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Regulation and
Antitrust Law
CHAPTER OUTLINE
I. Explain the effects of regulation of natural monopoly and oligopoly.
A. The Changing Scope of Regulation
B. The Regulatory Process
C. Economic Theory of Regulation
1. Public Interest Theory
2. Capture Theory
D. Natural Monopoly
E. Public Interest or Private Interest Regulation?
1. Marginal Cost Pricing
2. Average Cost Pricing
3. Rate of Return Regulation
4. Price Cap Regulation
F. Oligopoly Regulation
Chapter
17
2. Describe U.S. antitrust law and explain three antitrust policy debates.
A. The Antitrust Laws
B. Three Antitrust Policy Debates
1. Resale Price Maintenance
2. Tying Arrangements
3. Predatory Pricing
C. A Recent Antitrust Showcase: The United States Versus Microsoft
1. The Case against Microsoft
2. Microsoft’s Response
3. The Outcome
D. Merger Rules
 What’s New in this Edition?
Chapter 17 is lightly revised. The Eye on the U.S. economy
now discusses airline deregulation.
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 Where We Are
Chapter 17 is the last chapter devoted to studying industry
structure. In this chapter, we investigate different types of
regulation imposed by the government. We also review the
history of antitrust law and current topics in antitrust cases.
 Where We’ve Been
In the previous four chapters we’ve reviewed four types of
market structure and studied how firms in each market
structure selected their profit-maximizing output and price.
We’ve compared the efficiency of the outcomes generated by
each market structure. This chapter builds on the previous
work because those chapters explained why competition is
desirable, which is the thrust of the antitrust laws. In addition, Chapter 14 briefly examined natural monopolies, a topic re-examined in depth in this chapter.
 Where We’re Going
The next chapter leaves behind the industry structure and
the output side of firms to begin a two-chapter unit studying
input markets and the distribution of income. Chapter 18
leads off by examining the different types of factors (labor,
capital, land, and entrepreneurship) and discussing, as well
as analyzing, the markets in which these factors are traded.
IN THE CLASSROOM
 Class Time Needed
You can complete this chapter in one session. If you want to spend more time,
you can bring in current events, such as the situation in the California electricity
market or perhaps some on-going regulation or deregulation issue from your
state.
An estimate of the time per checkpoint is:

17.1 Regulation—25 to 35 minutes

17.2 Antitrust Law—15 to 30 minutes
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CHAPTER LECTURE
17.1
Regulation
Regulation consists of rules administered by a government agency to influence economic activity
by determining prices, product standards and types, and the conditions under which new firms
may enter an industry.
The Changing Scope of Regulation and the Regulatory Process


The Interstate Commerce Commission, the first federal regulatory agency, was organized
in 1887 to regulate interstate railroads. Since the 1930s, the number of regulatory agencies
greatly increased (at both the state and federal levels). By the 1970s, almost one quarter of
all industry was regulated. In the last 25 years, there has been a tendency for deregulation, which is the process of removing restrictions on prices, product standards and
types, and entry conditions.
The regulatory agencies are run by bureaucrats. Each agency adopts a set of rules and
practices designed to control the prices and other aspects of economic behavior in the industry it is assigned to regulate. Regulated firms generally are free to choose the level of
technology and quantities of inputs but they generally are not free to set their own prices.
Economic Theory of Regulation


The public interest theory of regulation maintains that regulation seeks an efficient allocation of resources.
The capture theory of regulation maintains that regulation helps producers maximize
their economic profit. The producers “capture” the regulators and so the regulators do
what is best for the producers. It assumes that the cost of regulation is high, and as a result, regulation will increase the surplus of small, easily identifiable groups with low organization costs.
Be sure to point out the tension between getting competent regulators to represent the interests of
the consumers and the motivations surrounding these regulatory analysts. Emphasize that the
information necessary to efficiently regulate an industry is vast and complex. Production costs,
for example, are typically very difficult to estimate without highly specialized knowledge of the
industry. Who is more likely to have this type of specialized knowledge than people hired from
the ranks of the firms that are being regulated? These people have the requisite knowledge but
they might retain some allegiance to and empathy for the managers that they recently worked
with or firms that they worked for. This point means the loyalties of the regulators might be surreptitiously swayed by their past personal relationships.
