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1 Regulation and Antitrust Law l Principles of Microeconomic Theory, ECO 284 l John Eastwood l CBA 247 l 523-7353 l address:

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Presentation on theme: "1 Regulation and Antitrust Law l Principles of Microeconomic Theory, ECO 284 l John Eastwood l CBA 247 l 523-7353 l address:"— Presentation transcript:

1 1 Regulation and Antitrust Law l Principles of Microeconomic Theory, ECO 284 l John Eastwood l CBA 247 l l address:

2 2 Learning Objectives Define regulation and antitrust law Distinguish between the public interest and capture theories of regulation Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

3 3 Learning Objectives (cont.) Explain how antitrust law has been applied in a number of landmark cases Explain how antitrust law is used today

4 4 Learning Objectives Define regulation and antitrust law Distinguish between the public interest and capture theories of regulation Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

5 5 Market Intervention Government intervention in the monopolistic and oligopolistic markets Regulation Antitrust law

6 6 Market Intervention Regulation Rules administered by a government agency to influence economic activity Antitrust Law Laws that regulate and prohibit certain kinds of market behavior

7 7 Learning Objectives Define regulation and antitrust law Distinguish between the public interest and capture theories of regulation Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

8 8 Economic Theory of Regulation Four Factors Affecting the Demand for Regulation Consumer surplus per buyer Number of buyers Producer surplus per firm Number of firms

9 9 Economic Theory of Regulation Three Factors Affecting the Supply of Regulation Consumer surplus generated per buyer Producer surplus generated per firm The number of voters benefited

10 10 Economic Theory of Regulation Political Equilibrium The amount of regulation is such that no interest group finds it worthwhile to press for changes and no group of politicians finds it worthwhile to offer different regulations.

11 11 Economic Theory of Regulation Political Equilibrium Public Interest Theory Regulations are supplied to satisfy the demand of consumers and producers to maximize total surplus Capture Theory Regulations are supplied to satisfy the demand of producers to maximize producer surplus--maximize economic profit.

12 12 Regulation and Deregulation Numerous regulatory agencies have been developed since Since 1977, industry has been going through a gradual process of deregulation.

13 13 Regulation and Deregulation The Regulatory Process Bureaucrats are appointed Agencies adopt a set of practices and rules Agency grant certification to a company Price and Quantity Regulation

14 14 Regulation and Deregulation Natural Monopoly Industry in which one firm can supply the entire market at a lower cost than two or more firms can

15 15 Regulation and Deregulation Marginal Cost Pricing Rule Sets price equal to marginal cost If the Firm Incurs a Loss Price discrimination Two-part tariff Subsidy

16 16 Learning Objectives Define regulation and antitrust law Distinguish between the public interest and capture theories of regulation Explain how regulation affects prices, outputs, profits, and the distribution of the gains from trade between consumers and producers

17 17 Natural Monopoly: Marginal Cost Pricing Quantity (millions of households) D ATC Price & Cost (dollars per household per month) MC

18 18 Total surplus Natural Monopoly: Marginal Cost Pricing Quantity (millions of households) D ATC Price & Cost (dollars per household per month) Loss per household MC

19 19 Regulation and Deregulation Average Cost Pricing Rule Sets price equal to average total cost Firm Earns a Normal Profit

20 20 Natural Monopoly: Average Cost Pricing Quantity (millions of households) D ATC Price & Cost (dollars per household per month) MC

21 21 Natural Monopoly: Average Cost Pricing Quantity (millions of households) D ATC Price & Cost (dollars per household per month) MC Consumer surplus Producer surplus Deadweight loss

22 22 Regulation and Deregulation Capturing the Regulator Maximizes profit

23 23 Natural Monopoly Profit Maximization Quantity (millions of households) D ATC Price & Cost (dollars per household per month) MC MR 18

24 24 Natural Monopoly Profit Maximization Quantity (millions of households) D ATC Price & Cost (dollars per household per month) MC Consumer surplus Deadweight loss Economic profit MR 18

25 25 Regulation and Deregulation How do agencies determine a regulated price? Answer: Rate of Return Regulation

26 26 Regulation and Deregulation Rate of Return Regulation Sets price that enables the firm to earn a specific percent of return on its capital Inflating Costs Firms will be motivated report costs as high as possible.

