1. ©Prentice Hall 2003 The Economic Way of Thinking 10e 1 “The Economic Way of Thinking” 10 th Edition by Paul Heyne, Peter Boettke, and David Prychitko “Competition and Government Policy” PowerPoint Slides prepared by Assistant Professor Paul Harris Camden County College

2. The Economic Way of Thinking 10e ©Prentice Hall 2003 2 Chapter Outline I.Introduction II.The Pressures of Competition III.Controlling Competition IV.The Ambivalence of Government Policies V.Selling Below Cost VI.What is the Appropriate Cost? VII.“Predators” and Competition

3. The Economic Way of Thinking 10e ©Prentice Hall 2003 3 VIII.Regulating Prices IX.“Antitrust” Policy X. Interpretations and Applications XI. Vertical Restraints: Competitive or Anticompetitive XII. The Range of Opinion XIII. Toward Evaluation XIV. Once over Lightly Chapter Outline

4. The Economic Way of Thinking 10e ©Prentice Hall 2003 4 Introduction Questions Will economic competition disappear unless the government has an active program to preserve it? When the government prohibits mergers, is it preventing competitors from eliminating rivals?

5. The Economic Way of Thinking 10e ©Prentice Hall 2003 5 Introduction Questions When sellers face so little competition that they can charge prices far above cost, can government protect consumers from exploitation by regulating prices? How is competition measured in an industry?

6. The Economic Way of Thinking 10e ©Prentice Hall 2003 6 The Pressures of Competition Price > Marginal CostPrice > Marginal Cost –Sellers facing downward sloping demand curves Invites CompetitionInvites Competition ExampleExample –Piece of pie costs 50 cents to produce. –Seller sells the pie for $1.50. Price > Marginal CostPrice > Marginal Cost –Sellers facing downward sloping demand curves Invites CompetitionInvites Competition ExampleExample –Piece of pie costs 50 cents to produce. –Seller sells the pie for $1.50.

7. The Economic Way of Thinking 10e ©Prentice Hall 2003 7 P Q D Temptation!.50 Marginal cost $1.50 Price The Pressures of Competition

8. The Economic Way of Thinking 10e ©Prentice Hall 2003 8 Question What will the cafes around town begin to do to attract customers? Sellers Probe for information on the demand for their product Try to stimulate demand by advertising and providing reliable service The Pressures of Competition

9. The Economic Way of Thinking 10e ©Prentice Hall 2003 9 Question What will the cafes around town begin to do to attract customers? Sellers Probe for information on the demand for their product Try to stimulate demand by advertising and providing reliable service The Pressures of Competition The best price for anyone to set next may depend on the price set last. the price set last.

10. The Economic Way of Thinking 10e ©Prentice Hall 2003 10 P Q Demand curve as seller perceives it D The Pressures of Competition

11. The Economic Way of Thinking 10e ©Prentice Hall 2003 11 Controlling Competition Question Why don’t sellers agree not to compete? High Transaction Costs Collusion is illegal. Difficult to devise agreement. Collusion may attract other firms. Question Why don’t sellers agree not to compete? High Transaction Costs Collusion is illegal. Difficult to devise agreement. Collusion may attract other firms.

12. The Economic Way of Thinking 10e ©Prentice Hall 2003 12 Controlling Competition Question Why don’t sellers agree not to compete? High Transaction Costs Collusion is illegal. Difficult to devise agreement. Collusion may attract other firms. Question Why don’t sellers agree not to compete? High Transaction Costs Collusion is illegal. Difficult to devise agreement. Collusion may attract other firms. Cartel’s Two Problems…… 1.Prevent members from competing 2.Prevent new firms from entering

13. The Economic Way of Thinking 10e ©Prentice Hall 2003 13 QuestionQuestion –Are there legal ways to restrict competition? ExamplesExamples –Washington, D.C. Medical Society –Plumbers –Woolen Makers –Barbers The Pressures of Competition

14. The Economic Way of Thinking 10e ©Prentice Hall 2003 14 The Ambivalence of Government Policies QuestionQuestion –Should the government be relied on to preserve competition in the economy? ExplainExplain –Concern for competition is not the same as concern for competitors.

15. The Economic Way of Thinking 10e ©Prentice Hall 2003 15 A law that restricts competitors restricts competition. A law that restricts competitors restricts competition. Common justification for such laws is that they preserve competition by preventing “predatory” practices. Common justification for such laws is that they preserve competition by preventing “predatory” practices. The Ambivalence of Government Policies

16. The Economic Way of Thinking 10e ©Prentice Hall 2003 16 Selling Below Cost QuestionQuestion –Should there be laws that prevent firms from selling below cost? Many states have such laws.Many states have such laws. QuestionQuestion –Why would some business firms be in favor of such a law?

17. The Economic Way of Thinking 10e ©Prentice Hall 2003 17 Public ViewPublic View –Price cutting may lead to monopolies. QuestionQuestion –Is this bad? Selling Below Cost

18. The Economic Way of Thinking 10e ©Prentice Hall 2003 18 What is the Appropriate Cost? ProblemProblem –How to determine the cost below which prices cannot be set. QuestionQuestion –Once an item is bought, isn’t it a sunk cost? QuestionQuestion –What should a firm do if they cannot sell their product before it spoils?

19. The Economic Way of Thinking 10e ©Prentice Hall 2003 19 Marginal costs should be considered. Business people are concerned with: Additional revenues resulting from a decision. Additional costs from the same decision. Question When would a grocer want to sell a newspaper below cost? What is the Appropriate Cost?`

20. The Economic Way of Thinking 10e ©Prentice Hall 2003 20 “Predators” and Competition Protecting competitors is not the same as preserving competition. Predatory Pricing Reducing prices below cost in order to drive out rivals Intend to raise prices afterward to recoup losses

21. The Economic Way of Thinking 10e ©Prentice Hall 2003 21 “Predators” and Competition Question How long will it take for such a policy to work? The longer it takes the larger will be the short term losses. Question Is it likely that the predatory firm will will be able to destroy enough of its rivals to secure the degree of market power it must have to earn enough long run profits to justify short term losses?

