Chapter 13 Antitrust and Regulation Key Concepts Summary

Chapter 13 Antitrust and Regulation • Key Concepts • Summary • Practice Quiz • Internet Exercises © 2002 South-Western College Publishing 1

What is a trust? A combination or cartel consisting of firms that place their assets in the custody of a board of trustees 2

What is predatory pricing? The practice of one or more firms temporarily reducing prices in order to eliminate competition and then raising prices 3

When was the age of the robber barons? In the later part of the 1800’s 4

What was done to limit the power of trusts? Congress passed laws aimed at preventing firms from engaging in anticompetitive activities 5

What is the Sherman Act? The federal antitrust law enacted in 1890 that prohibits monopolization and conspiracies to restrain trade 6

What is the Clayton Act? A 1914 amendment that strengthens the Sherman Act by making it illegal for firms to engage in certain anticompetitive business practices 7

What business practices were declared illegal under the Clayton Act? • Price discrimination • Exclusive dealing • Tying contracts • Stock acquisition of competing companies • Interlocking directorates 8

Was the Clayton Act an improvement over the Sherman Act? Although more specific than the Sherman Act, the Clayton Act is also vague 9

What is the Federal Trade Commission Act? The federal act that in 1914 established the Federal Trade Commission (FTC) to investigate unfair competition 10

What is the Robinson-Patman Act? A 1936 amendment to the Clayton Act that strengthens the Clayton Act against price discrimination 11

What is the basic purpose of the Robinson-Patman Act? To prevent large sellers from offering different prices to different buyers where the effect is to harm even a single small firm 12

What is the Celler-Kefauver Act? A 1950 amendment to the Clayton Act that prohibits one firm from merging with a competitor by purchasing its physical assets if the effect is to substantially lessen competition 13

What are some key antitrust cases? • Standard Oil Case 1911 • Alcoa Case 1945 • IBM Case 1982 • AT&T Case 1982 • MIT Case 1992 • Microsoft Case 1995 14

What was the outcome of the standard oil case? The rule of reason 15

What is the rule of reason? The antitrust doctrine that the existence of monopoly alone is not illegal unless the monopoly engages in illegal business practices 16

What was the outcome of the Alcoa case? The per se rule 17

What is the per se rule? The antitrust doctrine that the existence of monopoly alone is illegal, regardless of whether or not the monopoly engages in illegal business practices 18

What was the result of the IBM case? A switch back to the rule of reason 19

What was the result of the AT&T case? Technology made this government-regulated natural monopoly obsolete, and AT&T was found guilty of anticompetitive pricing 20

What was the result of the MIT case? Eight Ivy League schools agreed to stop colluding to fix prices, and MIT was found guilty of price fixing 21

What was the result of the Microsoft case? Microsoft was not allowed to purchase Intuit Inc. , a competitor in the personal finance software industry 22

What was the Microsoft case of 2001? This case charged Microsoft with predatory pricing by tying its monopoly in Windows to its Internet Explorer browser 23

How can firms avoid charges of price fixing? They can merge into one company 24

When did a lot of mergers begin taking place? In the 1980’s 25

What are the different types of mergers? • Horizontal • Vertical • Conglomerate 26

What is a horizontal merger? A merger of firms that competes in the same market 27

What is a vertical merger? A merger of a firm with its suppliers 28

What is a conglomerate merger? A merger between firms in unrelated markets 29

What can be said about conglomerate mergers? They are generally allowed because they do not significantly decrease competition 30

What can be said about antitrust laws in other countries? They are weak in comparison to U. S. antitrust laws 31

What is the history of government regulation? From the later part of the 1800’s to the 1970’s, there was an increase in regulation; in the 1970’s there was a movement away from regulation 32

What is the basic argument in favor of government regulation? Market failure 33

In what ways does the market fail? • Natural monopoly • Externalities • Imperfect information 34

What is a natural monopoly? An industry in which longrun average cost is minimized when only one firm serves the market 35

What is marginal cost pricing? A system of pricing in which the price charged equals the marginal cost of the last unit produced 36

P $50 $40 $30 $25 $20 $15 $10 $5 Regulated Monopoly Fair return price efficient price A B MR C 1 2 3 4 5 6 7 LRAC LRMC D Q 8 9 37

