Economic Regulation and Antitrust Policy Power Point Slides

Economic Regulation and Antitrust Policy Power. Point Slides prepared by: Andreea CHIRITESCU Eastern Illinois University © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 1

Types of Government Regulation • Firms with market power – Raise the price without losing all its customers to rival firms – Downward-sloping demand curve – Produce less of the good than would be socially optimal – Monopoly – insulated from competition • Not too innovative • May influence public choice © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2

Types of Government Regulation • Government policies - firm behavior – Social regulation – Economic regulation – Antitrust policy • Social regulations – Aimed at improving health and safety • Control over – Unsafe working conditions, dangerous products • Health care reform © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3

Types of Government Regulation • Economic regulations – Control: price, output, entry of new firms, quality of service • In industries in which monopoly appears inevitable or even desirable – Control over natural monopolies • Local electricity transmission, local phone service, and a subway system • Land air transportation © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 4

Types of Government Regulation • Antitrust policy – Preventing monopoly – Fostering competition in markets where competition is desirable – Outlaws monopolies and cartels © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 5

Regulating a Natural Monopoly • Natural monopoly – Downward-sloping LRAC curve – Economies of scale – Average production cost is lowest when a single firm supplies the market © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 6

Regulating a Natural Monopoly • Unregulated profit maximization – Produce where MR=MC – Economic profit – Some consumer surplus – Inefficient in terms of social welfare • Price far exceeds marginal cost • Higher social welfare if output expanded © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 7

Regulating a Natural Monopoly • Government – Can increase social welfare – Force the monopolist to lower the price and expand output • Public utilities – Government-owned monopolies – Government regulated monopolies © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 8

Regulating a Natural Monopoly • Setting P (marginal benefit)=MC – Where D intersects MC – Higher consumer surplus – Monopolist: economic loss – In long-run: monopolist exits the market © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 9

Regulating a Natural Monopoly • Subsidizing the natural monopolist – Monopolist: produce where P=MC – Government covers the loss – Firm: earn normal profit – Drawback: government must raise taxes, forgo public spending © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 10

Regulating a Natural Monopoly • Setting P=average cost – ‘Fair return’: normal profit – Stay in business without a subsidy – Higher social welfare (than unregulated) – Marginal benefit exceeds marginal cost • Expanding output would increase social welfare © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 11

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 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 12

Exhibit 1 Regulating a Natural Monopoly Dollars per trip With a natural monopoly, the longrun average cost curve slopes downward where it intersects the Demand market demand curve. The unregulated firm maximizes profit by producing where marginal c b revenue equals marginal cost, in $4. 00 this case, 50 million trips per Profit month at a price of $4. 00 per trip. This outcome is inefficient because 2. 50 price, or marginal benefit, exceeds h g 1. 50 marginal cost. To achieve the 1. 25 LRAC efficient output rate, regulators Loss f e 0. 50 Long-run MC could set the price at $0. 50 per trip. The subway would sell 105 million 0 50 MR 90 105 Trips per month trips per month, which would be an efficient outcome. But at that price, (millions) the subway would lose money and The subway would sell 90 million trips per month and would require a subsidy to keep just break even (because price equals average cost). Social going. As an alternative, regulators welfare could still be increased by expanding output as long could set the price at $1. 50 per trip. as the price, or marginal benefit, exceeds marginal cost, but that would result in an economic loss a © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 13

Alternative Theories • Views of government regulation – Economic regulation is in the public interest • Promotes social welfare by keeping prices down – Economic regulation is in the special interest of producers © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 14

Alternative Theories • Producers’ special interest – Well-organized producer groups • Expect to gain from economic regulation • Persuade public officials to impose restrictions – Consumers have no special interest – Reduce competition – Increase prices © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 15

Alternative Theories • Capture theory of regulation – Producers have • Political power • Strong stake in the regulatory outcome – Leads them to “capture” the regulating agency • Prevail on it to serve producer interests © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 16

Airline regulation and deregulation • 1938 Civil Aeronautics Board – Regulated interstate airlines – 40 years: No new interstate airline – Created a cartel • Fixed prices among the 10 major airlines • Blocked new entry – Capture theory of regulation © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17

Airline regulation and deregulation • 1938 Civil Aeronautics Board – Labor unions • Higher wages • Pilots worked 2 weeks/month – High price – No regulatory power over airlines that flew only intrastate routes • Fares on intrastate airlines were only half those on identical routes flown by regulated airlines © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18

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) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 19

Airline regulation and deregulation • 1978 Deregulation • Fierce competition – Mergers – Disappeared – Bankrupt • • Lower wages Lower fares More flights Saving lives (less driving) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 20

Antitrust Law and Enforcement • Antitrust policy – Reduce anticompetitive behavior – Promote competition – Attempts to promote socially desirable market performance © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 21

Origins of Antitrust Policy • Economic developments – Bigger forms serving wider markets – Technology: economies of scale – Railroad: reduced transport costs • 1873 -1883 sharp economic decline – Competing firms formed a trust • Sugar, tobacco, oil industries • Widespread criticism © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 22

Origins of Antitrust Policy • Sherman Antitrust Act of 1890 – First national legislation in the world against monopoly – Prohibited trusts, restraint of trade, monopolization – Vague and ineffective • Allowed room for much anticompetitive activity © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 23

