1. Government Regulation of Industry ESD 11 November 13, 2000 Richard Tabors

2. Why Regulate an Industry? u Economic (focus of this class) –National Objectives –Natural Monopoly –Exercising Monopoly (Market) Power u Other –Trade –Environment –Welfare –Employment Practices (OSHA)

3. How would you know that you needed to regulate and industry? u There is only one player in the market. u There are fewer and fewer players in the market. –Can you have competition with only two players? »Yes, but it only occurs infrequently u Someone is making too much money. –How much is too much? –“Ability to keep the price above marginal cost for a significant amount of time.” Above = > 5% and the time is determined by the natural cycle of the market u Someone is being predatory with respect to the other players in the market.

4. Who Actually Regulates at the Federal Level in the US? u Congress decides on what gets regulate u Congress decides on who gets regulated u Congress decides on what agency will be responsible for regulation u The regulating agency writes (and publishes) the rules subject to hearing u Challenges to the regulations are (generally) heard in the Federal Court System u Congress decides if it likes the regulations and amends them (frequently?...)

5. Who bears the costs of Regulation u The regulated… u Cost is a function of the level of regulation required and /or the level of market activity in the regulated sector –kWh transmitted –mmbtu of Natural Gas u Should cost be a concern in regulation? –All businesses answer yes –All consumer advocates (or at least most) answer no. u The Clinton Administration (with Gore in the lead) put forth an effort to make government more efficient at lower cost – clearly aimed at regulation.

6. Sherman Antitrust Act u To prevent trusts from creating restraints on trade or commerce, and reducing competition, Congress passed the Sherman Antitrust Act in 1890. The Sherman Act was designed to maintain economic liberty, and to eliminate restraints on trade and competition. The Sherman Act is the main source of Antitrust law. u The Sherman Act is a Federal statute, and as such, has a scope limited by Constitutional constraints on the Federal government, but the Commerce clause allows for a very wide interpretation and application of this act: The Act applies to all transactions and business involved in interstate commerce, or if the activities are local, affecting interstate commerce. The latter phrase has been interpreted to allow broad application of the Sherman Act

7. Commerce and Trade u Title 15 of the US Code u US Code is the listing of all Laws and Procedures by area. u Procedures include “how to write a law”… “how to get it printed”

8. The Rules u Sec. 1. Trusts, etc., in restraint of trade illegal; penalty u “Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal. Every person who shall make any contract or engage in any combination or conspiracy hereby declared to be illegal shall be deemed guilty of a felony, and, on conviction thereof, shall be punished by fine not exceeding $10,000,000 if a corporation, or, if any other person, $350,000, or by imprisonment not exceeding three years, or by both said punishments, in the discretion of the court.” u Amended multiple times to update “felony” from “misdemeanor” and to get the $ penalty to keep up with inflation.

9. What is a Market? u Rules for the ideal market: –A Homogeneous product –Buyers and sellers can find one another –Perfect information is available –Entry and exit is free u Vocabulary of the imperfect market –Market power –Imperfect measure of the imperfect market = HHI u In general: –“A place where an independent buyer and an independent seller can exchange goods at an agreed upon PRICE” u The Key: PRICE

10. The Contestable Market u For a monopoly to continue to exist it must either be regulated or stay ahead of the crowd u If it can not stay ahead of the crowd then competition will enter and force the price back to the marginal cost of the last unit on the supply curve.

11. Role of Economic Rationality u All persons / firms … u Behavior is based on desire to maximize utility (profit) u Monopolies work to do so by concentrating the means of production (source) so as to be able to raise price u Monopsony is the reverse. (?Does it exist?)

12. Measures of Market Performance: Structure u Vertical Relationships u Horizontal Markets –Number of Players –Size Distribution –Concentration u Technological Issues –Scale and scope economies –Minimum efficiency size / minimum viable size –Barriers to entry

13. Measures of Market Performance: Conduct and Performance u Conduct –Pricing –Behavior »Rivalrous »Collusive »Predatory –Entry u Performance –Operational Efficiency –Producer and consumer surplus –Product/service/contract differentiation –Technological innovation

14. What is the process? u Sec. 9. Jurisdiction of courts; duty of United States attorneys; procedure u “The several district courts of the United States are invested with jurisdiction to prevent and restrain violations of section 8 of this title; and it shall be the duty of the several United States attorneys, in their respective districts, under the direction of the Attorney General, to institute proceedings in equity to prevent and restrain such violations. Such proceedings may be by way of petitions setting forth the case and praying that such violations shall be enjoined or otherwise prohibited. When the parties complained of shall have been duly notified of such petition the court shall proceed, as soon as may be, to the hearing and determination of the case; and pending such petition and before final decree, the court may at any time make such temporary restraining order or prohibition as shall be deemed just in the premises.”8

15. Mergers and Acquisitions u Vertical –Combinations up/down the supply chain –Examples? u Horizontal –Across competitors –Examples?

16. Mergers and Acquisitions u How would you know (future) if the resulting entity was going to have market power? u The Hirschman Herfindahl Index (HHI) Measure of Market Concentration –Company% % 2 »A20 400 »B502500 »C30 900 –Total1003800

17. HHI Ranges u < 1000 OK u >1000 < 1800Refutable Presumption u >1800Concentrated u Implications u 5 equal sized firms and HHI of 2000 u 10 equal sized firms and HHI of 1000

18. Other Measures u Lerner Index –Measures the actions of a firm to prevent others from competing as opposed to the potential as in the HHI u Game theory: Simulation of Strategic Behavior –Bertrand Equilibrium – market players strive to maximize their benefits through control of the price –Cournot Equilibrium – market players strive to maximize their benefits through adjustment to the quantity supplied –Nash Equilibrium – market players maximize their benefits in response to the action of all other players –Supply Function Equilibrium – market players strive to maximize their benefits through both pricing and quantity strategic behavior

19. Summary u Regulation is a fact of life in organized society u Industries are regulated for Economic behavior but also for social, environmental, etc. behavior u Regulation is expensive –Cost of economic regulation is born by the regulated –Cost of other forms of regulation is born by tax revenues u Regulation of industry is beneficial to society –Otherwise we would not do it …