27 27 Natural Monopoly: Inflating Costs Quantity (millions of households) D ATC Price & Cost (dollars per household per month) MC MR 18 ATC (inflated )

28 28 Natural Monopoly: Inflating Costs Quantity (millions of households) D ATC Price & Cost (dollars per household per month) MC Economic profit MR 18 ATC (inflated ) Profit is maximized

29 29 Regulation and Deregulation Incentive Regulation Schemes Gives a firm an incentive to operate efficiently and keep costs under control. Public Interest or Capture? Not completely clear which one Both predict Price exceeds MC Except for local phone service…

30 30 Rate of Return in Regulated Monopolies Electricity Gas Railroad Average of above Economy Average Years Industry1962–691970–77

31 31 Gains from Deregulating Natural Monopolies ConsumerProducerTotal surplussurplussurplus Industry (billions of 1990 dollars) Railroads Telecommunications Cable television Total

32 32 Regulation and Deregulation Cartel Regulation Place an output limit on each firm in the industry. Prevent cheating Regulation - Which One is Used? Public interest Capture theory

33 33 Collusive Oligopoly Quantity (number of trips) D Price & Cost (dollars per trip) MR Producer interest regulation MC Public interest regulation

34 34 Rates of Return in Regulated Oligopolies Airlines Trucking Economy Average Years Industry1962–691970–77

35 35 Gains from Deregulating Oligopolies ConsumerProducerTotal surplussurplussurplus Industry (billions of 1990 dollars) Airlines Trucking Total

36 36 Regulation and Deregulation Making Predictions Why were the transportation and telecommunications industries deregulated? Economists became more confident and vocal We can expect to see more deregulation.

37 37 Learning Objectives (cont.) Explain how antitrust law has been applied in a number of landmark cases Explain how antitrust law is used today

38 38 Antitrust Laws Sherman Act 1890*Combination, trust or conspiracy to restrict interstate or international trade. * Monopolization or attempt to monopolize interstate or international trade Clayton Act 1914* Price discrimination if the effect is to Robinson-Patman 1936 substantially lessen competition or create Amendment monopoly and if such discrimination is not Cellar-Kefauver 1950 justified by cost differences Amendment* Contracts force other goods to be bought from same firm * Acquisition of competitors’ shares or assets * Interlocking directorships among competing firms Year Name of law PassedWhat the law prohibits

39 39 Antitrust Laws Federal Trade1914* Unfair methods of competition and Commission Act unfair or deceptive business practices Year Name of law PassedWhat the law prohibits

40 40 Landmark Antitrust Cases Federal Trade Commission was established in 1914 to enforce the antitrust laws. Rule of reason Monopolies arising from mergers and agreements are not necessarily illegal. Vertical and Horizontal Integration were found to be illegal

41 41 Landmark Antitrust Cases American Tobacco 1911 Guilty: Ordered to divest themselves of and Standard Oil Co.Large holdings in other companies: “rule of reason” enunciated--only unreasonable combinations guilty under Sherman Act. U.S. Steel Co Not Guilty: U.S. Steel had a very large market share (near monopoly), mere size alone is not an offense”; application of the “rule of reason.” Socony-Vacuum Oil Co Guilty: Combination was formed for price fixing; no consideration of “reasonableness” applied. Case Year Verdict and consequence

42 42 Landmark Antitrust Cases Alcoa 1945 Guilty: Too big--had too large a share of the market; end of “rule of reason.” General Electric, 1961 Guilty: Price-fixing conspiracy; executives Westinghouse & othersfined and jailed Brown Shoe 1962 Guilty: Ownership of Kinney, a retail chain, reduced competition; ordered to sell Kinney shoes, (Brown supplied 8 percent of Kinney's and Kinney sold 2 percent of nations shoes) Von’s Grocery 1965 Guilty: Merger of two supermarkets in Los Angeles would restrain competition (themerged firm would have had 7.5 percent of the L.A. market). Case YearVerdict and consequence

43 43 Landmark Antitrust Cases IBM 1982Case dismissed as being “without merit.” AT&T 1983Agreement between AT&T and government that the company would divest itself of all local telephone operating companies --80 % of its assets. Case Year Verdict and consequence

44 44 Learning Objectives (cont.) Explain how antitrust law has been applied in a number of landmark cases Explain how antitrust law is used today

45 45 Landmark Antitrust Cases Three Recent Antitrust Cases IBM AT&T Microsoft

46 46 Landmark Antitrust Cases Current Merger Rules The Department of Justice uses the Herfindahl- Hirschmand (HHI) to evaluate mergers. Less than 1,000 — competitive 1,000 to 1,800 — moderately concentrated challenged if merger would increase the index by 100 points above 1,800 — concentrated market challenged if merger would increase the index by 50 points

47 47 The HHI Merger Guidelines

48 48 Proposed Mergers (1986) Market definition Narrow: carbonated soft drinks HHI > 2400 – highly concentrated Coke 39% PepsiCo 28% Dr Pepper 7% 7-Up 6% RJR 5% Market definition Broad: carbonated soft drinks, fruit juices and bottle water sold by these four companies HHI 120 – highly competitive Dept. of Justice chose the narrow definition & blocked both mergers

49 49 Landmark Antitrust Cases Is the public interest served? Original intent was to protect and pursue the public interest However, the interest of the producer sometimes comes into play. Is our court system more likely to serve the public interest than our regulators?


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