What is a normal profit? The accounting profit required to induce a firm’s owners to employ their resources in the firm 38

Do production costs include normal profit? Yes, because normal profit is considered a necessary expense of a business 39

What kind of profit is made at the fair return price? Normal Profit 40

What happens when pollution is present? Pollution causes polluting firms to overproduce, while causing firms that pay the cost of cleaning up the pollution to underproduce 41

What can be done when the externality of pollution is present? The government can regulate the industry to minimize the pollution 42

What happens with imperfect information? Deficient information on unsafe products can cause consumers to overconsume a product 43

P $20 Impact of Imperfect Information S E 1 $15 E 2 $10 $5 D 1 D 2 25 50 75 100 Q 44

Decrease in quantity supplied Increase in Demand Consumers informed of defect 45

Key Concepts 46

Key Concepts • • • What is a trust? What is predatory pricing? What is the Sherman Act? What is the Clayton Act? What is the Federal Trade Commission Act? What is the Robinson-Patman Act? What is the Celler-Kefauver Act? What is the rule of reason? What is the per se rule? 47

Key Concepts cont. • • • What are the different types of mergers? What is a horizontal merger? What is a vertical merger? What is a conglomerate merger? What can be said about antitrust laws in other countries? • What is a natural monopoly? • What happens when pollution is present? • What happens with imperfect information? 48

Summary 49

A trust is a cartel that places the assets of competing companies in the custody of a board of trustees. During the last decades of the 19 th century, trusts engaged in anticompetitive strategies to eliminate competition and raise prices, such as predatory pricing. 50

The Sherman Act of 1890 and the Clayton Act of 1914 are the two most important antitrust laws. The Sherman Act marked the first attempt of the U. S. government to outlaw monopolizing behavior. Because this act was vague, the Clayton Act was passed to define anticompetitive behavior more precisely. 51

The Clayton Act prohibited (1) price discrimination, (2) exclusive dealing, (3) tying contracts, (4) stock acquisition, and (5) interlocking directorates. 52

The Robinson-Patman Act of 1936 strengthened the Clayton Act by prohibiting certain forms of price discrimination. This law is called the “Chain Store Act” because it was aimed at large retail chain stores that were obtaining volume discounts. 53

The Celler-Kefauver Act of 1950 strengthened the Clayton Act declaring illegal the acquisition of the assets of one firm by another firm if the effect is to lessen competition. 54

The rule of reason and the per se rule are the two main philosophies the courts have used in interpreting antirust law. Under the rule of reason, monopolist were not subject to prosecution unless they acted in an anticompetitive manner. 55

The Supreme Court decision in the Alcoa case of 1945 replaced the rule of reason with the per se rule, which states that the mere existence of monopoly is illegal. Today, the trend is in favor of dominant firms because of international competition. 56

A horizontal merger is a merger of two competing firms. A vertical merger is a merger of two firms where one produces an input used by the other firm. A conglomerate merger is a merger of two firms producing unrelated products. 57

Deregulation is a movement that began in the 1980’s to eliminate regulations primarily in the transportation and telecommunications industries. Today, the current trend is toward further deregulation resulting from federal budget cuts. 58

Marginal cost pricing is a competitive pricing strategy for a regulated natural monopoly. Using this approach, regulators set the monopolist’s price equal to its marginal cost. Another method is for regulators to establish a fairreturn price equal to long-run average cost and the monopolist earns zero economic profit. 59

Regulation of a natural monopoly is justified on the basis of market failure. Two other cases based on market failure include externalities and imperfect information. 60

P $50 $40 $30 $25 $20 $15 $10 $5 Regulated Monopoly Fair return price efficient price A B LRAC MR C 1 2 3 4 5 6 7 LRMC D 8 9 Q 61

Chapter 13 Quiz © 2002 South-Western College Publishing 62

1. Which of the following is illegal under the Sherman Act? a. Attempts to monopolize. b. Price fixing. c. Formation of cartels. d. All of the above are illegal under the Sherman Act. D. The Sherman Act of 1890 is the federal antitrust law to curb trusts, but the federal government did not win a notable case until 1911. 63

2. Officers of five large buildingmaterials companies meet and agree that none of them will submit bids on government contracts lower than an agreed-upon level. This is an example of a. price fixing. b. vertical restriction. c. a tying contract. d. an interlocking directorate. A. The Sherman Act was enacted with vague language, but price fixing is clearly a “conspiracy in restraint of trade”. 64

