Chapter 13

Chapter 13Antitrust, Regulation, and Deregulation1The Governments Role in Promoting EfficiencyWhat is the role of government in promoting economic efficiency when there is market failure (the unregulated market is inefficient).Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-22Why the Government Might InterveneThree main reasons why the government would intervene in a market:To promote productive efficiencyResources are employed at the lowest cost.To promote innovationCreation and application of new technologyTo promote allocative efficiencyResources are distributed in the way that society values most.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-33Why the Government Might Intervene (contd)Most economists agree that the best way to achieve efficiency and promote innovation is through competition.However, competitive markets do not always arise naturally, and may even be undesirable in some cases. (market failure)Too few competitors / barriers to entryExternalities (costs/benefits not price in market)Assymetric informationCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-44Natural and Optimal Market Structures The natural structure of a market is the degree of competition that would occur in the absence of government intervention.The optimal structure of a market is the degree of competition that maximizes allocative efficiency.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-55Natural and Optimal Market Structures (contd) The government will tend to intervene if the natural structure differs significantly from the optimal structure.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-66The Perfect Competition BenchmarkThe efficiency of a market is measured by comparing the existing price and output to the price and output that would result from marginal cost pricing in a perfectly competitive market.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-77Figure 13.1 Consumer and Producer Surplus With Competitive and Monopoly PricingCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-8

83 Major Pieces of Legislation to address Anti-Competitive MarketsSherman Anti-trust Act (1890)Anti-competitive behavior, mergersClayton Act (1914)Price discrimination (simple)Tie-in salesRobinson-Putman (1936)More detailed/complex definition of price discriminationCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-9Sherman Anti-Trust ActDivided into three sections. Sec 1 delineates and prohibits specific means of anticompetitive conduct, (e.g., contracts/agreements)Sec 2 deals with end results that are anticompetitive in nature. (actual pricing tactics, or non-compete)Sec 3 simply extends the provisions of Section 1 to U.S. territories and the District of Columbia.

Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-10Sherman Anti-Trust ActSection 1: "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal."[13] Section 2: "Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony [. . . ]"[14Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-11The Sherman Antitrust Act of 1890 (contd)Under the Sherman Act, courts may:Break monopolies up into smaller firmsDivestiture divest the company of its smaller firms1980 AT&T break-upProhibit certain business practicesPredatory pricing: P < min ATC to drive competitors outSupposedly Standard Oil in the 30sPrice fixing: setting P > MC and agreeing not to competeEastern/American AirlinesNot compete: geographic/product linesImpose fines on firmsCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-1212The Clayton Act of 1914The Clayton Act prohibits:Price discrimination that reduces competitionProduct tie-insRequired purchase of another more elastic good to be able to purchase monopoly goodIBM and computer cardsThe purchase of stock issued by competing companiesServing on the board of directors of a competing companyCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-1313The Clayton Act of 1914 (contd)Established treble damagesPlaintiffs can recover three times the actual damage.Exempted labor unions from antitrust lawCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-1414The Federal Trade Commission Act of 1914Created the Federal Trade Commission (FTC), the agency that identifies and pursues antitrust casesDepartment of Justice (DOJ), agency for attorneys that prosecute the casesCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-1515The Robinson-Patman Act of 1936Clarified the definition of price discriminationdiscrimination in price;on at least 2 consummated sales;from the same seller;to 2 different purchasers;of "commodities" of like grade and quality;the effect may be "substantially to lessen competition or tend to create a monopoly in any line of commerce."

Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-1616Enforcement of Antitrust PolicyThe Department of Justice (DOJ) and the Federal Trade Commission (FTC) have the power to sue firms in order to:Force violators to stop anticompetitive practicesBreak up existing firms into smaller onesPrevent the formation of very large firmsImpose fines on firms that violate antitrust legislation Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-1717Changes in EnforcementSince the Sherman Act of 1890, enforcement of antitrust legislation has become less stringent.Technological change and globalization have lead to increased competition. (contestable markets)Telecomm wireless and landlinesMusic record manufacturers and ITunesCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-1818MergersIn addition to enforcing antitrust laws, the FTC may try to block or alter a merger.A merger occurs when two firms combine to form a single firm.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-191920How do we tell?Market concentration refers to the size and distribution of firm market shares and the number of firms in the market.Economists use two measures of industry concentration:Four-firm Concentration Ratio The Herfindahl-Hirschman Index2021Attempts to Measure Market Concentrationfour-firm concentration ratio is often utilized to characterize/determine whether a market is an oligopoly. market share of the four largest firms in an industryHerfindahl index, also known as Herfindahl-Hirschman Index or HHI,widely applied in competition law and antitrust. sum of the squares of the market shares of each individual firm.Decreases in the Herfindahl index generally indicate a loss of pricing power and an increase in competition, whereas increases imply the opposite.22Four-Firm Concentration RatioThe four-firm concentration ratio (CR4) measures market concentration by adding the market shares of the four largest firms in an industry.If CR4 > 60, then the market is likely to be oligopolistic. 2223ExampleFirmMarket ShareNike62%New Balance15.5%Asics10%Adidas4.3%

2324Figure 12.11 Four-Firm Concentration Ratio (CR4) for Selected Industries in 1997

2425The Herfindahl-Hirschman IndexThe Herfindahl-Hirschman index (HHI) is found by summing the squares of the market shares of all firms in an industry.Advantages over the CR4 measure:Captures changes in market sharesUses data on all firms2526ExampleFirmMarket ShareNike62%New Balance15.5%Asics10%Adidas4.3%

2627Example (contd)FirmMarket ShareNike22.95%New Balance22.95%Asics22.95%Adidas22.95%What happens if market shares are evenly distributed?

