Download Chapter 15

Chapter 15
Economic Regulation and
Antitrust Policy
© 2006 Thomson/South-Western
1
Government Regulation
Three kinds of government policies designed to alter
or control firm behavior
Social regulation
Consists of measures designed to improve health and
safety
Economic regulation
Controls the price, the output, the entry of new firms,
and the quality of service in industries in which
monopoly appears inevitable  natural monopolies
Antitrust activity
Attempts to prohibit firm behavior that tries to
monopolize markets
2
Price Equal to Marginal Cost
The government can subsidize the firm so it
earns a normal profit
Drawback is that to provide the subsidy the
government must raise taxes or forgo public
spending in some other area – there is an
opportunity cost to the subsidy approach
3
Regulating a Natural Monopoly
Setting price
equal to average
cost provides a
normal profit for
a monopolist.
This occurs at
point h
Monopolist can
stay in business
without a subsidy
4
Regulatory Dilemma
Regulators usually face a fuzzier picture of
things
Demand and cost curves can only be estimated
and the regulated firm may not always be
completely forthcoming with this information
For example, a utility may overstate its costs so
it can charge a higher price and earn more than
a normal profit
5
Alternative Theories
One view is that economic regulation
is in the public interest
Competing view is that economic
regulation is not in the public interest,
but rather in the special interest of
producers
6
Antitrust Law and Enforcement
Attempts to curb the normal anticompetitive
tendencies by:
 Promoting
the sort of market structure that will
lead to greater competition
Reducing anticompetitive behavior
Promoting socially desirable market
performance
7
Sherman Antitrust Act of 1890
Prohibited the creation of trusts and
monopolization
Its vague language failed to define what
constituted such activities and hampered
its enforcement
8
Clayton Act of 1914
Prohibits
Price discrimination
Tying contracts
Exclusive dealing
Interlocking directorates
Mergers
9
Other Acts
 Federal Trade Commission Act of 1914

a federal body was established to help enforce antitrust
laws
 Celler-Kefauver Anti-Merger Act passed in 1950

prevents one firm from buying the assets of another firm
if the effect is to reduce competition
 Horizontal mergers  the merging of firms that produce
the same product
 Vertical mergers  the merging of firms where one
supplies inputs to the other or demand output from the
other
10
Per Se Illegal
 The courts have interpreted antitrust laws in
essentially two ways
 One set of practices has been declared per se illegal
 Another set of practices falls under the rule of reason
 Per se illegal: illegal regardless of the economic
rationale or consequences
 Government need only show that the offending practice
took place  need only examine the firm’s behavior
11
Rule of Reason
 Set forth in 1911 when the Supreme Court held
that Standard Oil had illegally monopolized the
petroleum refining industry and engaged in
predatory pricing

Predatory pricing is the practice of temporarily selling
below marginal cost or dropping the price only in certain
markets in the hope of driving rivals out of business
 Court focused on both the company’s behavior and
the market structure that resulted from that
behavior
12
Mergers and Public Policy
The measure of sales concentration used
is the Herfindahl index
 found
by squaring the percent market share
of each firm in the market and then
summing those squares
For example, if the industry consists of
100 firms of equal size, the index is 100
[(100 x (1)2]
13
HHI Based on Market Share in
Three Industries
14
Mergers and Public Policy
The Justice Department sorts all mergers into two
categories:
Horizontal mergers
Nonhorizontal mergers
Any merger in an industry where two conditions
are met is challenged:
The post-merger Herfindahl index would exceed 1800
The merger would increase the index by more than 100
points
15
Merger Waves
16
Competitive Trends
Shepherd sorted industries into four groups:
Pure monopoly: a single firm controlled the
entire market and was able to block entry
Dominant firm: a single firm had over half the
market share and had no close real rival
Tight oligopoly: the top four firms supplied more
than 60 percent of market output, with stable
market shares and evidence of cooperation
Effective competition: firms in the industry
exhibited low concentration, low entry barriers,
and little or no collusion
17
Competitive Trends
Increase in competitiveness of economy
stems from:
Growth in imports accounted for one-sixth of
the overall increase in competition
Deregulation accounted for one-fifth of the
increase in competition
Antitrust activity accounted for two-fifths of
the growth in competition
18
Exhibit 4: Competitive Trends in the U.S.
Economy
19
Problems with Antitrust Legislation
Too much emphasis on the competitive model
Joseph Schumpeter argued half a century ago that
competition should be viewed as a dynamic process,
one of creative destruction
Firms may grow large because they are more
efficient than rivals at offering what the consumers
want  firm size should not be the primary concern
Market experiments have shown that most of the
desirable properties of perfect competition can be
achieved with a relatively small number of firms
20
Problems with Antitrust Legislation
Abuse of antitrust
Parties that can show injury from firms
violating antitrust laws can sue the offending
company and recover treble damages
Growing importance of international
markets
A standard approach to measuring the market
power of a firm is its share of the market
With growth of international trade, local – or
even national – market share becomes less
relevant
21