Download The Economic Way of Thinking 10e ©Prentice Hall 2003

“The Economic Way of Thinking”
10th Edition
by Paul Heyne, Peter Boettke,
and David Prychitko
“Competition and
Government Policy”
PowerPoint Slides prepared by
Assistant Professor
Paul Harris
Camden County College
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The Economic Way of Thinking 10e
©Prentice Hall 2003
Chapter Outline
I.
II.
III.
IV.
Introduction
The Pressures of Competition
Controlling Competition
The Ambivalence of Government
Policies
V. Selling Below Cost
VI. What is the Appropriate Cost?
VII. “Predators” and Competition
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The Economic Way of Thinking 10e
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Chapter Outline
VIII. Regulating Prices
IX. “Antitrust” Policy
X. Interpretations and Applications
XI. Vertical Restraints: Competitive or
Anticompetitive
XII. The Range of Opinion
XIII. Toward Evaluation
XIV. Once over Lightly
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Introduction
Questions
Will economic competition disappear
unless the government has an active
program to preserve it?
When the government prohibits mergers,
is it preventing competitors from
eliminating rivals?
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Introduction
Questions
When sellers face so little competition
that they can charge prices far above
cost, can government protect consumers
from exploitation by regulating prices?
How is competition measured in an
industry?
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The Pressures of Competition
• Price > Marginal Cost
– Sellers facing downward sloping demand
curves
• Invites Competition
• Example
– Piece of pie costs 50 cents to produce.
– Seller sells the pie for $1.50.
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The Pressures of Competition
P
$1.50
D
Price
Temptation!
.50
Marginal cost
Q
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The Pressures of Competition
Question
What will the cafes around town begin
to do to attract customers?
Sellers
Probe for information on the demand for
their product
Try to stimulate demand by advertising
and providing reliable service
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The Pressures of Competition
Question
What will the cafes around town begin
to do to attract customers?
The best price for anyone
Sellers to set next may depend on
Probe forthe
information
on the demand for
price set last.
their product
Try to stimulate demand by advertising
and providing reliable service
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The Pressures of Competition
P
Demand curve
as seller
perceives it
D
Q
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Controlling Competition
Question
Why don’t sellers agree not to compete?
High Transaction Costs
Collusion is illegal.
Difficult to devise agreement.
Collusion may attract other firms.
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Controlling Competition
Question
Cartel’s
Problems……
Why
don’t Two
sellers
agree not to compete?
1. PreventCosts
members from
High Transaction
competing
Collusion is illegal.
2. Prevent new firms from
Difficultentering
to devise agreement.
Collusion may attract other firms.
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The Pressures of Competition
• Question
– Are there legal ways to restrict
competition?
• Examples
– Washington, D.C. Medical Society
– Plumbers
– Woolen Makers
– Barbers
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The Ambivalence of
Government Policies
• Question
– Should the government be relied on to
preserve competition in the economy?
• Explain
– Concern for competition is not the same
as concern for competitors.
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The Ambivalence of
Government Policies
A law that restricts competitors
restricts competition.
Common justification for such
laws is that they preserve
competition by preventing
“predatory” practices.
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Selling Below Cost
• Question
– Should there be laws that prevent
firms from selling below cost?
• Many states have such laws.
• Question
– Why would some business firms be in
favor of such a law?
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Selling Below Cost
• Public View
– Price cutting may lead to
monopolies.
• Question
– Is this bad?
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What is the
Appropriate Cost?
• Problem
– How to determine the cost below which
prices cannot be set.
• Question
– Once an item is bought, isn’t it a sunk cost?
• Question
– What should a firm do if they cannot sell
their product before it spoils?
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What is the
Appropriate Cost?`
Marginal costs should be considered.
Business people are concerned with:
Additional revenues resulting from a
decision.
Additional costs from the same decision.
Question
When would a grocer want to sell a
newspaper below cost?
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“Predators” and Competition
Protecting competitors is not the same as
preserving competition.