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Natural Monopoly
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A natural monopoly is an industry in
which one firm can supply the entire
market at a lower price than two or
more firms can. The figure shows a
natural monopoly. The definition of a
natural monopoly means that the
firm’s ATC curve falls throughout the
relevant range of production. As a result, the firm’s MC curve is below its
ATC curve when the MC curve crosses the firm’s demand curve.
A marginal cost pricing rule sets
price equal to marginal cost, P = MC.
In the figure, the firm sets a price of
Pmc and produces Qmc.
 The rule leads to the efficient level of production in the industry,
so it maximizes the total surplus in the industry. It is in the public interest. But the
firm incurs an economic loss because P < ATC.
An average cost pricing rule sets price equal to average total cost, P = ATC. In the figure,
the firm sets a price of Patc and produces Qatc..
 The rule leads to an inefficient level of production so there is a deadweight loss. But
the firm earns a normal profit because P = ATC.
Implementing pricing rules is difficult because the regulator does not know the firm’s
true costs. So regulators often use two practical pricing rules:
 Rate of return regulation is regulation that sets the price at a level that allows the
regulated firm to earn a specified target percent return on its capital. When this policy is used, the managers of the regulated firm have the incentive to inflate its costs
for beneficial amenities that do not promote efficiency but instead give the managers
more amenities.
 A price-cap regulation is a regulation that specifies the highest price that a firm is
permitted to set—a price ceiling. Price cap regulation gives managers an incentive to
minimize costs because if the firm decreases its costs and earns an economic profit,
the firm will be allowed to keep all (or part) of the profit. Typically price cap regulation also requires earnings sharing regulation, under which profits that rise above a
target level must be shared with the firm’s customers.
Oligopoly Regulation
A cartel is a collusive agreement among a number of firms that is designed to restrict output and
achieve a higher profit for cartel members. Cartels are illegal in the United States but still might
arise in oligopoly industries. Regulation in these industries can be in the social interest—in which
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case the price and quantity equal their competitive levels and the outcome is efficient—or the
regulators might be captured—in which case the firms earn an economic profit and the regulation acts against the social interest.
17.2
Antitrust Law
Antitrust law provides an alternative way in which the government may influence resource allocation in the marketplace. Antitrust law regulates or prohibits certain kinds of market behavior,
such as monopoly and monopolistic practices.
The Antitrust Laws
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The Sherman Act was the first antitrust law and was passed in 1890.
 Section 1 outlawed any “combination, trust, or conspiracy that restricts interstate
trade.”
 Section 2 prohibited the “attempt to monopolize.”
The Clayton Act was passed in 1914. It made illegal specific business practices if the practices “substantially lessen competition or create monopoly.” Practices outlawed include
price discrimination, tying arrangements, requirements contacts, exclusive dealing, territorial confinement, acquiring a competitor’s shares or assets, or becoming a director of a
competing firm.
The Federal Trade Commission was formed in 1914 to look for “unfair methods of competition and unfair or deceptive business practices.”
Three Antitrust Policy Debates

Price fixing is always illegal. But other practices generate debates:
 Resale price maintenance occurs when a manufacturer agrees with a distributor on
the price at which the product will be resold. Agreements between a manufacturer
and distributors are illegal but it is legal for a manufacturer to force a distributor to
accept guidance. This practice is inefficient if it allows retailers of the goods to operate
a cartel and charge the monopoly price. It is efficient if it allows manufacturers to induce dealers to provide the efficient standard of service when selling the product.
 A tying arrangement is an agreement to sell one product only if the buyer agrees to
buy another, different product. A tying arrangement sometimes allows manufacturers to price discriminate.
 Predatory pricing is setting a low price to drive competitors out of business with the
intention of setting a monopoly price when the competition is gone. Economists are
skeptical that predatory pricing occurs frequently because, unless there is some barrier to entry, the predatory firm is unable to charge a monopoly price after the competition is eliminated.
A Recent Antitrust Showcase: The United States Versus Microsoft

In 1998 the U.S. Department of Justice began a trial in which it said that Microsoft possessed monopoly power, used predatory pricing and tying arrangements to establish Internet Explorer, and used other anti-competitive practices.
