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Eco 100Lecture 7-2

Feb18, 2009

Intro to Regulation:

Overview, Goals, History

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Government Regulation

• Major categories – Anti-competitive behavior

• Price Discrimination• Collusion• Mergers/acquisitions

– Deregulation– Natural Monopolies

• Regulatory solutions• Deregulating where economies of scale no longer exist• Managed competition

– Externalities• Pollution• Fishing, forestry, mining, oil drilling

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Government Regulation

• Tools available– Statutory

• Prohibitive– E.g. Price fixing/restricting output, cartels, collusive behavior

• Fines, breakup (divestiture)

– Deregulation• Removing regulation

– Airlines, Banking

• Incentive mechanisms– Managed competition

– Incentive design

– Taxes, subsidies and tradable permits (property rights)

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Promoting Efficiency

• Goals of regulation– Efficiency in Production

• Produce at least cost

– Efficiency in Allocation• Value consumers place on goods = opportunity

costs of resources used

– Promote Technological Innovation• Regulatory incentives should promote, or at least

not discourage, development and adoption of new cost saving technology

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Efficiency in Production

• Produce Goods at Least Cost– Firms to operate at the minimum of their Long

Run Average Cost Curve

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Efficiency in Allocation

• Marginal value consumers place on last (marginal unit) produced to equal the resource “opportunity” costs– MV = MC at the marginal unit

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Promote Technological Innovation

• Ensure regulatory design promotes rate of technical change similar to perfect competition– Technologically neutral, e.g. wireless,

landline, cable

• Doesn’t inhibit technological change

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Government Regulatory AgenciesAdministrative Agencies

• Federal Trade Commission (1914) Act– “empowered to pursue abuses of trade that could lessen competition”

• Department of Justice (DOJ)– Jointly charged with FTC for overseeing and enforcing antitrust policy– Established by the Judiciary Act of 1789 – 1870 Act: handle the legal business of the United States. – control over all criminal prosecutions and civil suits in which the United

States had an interest • Federal Communications Commission (FCC)

– established by the Communications Act of 1934 – charged with regulating all non-Federal Government use of the radio

spectrum (including radio and television broadcasting), and all interstate telecommunications (wire, satellite and cable) as well as all international communications that originate or terminate in the United States.

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What Happens in Different Markets?

• Monopoly– Single-price monopolist (price fixing)– Price Discrimination

• Multi-part tariffs• Oligopoly

– Cartels– Passive collusion: Stackleberg leader, Sticky prices

• Monopolistic Competition– Limited price competition (brand name loyalty)

• Limited market power– Product differentiation

• Greater variety• Perfect Competition

– No efficiency loss, incentive to innovate, extensive price competition– No product differentiation

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Perfect Competition

• Standard of comparison for all market models (optimal)– Productive efficient

• Firms operate at min of LRAC or exit

– Technological innovate• Innovate or die

– Allocative efficient• Consumers value marginal unit at MV

– Equals firm’s cost of producing marginal unit

• No deadweight loss

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Monopoly/Cartels

• Not Efficient in Production– Never operate at min of LRAC– Underutilized capacity and resources

• Not Technologically Innovative– No incentive to invest in/develop new

technology when you’re the only firm

• Not Efficient in Allocation– P (=MV) > MR = MC– Deadweight loss

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Monopolistic Competition

• Not Efficient in Production– Never operate at min of LRAC– Underutilized capacity and resources

• Technologically Innovative– Competition with other firms provides incentive

• Not Efficient in Allocation– P (=MV) > MR = MC– Deadweight loss (but not as great as Monopoly)

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How Has the Government Sought to Regulate Markets?

• Punishing Anti-Competitive Behavior– Pricing/market tactics

• Collusion– Price-fixing, restricting output

• Price Discrimination• Predatory Pricing

– Impose fines for AC tactics

• Preventing Anti-competitive Behavior– Mergers and Acquisitions

• Review by appropriate administrative agency

– Divestiture/breakups

• Regulating Natural Monopolies• Deregulation(sic) of Selected Industries

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Punishing AC Behavior

• Punishing firms for behaving like a monopoly– Sherman anti-trust Act (1890)

• “conspiring to fix prices or restrict output”

– Clayton Act (1914)• More sophisticated price discrimination• Tie-in sales – requiring the purchase of 2nd good• Stock purchases/acquisitions

– Robinson-Patman(1936)• 3rd degree price discrimination • Amendment to Clayton Act

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Reviewing Mergers

• Primarily aimed at preventing mergers or acquisitions that reduce competition– FCC regulates communications media

(newspapers, tv, telecomm, radio)– FTC and DOJ regulate the rest

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How do they determine whether a merger reduces competition?

• Herfindahl-Hirschman Index or HHI, – measure of the size of firms in relationship to the

industry – Meant to be an indicator of the amount of competition– 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

• DOJ guidelines– Mergers resulting in HHI > 1800 can be challenged

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Are All Mergers Equal?

• Conglomerate – Merger of firms in unrelated industries

• Vertical Merger– Merger of firms upstream/downstream from each other in

production stream• FCC: ownership of more than 1 media type• Microsoft

• Horizontal Mergers– Firms in the same industry

• Telecomm industry– AT&T divestiture– Verizon/GTE merger; RBOC mergers

• Would the HHI be a valid measure of competitiveness?