Predatory Pricing
Reducing prices below cost in order to drive
out rivals
Intend to raise prices afterward to recoup
losses
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“Predators” and Competition
Question
How long will it take for such a policy to work?
The longer it takes the larger will be the short
term losses.
Question
Is it likely that the predatory firm will will be
able to destroy enough of its rivals to secure the
degree of market power it must have to earn
enough long run profits to justify short term
losses?
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Regulating Prices
Questions
How are prices set for firms that
are investor owned?
How will regulators determine
the costs of running the
enterprise?
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Regulating Prices
• Prices should be set to enable firms
to earn a normal profit.
• Question
– But what are the costs?
• Innovation
• Cost control
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Regulating Prices
Question
Who will regulate the regulators?
Capture Theory
Regulators tend to acquire an
interest in the well-being of the
industry.
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Regulating Prices
• Examples
– Banking
– Airlines
– Telephone
• Problem
– Is competition unable to constrain the
behaviors of the firms in the regulated
industry?
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Regulating Prices
The movement towards deregulation of
the past two decades has not settled all
the issues.
History
There are more margins on which
competition can occur
Competition has some advantages
over commissions
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“Antitrust” Policy
Laws have been passed to promote
competition.
Federal
State
Local
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“Antitrust” Policy
Sherman Antitrust Act -- 1890
Forbids all contracts,
combinations, or conspiracies
in restraint of interstate trade
and all attempts to monopolize
any part of interstate trade
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Interpretations
and Applications
Clayton Act -- 1914
Made illegal mergers that
“substantially” lessen
competition
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Interpretations
and Applications
• Federal Trade Commission
Act
– Created Federal Trade
Commission
• Prohibited “unfair”
practices
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Interpretations
and Applications
• Question
– When does a merger substantially
lessen competition?
• Horizontal
• Conglomerate
• Vertical
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Interpretations
and Applications
• Question
– What is an illegal trade practice?
• Summary
– Restriction on competitors will restrict their
ability to compete.
– We must decide when we want the government to
restrict a firm’s competitive efforts.
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Vertical Restraints: Competitive
or Anticompetitive
Vertical restraints have been
controversial.
1937 - 1976
Federal legislation exempted stateendorsed price-fixing agreements
between manufacturers and
retailers.
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Vertical Restraints: Competitive
or Anticompetitive
• Questions
– Why would a manufacturer want
retailers to charge more and sell
less?
– Why would a manufacturer want
fewer retailers selling its products?
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The Range of Opinion
• Question
– Is the whole body of “antitrust” law perhaps
more of a hindrance than a help to
competition?
• Opinions
– Retain the Sherman Act and the anti-merger
provisions of the Clayton Act only.
– The Sherman and Clayton acts, in their
entirety, have made important contributions.
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The Range of Opinion
Opinions
They would be improved if they
were more seriously enforced.
They are both harmless rhetoric.
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Toward Evaluation
Competitive restrictions reduce the
availability of substitutes and allow
sellers to increase their own wealth.
Competition is a process, not a state of
affairs.
An inadequate situation must be
compared with more desirable situations
that are attainable.
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Once Over Lightly
 A gap between the
price of a good and
the marginal cost of
making it available
is a source of
potential advantage
to someone.
 Competition occurs
in the economy as
people locate such
differentials, and
exploit them.
 There are usually so
many forms of
competition that it is
difficult to anticipate
and head them all
off.
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The Economic Way of Thinking 10e
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Once Over Lightly
 Firms try to obtain
Government
assistance in
excluding
competition.
Government
regulation of
pricing and other
business practices
has often blocked
the development
of competition
that might
otherwise arisen.
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The Economic Way of Thinking 10e
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Once Over Lightly
 Competition is a
process in which
competitors engage.
 We cannot have
competition without
competitors.
We cannot have
competition if we
legally prohibit
competitors from
taking actions
intended to
increase their
share of the
market.
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The Economic Way of Thinking 10e
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Next,
Chapter 12
“The
Distribution
of Income”.
End of Chapter 11
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The Economic Way of Thinking 10e
©Prentice Hall 2003