18 Limiting Market Power: Regulation and Antitrust... The one law you can’t repeal is supply and demand. WILLIAM SAFIRE, NEW YORK TIMES, JULY 13, 1998

18

Limiting Market Power:Regulation and Antitrust. . . The one law you can’t repeal is supply and

demand.WILLIAM SAFIRE, NEW YORK TIMES, JULY 13, 1998

● The Public Interest Issue: Monopoly Power Versus Mere Size

● Part 1: Regulation♦ What is Regulation and Who Regulates What?

♦ Some Objectives of Regulation

♦ Two Key Issues That Face Regulators

♦ The Pros and Cons of “Bigness”

♦ Deregulation

● The Public Interest Issue: Monopoly Power Versus Mere Size

● Part 1: Regulation♦ What is Regulation and Who Regulates What?

♦ Some Objectives of Regulation

♦ Two Key Issues That Face Regulators

♦ The Pros and Cons of “Bigness”

♦ Deregulation

ContentsContents

Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

● Part 2: Anti-Trust Laws and Policies♦ The Public Image of Business When Anti-

Trust Laws Were Born

♦ Measuring Market Power: Concentration

♦ A Crucial Problem for Anti-Trust

♦ Mergers and Competition

♦ Use of Antitrust Laws to Prevent Competition

● Part 2: Anti-Trust Laws and Policies♦ The Public Image of Business When Anti-

Trust Laws Were Born

♦ Measuring Market Power: Concentration

♦ A Crucial Problem for Anti-Trust

♦ Mergers and Competition

♦ Use of Antitrust Laws to Prevent Competition

Contents (continued)Contents (continued)


Part I: Regulation

Copyright© 2003 Southwestern/Thomson Learning. All rights reserved.

The Public Interest Issue: Monopoly Vs Mere SizeThe Public Interest Issue: Monopoly Vs Mere Size

● Firms that possess monopoly power may threaten the public interest.

● The abuse of monopoly power is undesirable because:♦ High prices reduce the wealth of consumers.

♦ High prices lead to resource misallocation.

♦ Efficiency and innovation may be stifled.

● Firms that possess monopoly power may threaten the public interest.

● The abuse of monopoly power is undesirable because:♦ High prices reduce the wealth of consumers.

♦ High prices lead to resource misallocation.

♦ Efficiency and innovation may be stifled.


How and Why Did Regulation Arise?

The Public Interest Issue: Monopoly Vs Mere SizeThe Public Interest Issue: Monopoly Vs Mere Size

● But firms that are big do not necessarily have market power♦ oligopoly market

♦ easy entry

● But firms that are big do not necessarily have market power♦ oligopoly market

♦ easy entry


What Is Regulation and Who Regulates What?What Is Regulation and Who Regulates What?

● Regulation: government agencies that enforce rules about business conduct enacted by Congress

● Types of government regulation of industry ♦ Limiting market power

♦ Promoting consumer and worker protection and safety

● Regulation: government agencies that enforce rules about business conduct enacted by Congress

● Types of government regulation of industry ♦ Limiting market power

♦ Promoting consumer and worker protection and safety


What Is Regulation and Who Regulates What?What Is Regulation and Who Regulates What?

● Federal Communications Commission: broadcasting and telecommunications

● Federal Energy Regulatory Commission: interstate transmission of electric power and sale of natural gas

● Securities and Trade Commission: sales of securities

● Federal Reserve System: banking

● Federal Communications Commission: broadcasting and telecommunications

● Federal Energy Regulatory Commission: interstate transmission of electric power and sale of natural gas

● Securities and Trade Commission: sales of securities

● Federal Reserve System: banking


Some Objectives of RegulationSome Objectives of Regulation

● Control of market power resulting from economies of scale and scope

● The pricing of “bottleneck” facilities and the parity-pricing principle

● Universal service and rate averaging

● Control of market power resulting from economies of scale and scope

● The pricing of “bottleneck” facilities and the parity-pricing principle

● Universal service and rate averaging

FIGURE 18-1 Economies of ScaleFIGURE 18-1 Economies of Scale


AC

MC

Pri

ce a

nd

Co

st p

er U

nit

Quantity Produced per Year

A

B

100 50 0

P

5

$7

3


Two Key Issues That Face RegulatorsTwo Key Issues That Face Regulators

● Prices intended to promote the public interest may cause financial problems for firms.

