1. Chapters 15, 16, and 17 © 2009 South-Western/ Cengage Learning Unit 7

2. Chapter 15 Economic Regulation and Antitrust Policy © 2009 South-Western/ Cengage Learning

3. Types of Government Regulation Market power –Raise the price without losing all sales to rivals –Firms downward-sloping demand curve 3

4. Types of Government Regulation Government regulations –Social regulations Improve health and safety –Economic regulations Control: price, output, entry of new firms, quality of service –Desirable monopolies Control natural monopolies –Antitrust policy Outlaws monopolies and cartels 4

5. Regulating a Natural Monopoly Natural monopoly –Downward-sloping LRAC curve Unregulated profit maximization –MR=MC –Economic profit –Consumer surplus –P>MC, higher social welfare if output expanded 5

6. Regulating a Natural Monopoly Government –Increase social welfare –Lower P, expand Q Public utilities –Government-owned monopoly –Government regulated monopoly 6

7. Regulating a Natural Monopoly Setting P=MC –Where D intersects MC –Higher consumer surplus –Monopolist: economic loss –In long-run: monopolist exits the market –Needs subsidizing 7

8. Regulating a Natural Monopoly Subsidizing the natural monopolist –Government covers the loss –Firm: earn normal profit –Drawback: government must raise taxes, forgo public spending Setting P=average cost –‘Fair return’: normal profit Stay in business without a subsidy –Higher social welfare (than unregulated) 8

9. Regulating a Natural Monopoly Setting P=MC or P=average cost –Reduce P –Increase output –Erase economic profit –Increase consumer surplus –Increase social welfare 9

10. Regulating a Natural Monopoly The regulatory dilemma –If p=MC Socially optimal allocation of resources –Marginal benefit=MC Monopolists: loss Requires government subsidy –If p=average cost Monopolist: normal profit No socially optimal allocation 10

11. Alternative Theories: Econ. Regulation Economic regulation –Public interest, promotes social welfare –Special interest of producers ‘Capture theory of regulation’ Producer groups –Expect to gain –Persuade public officials to impose restrictions Consumers have no special interest Reduce competition Increase prices 11

12. Antitrust Law and Enforcement Antitrust policy –Reduce anticompetitive behavior –Promote competition Origins of antitrust policy –Developments Technology: economies of scale Railroad: reduced transport costs Bigger firms, wider markets 12

13. Origins of Antitrust Policy 1873-1883 sharp economic decline –Competing firms formed a trust Sugar, tobacco, oil industries Widespread criticism Sherman antitrust act of 1890 –Trusts, restraint of trade, monopolization Clayton act of 1914 –Price discrimination, tying contracts, exclusive dealing 13

14. Origins of Antitrust Policy Federal trade commission act of 1914 –Federal trade commission –Enforce antitrust laws Cellar-Kefauver anti-merger act –Horizontal mergers –Vertical mergers 14

15. Antitrust Enforcement Antitrust division of the US Justice Department FTC Consent decree Court trial Judge decides 15

16. Per Se Illegality and Rule of Reason Per se illegal –Illegal regardless of the economic rationale or consequences –Firm’s behavior Rule of reason –Reasons and its effect on competition –Firm’s behavior –Market structure 16

17. Mergers and Public Policy Antitrust division and FTC –Approve/deny mergers and acquisitions –Herfindahl-Hirschman Index HHI Sales concentration Horizontal mergers –Firms in the same market Nonhorizontal mergers –Challenged mergers if Post-merger HHI>1800 Merger increases HHI by >100 points 17

18. Exhibit 2 Herfindahl-Hirschman Index (HHI) based on market share in three industries 18 Industry IIndustry IIIndustry III Firm Market Share (%) Market Share Squared Market Share (%) Market Share Squared Market Share (%) Market Share Squared A B C D Remaining 40 firms 23 18 13 6 1 each 529 324 169 36 40 15 1 each 225 40 57 1 1 each 3,249 1 40 HHI1,0989403,292 Each of the three industries has 44 firms. The HHI is found by squaring each firm’s market share then summing the squares. Only the market share of the top four firms differ across industries; the remaining 40 firms have 1% market share each. The HHI for Industry III is nearly triple that for each of the other two industries.

19. Exhibit 3 U.S. merger waves in the past century 19 WaveYears Dominant type of mergerExamplesStimulus First Second Third Fourth 1887-1904 1916-1929 1948-1969 1982- present Horizontal Vertical Conglomerate Horizontal and vertical U.S. Steel, Standard Oil Copper refiner with fabricator Litton Industries Banking, tele- communications, health services, insurance Span national markets Stock market boom Diversification Span national and global markets, stock market boom

20. Exhibit 4 Competitive trends in the US economy: 1939 to 2000 20

21. Recent Competitive Trends Increased competition in US Growing world trade Three major automakers –80% of US market in 1970; only 54% by 2006 Deregulation International phone service –$0.88 a minute in 1997; under $0.10 by 2007 Technological change Three major TV networks –90% in 1980; under 40% by 2007 21

22. Chapter 16 Public Goods and Public Choice © 2009 South-Western/ Cengage Learning

23. Private, Public Goods, and in Between 1.Private goods –Rival in consumption –Exclusive –Provided by private sector 2.Public goods –Nonrival in consumption –Nonexclusive –Provided by government 23