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However, Microsoft countered that it has not violated antitrust law. Microsoft said that
Windows was vulnerable to competition because there are no barriers to entry and that
incorporating Internet Explorer into Windows is an attempt to increase customer value of
the operating system software, rather than trying to monopolize the browser software
market.
The final court decision found Microsoft was in violation of the anti-trust laws and ordered Microsoft to disclose details of its operating systems software to other software
developers so they could more effectively compete against it.
Merger Rules
The Department of Justice uses guidelines to determine which mergers to examine and possibly
block. The Herfindahl-Hirschman Index (HHI) (introduced in Chapter 15) is one of those guidelines. If the original HHI is less than 1,000, a merger is not challenged. If the original HHI is between 1,000 and 1,800, any merger that raises the HHI by 100 or more is challenged. If the original HHI is greater than 1,800, any merger that raises the HHI by more than 50 is challenged.
Chapter 17 . Regulation and Antitrust Law
 Lecture Launchers
1.
I (Maggy Shannon) like to give the students the historical background behind many economic issues. Antitrust law is a natural for this approach. I
explain how absent regulation, the post-Civil War U.S. railroad industry
consolidated as firms sought to maximize profit. The first landmark federal
antitrust legislation, the Sherman Act (1890), was a direct reaction to this
consolidation. In Standard Oil Co. of New Jersey v. United States (1911) Justice John Harlan explained “All who recall the condition of the country in
1890 will remember that there was everywhere, among the people generally, a deep feeling of unrest. The Nation had been rid of human slavery -fortunately, as all now feel -- but the conviction was universal that the
country was in real danger from another kind of slavery sought to be fastened on the American people, namely, the slavery that would result from
aggregations of capital in the hands of a few individuals and corporations
controlling, for their own profit and advantage exclusively, the entire business of the country, including the production and sale of the necessaries of
life. Such a danger was thought to be then imminent, and all felt that it
must be met firmly and by such statutory regulations as would adequately
protect the people against oppression and wrong.” While Justice Harlan’s
opinion is both a concurring and dissenting one, his explanation of the need
for the Sherman Act illustrates the basic principle of regulation and antitrust law: that capitalism unrestrained can devolve into harmful monopoly.
Consequently, some trade must be restrained so that the greater part may
remain free. (The complete text of Mr. Justice Harlan’s opinion is at
http://supct.law.cornell.edu/supct/html/historics/USSC_CR_0221_0001_ZX.
html )
2.
Some students are familiar with the government’s case against Microsoft or,
if not with the details, with the fact that the government had filed suit.
When you discuss this case, be sure to point out that many expert witnesses
were called at Microsoft’s trial. And, of course, each side brought its own
economists…some of whom were paid over $1,000 an hour! More seriously,
you can emphasize the tension between combining formerly separate goods
into a product as a monopolizing action (tying agreements) and combining
goods as a form of technological advancement to enhance consumer surplus (product innovation). The Microsoft defense to antitrust charges alluded to the inevitable combining of web browsers into computer operating
system software. Microsoft could be truly enhancing its product but it also
could be using its market power in one market to capture market power in
another, more competitive market. If students are not sympathetic to Microsoft’s argument, ask them if when they buy a car, they also expect to get
tires installed by the manufacturer. Challenge them about this point—aren’t
there independent tire companies? Why is the tire tied to purchase of the
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automobile? If students object that “you need a tire for the car to run,”
quickly ask them if a radio should be tied to the purchase of the car? Why
shouldn’t the purchase of a radio be an independent decision? You don’t
need to take sides with this discussion. Just point out to your students that
arguments aren’t always as clear cut as they might seem initially. Also, after
your lectures on the chapter have concluded, you can ask your students if
they think that the outcome of the Microsoft case was efficient or equitable.
3.
Get your students to go to Federal Register Web site, located at
www.archives.gov/federal_register/the_federal_register/indexes.html. They
(and you) will be amazed at the volume and detail of regulatory activity,
almost all of which has an economic dimension and impact.
There is no free lunch in regulating firms and industries that embody market power. Make the issue of industry regulation intriguing for the students
by emphasizing the following countervailing opportunity costs that arise in
regulating the firms in those industries that are creating a market failure.
