoly in operating-system software
Anticompetitive means
Microsoft attempted to monopolize the browser market
Unlawful “tying” Internet Explorer with Windows

43. Out-of-court settlement
Microsoft on trial
Out-of-court settlement
Personal-computer makers
Greater freedom to install non-Microsoft software on new machines
Banned retaliation against companies that take advantage of these freedoms
Prohibited exclusive contracts
Microsoft - disclose design information to hardware and software makers

44. Antitrust charges brought by the European Union
Microsoft on trial
Antitrust charges brought by the European Union
Settled most charges by 2010
Windows software
90% of the world’s computers
Microsoft
Stock market value = $225 billion in May 2010

45. Recent Competitive Trends
Growing world trade and competition
Three major automakers
80% of US market in 1970
Only 45% by 2010
Deregulation of international phone service
$0.88 a minute in 1997
Under $0.10 by 2010

46. Recent Competitive Trends
Technological change
Prime-time audience share of three major TV networks
90% in 1980
Under 30% today
FOX became a fourth major network
Cable and satellite technology delivered hundreds of networks and channels

47. Problems with Antitrust Policy
Competition may not require that many firms
Antitrust policy should not necessarily aim at increasing the number of firms in each industry
Firm size should not be the primary concern
Most of the desirable properties of perfect competition can be achieved with relatively few firms

48. Problems with Antitrust Policy
Antitrust abuses
Treble damage suits
Parties -show injury from firms that violate antitrust laws
Can sue the offending company
Recover three times the damages sustained
Abused
Used to intimidate an aggressive competitor
Used to convert a contract dispute into treble damage payoffs

49. Problems with Antitrust Policy
Growth of international markets
Market power of a firm
Its share of the market
With greater international trade
Local and national market share becomes less relevant
Antitrust enforcement that focuses on domestic producers makes less economic sense

50. Problems with Antitrust Policy
Bailing out troubled industries
Financial institutions and two of the big three automakers
Intent: to promote financial stability and keep the economy from sinking further
Long-term effect
Remains to be seen