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Chapter Twelve Antitrust Policy and Regulation. 12 | 2 Copyright © Houghton Mifflin Company. All rights reserved. Antitrust Policy Antitrust Policy –

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Presentation on theme: "Chapter Twelve Antitrust Policy and Regulation. 12 | 2 Copyright © Houghton Mifflin Company. All rights reserved. Antitrust Policy Antitrust Policy –"— Presentation transcript:

1 Chapter Twelve Antitrust Policy and Regulation

2 12 | 2 Copyright © Houghton Mifflin Company. All rights reserved. Antitrust Policy Antitrust Policy – Government actions designed to promote competition among firms in the economy; also called competition policy or antimonopoly policy. Sherman Antitrust Act of 1890 – A law passed in the United States to reduce anticompetitive behavior; Section 1 makes price fixing illegal and Section 2 makes attempts to monopolize illegal.

3 12 | 3 Copyright © Houghton Mifflin Company. All rights reserved. A Brief History: The Sherman Antitrust Act was used in breaking up the monopoly of Standard Oil. In 1911, Standard oil was broken into a number of companies: Mobil (New York), Chevron (California), Amoco (Indiana), Exxon (New Jersey). Antitrust Policy (cont’d)

4 12 | 4 Copyright © Houghton Mifflin Company. All rights reserved. In the 1970s, the government brought antitrust action against IBM for its control on mainframe computers. The government withdrew its case when IBM was facing competition against Digital Equipment and Apple Computers. The government also managed to break down AT&T into three firms: AT&T, MCI and Sprint. Antitrust Policy (cont’d)

5 12 | 5 Copyright © Houghton Mifflin Company. All rights reserved. The most recent case was brought against Microsoft, where a federal judge ordered the breakup of Microsoft in However, the order was reversed in Antitrust Policy (cont’d)

6 12 | 6 Copyright © Houghton Mifflin Company. All rights reserved. Predatory Pricing One way to drive out competition and achieve monopolization is through predatory pricing. Predatory pricing - action on the part of one firm to set a price below its shutdown point in order to drive its competition out of business. Note: predatory pricing does not occur if the firm can sell at a lower cost because it is efficient. For example, small retailers sued Wal- Mart for predatory pricing and lost because lower Wal-Mart prices were due to higher efficiency.

7 12 | 7 Copyright © Houghton Mifflin Company. All rights reserved. Intel vs. AMD: Predatory Pricing On June 27, 2005, Advanced Micro Devices (AMD) filed a lawsuit against Intel, complaining that Intel unlawfully maintained market power by offering rebates, discounts, and other incentives to convince PC makers around the world to use Intel, rather than AMD, chips.

8 12 | 8 Copyright © Houghton Mifflin Company. All rights reserved. According to AMD: “Intel has also imposed on OEMs a system of first-dollar rebates that create exclusivity or near- exclusivity and artificially foreclose AMD from competing meaningfully. Intel’s “penetration” or “loyalty” rebates are not based on efficiencies or cost savings, but instead are designed to avoid head-to-head price competition with AMD and leverage Intel’s market position.” Intel vs. AMD: Predatory Pricing (cont’d)

9 12 | 9 Copyright © Houghton Mifflin Company. All rights reserved. Intel dismissed the claims as "factually incorrect and contradictory.” Further, they claim: “AMD has made its own business decisions and choices that have determined its position in the marketplace. AMD seeks to instead blame Intel for the many business failures AMD has experienced." Intel vs. AMD: Predatory Pricing (cont’d)

10 12 | 10 Copyright © Houghton Mifflin Company. All rights reserved. Mergers Clayton Antitrust Act – A law passed in 1941 in the United States aimed at preventing monopolies from forming through mergers. Federal Trade Commission (FTC) – The government agency established to help enforce antitrust legislation in the US; it shares that responsibility with the Antitrust Division of the Department of Justice.

11 12 | 11 Copyright © Houghton Mifflin Company. All rights reserved. Antitrust Division of the Department of Justice – The division of the Justice Department that enforces antitrust legislation, along with the FTC. Herfindahl-Hirschman Index (HHI) – An index used to measure concentration in an industry. The HHI takes a minimum value of zero and a maximum value of 10,000 (a monopoly). Mergers (cont’d)

12 12 | 12 Copyright © Houghton Mifflin Company. All rights reserved. Herfindahl – Hirschman Index The HHI is calculated by the squared sum of the market share of each firm in the industry. Where s i is firm i’s share in the market. S i = 5 when the market share is 5 percent.

13 12 | 13 Copyright © Houghton Mifflin Company. All rights reserved. Herfindahl – Hirschman Index (cont’d) Examples: If a firm is a monopoly, then the HHI is: If two firms have equal share of the market, the HHI is:

14 12 | 14 Copyright © Houghton Mifflin Company. All rights reserved. Merger Guidelines A merger that results in a post merger HHI of 1000 will not be challenged by the FTC. A merger that results in a post merger HHI of will be challenged by the FTC if the increase in the HHI is greater than 100. A merger that results in a post merger HHI of more than 1800 will be challenged by the FTC if the increase in the HHI is greater than 50.