Emphasize the tension between the potential for efficiency in production
inherent with a natural monopoly and the inefficiency potential from the
firm exercising its inherent market power. Be sure the students understand
that economies of scale or scope enable the unregulated natural monopoly
to provide products and services at the lowest possible cost, but the lack of
competition also enables the firm to increase producer surplus at the expense of consumer surplus and creates a significant deadweight loss to society.
 Land Mines
1.
To help present the differences between marginal cost pricing and average
cost pricing, draw matching graphs side-by-side. Show students the prices
that will be allowed by regulators. Ask students which regulation is “better.” Be sure to show your students that marginal cost pricing generates an
economic loss even though output is at the competitive level.
2.
A large percentage of students read the Clayton Act as always prohibiting
the activities listed, such as price discrimination or exclusive deals. Ask
your students why airlines and movie theaters can price discriminate even
though it is outlawed by the Clayton Act. Ask them why Coke and McDonald’s are allowed to have an exclusive deal so that only Coke products can
be purchased at McDonald’s while Pepsi and KFC have similar exclusive
deal. The objective is to force the students to understand that the business
practices mentioned in the Clayton Act are illegal only if they substantially
lessen competition or create monopoly. You can state this qualifying phrase
as often as you like but real-life, specific examples are necessary to hammer
the point home!
Chapter 17 . Regulation and Antitrust Law
ANSWERS TO CHECKPOINT EXERCISES
 CHECKPOINT 17.1 Regulation
1a. The firm produces 200,000 cans, which is the quantity at which marginal
cost equals marginal revenue.
1b. The firm sets a price of $0.30 a can, which, as the demand curve shows, is
the maximum price at which consumers are willing to buy the 200,000 cans
produced.
1c. If the monopoly can capture the regulator, the firm gets the regulator to allow it to maximize its economic profits. This outcome occurs when 200,000
cans are produced.
1d. The monopoly’s goal is to produce 200,000 cans. When it is producing
200,000 cans, its price is $0.30 a can. And when 200,000 cans are produced,
the company’s average fixed cost is $0.15 a can and its average variable cost
is equal to its marginal cost, $0.10 a can. So average total cost is $0.25 a can,
which is $0.05 below its price of $0.30 a can. So the maximum excess average total cost the company would claim is $0.05 a can.
1e. Only if the regulated monopoly produces 400,000 cans (where demand
equals marginal cost) does it produce an efficient outcome.
 CHECKPOINT 17.2 Antitrust Law
1.
From the FTC website, BP Amoco PLC and ARCO were required to divest:
(1) all of ARCO’s assets and interests related to and primarily used with or
in connection with ARCO’s Alaska businesses;
(2) all of ARCO’s assets related to its Cushing, Oklahoma crude oil business.
In particular, the FTC said “Proposed Respondents will divest all of
ARCO’s Alaska assets to Phillips Petroleum Company ("Phillips"), an approved up-front buyer. The vast majority of these assets must be divested
to Phillips within 30 days of the signing of the Proposed Consent Order.
Some of the ARCO Alaska assets require third-party or governmental approvals and Proposed Respondents have up to six (6) months to divest
those particular assets. Proposed Respondents will divest the Cushing assets to an acquirer or acquirers that receive the prior approval of the Commission and in a manner approved by the Commission. They must divest
the Cushing assets within four (4) months of signing the Proposed Consent
Order.”
2.
The Standard Oil Company was broken up years ago because the courts believed that it was restraining trade to an unreasonable level. In recent years,
some of these individual firms have merged. These actions are a result of
the market changing. This outcome would be analogous to the government
allowing fragmented portions of the old AT&T to merge. The communica-
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tions market has changed and new types of competitors have developed. In
the petroleum industry, the government has decided that the merged firms
now represent a more efficient operation and that they face sufficient competition to restrain their behavior.
Chapter 17 . Regulation and Antitrust Law
ANSWERS TO CHAPTER CHECKPOINT EXERCISES
1.
The first federal antitrust law, the Sherman Act, was passed in 1890. The
second major law, the Clayton Act, was passed in 1914. Section 1 of the
Sherman Act prohibits “every contract, … or conspiracy in restraint of
trade.” Section 2 makes illegal “attempts to monopolize.” The Clayton Act,
along with its two amendments, the Robinson-Patman Act (1936) and the
Celler-Kefauver Act (1950), prohibit specific business practices “only if
they substantially lessen competition or create monopoly.” The practices
are
 Price discrimination
 Tying arrangements
 Requirements contracts
 Exclusive dealing
 Territorial confinement
 Acquiring a competitor’s shares or assets
 Becoming a director of a competing firm
These practices are outlawed because they lead to an inefficient use of resources. Firms that gain monopoly power restrict their output and boost
their prices, which harms consumers and creates a deadweight loss.