● How to prevent firms with monopoly power from earning excessive profits without eliminating all incentives for efficiency and innovation

● Prices intended to promote the public interest may cause financial problems for firms.

● How to prevent firms with monopoly power from earning excessive profits without eliminating all incentives for efficiency and innovation



● Marginal versus Average Cost Pricing

● In many regulated industries, firms would go bankrupt if P = MC because:♦ Many exhibit significant economies of scale.

♦ In industry with economies of scale, long-run average cost curve is downward sloping.

♦ If average cost is declining, marginal cost must be below average cost.

● Marginal versus Average Cost Pricing

● In many regulated industries, firms would go bankrupt if P = MC because:♦ Many exhibit significant economies of scale.

♦ In industry with economies of scale, long-run average cost curve is downward sloping.

♦ If average cost is declining, marginal cost must be below average cost.



● Marginal versus Average Cost Pricing♦ Setting price equal to average cost is also

problematic, especially for a multi-product firm.

♦ The Ramsay pricing rule is a regulatory solution.

● Marginal versus Average Cost Pricing♦ Setting price equal to average cost is also

problematic, especially for a multi-product firm.

♦ The Ramsay pricing rule is a regulatory solution.



● Preventing Monopoly Profit but Keeping Incentives for Efficiency and Innovation♦ When regulators control profits, they face the

danger of removing the useful incentive effects of profits.

♦ The existence of regulatory lag may offer some incentive for efficiency.

● Preventing Monopoly Profit but Keeping Incentives for Efficiency and Innovation♦ When regulators control profits, they face the

danger of removing the useful incentive effects of profits.

♦ The existence of regulatory lag may offer some incentive for efficiency.



● Price Caps as Incentives for Efficiency♦ An adjusting price cap is a way of controlling

profits yet retaining some of the incentive effects of profits.

● Price Caps as Incentives for Efficiency♦ An adjusting price cap is a way of controlling

profits yet retaining some of the incentive effects of profits.


The Pros and Cons of “Bigness”The Pros and Cons of “Bigness”

● Bigness in industry may benefit the general public:♦ Economies of large size: where small-scale

operation is inefficient

♦ Required scale for innovation

● Bigness in industry may benefit the general public:♦ Economies of large size: where small-scale

operation is inefficient

♦ Required scale for innovation


DeregulationDeregulation

● Effects of Deregulation♦ Effects on prices: generally lower prices

♦ Effects on local services: some communities have been hurt, some have gained

♦ Effects on entry: many new competitors

● Effects of Deregulation♦ Effects on prices: generally lower prices

♦ Effects on local services: some communities have been hurt, some have gained

♦ Effects on entry: many new competitors



● Effects of Deregulation♦ Effects on unions: unions have been hurt

♦ Effects on concentration and mergers: many mergers following deregulation

♦ Effects on product quality: “no frills” services have become common

● Effects of Deregulation♦ Effects on unions: unions have been hurt

♦ Effects on concentration and mergers: many mergers following deregulation

♦ Effects on product quality: “no frills” services have become common



● Effects of Deregulation♦ Effects on safety: no change

♦ Effects on profits and wages: profits and wages have been depressed

♦ Conclusion: Deregulation has helped some and hurt others, but, in general, it has promoted the welfare of consumers.

● Effects of Deregulation♦ Effects on safety: no change

♦ Effects on profits and wages: profits and wages have been depressed

♦ Conclusion: Deregulation has helped some and hurt others, but, in general, it has promoted the welfare of consumers.