15 12 | 15 Copyright © Houghton Mifflin Company. All rights reserved. Market Definition Market Definition – The demarcation of a geographic region and a category of goods or services in which firms compete. Market definition can affect the size of the HHI and the decision of the FTC to intervene. Table 12.2 gives the different market definitions in the beverage industry.

16 12 | 16 Copyright © Houghton Mifflin Company. All rights reserved. Market Definition (cont’d)

17 12 | 17 Copyright © Houghton Mifflin Company. All rights reserved. From Table 12.2, we can see that some mergers that are blocked if the industry is defined narrowly could arguably be allowed if the market is defined more broadly. For example, the FTC blocked the merger of Coca-Cola with Dr. Pepper because the HHI increased by 341 in the carbonated soft drink market. However, the HHI would only increase by 74 if the broader market definition was used. Market Definition (cont’d)

18 12 | 18 Copyright © Houghton Mifflin Company. All rights reserved. A Blocked Merger: PeopleSoft and Oracle DOJ Blocks PeopleSoft-Oracle Merger Dealing what could be a fatal blow to the hostile takeover bid, the Department of Justice and seven states will file suit to block Oracle's bold offer for rival PeopleSoft. According to the DOJ the merger would eliminate competition between two of the nation's leading providers of human resource and financial management enterprise software applications, resulting in higher prices, less innovation and fewer choices for the businesses, government agencies, and other organizations that depend on this type of software. Source:

19 12 | 19 Copyright © Houghton Mifflin Company. All rights reserved. The DOJ concluded that Oracle, PeopleSoft, and German behemoth SAP are the only companies that currently compete to develop and sell the high-function integrated human resource management and financial management services software for large enterprises. Antitrust experts and financial analysts had predicted that Oracle would be blocked if Justice Department regulators use a narrow definition of the application software market. A wider definition, by contrast, would have included competitors such as Microsoft, Siebel Systems, and i2 Technologies. A Blocked Merger: PeopleSoft and Oracle (cont’d) Source:

20 12 | 20 Copyright © Houghton Mifflin Company. All rights reserved. Horizontal vs. Vertical Mergers Horizontal Merger – A combining of two firms that sell the same good or the same type of good. (e.g., Daimler Corporation merges with Chrysler Corp). Vertical Merger – A combining of two firms, one of which supplies goods to the other. (e.g., Chrysler Corporation merges with Goodyear Tires). Note: Merger guidelines apply only to horizontal mergers.

21 12 | 21 Copyright © Houghton Mifflin Company. All rights reserved. Price Fixing Price Fixing – The situation in which firms conspire to set prices for goods sold in the same market. Per Section 1 of the Sherman Antitrust Act, price fixing is illegal.

22 12 | 22 Copyright © Houghton Mifflin Company. All rights reserved. One of the most famous cases of price-fixing involved Westinghouse and General Electric. Both firms were found guilty of setting prices of generators and other equipment and were required to pay treble damages of $500 million. Treble Damages – Penalties awarded to the injured party equal to three times the value of the injury. Price Fixing (cont’d)

23 12 | 23 Copyright © Houghton Mifflin Company. All rights reserved. Price-Cost Margins Recall from Chapter 10: Price cost margin – the difference between price and the marginal cost divided by the price. = Price minus marginal cost Price

24 12 | 24 Copyright © Houghton Mifflin Company. All rights reserved. Table 12.3 gives estimates of the price- cost margins for firms in different industries. Notice that the price-cost margin for food and beverages is very high (.50), while very low for coffee roasting (0.04), rubber (0.05), and retail gasoline (0.10). Price-Cost Margins (cont’d)

25 12 | 25 Copyright © Houghton Mifflin Company. All rights reserved. Price-Cost Margins (cont’d)

26 12 | 26 Copyright © Houghton Mifflin Company. All rights reserved. Vertical Restraints Firms also engage in practices that restrict trade vertically, i.e., from suppliers to producer. The following are ways firms implement vertical restraints: 1)Exclusive territories – The regions over which a manufacturer limits the distribution or selling of its products to one retailer or wholesaler.