2a. The meetings are definitely illegal under Section 1 of the Sherman Act. The
firms want to fix their prices such that they will earn an economic profit.
2b. The proposed merger is likely illegal under Section 2 of the Sherman Act
and/or the Clayton’s Act prohibition of acquiring a competitor’s shares or
assets. Amazon wants to merge to gain the market power to raise its price
and earn an economic profit.
2c. This is probably legal, especially if the pharmaceutical manufacturer does
not require that the drug stores buy all of its drugs from only the one company. If the manufacturer does impose this requirement, the action might
be prohibited as a requirements contract under the Clayton Act. But even
in this case, it would be illegal only if it substantially lessened competition.
2d. The action is almost certainly legal. It does not run afoul of the Clayton
Act’s prohibition of tying contracts because it seems very unlikely to substantially lessen competition or create monopoly.
2e. The video store is imposing a tying contract. This action is illegal under the
Clayton Act only if it substantially lessens competition or creates monopoly. If there is enough competition in the video rental market, this action
would be legal.
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3.
Figure 17.1 illustrates the case of Hawaii Cable.
4.
Figure 17.2 illustrates the situation when Hawaii Cable is unregulated. Hawaii Cable produces the quantity at which marginal revenue
equals marginal cost, so it serves 20,000 households. The price is $60 a month. The economic
profit, consumer surplus, and deadweight loss
are indicated.
5.
Figure 17.3 illustrates the situation when Hawaii Cable is regulated in the public interest.
Hawaii Cable produces the quantity at which
the marginal cost curve intersects the demand
curve, so it serves 40,000 households. The price
is $20 a month. The consumer surplus is illustrated. There is no deadweight loss. There also
is no economic profit. Hawaii Cable incurs an
economic loss.
Chapter 17 . Regulation and Antitrust Law
6.
Figure 17.4 illustrates the situation when
Hawaii Cable is regulated using a price cap.
The price cap is set at $40 a month. If Hawaii Cable serves 30,000 households and
the price is $40 a month. The consumer surplus and deadweight loss are illustrated.
Because the price cap is set equal to Hawaii
Cable’s average total cost, there is no economic profit. Hawaii Cable earns a normal.
7.
If the price cap for Hawaii Cable is set too
low for the firm to earn normal profit, then
the firm is incurring an economic loss. If the
regulator refuses to raise the price cap, Hawaii Cable would go out of business.
8a. If the firms behave as a cartel, they select the
monopoly quantity, where MR = MC, and set
the monopoly price. Figure 17.5 illustrates
that the monopoly quantity is 30,000 calls a
day and the price is 15¢ a call.
8b. If the firms are regulated in the public interest, they produce the quantity at which the
marginal cost curve intersects the demand
curve. Figure 17.5 illustrates that the quantity is 40,000 calls a day and the price is 13.3¢ a
call.
8c. If the companies capture the regulator, the
output and price is the monopoly output and
price, 30,000 calls a day and a price of 15¢ a
call.
8d. The deadweight loss when the firms capture
the regulator is illustrated in Figure 17.5
9a. Marginal cost pricing leads to resource use being efficient.
9b. Efficient regulation sets the price equal to the marginal cost. Marginal cost
pricing would not lead to the firms incurring an economic loss because the
price, which is determined by where the marginal cost curve intersects the
demand curve, is greater than the average total cost.
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9c. Figure 17.6 illustrates an efficient price cap
regulation The price cap is set at 13.3¢ a call,
the same as with marginal cost pricing. The
number of calls is the efficient quantity,
40,000 calls a day.
9d. Because the regulation is efficient, there is no
deadweight loss.
10. Land Line might be able to drive Cellular City out of business if it sets a low
enough price. But to do so Land Line would incur an economic loss. If Land
Line did manage to drive Cellular City out of business and then Land Line
set the monopoly price and quantity, the economic profit Land Line earns
gives a new competitor the incentive to enter the market. And, if there are
no barriers to entry, Land Line cannot block the entry of a new competitor.
