Download 17.2 antitrust law

Regulation and
Antitrust Law
CHAPTER
17
CHAPTER CHECKLIST
When you have completed your study of this
chapter, you will be able to
1
Explain the effects of regulation of natural monopoly
and oligopoly.
2
Describe U.S. antitrust law and explain three
antitrust policy debates.
17.1 REGULATION
Regulation
Rules administered by a government agency to
influence economic activity by determining prices,
product standards and types, and the conditions under
which new firms can enter an industry.
17.1 REGULATION
The Changing Scope of Regulation
1877—Interstate Commerce Commission (ICC)
1930s—agencies established to regulate power,
communications, securities, banking, and more
1970s—agencies to regulate copyrights and energy
1980s and 1990s—deregulation
Deregulation is the process of removing restrictions on
prices, product standards, and entry conditions.
17.1 REGULATION
 The Regulatory Process
Governments appoint regulators and provide them with
an operating budget.
Agencies develop rules and practices based on
accounting procedures.
Rules are typically complex and hard to administer.
17.1 REGULATION
 Economic Theory of Regulation
Two broad economic theories of regulation are:
• Public interest theory
• Capture theory
17.1 REGULATION
Public Interest Theory
The public interest theory is that regulation seeks
an efficient use of resources.
Capture Theory
Capture theory is that regulated firm captures the
regulator and makes a monopoly profit.
17.1 REGULATION
Natural Monopoly
A natural monopoly is an industry in which one firm can
supply the entire market at a lower price than can two or
more firms.
17.1 REGULATION
Public Interest or Private Interest Regulation?
According to public interest theory, regulation achieves
an efficient use of resources, which occurs if marginal
cost equals marginal benefit (and price).
Marginal cost pricing rule
A rule that sets price equal to marginal cost to achieve an
efficient output in a regulated industry.
Figure 17.1 on the next slide illustrates this rule.
17.1 REGULATION
1. Price is set equal to marginal
cost of $10 a month.
2. At this price, the efficient quantity
(8 million households) is served.
3. Consumer surplus, shown by the
green triangle, is maximized.
4. The firm incurs a loss on each
household served, shown by the
red arrow.
17.1 REGULATION
Average cost pricing rule
A rule that sets price equal to average total cost to
enable a regulated firm to cover its costs.
Figure 17.2 on the next slide shows a natural monopoly
that is regulated by an average cost pricing rule.
17.1 REGULATION
1. Price is set equal to
average total cost of $15
a month.
2. At this price, less than the
efficient quantity (6 million
households) is served.
3. Consumer surplus shrinks
to the smaller green
triangle.
17.1 REGULATION
4. A producer surplus
enables the firm to pay its
fixed cost and break even.
5. A dead-weight loss,
shown by the gray
triangle, arises.
17.1 REGULATION
Rate of Return Regulation
Under rate of return regulation, a regulated firm must
set its price at a level that enables it to earn a specified
target percent return on its capital.
If the regulator could observe the firm’s true costs and
be sure that the firm was minimizing cost, this type of
regulation would be like average cost pricing.
But a firm might mislead the regulator and get close to
maximum monopoly profit under this regulation.
17.1 REGULATION
Price Cap Regulation
A price cap regulation is a price ceiling—a rule that
specifies the highest price the firm is permitted to
charge.
A price cap regulation can be combined with earnings
sharing regulation—a regulation that requires a firm to
make refunds to customers if its profit rises above a
target rate.
Figure 17.3 shows how price cap regulation works.
17.1 REGULATION
1. With no regulation, the
firm maximizes profit by
producing the quantity at
which MC = MR.
2. With a price cap,
3. The price cap outcome is
at the intersection of the
demand curve and the
price cap.
4. The price falls and output
increases.
17.1 REGULATION
 Oligopoly Regulation
Firms have an incentive to form a cartel.
Cartels are illegal in the United States.
Oligopoly might be regulated to achieve a competitive
outcome (public interest) or maximum profit (capture).
Figure 17.4 on the next slide shows these possible
outcomes.
17.1 REGULATION
1. Public interest regulation will
achieve the efficient
competitive outcome: a price of
$20 a trip and 300 trips a week.