3. A fabric shop cannot sell Singer sewing machines if it also sells other brands of sewing machines. This is an example of a. a resale price maintenance. b. territorial restrictions. c. a tying agreement. d. exclusive dealing. D. If the effect is to “substantially lessen competition” such as an agreement between a manufacturer and a retailer is a violation of the Clayton Act of 1914. 65

4. Under the Clayton Act, horizontal mergers by stock acquisition were a. not considered. b. illegal if they could be shown to lessen competition. c. illegal under any circumstances. d. legal if they could be shown to lessen competition. B. Horizontal mergers are combinations among competitors in the same industry which, if allowed, eliminate existing competition. 66

5. Under the Clayton Act, which of the following was illegal even if it was not shown to lessen competition substantially? a. Price discrimination. b. Tying contracts. c. Horizontal mergers by stock acquisition. d. Interlocking directorates. D. Interlocking directorates is the situation in which a director of one company serves on the board of directors of a competing company. 67

6. The importance of the Federal Trade Commission Act of 1914 is that it a. set up an independent antitrust agency with the power to investigate complaints. b. strengthened the law against mergers. c. strengthened the law against price discrimination. . d. none of the above. A. The FTC Act of 1914 established a five-member commission appointed by the president to investigate “unfair methods of competition. ” 68

7. Which of the following is concerned primarily with price discrimination? a. The Sherman Act. b. The Clayton Act. c. The Robinson -Patman Act. d. The Celler-Kefauver Act. C. The Robinson-Patman Act of 1936 is an amendment to the Clayton Act that strengthens the Clayton Act against price discrimination. 69

8. Which of the following is concerned primarily with mergers? a. The Sherman Act. b. The Clayton Act. c. The Robinson-Patman Act. d. The Celler-Kefauver Act. D. The Celler-Kefauver Act is called the “antimerger act” because it closed the loophole in the Clayton Act by prohibiting mergers by sale of physical assets. 70

9. The Utah Pie case was brought under which of the following laws? a. The Sherman Act. b. The Federal Trade Commission Act. c. The Robinson-Patman Act. d. The Celler-Kefauver Act. C. Utah Pie was a small frozen desert pie firm in Salt Lake City that used three outside national competitors for price discrimination. The Supreme Court ruled in Utah Pie’s favor. 71

10. Although U. S. Steel controlled nearly 75% of the domestic iron and steel industry, in 1920 the Supreme Court ruled that the firm was not in violation of the Sherman Act because there was no evidence of abusive behavior. What antitrust doctrine was the court applying in this case? a. The rule of reason. b. The per se rule. c. The marginal cost pricing rule. d. The natural monopoly rule. A. The rule of reason applied when a firm was not engaged in anticompetitive 72 behavior.

11. In which antitrust case did the Supreme Court begin to apply the per se rule to determine whether a firm was in violation of the Sherman Act? a. The Standard Oil case. b. The Alcoa case. c. The IBM case. d. The MIT case. B. The Supreme Court decision in the Alcoa case of 1945 replaced the rule of reason with the per se rule, which states that the mere existence of monopoly is illegal. 73

12. The Interstate Commerce Commission (ICC) was established in a. 1887. b. 1890. c. 1929. d. 1933. A. The ICC was established for the original purpose of regulating rail prices by reducing duplicate trains, depots, and tracks. 74

13. Today, the Civil Aeronautics Board (CAB) regulates airline a. ticket prices. b. routes. c. safety. d. all of the above. e. none of the above; the CAB was abolished in 1984. E. The CAB was established in 1938 to regulate airline fares and air routes. 75

14. Which of the following provides the basis for regulation? a. Natural monopoly. b. Externalities. c. Imperfect information. d. All of the above. e. None of the above. D. In each of these cases, the argument in favor of regulation is market failure. 76

15. Consider a regulated natural monopoly. If the regulatory commission wants to establish a fair-return price, then it should set a price ceiling where the demand curve crosses the monopoly’s long-run a. marginal revenue curve. . b. average revenue curve. c. marginal cost curve. d. average cost curve. D. One method for regulators to establish a fair-return price is to set price equal to long-run average cost and the monopolist earns zero economic profit 77

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