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CChapter 13hapter 13

Antitrust and Antitrust and RegulationRegulation

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Gottheil - Principles of Economics, 4e

Economic PrinciplesEconomic Principles

Regulating a natural monopoly

“Fair” price

Marginal cost pricing

Laissez-faire

Nationalization

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The theory of contestable markets

The theory of countervailing power

The theory of creative destruction

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Patents

Antitrust legislation

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Paradise LostParadise Lost

To many economists, perfect competition is the closest thing on earth to paradise.

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Under perfect competition, market prices are at their lowest levels, all goods are produced at the minimum point on their average cost curves, and the quantities supplied are greater than would be forthcoming under any other market condition.

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Unfortunately, perfect competition does not exist in the real world.

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The real world is one of monopoly, monopolistic competition and oligopoly.

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Learning to Cope Learning to Cope Without Perfect Without Perfect

CompetitionCompetitionThere are several competing views among economists regarding what we should do about monopolies and oligopolies.

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EXHIBIT 1 WHAT TO DO ABOUT MONOPOLY

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CompetitionCompetition1. Regulating monopoly: Monopolies are inevitable and undesirable. Use government regulation to make monopoly price conform more closely to the price that would exist if the markets were competitive.

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CompetitionCompetition2. Nationalizing the industry: Monopolies are inevitable and undesirable. Government should take over the monopolies.

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CompetitionCompetition3. Laissez-faire: Monopolies are inevitable, but not necessarily undesirable. Government policy of non-intervention in market outcomes. Translated, it means “leave it be.”

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CompetitionCompetition4. Encouraging concentration: Monopolies are inevitable and desirable. Government should promote less-competitive markets because they are technically superior, generate low prices and benefit society.

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CompetitionCompetition5. Splitting up monopoly: Monopolies are neither inevitable nor desirable. Government should promote anti-monopoly legislation, break monopolies into fragments and prevent their restoration.

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The Economics of The Economics of RegulationRegulation

Regulation

• Although the ownership of the regulated firm remains in private hands, pricing and production decisions of the firm are monitored by a regulatory agency directly responsible to the government.

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EXHIBIT 2 THE CITY BUS COMPANY

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Exhibit 2: The City Bus Exhibit 2: The City Bus CompanyCompany

1. Using the MR = MC rule, what fare and passenger capacity maximizes profit in Exhibit 1? • Profit is maximized at a fare of $1.80 and service to 80,000 passengers.

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2. What is the profit of the bus company at a price of $1.80 and service to 80,000 passengers? • Profit = (Price × Number of passengers) - (Average cost per passenger × Number of passengers)

• Profit = ($1.80 × 80,000) - ($1.20 × 80,000) = $48,000.

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3. What fare would lead to zero economic profit for the bus company? • The company would achieve zero economic profit where price equals average total cost (P = ATC).

• P = ATC at $0.90.

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4. Why is zero economic profit considered a “fair” price?

• The price is considered “fair” because the company is entitled to cover its costs, as well as enjoy normal profit, and passengers enjoy a lower bus fare.

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Benefits of government regulation of the bus service include:• Lower bus fares

• Increased number of passengers

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Concerns with bus company regulation include:

• The possibility that the ATC will begin to shift upward. Since price is set at ATC, when ATC goes up, bus fare also goes up. Under this scenario, there is little incentive to try to control ATC.

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Government commissions regulating markets must be vigilant in monitoring cost drift and keeping costs under control.

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• A regulatory agency’s policy of pricing a good or service produced by a regulated firm at the firm’s marginal cost, P = MC.

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• P = MC indicates society’s optimal use of resources.

• The value that people place on a service is indicated by the price they are willing to pay.

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• At P = ATC, or a $0.90 fare, the price people are willing to pay for the service is higher than the cost to produce the service ($0.40).

• In other words, P = ATC > MC.

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5. What are price and quantity when P = MC in Exhibit 1?

• At P = MC, price is $0.30. Quantity is 180,000.

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6. Why must the city subsidize bus transportation if price is regulated at P = MC?• At P = MC, revenue for the bus company = ($0.30 × 180,000) = $54,000.

• Average total cost is $0.70.

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• Total cost for the firm = ($0.70 × 180,000) = $126,000.• At P = MC the bus company suffers a loss of $(126,000 - 54,000) = $72,000.

6. Why must the city subsidize bus transportation if price is regulated at P = MC?

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• Who makes up a regulatory commission, and what interests they represent, is a delicate matter.

• Sometimes regulatory commissions end up protecting the monopolies they are supposed to regulate.

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Deregulation

• The process of converting a regulated firm into an unregulated firm.

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The Economics of The Economics of NationalizationNationalization

Nationalization

• Government ownership of a firm or industry. Price and production decisions are made by an administrative agency of the government.

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Governments can nationalize industries by either buying out the shares held by the shareholders or by simply confiscating the property.

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• Governments typically buy firms by exchanging their own bonds for the nationalized firm’s shares.

• Assessing the firm’s net worth can be a problem, but governments have generally been generous when nationalizing a firm.

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What pricing options does the government have, once it has nationalized a firm?• The options available to the government are exactly the same as those available to the regulatory commission under regulation.

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What pricing options does the government have, once it has nationalized a firm?• The government can act as a profit-maximizing firm and follow the MR = MC rule, it can set price at ATC, or it can set price at MC.