22. The Economic Way of Thinking 10e ©Prentice Hall 2003 22 Regulating Prices Questions How are prices set for firms that are investor owned? How will regulators determine the costs of running the enterprise?

23. The Economic Way of Thinking 10e ©Prentice Hall 2003 23 Prices should be set to enable firms to earn a normal profit.Prices should be set to enable firms to earn a normal profit. QuestionQuestion –But what are the costs? InnovationInnovation Cost controlCost control Prices should be set to enable firms to earn a normal profit.Prices should be set to enable firms to earn a normal profit. QuestionQuestion –But what are the costs? InnovationInnovation Cost controlCost control Regulating Prices

24. The Economic Way of Thinking 10e ©Prentice Hall 2003 24 Question Who will regulate the regulators? Capture Theory Regulators tend to acquire an interest in the well-being of the industry. Regulating Prices

25. The Economic Way of Thinking 10e ©Prentice Hall 2003 25 ExamplesExamples –Banking –Airlines –Telephone ProblemProblem –Is competition unable to constrain the behaviors of the firms in the regulated industry? Regulating Prices

26. The Economic Way of Thinking 10e ©Prentice Hall 2003 26 The movement towards deregulation of the past two decades has not settled all the issues. History There are more margins on which competition can occur Competition has some advantages over commissions The movement towards deregulation of the past two decades has not settled all the issues. History There are more margins on which competition can occur Competition has some advantages over commissions Regulating Prices

27. The Economic Way of Thinking 10e ©Prentice Hall 2003 27 “Antitrust” Policy Laws have been passed to promote competition. FederalStateLocal

28. The Economic Way of Thinking 10e ©Prentice Hall 2003 28 Sherman Antitrust Act -- 1890 Forbids all contracts, combinations, or conspiracies in restraint of interstate trade and all attempts to monopolize any part of interstate trade “Antitrust” Policy

29. The Economic Way of Thinking 10e ©Prentice Hall 2003 29 Interpretations and Applications Clayton Act -- 1914 Made illegal mergers that “substantially” lessen competition

30. The Economic Way of Thinking 10e ©Prentice Hall 2003 30 Federal Trade Commission ActFederal Trade Commission Act –Created Federal Trade Commission Prohibited “unfair” practicesProhibited “unfair” practices Interpretations and Applications

31. The Economic Way of Thinking 10e ©Prentice Hall 2003 31 QuestionQuestion –When does a merger substantially lessen competition? HorizontalHorizontal ConglomerateConglomerate VerticalVertical Interpretations and Applications

32. The Economic Way of Thinking 10e ©Prentice Hall 2003 32 QuestionQuestion –What is an illegal trade practice? SummarySummary –Restriction on competitors will restrict their ability to compete. –We must decide when we want the government to restrict a firm’s competitive efforts. QuestionQuestion –What is an illegal trade practice? SummarySummary –Restriction on competitors will restrict their ability to compete. –We must decide when we want the government to restrict a firm’s competitive efforts. Interpretations and Applications

33. The Economic Way of Thinking 10e ©Prentice Hall 2003 33 Vertical Restraints: Competitive or Anticompetitive Vertical restraints have been controversial. 1937 - 1976 Federal legislation exempted state- endorsed price-fixing agreements between manufacturers and retailers.

34. The Economic Way of Thinking 10e ©Prentice Hall 2003 34 QuestionsQuestions –Why would a manufacturer want retailers to charge more and sell less? –Why would a manufacturer want fewer retailers selling its products? Vertical Restraints: Competitive or Anticompetitive

35. The Economic Way of Thinking 10e ©Prentice Hall 2003 35 The Range of Opinion QuestionQuestion –Is the whole body of “antitrust” law perhaps more of a hindrance than a help to competition? OpinionsOpinions –Retain the Sherman Act and the anti-merger provisions of the Clayton Act only. –The Sherman and Clayton acts, in their entirety, have made important contributions.

36. The Economic Way of Thinking 10e ©Prentice Hall 2003 36 The Range of Opinion Opinions They would be improved if they were more seriously enforced. They are both harmless rhetoric.

37. The Economic Way of Thinking 10e ©Prentice Hall 2003 37 Toward Evaluation Competitive restrictions reduce the availability of substitutes and allow sellers to increase their own wealth. Competition is a process, not a state of affairs. An inadequate situation must be compared with more desirable situations that are attainable.

38. The Economic Way of Thinking 10e ©Prentice Hall 2003 38 Once Over Lightly  A gap between the price of a good and the marginal cost of making it available is a source of potential advantage to someone.  Competition occurs in the economy as people locate such differentials, and exploit them.  There are usually so many forms of competition that it is difficult to anticipate and head them all off.

39. The Economic Way of Thinking 10e ©Prentice Hall 2003 39 Once Over Lightly  Firms try to obtain Government assistance in excluding competition.  Government regulation of pricing and other business practices has often blocked the development of competition that might otherwise arisen.

40. The Economic Way of Thinking 10e ©Prentice Hall 2003 40 Once Over Lightly  Competition is a process in which competitors engage.  We cannot have competition without competitors.  We cannot have competition if we legally prohibit competitors from taking actions intended to increase their share of the market.

41. The Economic Way of Thinking 10e ©Prentice Hall 2003 41 End of Chapter 11 Next, Chapter 12 “The Distribution of Income”.