So any economic profit Land Line manages to earn might be very short
lived.
11. The antitrust authorities blocked the merger between PepsiCo and 7-Up
and between Coca-Cola and Dr. Pepper because the authorities believed
that these mergers would significantly lessen competition in the market for
soft drinks. Based on the pre-merger HHI, the market before any of the
mergers occurred already was concentrated. These mergers would make
the market even more concentrated and less competitive, so the antitrust
authorities, behaving in the public interest, blocked the mergers.
12a. OPEC would definitely be in violation of Section 1 of the Sherman Act because OPEC is fixing the price of petroleum and seeking to restrict trade.
12b. If OPEC was made to behave competitively, the price of oil would tumble.
The quantity would increase and consumer surplus would increase. The
deadweight loss would decrease. OPEC’s producer surplus would decrease.
13a. If Land Line and Cellular City merge, they would become a monopoly. The
price of a local call would rise and the quantity would decrease.
Chapter 17 . Regulation and Antitrust Law
13b. Once Land Line and Cellular City are a monopoly, the higher price and
decreased quantity decreases consumer surplus, increases producer surplus, and creates a deadweight loss.
13c. The antitrust authorities would move to block this merger because it
would create a monopoly.
14a. The merger is not in the public interest. The merged firm, Super Burger
Chain, would eliminate competition in the fast food market. It would have
significant market power, would raise the price of a burger, and would result in an inefficient use of resources.
14b. The price of a burger would rise. The Super Burger Chain would have a
large share of the market for fast food hamburgers and would be able to
use its market power to raise the price of a burger.
14c. Consumer surplus would decrease, producer surplus would increase, and
a deadweight loss would be created.
14d. The antitrust authorities would block the merger because it would raise the
HHI well beyond the threshold necessary for them to take action.
14e. The merger is in the interest of the firms because the Super Burger Chain
would limit competition and have significant market power. Almost certainly Super Burger Chain would be able to raise the price of a fast food
hamburger and earn an economic profit.
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 Critical Thinking
15a. Your students’ answers will vary. One issue they might discuss concerns
the point that there would be a massive public outcry if the government
tries to regulate the Internet. In addition, it is not obvious that price and
quantity regulation are needed for the Internet because, at least currently,
the Internet appears competitive with relatively easy entry into many aspects of it. However, if a few firms such as AOL or Google grow extremely
large the government in the future might consider some sort of economic
regulation.
15b. Again, your students’ answers will vary. Some points they might mention
include the fact that there are many special interest groups strongly opposed to taxing e-commerce, such as firms engaged in e-commerce and
consumers who are heavy buyers of products sold by e-commerce. In addition, imposing the tax would be difficult, at least at the state level. If one
state moved to tax e-commerce sales from firms located within that state,
the firm could easily move to another state.
15c. Your students’ answers will vary. But there seem to be no specially difficult aspects of antitrust law when it comes to the Internet.
15d. Your students’ answers will vary. But there do not seem to be an immense
number of new antitrust issues created by the Internet. Attempts to monopolize are as difficult as always to prove. And the Clayton Act prohibition of acquiring a competing firm if it substantially lessens competition also remains difficult to prove.
16a. Your students’ answers will vary. Those students who believe that Microsoft attempted to monopolize the market will assert that Microsoft used
predatory pricing and tying agreements to drive out competitors, such as
Netscape and IBM. Those students who disagree will assert that Microsoft
was being innovative and through this innovation kept prices low for consumers.
16b. Your students’ answers will vary. Those who agree that Microsoft engaged
in predatory pricing will point to the zero price of Internet Explorer and
then suggest that if Microsoft had been allowed to keep Internet Explorer a
separate piece of software that the price would be significantly higher
now. Those who disagree will point to the fact that Internet Explorer is
now bundled with Windows and will assert that its price remains zero.
16c. Your students’ answers will vary. Those who agree that Microsoft engaged
in an illegal tying arrangement will assert that there is no natural reason
for bundling Internet Explorer with Windows. For instance, they might
point out that Word is not bundled with Windows because similarly, there
is no natural reason for including the two pieces of software together.