FIGURE 18-2 A “Hub and Spoke” Airline Routing Pattern

FIGURE 18-2 A “Hub and Spoke” Airline Routing Pattern


B

A

F

C

E

D

H

FIGURE 18-3 U.S. Airline Accident Rates, 1960-2000

FIGURE 18-3 U.S. Airline Accident Rates, 1960-2000


Deregulation (1978)

Fatal Accidents

All Accidents

Rat

e p

er 1

00,0

00 D

epar

tu

res

0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

1960 1965 1970 1975 1980 1985 1990 1995 2000

Part 2: Antitrust Laws and Policies


The Antitrust LawsThe Antitrust Laws

● The Sherman Act (1890)

● The Clayton Act (1914)

● The Federal Trade Commission Act (1914)

● The Robinson-Patman Act (1936)

● Celler-Kefauver Antimerger Act (1950)

● The Sherman Act (1890)

● The Clayton Act (1914)

● The Federal Trade Commission Act (1914)

● The Robinson-Patman Act (1936)

● Celler-Kefauver Antimerger Act (1950)

TABLE 18-1 Basic Antitrust LawsTABLE 18-1 Basic Antitrust Laws




● The Sherman Act♦ “Per Se” Issues: courts have consistently held

that price fixing among competitors is illegal

● The Sherman Act♦ “Per Se” Issues: courts have consistently held

that price fixing among competitors is illegal



● The Sherman Act♦ Rule of Reason: Courts have developed

different and varying standards for deciding when large companies have illegally:■ Monopolized trade■Engaged in tacit collusion■Used predatory pricing

♦ According to the “rule of reason,” size alone is not an offense.

● The Sherman Act♦ Rule of Reason: Courts have developed

different and varying standards for deciding when large companies have illegally:■ Monopolized trade■Engaged in tacit collusion■Used predatory pricing

♦ According to the “rule of reason,” size alone is not an offense.



● The Clayton Act♦ Prohibited price discrimination in restraint of

trade

♦ Prohibited tying contracts

♦ Prohibited stock purchases that reduced independence

♦ Prohibited interlocking directorates

● The Clayton Act♦ Prohibited price discrimination in restraint of

trade

♦ Prohibited tying contracts

♦ Prohibited stock purchases that reduced independence

♦ Prohibited interlocking directorates



● The Federal Trade Commission Act♦ The FTC was created to investigate “unfair”

and “predatory” competitive practices.

♦ In 1938, the FTC was also charged with preventing false and deceptive advertising.

● The Federal Trade Commission Act♦ The FTC was created to investigate “unfair”

and “predatory” competitive practices.

♦ In 1938, the FTC was also charged with preventing false and deceptive advertising.



● The Robinson-Patman Act♦ Sought to protect small wholesale and retail

firms from the “unfair competition” of chain stores and mass distributors

● The Robinson-Patman Act♦ Sought to protect small wholesale and retail

firms from the “unfair competition” of chain stores and mass distributors


Measuring Market Power: ConcentrationMeasuring Market Power: Concentration

● Concentration: Definition and Measurement—The Herfindahl-Hirschman Index♦ Four-firm concentration ratio

■% of industry’s output produced by four largest firms

■ a common, but flawed, measure of concentration.

● Concentration: Definition and Measurement—The Herfindahl-Hirschman Index♦ Four-firm concentration ratio

■% of industry’s output produced by four largest firms

■ a common, but flawed, measure of concentration.



● Concentration: Definition and Measurement—The Herfindahl-Hirschman Index♦ The Herfindahl-Hirschman Index is a more

accurate measure of industry concentration and is used by the Department of Justice in analyzing potential mergers.

● Concentration: Definition and Measurement—The Herfindahl-Hirschman Index♦ The Herfindahl-Hirschman Index is a more

accurate measure of industry concentration and is used by the Department of Justice in analyzing potential mergers.

