1. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 1 ECON Designed by Amy McGuire, B-books, Ltd. McEachern 2008-2009 15 CHAPTER Economic Regulation and Antitrust Policy Micro

2. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 2 LO 1 Types of Government Regulation  Market power –Raise the price Without losing all sales to rivals –Firms Downward-sloping demand curve

3. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 3 LO 1 Types of Government Regulation  Government regulations –Social regulations Improve health and safety –Economic regulations Control: price, output, entry of new firms, quality of service –Desirable monopolies Control natural monopolies –Antitrust policy Outlaws monopolies and cartels

4. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 4 LO 2 Regulating a Natural Monopoly  Natural monopoly –Downward-sloping LRAC curve  Unregulated profit maximization –MR=MC –Economic profit –Consumer surplus –P>MC, higher social welfare if output expanded

5. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 5 LO 2 Regulating a Natural Monopoly  Government –Increase social welfare –Lower P, expand Q  Public utilities –Government-owned monopoly –Government regulated monopoly

6. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 6 LO 2 Regulating a Natural Monopoly  Setting P=MC –Where D intersects MC –Higher consumer surplus –Monopolist: economic loss –In long-run: monopolist exits the market –Needs subsidizing

7. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 7 LO 2 Regulating a Natural Monopoly  Subsidizing the natural monopolist –Government covers the loss –Firm: earn normal profit –Drawback: government must raise taxes, forgo public spending  Setting P=average cost –‘Fair return’: normal profit Stay in business without a subsidy –Higher social welfare (than unregulated)

8. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 8 LO 2 Regulating a Natural Monopoly  Setting P=MC or P=average cost –Reduce P –Increase output –Erase economic profit –Increase consumer surplus –Increase social welfare

9. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 9 LO 2 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

10. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 10 Exhibit 1 LO 2 Regulating a Natural Monopoly 10590500 Trips per month (millions) $4.00 2.50 1.50 1.25 0.50 Dollars per trip Demand MR Long-run MC LRAC a b c h g e f Profit Loss Natural monopoly maximizes profit: MR=MC, q=50, p=$4. Inefficient: p>MC. Efficient output rate: set p=$0.50, then q=105 efficient outcome. But the firm: economic loss; requires subsidy. Alternative: set p=$1.50; then q=90, the firm breaks even (p=average cost); earns normal profit. Social welfare could still be increased by expanding output as long as the price >MC; but that would result in an economic loss, requiring a subsidy.

11. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 11 Alternative Theories: Economic Regulation  Economic regulation  Public interest, promotes social welfare  Special interest of producers  ‘Capture theory of regulation’  Producer groups  Expect to gain  Persuade public officials to impose restrictions  Consumers have no special interest  Reduce competition  Increase prices LO 3

12. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 12 LO 3 Case Study Airline Regulation and Deregulation  1938 Civil Aeronautics Board  Regulated interstate airlines  40 years: No new interstate airline  Fixed prices among the 10 major airlines  Blocked new entry  Labor unions  Higher wages  Pilots worked 2 weeks/month  High price

13. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 13 LO 3 Case Study Airline Regulation and Deregulation  1978 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)

14. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 14 LO 3 Case Study Airline Regulation and Deregulation  Fierce competition  Mergers  Disappeared  Bankrupt  Lower wages  Lower fares  More flights  Saving lives

15. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 15 Antitrust Law and Enforcement LO 4  Antitrust policy –Reduce anticompetitive behavior –Promote competition  Origins of antitrust policy –Developments Technology: economies of scale Railroad: reduced transport costs Bigger firms, wider markets

16. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 16 Origins of Antitrust Policy LO 4  1873-1883 sharp economic decline –Competing firms formed a trust Sugar, tobacco, oil industries Widespread criticism  Sherman Antitrust Act of 1890 –Trusts, restraint of trade, monopolization  Clayton Act of 1914 –Price discrimination, tying contracts, exclusive dealing

17. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 17 Origins of Antitrust Policy LO 4  Federal Trade Commission Act of 1914 –Federal Trade Commission –Enforce antitrust laws  Cellar-Kefauver Anti-Merger Act –Horizontal mergers –Vertical mergers

18. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 18 Antitrust Enforcement LO 4  Antitrust division of the U.S. Justice Department  FTC  Consent decree  Court trial  Judge decides

19. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 19 Per Se Illegality and Rule of Reason LO 4  Per se illegal –Illegal regardless of the economic rationale or consequences –Firm’s behavior  Rule of reason –Reason and its effect on competition –Firm’s behavior –Market structure

20. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 20 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 –Challenged mergers if Post-merger HHI>1800 Merger increases HHI by >100 points LO 5

21. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 21 Exhibit 2 LO 5 Herfindahl-Hirschman Index (HHI) Based on Market Share in Three Industries Each of the three industries has 44 firms. The HHI is found by squaring each firm’s market share then summing the squares. Only the market share of the top four firms differ across industries; the remaining 40 firms have 1% market share each. The HHI for Industry III is nearly triple that for each of the other two industries.

22. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 22 Exhibit 3 LO 5 U.S. Merger Waves in the Past Century

23. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 23 Merger Waves  First 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 LO 5

24. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 24 Competitive Trends in the US Economy LO 6 1.Pure monopoly –One firm controls the market –Block entry 2.Dominant firm –One firm: more than half market share –No close rival

25. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 25 Competitive Trends in the U.S. Economy LO 6 3.Tight oligopoly –Top 4 firms: more than 60% of market output –Evidence of cooperation 4.Effective competition –Low concentration –Low barriers to entry –Little or no collusion

26. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 26 Exhibit 4 LO 6 Competitive Trends in the U.S. Economy: 1939 to 2000

27. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 27 Competitive Trends in the U.S. Economy LO 6  Growth in competition (1958-2000) –Competition from imports One-sixth –Deregulation One-fifth –Antitrust policy Two-fifths

28. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 28 LO 6 Case Study 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

29. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 29 Recent Competitive Trends LO 6  Increased competition in U.S.  Growing world trade –Three major automakers 80% of U.S. market in 1970; only 54% by 2006  Deregulation –International phone service $0.88 a minute in 1997; under $0.10 by 2007  Technological change –Three major TV networks 90% in 1980; under 40% by 2007

30. Chapter 15Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 30 Problems with Antitrust Policy LO 6  Competition may not require that many firms  Abuse of antitrust  Growth of international markets