chapiter 15

Chapter 15

Economic Regulation

and Antitrust Policy

Types of Government Regulation

• Market power– Raise the price

• without losing all sales to rivals

– Firms• downward-sloping demand curve

2

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

3

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

4


• Government– Increase social welfare

– Lower P, expand Q

• Public utilities– Government-owned monopoly

– Government regulated monopoly

5


• Setting P=MC– Where D intersects MC

– Higher consumer surplus

– Monopolist: economic loss

– In long-run: monopolist exits the market

– Needs subsidizing

6


• 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)7


• Setting P=MC or P=average cost– Reduce P

– Increase output

– Erase economic profit

– Increase consumer surplus

– Increase social welfare

8


• 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

9

Exhibit 1Regulating a natural monopoly

10

10590500 Trips per month (millions)

$4.00

2.50

1.501.250.50

Dol

lars

per

trip

Demand

MR Long-run MC

LRAC

a

bc

h g

ef

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.

Alternative Theories: Econ. 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

11

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 price12


• 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)

13


• Fierce competition• Mergers• Disappeared• Bankrupt

• Lower wages

• Lower fares

• More flights

• Saving lives

14

Antitrust Law and Enforcement

• Antitrust policy– Reduce anticompetitive behavior

– Promote competition

• Origins of antitrust policy– Developments

• Technology: economies of scale• Railroad: reduced transport costs• Bigger firms, wider markets

15

Origins of Antitrust Policy

• 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 dealing16

Origins of Antitrust Policy

• Federal trade commission act of 1914– Federal trade commission

– Enforce antitrust laws

• Cellar-Kefauver anti-merger act– Horizontal mergers

– Vertical mergers

17

Antitrust Enforcement

• Antitrust division of the US Justice Department

• FTC• Consent decree• Court trial• Judge decides

18

Per Se Illegality and Rule of Reason

• Per se illegal– Illegal regardless of the economic

rationale or consequences

– Firm’s behavior

• Rule of reason– Reasons and its effect on competition

– Firm’s behavior

– Market structure

19

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 20

Exhibit 2Herfindahl-Hirschman Index (HHI) based on market share in three industries

21

Industry I Industry II Industry III

Firm

MarketShare(%)

MarketShareSquared

MarketShare(%)

MarketShareSquared

MarketShare(%)

MarketShareSquared

ABCDRemaining

40 firms

2318136

1 each

52932416936

40

15151515

1 each

225225225225

40

57111

1 each

3,249111

40

HHI 1,098 940 3,292

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.

Exhibit 3U.S. merger waves in the past century

22

Wave Years Dominant type of merger Examples Stimulus

First

Second

Third

Fourth

1887-1904

1916-1929

1948-1969

1982-present

Horizontal

Vertical

Conglomerate

Horizontal and vertical

U.S. Steel, Standard Oil

Copper refiner with fabricator

Litton Industries

Banking, tele-communications, health services, insurance

Span national markets

Stock market boom

Diversification

Span national and global markets, stock market boom

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

23

Competitive Trends in the US Economy

1. Pure monopoly– One firm controls the market

– Block entry

2. Dominant firm– One firm: more than half market share

– No close rival

24


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

25

Exhibit 4Competitive trends in the US economy: 1939 to 2000

26


• Growth in competition (1958-2000)– Competition from imports

• One-sixth

– Deregulation• One-fifth

– Antitrust policy• Two-fifths

27

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 behavior28

Recent Competitive Trends

• Increased competition in US• Growing world trade

• Three major automakers– 80% of US 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 29

Problems with Antitrust Policy

• Competition may not require that many firms

• Abuse of antitrust• Growth of international markets

30

chapiter 15

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