Those who disagree will assert that a browser is needed for an operating
Chapter 17 . Regulation and Antitrust Law
system to be complete. They might use an analogy, for instance, a battery
is included when a car is purchased because without the battery the car
would not operate.
16d. Your students answers will vary. Those who think that code sharing will
lead to efficiency will assert that the code sharing will keep the market
competitive. Those who disagree might suggest that Microsoft will come
up with new ways to hinder its competition and retain significant market
power.
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 Web Exercises
17a. Intel is probably not a natural monopoly.
17b. From the Web site, in 1998 “The FTC alleged that Intel illegally used its
market power when it denied three of its customers continuing access to
technical information necessary to develop computer systems based on Intel microprocessors, and took other steps to punish them for refusing to license key patents on Intel’s terms. … Over the years, Intel has promoted
and marketed its microprocessors by providing customers with technical
information in advance of the official commercial release of new microprocessor products. This makes it possible for computer makers to have computers based on new Intel microprocessors ready to sell at the time of the
official commercial release of the microprocessors, or shortly afterwards.
… This is part of the mutually beneficial relationship between Intel and its
customers. Intel benefits because its customers—computer systems manufacturers—commit resources to designing new computer products that incorporate the new Intel microprocessors. The customers benefit because
they are able to introduce “leading edge” computer products with the latest microprocessor technology on a timely basis, the complaint states. The
FTC alleged that on at least three occasions, Intel has terminated or threatened to terminate its mutually beneficial relationships in a selective, targeted fashion to retaliate against the firms that sought to protect or assert
patent rights in rival microprocessor technologies or that refused to license
such rights to Intel. This retaliation has primarily taken the form of cutting
off access to technical information needed to design computer systems
based on soon-to-be-released Intel microprocessors. By its actions, Intel
sought to injure the customer until that customer surrendered the patent
licenses Intel desired.”
17c. Intel agreed to make its chips more widely available and to allow other
companies to enforce their patents. This agreement will increase the quantity of chips, lower the price, and increase consumer surplus.
17d. Intel’s agreement should increase the quantity of chips and lower the price.
It should increase consumer surplus and decrease producer surplus.
18a. Before 1996, electric utilities in California were regulated as they had been
for many previous years. Prices were set by the state and the companies
owned their own generating plants as well as their transmission and distribution networks.
18b. The 1996 deregulation required that the transmission lines be transferred
to a non-profit organization, the Independent System Operator. Utilities
continued to own the distribution networks but they were required to sell
their generating plants to independent, unregulated private firms. As a result, the wholesale price of electricity was deregulated, though the retail
Chapter 17 . Regulation and Antitrust Law
price remained regulated by the state. Further, the utilities were not allowed to sign long-term contracts with the private power producers. Rather the utilities were required to buy power each day.
18c. The retail price of electricity has remained regulated; the electric utility
companies have not been allowed to sign long-term contracts with private
power producers; the electric utilities have not been allowed to own their
own generating plants.
18d. When the equilibrium price exceeds the price cap, the price cap becomes
binding. The quantity of electricity generated and offered for sale is less
with the price cap than if the price were allowed to reach its equilibrium.
Shortages of electricity are the result.
18e. If the state had used an earnings-sharing plan, at first consumers would
have benefited because initially the policy created profits for the electricity
utility companies. But after 2000 consumers would have been hit by rapidly rising prices. Quite likely there would be fewer rolling blackouts, but the
price of electricity would be higher.
19a. Your students’ answers will vary because there are literally hundreds of
different cases.
19b. Your students’ answers will vary, depending on the case they select. For
instance, in U.S. v Greyhound Lines, Inc. Greyhound was alleged to violate
Section 1 of the Sherman Act because Greyhound prohibited local bus
companies from selling tickets for intercity bus transportation via other
companies within a 25-mile radius of Greyhound’s terminals. It was alleged that the effect of this provision was to restrict competition in the
provision of intercity bus transportation service.
19c. The price of intercity bus travel rose and the quantity of intercity bus travel
decreased. Consumer surplus decreased, producer surplus increased, and
a deadweight loss was created.
19d. The outcome was that Greyhound agreed to eliminate this practice.
19e. The price of intercity bus travel fell and the quantity of intercity bus travel
increased. Consumer surplus increased, producer surplus decreased, and
the deadweight loss decreased.