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• Some people believe that the government-run industries are inherently inefficient.

• One reason government may appear inefficient is that it often takes over industries that were struggling in the first place.

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• Another reason for the fear of inefficiency is that governments cannot go bankrupt.

• While private firms cannot absorb large losses over the long term, governments can continue to subsidize failing industries indefinitely.

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• It is virtually impossible to distinguish ownership on the basis of performance, however.

• There are many examples of government-run industries which perform well, including airlines, colleges, and football teams.

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The Economics of Laissez-The Economics of Laissez-FaireFaire

• Some economists are not at all disturbed by monopolies.

• They believe that even with considerable industry concentration, there is still enough competition to generate acceptable price and output levels.

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Three theories try to explain why monopolies are not undesirable:1. Contestable markets

2. Countervailing power

3. Creative destruction

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Contestable market

• A market in which prices in highly concentrated industries are moderated by the potential threat of firms entering the market.

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According to this theory, does there actually need to be competitors in a market in order to moderate prices? • No. There only needs to be a potential threat of competition in order to moderate prices.

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• Critics of the contestable market theory find the argument compelling, but the applicability limited.

• They argue that in reality, barriers to entry and the cost of shifting resources make the market uncontestable.

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Countervailing power

• The exercise of market power by an economic bloc is ultimately counteracted by the market power of a competing bloc, so that no bloc exercises undue market power.

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The countervailing power theory argues that while competition may not exist among firms within a highly concentrated industry, it may still exist among highly concentrated industries.

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What are the four competing power blocs, according to the countervailing power theory?• The four competing blocs power are industrial, labor, agricultural and retail.

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For example, in the canned food industry, the oligopoly power of industrial producers of canned food is checked by the oligopoly power of the major retail grocery stores.

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Creative destruction

• Effective competition that exists not among firms within highly concentrated industries but between the highly concentrated industries themselves. Such competition ensures competitive prices.

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• The theory argues that while it may be difficult for firms to break into a monopolized industry, it is much less difficult for them to break the monopolized industry’s hold on a market by developing new products.

• Monopolies are destroyed by the creative process.

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Using the creative destruction theory, how was the coal oligopoly destroyed?• The coal oligopoly was destroyed not by more competition, but by the development of petroleum.

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The Economics of The Economics of Encouraging Encouraging

MonopolyMonopoly• Some economists prefer the monopoly structure to competition.

• They rely on Schumpeter’s argument that monopolies can take advantage of economies of scale.

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Exhibit 3: Firm Size Exhibit 3: Firm Size and Economies of and Economies of

ScaleScaleWhat is the lowest ATC that can be achieved by the competitive firm and the monopoly in Exhibit 2?• The lowest ATC that can be achieved by the competitive firm is $6. The monopoly can achieve an ATC of $2.

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MonopolyMonopolyGovernment, in this scenario, can foster an environment favorable to innovating industries. It can award and protect patents and encourage research and development by providing tax incentives.

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MonopolyMonopolyPatent

• Exclusive right granted by government to a market product or process for 20 years.

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The Economics of The Economics of Splitting Up Splitting Up MonopolyMonopolySplitting up monopolies is the

preferred option when:• Competition among many small firms is preferable.

• Laissez-faire theory doesn’t hold up in reality.

• Government regulation and nationalization are inefficient.

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The Economics of The Economics of Splitting Up Splitting Up MonopolyMonopoly

• Proponents of splitting up monopolies argue that monopolies come into being and persist by unfair market practices.

• The role of the government is to stop crime.

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The Economics of The Economics of Splitting Up Splitting Up MonopolyMonopoly

Antitrust policy

• Laws that foster market competition by prohibiting monopolies and oligopolies from exercising excessive market power.

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The History of The History of Antitrust LegislationAntitrust Legislation

The core of elements of federal antitrust legislation are:• Sherman Antitrust Act of 1890

• Clayton Act of 1914

• Federal Trade Commission Act of 1914

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The History of The History of Antitrust LegislationAntitrust Legislation

The effectiveness of antitrust legislation is limited by the funding appropriated to the agencies delegated the responsibility of ensuring the laws are enforced.

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Antitrust Goes to Antitrust Goes to CourtCourt

The rule of reason

• A judicial standard or criterion by which a firm’s size within an industry is insufficient evidence for the court to rule against it in an antitrust suit. Evidence must show that the firm actually used its size to violate antitrust laws.

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• The issue, according to this criterion, is the firm’s behavior, not its size or its share of the market.

The rule of reason

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• This criterion has been favored by the courts during the early twentieth century and since the 1970s.

The rule of reason

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Per se

• A judicial standard or criterion by which a firm’s size within an industry is considered sufficient evidence for the court to rule against it in an antitrust suit.

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• The issue, according to this criterion, is the size of the firm. The antitrust legislation does not differentiate between good and bad monopolies.

Per se

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The courts and Congress have been lenient since the 1980s in applying antitrust legislation to conglomerates.

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Do We Have a Policy Do We Have a Policy on Monopoly?on Monopoly?

• The U.S. does not have a clear and consistent policy on what to do about monopoly.

• For example, the utility industry is highly regulated, the post office is nationalized, and conglomerates are generally left alone.

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