2. Regulation in the producers’
interest will limit output to 200
trips a week (where industry
marginal revenue, MR, is equal
to industry marginal cost, MC),
and the price will be $30 a trip.
17.2 ANTITRUST LAW
Antitrust law
The body of law that regulates and prohibits certain
kinds of market behavior, such as monopoly and
monopolistic practices.
 Antitrust Laws
The first antitrust law, the Sherman Act, passed in 1890.
The Clayton Act of 1914 supplemented the Sherman
Act.
17.2 ANTITRUST LAW
17.2 ANTITRUST LAW
17.2 ANTITRUST LAW
 Three Antitrust Policy Debates
Price fixing is illegal and uncontroversial.
Some other practices generate debate. Three of them
are
• Resale price maintenance
• Tying arrangements
• Predatory pricing
17.2 ANTITRUST LAW
Resale Price Maintenance
Resale price maintenance is an agreement between a
manufacturer and a distributor on the price at which a
product will be resold.
Resale price maintenance agreements (called vertical
price fixing) are illegal under the Sherman Act.
But it is not illegal for a firm to refuse to supply a retailer
who won’t accept the manufacturer’s guidance on what
the price should be.
17.2 ANTITRUST LAW
Resale price maintenance is inefficient if it enables a
manufacturer and dealers to operate a cartel and
charge the monopoly price.
Resale price maintenance can be efficient if it permits
retailers to provide an efficient level of service in selling
a product.
17.2 ANTITRUST LAW
Tying Arrangements
A tying arrangement is an agreement to sell one
product only if the buyer agrees to also buy another
different product.
Example: textbook plus Web site bundle
It is sometimes possible to use tying as a way of price
discriminating.
17.2 ANTITRUST LAW
Predatory pricing
Predatory pricing is setting a low price to drive
competitors out of business with the intention of setting a
monopoly price when the competition has gone.
If a firm engaged in this practice, it would incur a loss
while its price were low.
The firm would gain only if the high monopoly price didn’t
induce entry.
Most economists say that predatory pricing is unprofitable
and doesn’t occur.
17.2 ANTITRUST LAW
A Recent Antitrust Showcase: The United
States Versus Microsoft
The Case Against Microsoft
The Department of Justice claimed that Microsoft:
• Possesses monopoly power in the market for PC
operating systems.
• Uses predatory pricing and tying agreements to
achieve monopoly in the market for Web browsers.
• Uses other anticompetitive practices to strengthen
its monopoly in these two markets.
17.2 ANTITRUST LAW
Microsoft’s Response
• Microsoft challenged all claims.
• It said that Windows competes with Macintosh.
• Windows dominates because it is the best product.
• Internet Explorer with Windows 98 provides a
product of greater consumer value.
• The browser and operating system is one product.
17.2 ANTITRUST LAW
The Outcome
The court rules that Microsoft was in violation of the
Sherman Act and ordered that the company be broken
into two firms:
• One that produces operating systems
• One that produces applications
Microsoft successfully appealed this order.
In its final judgment, the court ordered Microsoft to
reveal details of its code to other software developers.
17.2 ANTITRUST LAW
 Merger Rules
The Department of Justice uses guidelines to determine
which mergers it will examine and possibly block in the
bases of the Herfindahl-Hirschman index (HHI).
• An index between 1,000 and 1,800 indicates a
moderately concentrated market, and a merger
that would increase the index by 100 points is
challenged by the Department of Justice.
17.2 ANTITRUST LAW
• An index above 1,800 indicates a concentrated
market and a merger that would increase the index
by 50 points is challenged.
Figure 17.5 on the next slide summarizes these
guidelines and shows how its was applied to block
some mergers of well-known brand names during the
1980s.
17.2 ANTITRUST LAW
Regulation in YOUR Life
Regulation and deregulation touch your life at many points.
Pay attention as you go about your everyday affairs and
think about the regulation that you encounter.
You wake up to an alarm clock that uses regulated
electricity.
You turn on the regulated cable news channel.
You go to school on a regulated commuter train.
You use a lap top that runs Windows produced by a firm
that has been pulled through the courts.
It’s hard to get away from regulation and antitrust laws.
Regulation in YOUR Life
Think hard about who benefits from regulation and who
bears the cost of the regulation.
Do we really need all the regulation we’ve got?
Do we need more regulation in some areas?