27 12 | 27 Copyright © Houghton Mifflin Company. All rights reserved. 2)Exclusive trading – A condition of a contract by which a manufacturer does not allow a retailer to sell goods made by a competing manufacturer (e.g., KFC restaurants sell Pepsi, and do not to sell Coca-Cola products). Vertical Restraints (cont’d)

28 12 | 28 Copyright © Houghton Mifflin Company. All rights reserved. 3)Resale Price Maintenance – A situation in which a producer sets a list price and does not allow the retailer to offer a discount to customers. (e.g., Bose, an audio systems manufacturer, requires its retailers to sell only at the list price, and allows price drops on the product only on pre-determined dates). Vertical Restraints (cont’d)

29 12 | 29 Copyright © Houghton Mifflin Company. All rights reserved. Regulating Natural Monopolies Recall from Chapter 10: Natural Monopolies – A single firm in an industry in which average total cost is declining over the entire range of production, and the minimum efficient scale is larger than the market size. Recall from Chapter 8: Economies of scale – A situation in which the long run average total cost declines as the output of a firm is increased.

30 12 | 30 Copyright © Houghton Mifflin Company. All rights reserved. Some natural monopolies, such as water and electrical utilities are allowed by the government to exist as a monopoly in order to take advantage of the lower average total costs resulting from producing at a higher scale. However, these firms are regulated by the government, in order to make sure that the benefits of lower costs are passed to consumers. Figure 12.1 illustrates the advantages of allowing a monopoly to exist. Regulating Natural Monopolies (cont’d)

31 12 | 31 Copyright © Houghton Mifflin Company. All rights reserved. Regulating Natural Monopolies (cont’d) Figure 12.1

32 12 | 32 Copyright © Houghton Mifflin Company. All rights reserved. Alternative ways of regulation: 1)Marginal Cost Pricing – A regulatory method that stipulates that the firm charge a price that equals the marginal cost. With declining average total cost, marginal cost is lower than the average total cost, and the natural monopoly will experience a loss. This scenario is depicted in Figure Regulating Natural Monopolies (cont’d)

33 12 | 33 Copyright © Houghton Mifflin Company. All rights reserved. Regulating Natural Monopolies (cont’d) Figure 12.2

34 12 | 34 Copyright © Houghton Mifflin Company. All rights reserved. As we can see in Figure 12.2, a firm that sells at marginal cost will produce at the greatest quantity, and the lowest deadweight loss. Unfortunately, because marginal cost pricing causes firms to experience a loss, this pricing method will not work well in practice, as monopolies would choose not to continue operating. Regulating Natural Monopolies (cont’d)

35 12 | 35 Copyright © Houghton Mifflin Company. All rights reserved. 2)Average Total Cost Pricing - A regulatory method that stipulates that the firm charge a price that equals the average total cost. From Figure 12.2, we can see that average cost pricing allows firms to charge at a price higher than with marginal cost pricing. One drawback is that the firm will sell below the efficient quantity. Regulating Natural Monopolies (cont’d)

36 12 | 36 Copyright © Houghton Mifflin Company. All rights reserved. Because the price equals the average total cost, the firm will earn zero economic profits. Further, the lower quantity leads to a deadweight loss. The biggest concern with average cost pricing however, is that it does not provide incentives for a firm to lower costs, since costs are easily passed to consumers in the form of higher prices. Regulating Natural Monopolies (cont’d)

37 12 | 37 Copyright © Houghton Mifflin Company. All rights reserved. Incentive Regulation – A regulatory method that sets prices for several years ahead and then allows firms to keep any additional profits or suffer any losses over that period of time. Incentive regulation can be made difficult by asymmetric information, where the regulated firm can mislead regulators into thinking that costs are higher than reality. This example is illustrated in Figure Regulating Natural Monopolies (cont’d)

38 12 | 38 Copyright © Houghton Mifflin Company. All rights reserved. Regulating Natural Monopolies (cont’d) Figure 12.3

39 12 | 39 Copyright © Houghton Mifflin Company. All rights reserved. As seen in Figure 12.3, if the firm (who knows its cost structure better than the regulators) can mislead the regulators that its ATC is higher than the true ATC faced by the firm, then the monopoly can earn a larger profit with incentive regulation. Regulating Natural Monopolies (cont’d)

40 12 | 40 Copyright © Houghton Mifflin Company. All rights reserved. The Deregulation Movement Deregulation movement – The drive to reduce the government regulations controlling the government prices and entry in many industries. Deregulation may benefit some and harm others. The deregulation of the airline industry hurt larger airline companies, but benefited smaller regional airlines.

41 12 | 41 Copyright © Houghton Mifflin Company. All rights reserved. Key Points Antitrust policy Sherman Antitrust Act Predatory pricing Clayton Antitrust Act The Federal Trade Commission (FTC) The Antitrust Division of the Department of Justice Herfindahl- Hirschman index (HHI)

42 12 | 42 Copyright © Houghton Mifflin Company. All rights reserved. Market Definition Horizontal and vertical mergers Price fixing Treble damages Exclusive territories Exclusive dealings Resale price maintenance Key Points (cont’d)

43 12 | 43 Copyright © Houghton Mifflin Company. All rights reserved. Marginal cost pricing Average total cost pricing Incentive regulation Deregulation movement Key Points (cont’d)


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