Origins of Antitrust Policy • Clayton Act of 1914 – Improved the Sherman Act – Outlawed certain anticompetitive practices not prohibited by the Sherman Act • Price discrimination, tying contracts • Exclusive dealing, interlocking directorates • Buying the corporate stock of a competitor © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 24

Origins of Antitrust Policy • Tying contract – A seller of one good requires a buyer to purchase other goods as part of the deal • Exclusive dealing – A supplier prohibits customers from buying from other suppliers • Interlocking directorate – A person serves on the boards of directors of two or more competing firms © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 25

Origins of Antitrust Policy • Federal Trade Commission Act of 1914 – Federal trade commission (FTC) – Enforce antitrust laws – Commissioners, economists and lawyers • Cellar-Kefauver Anti-Merger Act – Prevents one firm from buying physical assets of another firm • If the effect is to reduce competition – Horizontal and vertical mergers © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 26

Origins of Antitrust Policy • Horizontal merger – One firm combines with another firm • That produces the same type of product • Vertical merger – One firm combines with another firm • From which it had purchased inputs or to which it had sold output © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 27

Antitrust Enforcement • Antitrust Division of the US Justice Department or the FTC – Charges a firm/group of firms with breaking the law – Acting on a complaint by a customer or a competitor – Accused • Sign a consent decree • Contest the charges: Court trial – Judge decides © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 28

Antitrust Enforcement • Consent decree – Accused party • Without admitting guilt • Agrees not to do whatever it was charged with • If the government drops the charges © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 29

Per Se Illegality • Per se illegal – Business practices deemed illegal – Regardless of their economic rationale or their consequences – Government – examine firm’s behavior © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 30

Rule of Reason • Rule of reason – Reasons of the offending practice and its effect on competition – Focus on • Firm’s behavior • Market structure resulting from that behavior • Predatory pricing – Pricing tactics employed by a dominant firm to drive competitors out of business © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 31

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 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 32

Mergers and Public Policy • Antitrust Division and FTC – Challenges any merger in an industry that meets two conditions • (1) the HHI exceeds 2, 500 • (2) the merger increases the index by more than 200 points © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 33

Exhibit 2 Herfindahl-Hirschman Index (HHI) Based on Market Share in Three Industries Each of the three industries shown has 44 firms. The HHI is found by squaring each firm’s market share then summing the squares. Under each industry, each firm’s market share is shown in the left column and the square of the market share is shown in the right column. For ease of exposition, only the market share of the top four firms differs across industries. The remaining 40 firms have 1 percent market share each. The HHI for Industry III is nearly triple that for each of the other two industries. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 34

Merger Waves • First wave – Technological progress in transportation, communication, and manufacturing • Second wave – Stock market boom of 1920 s • Third wave – After WWII • Fourth wave – One-third: hostile takeovers © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 35

Exhibit 3 U. S. Merger Waves in the Past Century © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 36

Competition Over Time • U. S. industries: 1. Pure monopoly • • One firm controls the market Blocks entry 2. Dominant firm • • One firm: more than half market share No close rival © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 37

Competition Over Time • U. S. industries: 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 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 38

Exhibit 4 Competitive Trends in the U. S. Economy: 1939 to 2000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 39

Competition Over Time • Growth in competition (1958 -2000) – Competition from imports • One-sixth of the overall increase in competition – Deregulation • One-fifth of the overall increase in competition – Antitrust policy • Two-fifths of the overall increase in competition © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 40

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 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 41

Microsoft on trial • Ruling – Microsoft maintained a monopoly in operating-system software • Anticompetitive means – Microsoft attempted to monopolize the browser market • Unlawful “tying” Internet Explorer with Windows © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 42

Microsoft on trial • Out-of-court settlement – Personal-computer makers • Greater freedom to install non-Microsoftware on new machines – Banned retaliation against companies that take advantage of these freedoms – Prohibited exclusive contracts – Microsoft - disclose design information to hardware and software makers © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 43

Microsoft on trial • Antitrust charges brought by the European Union – Settled most charges by 2010 • Windows software – 90% of the world’s computers • Microsoft – Stock market value = $225 billion in May 2010 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 44

Recent Competitive Trends • Growing world trade and competition – Three major automakers • 80% of US market in 1970 • Only 45% by 2010 • Deregulation of international phone service – $0. 88 a minute in 1997 – Under $0. 10 by 2010 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 45

Recent Competitive Trends • Technological change – Prime-time audience share of three major TV networks • 90% in 1980 • Under 30% today – FOX became a fourth major network – Cable and satellite technology delivered hundreds of networks and channels © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 46

Problems with Antitrust Policy • Competition may not require that many firms – Antitrust policy should not necessarily aim at increasing the number of firms in each industry – Firm size should not be the primary concern – Most of the desirable properties of perfect competition can be achieved with relatively few firms © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 47

Problems with Antitrust Policy • Antitrust abuses – Treble damage suits • Parties -show injury from firms that violate antitrust laws – Can sue the offending company – Recover three times the damages sustained • Abused – Used to intimidate an aggressive competitor – Used to convert a contract dispute into treble damage payoffs © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 48

Problems with Antitrust Policy • Growth of international markets – Market power of a firm • Its share of the market – With greater international trade • Local and national market share becomes less relevant – Antitrust enforcement that focuses on domestic producers makes less economic sense © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 49

Problems with Antitrust Policy • Bailing out troubled industries – Financial institutions and two of the big three automakers – Intent: to promote financial stability and keep the economy from sinking further – Long-term effect • Remains to be seen © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 50