TABLE 18-2 Concentration Ratios and H-H Indexes

TABLE 18-2 Concentration Ratios and H-H Indexes




● Concentration: Definition and Measurement♦ Three conclusions are widely accepted:

■If an industry has a very low concentration ratio, then its firms are very unlikely to have any market power either before or after the rise in concentration.

■If circumstances in the industry are favorable for successful price collusion, a rise in concentration will facilitate market power.

● Concentration: Definition and Measurement♦ Three conclusions are widely accepted:

■If an industry has a very low concentration ratio, then its firms are very unlikely to have any market power either before or after the rise in concentration.

■If circumstances in the industry are favorable for successful price collusion, a rise in concentration will facilitate market power.



● Concentration: Definition and Measure♦ Three conclusions are widely accepted

(cont’d):■Where the market is highly contestable, market

power will not be enhanced because an excessive price will attract new entrants who will soon force the price down.

● Concentration: Definition and Measure♦ Three conclusions are widely accepted

(cont’d):■Where the market is highly contestable, market

power will not be enhanced because an excessive price will attract new entrants who will soon force the price down.



● Evidence on Concentration in Reality♦ The concentration of industry has not increased

in the United States in the twentieth century.

● Evidence on Concentration in Reality♦ The concentration of industry has not increased

in the United States in the twentieth century.

TABLE 18-3 The Trend in Concentration in Manufacturing

TABLE 18-3 The Trend in Concentration in Manufacturing



A Crucial Problem for AntitrustA Crucial Problem for Antitrust

● It is often a challenge for the antitrust authorities to distinguish between vigorous competition and acts that undermine competition and support monopoly power.

● It is often a challenge for the antitrust authorities to distinguish between vigorous competition and acts that undermine competition and support monopoly power.


Anti-Competitive Practices and AntitrustAnti-Competitive Practices and Antitrust

● Predatory pricing = pricing that threatens to keep a competitor out of the market♦ One principle widely followed by the courts

holds that prices are predatory only if they are below either marginal or average variable costs.

● Predatory pricing = pricing that threatens to keep a competitor out of the market♦ One principle widely followed by the courts

holds that prices are predatory only if they are below either marginal or average variable costs.



● Even in cases where prices are below MC or AVC, predatory only under two conditions:♦ If evidence that the low price would have been

profitable only if it succeeded in destroying a rival or in keeping it out of the market.

♦ If a real probability that the allegedly predatory firm could raise prices to monopoly levels after the rival was driven out.

● Even in cases where prices are below MC or AVC, predatory only under two conditions:♦ If evidence that the low price would have been

profitable only if it succeeded in destroying a rival or in keeping it out of the market.

♦ If a real probability that the allegedly predatory firm could raise prices to monopoly levels after the rival was driven out.



● There have been many predatory pricing cases, but few convictions.

● There have been many predatory pricing cases, but few convictions.


Microsoft: Bottlenecks, Bundling, & Network Extern.Microsoft: Bottlenecks, Bundling, & Network Extern.

● Bottlenecks♦ MS Windows, an operating system that runs

about 90 percent of all personal computers, is a prime example of a bottleneck. ■Microsoft itself supplies not only Windows, but

also many applications.

♦ The worry is that Microsoft will use Windows in a way that favors its own programs and handicaps competing programs.

● Bottlenecks♦ MS Windows, an operating system that runs

about 90 percent of all personal computers, is a prime example of a bottleneck. ■Microsoft itself supplies not only Windows, but

also many applications.

♦ The worry is that Microsoft will use Windows in a way that favors its own programs and handicaps competing programs.


Microsoft: Bottlenecks, Bundling, & Network Extern.Microsoft: Bottlenecks, Bundling, & Network Extern.

● Bundling♦ Computer manufacturers receive a discount if

they buy a bundle of Microsoft programs, not just Windows alone. ■This means that rival producers of applications

have a price disadvantage in selling their products to PC owners.