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Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
ADDITIONAL EXERCISES FOR ASSIGNMENT
 Questions
 CHECKPOINT 17.1 Regulation
1. An unregulated natural monopoly cans
Mount Peak air, unique clean air that has no
substitutes. The monopoly's total fixed cost
is $120,000, and its marginal cost is 20 cents a
can. Figure 17.7 illustrates the demand for
Mount Peak air.
1a. How many cans of Mount Peak air does the
monopoly sell?
1b. What is the price of a can of Mount Peak air?
1c. If the monopoly captures the regulator, how
might the monopoly be regulated?
1d. If the monopoly can mislead the regulator
about its costs, what is the maximum excess
average total cost that it would claim?
1e. Would the regulated monopoly use resources efficiently?
 CHECKPOINT 17.2 Antitrust Law
1. Two recently proposed mergers were WorldCom and MCI and Alcoa and
Reynolds Aluminum. The WorldCom/MCI merger would have raised the
Herfindahl-Hirschman Index (HHI) from 1,850 to 3,000 and the Alcoa/Reynolds Aluminum merger would have raised the HHI from 1,270 to
1,800. What do you think the Department of Justice’s stance was on these
mergers?
 Answers
 CHECKPOINT 17.1 Regulation
1a. The firm will produce 400,000 cans, which is the quantity at which marginal
cost equals marginal revenue.
1b. The firm sets the price at $0.60 a can, which, as the demand curve shows, is
the maximum price for which consumers are willing to buy the 400,000
cans produced.
1c. If the monopoly can capture the regulator, the firm gets the regulator to allow it to maximize economic profit. This outcome occurs when 400,000 cans
a day are produced.
1d. The monopoly’s goal is to produce 400,000 cans. When it is producing
400,000 cans, its price is $0.60 a can. Now, when 400,000 cans are produced,
Chapter 17 . Regulation and Antitrust Law
the company’s average fixed cost is $0.30 a can and its average variable cost
is equal to its marginal cost, $0.20 a can. So the true average total cost is
$0.50 a can, and the maximum excess average total cost the company would
claim is an additional $0.10 a can.
1e. Only if the regulated monopoly produces 800,000 cans a day—the quantity
at which the demand curve and the marginal cost curve intersect—does it
produce an efficient outcome.

1.
CHECKPOINT 17.2 Antitrust Law
The Department of Justice challenged both mergers. The outcome was that
neither merger occurred. When the HHI is between 1,000 and 1,800, a merger in this market that would increase the index by 100 points is challenged
by the Department of Justice. And when the HHI is above 1,800, a merger
in this market that would increase the index by 50 points is challenged.
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Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE
USING EYE ON THE U.S. ECONOMY
 Airline Deregulation
Complaints about flying are so commonplace today that they are hardly worth
mentioning. Frequent fliers and even infrequent fliers decry the crowds and the
delays. Ask your students about their complaints—is flying “fun”? Once you
solicit a number of complaints, you can point out that these complaints actually
point out the success of airline deregulation. Ask your students to recall any
movies or film clips they have seen that feature people flying in the 1950s. At that
time, flying was so expensive and so few people flew that travelers dressed up
when they flew. Men wore suits and women formal dresses. Nowadays, of
course, tank tops, t-shirts, and shirts are common. Why the difference? Of course
the answer is that today travel by airline is so inexpensive millions of people fly
every week. As the data in the Eye’s figure shows, airline deregulation has
helped lessen the price of flying. Since 1985, there has been a general downward
trend in the price of flying. And, of course, there has been a massive upward
trend in the number of miles flown. In terms of supply and demand, the demand
has increased (with higher incomes and probably an increased preference to fly
because of improvements in the safety record) and because of deregulation, supply has increased even more. You can point out to your students that without
airline deregulation, there would be fewer complaints of overcrowding…but
even far fewer people flying. You can discuss with your students whether they
prefer being able to afford to fly frequently, even with the overcrowding, or being able to fly either infrequently or perhaps not at all.
 Regulatory Roller Coaster
This story clearly shows how markets change and cause regulators to view competition and efficient outcomes differently over time. You can have students discuss why prices have risen. Is it lack of regulation or demand for more channels?
What kind of innovations can produce effective competition for cable firms?
Why haven’t satellite dish systems produced this kind of competition?