1. Chapter Twelve Antitrust Policy and Regulation

2. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 2 Antitrust Policy Antitrust Policy: Government actions designed to promote competition among firms in the economy; also called competition policy or antimonopoly policy. –Prevents mergers that would increase monopoly power, prohibits price fixing, limits anti-competitive agreements Standard Oil and US Steel were trusts, formed by mergers Sherman Antitrust Act: A law passed in 1890 in the United States to reduce anticompetitive behavior; Section 1 prohibits price fixing, Section 2 makes attempts to monopolize illegal. Standard Oil: Mobil, Chevron, Amoco, Exxon –Exxon Mobil in 1999

3. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 3 Antitrust Policy, cont’d. Could not break up US Steel: Can’t use Sherman to break up a monopoly just because they are a monopoly. Must be able to prove that a firm is purposely making entry into the industry difficult. –Rule of Reason: An evolving standard by which antitrust cases are decided, requiring not only the existence of monopoly power but also the intent to restrict trade. –Later changed to “intent to willingly and maintain” a monopoly was proof enough –Microsoft was decided to be a monopoly, but decision was later reversed.

4. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 4 Predatory Pricing Predatory pricing: Action on the part of one firm to set a price below its shutdown point in order to drive its competitors out of business. –Very hard to prove. Ex: Walmart, American Airlines

5. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 5 Merger Policy No merger breakups since 1981 The Clayton Antitrust Act of 1914 aimed at preventing monopolies from forming through mergers Federal Trade Commission (FTC): The government agency established to help enforce antitrust legislation in the United States; shares this with the Antitrust Division of the Justice Department

6. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 6 The “Herf” The Herfindahl-Hirschman index (HHI or the Herf): An index ranging in value from 0 to 10,000 indicating the concentration in an industry; it is calculated by summing the squares of the market shares of all the firms in the industry. –One firm, (100) 2 = 10,000. –HHI is lower when there are more firms in the industry and market power is more equal –Merger guidelines: HHI above 1800 will be challenged if post- merger HHI rises by more than 50. HHI below 1000 will not be challenged. Between 1000-1800 a challenge will occur if HHI rises by more than 100 after a merger –HHI is used because it indicates how likely it is that firms in the industry after the merger will have enough market power to raise prices above MC, reduce Q, and create economic efficiency

7. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 7 The Herf Contestable Market: A market in which the threat of competition is enough to encourage firms to act like competitors Market Definition: Description of the types of goods and services included in the market and the geographic area of the market. –Narrow to Broad; example: Carbonated Soft Drinks to Nonalcoholic Drinks

8. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 8 Mergers and Price Fixing Horizontal merger: A combination of two firms that sell the same good or the same type of good –Almost always will increase market power Vertical merger: A combining of two firms, one of which supplies goods to the other –Not sure if it will increase market power Price Fixing: The situation in which firms conspire to set prices for goods sold in the same market. –Illegal under the Sherman Antitrust Act –Treble damages (included in the Clayton Act): Penalties awarded to the injured party equal to three times the value of the injury Westinghouse and General Electric: Found guilty of price-fixing and were fined $500 million and several executives served jail time

9. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 9 Price Cost Margins Price Cost Margin: P – MC / P –The higher the PCM, the more market power a firm has –Anheuser-Busch went from.3 to.03 after Miller introduced Lite Beer

10. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 10 Vertical Restraints Exclusive Territories: The regions over which a manufacturer limits the distribution or selling of its products to one retailer or wholesaler Exclusive Dealing: A condition of a contract by which a manufacturer does not allow a retailer to sell goods made by a competing manufacturer Resale Price Maintenance: The situation in which a producer sets a list price and does not allow the retailer to offer a discount to consumers. –Some controversy, but most believe these vertical restraints do not lead to monopoly. Often leads to greater economic efficiency

11. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 11 Natural Monopolies Sometimes it is more efficient to have one company deliver a good or service –Natural Monopoly: Single firm in an industry in which ATC is declining over the entire range of production and the minimum efficient scale is larger then the size of the market. –When ATC declines, we have economies of scale: a situation in which long-run ATC declines as the output of a firm increases

12. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 12 Figure 12.1: Natural Monopoly: Declining Average Total Cost

13. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 13 Alternative Methods of Regulation With a monopoly, costs will be lowered but price is still high which leads to deadweight loss. –To get advantages of lower costs and lower price, the government regulates. There is no deadweight loss with competition because P=MC. Marginal cost pricing: A regulatory method that stipulates that the firm charges at P= MC. –Problem is that firm is operating with a loss. There is no incentive for any firms to be in that industry.

14. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 14 ATC Pricing ATC pricing: A regulatory method that stipulates that the firm charges at P = ATC –Problem becomes that there is no incentive to reduce costs

15. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 15 Figure 12.2: Monopoly Price versus Alternative Regulatory Schemes

16. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 16 Incentive Regulation Incentive Regulation: A regulatory method that sets prices for several years ahead and then allows the firm to keep any additional profits or suffer any losses over that period of time –Sets based on ATC. Provides incentive to lower ATC –Can lead to Asymmetric information: Lies about ATC so that the price will be set higher and can gain more profits.

17. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 17 Figure 12.3: Asymmetric Information and Regulation

18. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 18 Regulate? Should regulate natural monopolies, but difficult to determine if one exists –Regulated trucking because of railroads. When stopped regulating, rates fell –Cable: When can receive over-the-air channels, cable is not a natural monopoly Stopped regulating because of several competitors like DirectTV, the Dish –Have to be careful when government officials regulate, they have reelection in mind. Want support of large unions (Teamsters), but want to protect consumers

19. Copyright © by Houghton Mifflin Company, Inc. All rights reserved12 - 19 The Deregulation Movement Deregulation Movement: Beginning in late 70’s under Carter, the drive to reduce government regulation controlling prices and entry in many industries –Air cargo, Air travel, Satellite transmissions, Crude oil, Radio –Reduced deadweight loss