Chapter 15

Economic Regulation

and Antitrust Policy

© 2009 South-Western/ Cengage Learning

Government Regulation

• Market power– the ability to affect the market price

• downward-sloping demand curve• prices are too high• output too low • inefficient (P ≠ MC)

2

How can firms grow?

• Mergers– Horizontal merger

• merger of 2 or more firms competing in the same market

– Vertical merger• merger of 2 or more firms at different stages

of the production process

– Conglomerate merger• merger of 2 or more firms in unrelated

markets3

Types of Government Regulation

• Government regulations– Social regulation

• Regulation aimed at improving health and safety

– Economic regulation• Regulation aimed at natural monopolies

4

Natural Monopoly

• Natural monopoly– Barrier to entry is economies of scale

• Unregulated profit maximization– Choose Q where MR=MC

– Economic profit

– Consumer surplus

– P > MC• higher social welfare if output expanded

5

Regulating a Natural Monopoly

• AC Pricing– regulatory agency allows the firm to

charge a price high enough to cover costs but no above normal profit• P=AC• Increase social welfare• Lower P, expand Q

– P > MC• inefficient

6

Regulating a Natural Monopoly

• Setting P = MC– Where D intersects MC

– Higher consumer surplus

– Monopolist: economic loss (P < AC)

– In long-run: monopolist exits the market

– Needs subsidizing

7

Regulating a Natural Monopoly

• Setting P = MC or P = AC– Reduce P

– Increase output

– Erase economic profit

– Increase consumer surplus

– Increase social welfare

8

Regulating a Natural Monopoly

• The regulatory dilemma– If P = MC

• Socially optimal allocation of resources– Marginal benefit = MC

• P < AC– Economic loss

• Requires government subsidy

– If P = AC• Monopolist: normal profit• Not socially optimal allocation

9

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• Reduces competition• Increases prices

10

Antitrust Legislation and Enforcement

• Antitrust policy– Reduce anticompetitive behavior

– Promote more efficient market structure

• Origins of antitrust policy– Developments

• Technology improvements: economies of scale

• Railroad: reduced transport costs• Bigger firms, wider markets

11

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– Outlaws many behaviors whose ultimate

goal is “restraint of trade”

12

Origins of Antitrust Policy

• Clayton Act of 1914– Outlaws specific behaviors whose

purpose is to “lessen competition”• Price discrimination, tying contracts,

exclusive dealing

• Federal Trade Commission Act of 1914– established Federal Trade Commission

– Enforce antitrust laws

13

Objectionable Behaviors• Price Fixing

– Any action by 2 or more firms to set price• Collusion• Outlawed by Sherman Antitrust Act

• Vertical Restraints– involves an agreement between producer and

retailer• Price Discrimination

– outlawed by Clayton Act where purpose is to reduce competition (rule of reason)

• Mergers14

Per Se Illegality and Rule of Reason

• Per se illegal– Illegal regardless of the economic

rationale or consequences

• Rule of reason– Reasons and its effect on competition

15

Mergers and Public Policy

• Antitrust division and FTC– Approve/deny mergers and acquisitions

• Concentration Ratio– Sales of 4 or 8 largest firms as a

percentage of total industry sales• Higher concentration

– More potential monopoly power

• Lower concentration– More competition

16

Mergers and Public Policy• Herfindahl-Hirschman Index HHI

• Sum of squared % market shares of all firms in the industry

• HHI = p12 + p2

2 + p32 + … + pn

2

where pi is the % market share of the ith firm

– Challenged mergers if• Post-merger HHI>1800• Merger increases HHI by >100 points• Mergers with HHI < 1000 rarely challenged

17

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

18

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

19

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

20

Competitive Trends in the US Economy

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

21

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

22

Competitive Trends in the US Economy

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

– Deregulation

– Antitrust policy

23

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 24

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 behavior25

Problems with Antitrust Policy

• Competition may not require that many firms

• Abuse of antitrust• Growth of international markets

26

Antitrust Enforcement

• Antitrust division of the US Justice Department and FTC– Fines

• Treble damages

– Jail– Injunctions

• Court order to cease behavior

– Break up firm into smaller firms• AT&T• Standard Oil 27