1. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter 10: Competition and Government Policy

2. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 38 Chapter 10 Outline Introduction The Pressures of Competition Controlling Competition The Ambivalence of Government Policies Selling Below Cost What is the Appropriate Cost? “Predators” and Competition

3. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 38 Chapter 10 Outline Regulating Prices “Antitrust” Policy Interpretations and Applications Vertical Restraints: Competitive or Anticompetitive The Range of Opinion Toward Evaluation

4. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 38 Introduction Questions –Will economic competition disappear unless the government has an active program to preserve it? –When the government prohibits mergers, is it preventing competitors from eliminating rivals?

5. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 38 Introduction Questions –When sellers face so little competition that they can charge prices far above cost, can government protect consumers from exploitation by regulating prices? –How is competition measured in an industry?

6. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 38 The Pressures of Competition Price > Marginal Cost –Sellers facing downward sloping demand curves Invites Competition Example –Piece of pie costs 50 cents to produce –Seller sells the pie for $1.50

7. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 38 The Pressures of Competition P Q D Temptation!.50 Marginal cost $1.50 Price

8. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 38 The Pressures of Competition P Q Demand curve as seller perceives it D

9. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 38 The Pressures of Competition Question –Are there legal ways to restrict competition? Examples –Washington, DC Medical Society –Plumbers –Woolen Makers –Barbers

10. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 38 Controlling Competition Question –Why don’t sellers agree not to compete? High transaction costs Collusion is illegal Difficult to devise agreement Collusion may attract other firms

11. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 38 Controlling Competition What about Cartels? –Cartels are fragile –To be successful for its members Must prevent competition among members Stop new competitors from entering the market Price Searchers and Takers seek to restrict entry –But open entry and exit = entrepreneurship

12. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 38 The Ambivalence of Government Policies Question –Should the government be relied on to preserve competition in the economy? Answer –Concern for competition is not the same as concern for competitors.

13. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 38 The Ambivalence of Government Policies A law that restricts competitors restricts competition. A law that restricts competitors restricts competition. Common justification for such laws is that they preserve competition by preventing “predatory” practices. Common justification for such laws is that they preserve competition by preventing “predatory” practices.

14. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 38 Selling Below Cost Should there be laws that prevent firms from selling below cost? Many states have such laws. Why would some business firms be in favor of such a law?

15. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 15 of 38 Selling Below Cost Public view –Price cutting may lead to monopolies Question –Is this bad?

16. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 38 What is Appropriate Cost? Problem –How to determine the cost below which prices cannot be set. Question –Once an item is bought, isn’t it a sunk cost? Question –What should a firm do if they cannot sell their product before it spoils?

17. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 38 What is the Appropriate Cost? Marginal costs should be considered Business people are concerned with: –Additional revenues resulting from a decision –Additional costs from the same decision Question –When would a grocer want to sell a newspaper below cost?

18. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 38 “Predators” and Competition Protecting competitors is not the same as preserving competition Predatory Pricing –Reducing prices below cost in order to drive out rivals –Intend to raise prices afterward to recoup losses

19. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 38 “Predators” and Competition Question –How long will it take for such a policy to work? The longer it takes the larger the short term losses Question –Is it likely that the predatory firm will be able to destroy enough of its rivals to secure the degree of market power it must have to earn enough long run profits to justify short term losses?

20. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 38 Regulating Prices Prices should be set to enable firms to earn a reasonable profit. How will regulators determine the costs of running the enterprise? –Innovation? –Cost control?

21. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 38 Regulating Prices Question –Who will regulate the regulators? Capture Theory –Regulators tend to acquire an interest in the well- being of the industry.

22. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 38 Regulating Prices Examples –Banking –Airlines –Telephone Problem –Is competition unable to constrain the behaviors of the firms in the regulated industry?

23. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 38 Regulating Prices The movement towards deregulation of the past two decades has not settled all the issues. History –There are more margins on which competition can occur –Competition has some advantages over commissions

24. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 38 “Antitrust” Policy Laws have been passed to promote competition –Federal –State –Local

25. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 38 “Antitrust” Policy Sherman Antitrust Act – 1890 –Forbids all contracts, combinations or conspiracies in restraint of interstate trade and all attempts to monopolize any part of interstate trade.

26. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 38 Interpretations and Applications Clayton Act – 1914 –Mergers that “substantially” lessen competition were made illegal.

27. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 38 Interpretations and Applications Federal Trade Commission Act –Created Federal Trade Commission Prohibited “unfair” practices

28. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 28 of 38 Interpretations and Applications Question –When does a merger substantially lessen competition? Horizontal Conglomerate Vertical

29. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 29 of 38 Interpretations and Applications Question –What is an illegal trade practice? Summary –Restriction on competitors will restrict their ability to compete. –We must decide when we want the government to restrict a firm’s competitive efforts.

30. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 30 of 38 Vertical Restraints: Competitive or Anticompetitive Vertical restraints have been controversial –(1937 – 1976) Federal legislation exempted state-endorsed price- fixing agreements between manufacturers and retailers.

31. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 31 of 38 Vertical Restraints: Competitive or Anticompetitive Questions –Why would a manufacturer want retailers to charge more and sell less? –Why would a manufacturer want fewer retailers selling its products?

32. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 32 of 38 The Range of Opinion Question –Is the whole body of “antitrust” law perhaps more of a hindrance than a help to competition? Opinion –Retain the Sherman Act and the anti-merger provision of the Clayton Act only –The Sherman and Clayton Acts, in their entirety, have made important contributions.

33. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 33 of 38 The Range of Opinion Opinions –They would be improved if they were more seriously enforced. –They are both harmless rhetoric

34. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 34 of 38 Toward Evaluation Competitive restrictions reduce the availability of substitutes and allow sellers to increase their own wealth. –Competition is a process, not a state of affairs. An inadequate situation must be compared with more desirable situations that are attainable.

35. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 35 of 38 Once Over Lightly The gap between the price of a good and the marginal cost of making it available is a source of potential advantage to someone. Competition occurs in the economy as people locate such differentials, and exploit them. There are usually so many forms of competition that it is difficult to anticipate and head them all off.

36. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 36 of 38 Once Over Lightly A gap between the price and marginal cost is a source of potential advantage to someone; and competition occurs. Competition takes many forms. Firms try to obtain government assistance to exclude competition. Government regulation has blocked competition.

37. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 37 of 38 Once Over Lightly Competition is a process. We cannot have competition without competitors. We cannot have competition if –We legally prohibit firms –from taking actions –to increase market share of the firm

38. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 38 of 38 End of Chapter 10 QUESTIONS?