2728Non-competitive OligopoliesNon-competitive/collusive behavior (cooperative oligopolies)Cartels: firms may collude to raise prices and restrict production in the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel.Dominant Firm/Price Leader:collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these markets for investment and product development. does not require formal agreement although for the act to be illegal there must be a real communication between companiesfor example, in some industries, there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership.Stackleberg price-leader model

Types of MergersConglomerate MergerFirms in unrelated industries merge.Vertical MergerA firm buys another firm that is either above it or below it in the supply chain.Horizontal MergerA combination of two firms that are in the same industryCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-2929The Governments Position on MergersThe governments position on mergers has changed over the years, from preventing the merger of relatively small firms to allowing the merger of large companies.Bush(43) focused only on horizontal mergersObama returned to review both horizontal and vertical mergers (Ticketmaster) In general, a merger that results in a Herfindahl-Hirschman Index of less than 1800 will not be challenged.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-3030DeregulationThe current trend is for the government to remove regulation and allow market forces to determine prices, output, profits, and industry structure.Factors favoring deregulation:Difficulty in determining a regulatory strategyAdvances in technology that have lead to increased competitionCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-3131Life LessonsTwo wrongs dont make a right.In the 1930s many states passed Fair Trade laws that effectively outlawed low prices.Fair trade same price in each marketDoesnt reflect different supply/costs (or demand)As a result, consumers faced higher prices and retail stores were protected from bankruptcy.These laws were eliminated in 1975. Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-3232Reasons For DeregulationIn deciding to deregulate an industry, the government must be confident that private market outcomes will be more efficient than regulated outcomes.Will deregulation affect product safety or reliability?Will deregulation eliminate service for some customers?Will the benefits of deregulation accrue to only a few customers?Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-3333Application: Deregulation of the Airline IndustryIn 1978, the U.S. Airline Deregulation Act removed regulations on prices, the number of carriers and route assignments.(some) Passengers have benefited from the resulting price competition among air carriers.FAA set similar rates for flights of similar difference, regardless of destination (and demand in large/small cities)legacy losses and gainsSmaller cities saw higher prices and fewer flightLarger cities: lower prices, more flightsCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-3434Application: Deregulation of theTelecommunicationsIn 1980, AT&T and the Baby Bells were broken up into 8 different companiesAT&T could offer only long distance service and had to compete with MCI and Sprint (no longer a monopoly)Baby Bells customer could choose their LD providerTook several years for AT&T market share to drop below 80%Colbert video its all back together again FCC missed that there were economies of scale led to mergers to reduce costs1996 Congress passed the Telecommunications ActCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-3535Application: Deregulation of theTelecommunications1996 Congress passed the Telecommunications ActRequired Baby Bells and GTE to open their local markets to all competitorsEstablished prices that Bells could charge competitors for renting their lines and switching equipment Prices were set below incurred (or historical) costsDecreased incentive to maintain and update existing equipmentPreviously business line rates set higher than costs to subsidize residential phone serviceNew entrants targeted business customers and high long distance usage customers (winners) Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-3636Strategy and PolicyThe Department of Justice takes on CingularAT&T Wireless merger In 2004, Cingular agree to buy AT&T Wireless, creating a company with an HHI of 8,000 in some markets.In 2005, the firm was required to divest the entire AT&T Wireless network in the 13 markets where concentration was highest.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-3737SummaryThe U.S. government may intervene in the private sector to promote productive efficiency, innovation, or allocative efficiency.U.S. antitrust policy is based on:The Sherman Act, which forbids monopoliesThe Clayton Act, which prohibits price discriminationThe Federal Trade Commission Act, which established the FTCCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-3838Summary (contd)Some actions are per se illegal; simply engaging in them is enough to establish guilt.Conglomerate mergers are not usually challenged.Vertical and horizontal mergers may be challenged if they reduce competition.In the case of a natural monopoly, it may be preferable for the government to regulate the firm.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-3939Summary (contd)Deregulation of an industry may be appropriate because of changes in technology and globalization.Copyright 2006 Pearson Addison-Wesley. All rights reserved.13-4040Table 13.1 Excerpts From Section 1 and 2 of the Sherman Antitrust ActCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-41

Table 13.2 Summary of Key U.S. Antitrust LegislationCopyright 2006 Pearson Addison-Wesley. All rights reserved.13-42