♦ The question: is Microsoft’s low bundle price legitimate or constitutes a case of predatory pricing to destroy competitors.

● Bundling♦ Computer manufacturers receive a discount if

they buy a bundle of Microsoft programs, not just Windows alone. ■This means that rival producers of applications

have a price disadvantage in selling their products to PC owners.

♦ The question: is Microsoft’s low bundle price legitimate or constitutes a case of predatory pricing to destroy competitors.


Mergers and CompetitionMergers and Competition

● Horizontal Mergers ♦ The merging firms compete directly by

supplying products that are identical or very similar

♦ Reviewed by both the Department of Justice and the Federal Trade Commission to prevent mergers that would reduce competition

● Horizontal Mergers ♦ The merging firms compete directly by

supplying products that are identical or very similar

♦ Reviewed by both the Department of Justice and the Federal Trade Commission to prevent mergers that would reduce competition



● Recent Surges in Merger Activity♦ Since the early 1980s, more permissive merger

guidelines have lead to a significant increase in merger activity that continues today.

● Recent Surges in Merger Activity♦ Since the early 1980s, more permissive merger

guidelines have lead to a significant increase in merger activity that continues today.



● Are Mergers Anti-Competitive? ♦ Mergers sometimes reduce competition,

particularly in markets that are not contestable.

♦ However, where there is reason to believe that mergers will not reduce competition, mergers may lead to greater efficiency.

● Are Mergers Anti-Competitive? ♦ Mergers sometimes reduce competition,

particularly in markets that are not contestable.

♦ However, where there is reason to believe that mergers will not reduce competition, mergers may lead to greater efficiency.



● Do Mergers Improve Performance? ♦ The evidence here is mixed.

♦ Several mergers have been disappointing and brought limited cost savings.

♦ Still, a number of recent studies of merger activity during the 1980s has reported significant productivity.

● Do Mergers Improve Performance? ♦ The evidence here is mixed.

♦ Several mergers have been disappointing and brought limited cost savings.

♦ Still, a number of recent studies of merger activity during the 1980s has reported significant productivity.


Use of Antitrust Laws to Prevent CompetitionUse of Antitrust Laws to Prevent Competition

● A serious concern is the potential misuse of the antitrust laws to prevent competition.

● Firms that try to protect themselves in this way always claim that their rivals have not achieved success through superior ability but, rather, by means that they call “monopolization.”

● A serious concern is the potential misuse of the antitrust laws to prevent competition.

● Firms that try to protect themselves in this way always claim that their rivals have not achieved success through superior ability but, rather, by means that they call “monopolization.”



● Various steps have been suggested to deal with the misuse of U.S. antitrust laws: ♦ Implementation of a “loser pays the legal

costs” rule

♦ Prescreening of suits by a government agency

● Various steps have been suggested to deal with the misuse of U.S. antitrust laws: ♦ Implementation of a “loser pays the legal

costs” rule

♦ Prescreening of suits by a government agency



● Anything that restricts anti-competitive, private antitrust suits will almost certainly also inhibit legitimate attempts by individual firms to defend themselves from genuine acts of monopolization by rival enterprises.

● Anything that restricts anti-competitive, private antitrust suits will almost certainly also inhibit legitimate attempts by individual firms to defend themselves from genuine acts of monopolization by rival enterprises.


Concluding ObservationsConcluding Observations

● Most economists believe that by the 1970s government intervention had clearly gone too far in some respects and that deregulation was, thus, in the public interest.

● However, the general issue is still open to considerable debate.

● Most economists believe that by the 1970s government intervention had clearly gone too far in some respects and that deregulation was, thus, in the public interest.

● However, the general issue is still open to considerable debate.

Documents

18 Limiting Market Power: Regulation and Antitrust... The one law you can’t repeal is supply and demand. WILLIAM SAFIRE, NEW YORK TIMES, JULY 13, 1998