24. Private, Public Goods, and in Between 3.Natural monopoly –Nonrival but exclusive –With congestion: private goods –Provided by private sector or government 4.Open-access good –Rival but nonexclusive –Regulated by government 24

25. Exhibit 1 Categories of goods 25

26. Optimal Provision of Public Goods Nonrival in consumption –Once produced: available to all consumers Market demand curve –Vertical sum of individual demand curves –Marginal benefit Efficient level of public good –Market D curve intersects MC curve 26

27. Paying for Public Goods Tax = marginal valuation –Free-rider problem People try to benefit from the public goods without paying for them –Ability to pay 27

28. The Underground Economy Unreported market activity –To avoid taxes –Illegal Tax avoidance –Legal –Pay least possible tax Tax evasion –Illegal –No or fraudulent tax return 28

29. The Underground Economy Underground economy grows more –Government regulation increase –Tax rates increase –Government corruption widespread Estimated: $1.4 trillion in 2007 29

30. Chapter 17 Externalities and the Environment © 2009 South-Western/ Cengage Learning

31. Optimal Level of Pollution External costs with fixed technology –Fixed-production technology Cut emissions: cut production –Marginal social cost Marginal private cost Marginal external cost 31

32. Optimal Level of Pollution Socially efficient production –Demand (marginal benefit) intersects marginal social cost curve –Government regulation Limit production Tax = marginal external cost –Marginal social cost = marginal benefit –Total social gain Total social cost (firms ignore external cost) 32

33. Optimal Level of Pollution External costs with variable technology –Variable technology Reduce emissions: alter the production process Cleaner technology –Production of cleaner air Diminishing returns 33

34. Optimal Level of Pollution Reducing greenhouse gases –Marginal social cost curve Upward-sloping –Marginal social benefit curve Downward-sloping Diminishing marginal benefit to society –Optimal level of air quality Marginal social benefit = marginal social cost –Higher than optimal level of air quality Social waste 34

35. Exhibit 2 The optimal reduction in greenhouse gas emissions 35 Dollars per unit Total social gain Marginal social cost Marginal social benefit AHigh Greenhouse gas emissions A’Low a b c Optimal level of greenhouse gas emissions: point a; marginal social benefit of reducing such emissions = the marginal social cost If some lower level of emissions were dictated by the government, the marginal social cost would exceed the marginal social benefit, and social waste would result.

36. Optimal Level of Pollution Shift in marginal social cost curve –Technological breakthrough: Lower marginal cost of cutting greenhouse gas Downward shift of MSC curve Lower optimal level of emissions Shift in marginal social benefit curve –Higher marginal benefit of reducing emissions Upward shift of MSB curve Lower optimal level of emissions 36

37. Exhibit 3 Effect of changes in costs or benefits of reducing greenhouse gas emissions 37 Marginal social benefit Marginal social cost Dollars per unit A 0 A’ Higher quality air Marginal social benefit Marginal social cost Dollars per unit A 0 A’’ Higher quality air MSC’ (a) Lower cost of reducing emissions(b) Greater benefit of reducing emissions MSB’

38. Optimal Level of Pollution Market for pollution rights –Government Sells pollution rights Limits maximum level of pollution per day –Firms D = marginal value of pollution Buy pollution rights –Value of pollution permits Fluctuates 38

39. Pollution Rights and Public Choice Pollution regulation –Special interest of polluters Before 1990 –Command-and-control environmental regulations Particular technologies to reduce emissions Market for pollution rights –Economic efficiency approach Reduce emissions: Cost-effective 39

40. Environmental Protection Environmental Protection Agency EPA Clean air act of 1970 Clean water act of 1972 Resource conservation and recovery act of 1976 Superfund law of 1980 40

41. Air Pollution Atmosphere –Economic resource –People value clean air; willing to pay more Smog –40% from automobile emissions –40% from consumer products –15% from manufacturing 41

42. Air Pollution Clean air act of 1970 –90% reduction in auto emissions –By 1990, average emissions fell Lead: 97% Monoxide: 41% Sulfur dioxide: 25% U.S. air quality: good U.S. – major source of fossil-fuel carbon dioxide emissions 42

43. Exhibit 5 (The 25 worst nation) Fossil-fuel carbon dioxide emissions per capita 43

44. Water Pollution Sources –Sewage –Chemicals Sewage –Dumped into waterways; no cleaning Negative externality –Federal money: treatment plants 44

45. Water Pollution Chemicals –10% from point pollution Factories, industrial sites –Two thirds – from nonpoint pollution Agricultural pesticides and fertilizers –In most states: pesticides have fouled some groundwater 45

46. Hazardous Waste and the Superfund Before 1980 –Firms Pay others to haul and dispose Not responsible for cleaning Superfund law of 1980 –Companies Pay others to haul and dispose Pay for clean up 46

47. Solid Waste:”Paper or Plastic?” U.S. households –4 pounds of garbage per resident per day Mostly packaging –200 million tons per year 70% of garbage - landfills Recycled: 15% of garbage –75% paper products 15% - incinerated –Trash-to-energy plants 47

48. Exhibit 6 Paper and cardboard recycling: top 25 among advanced economies 48

49. Solid Waste:”Paper or Plastic?” 2 out of 3 aluminum cans: recycled Returnable deposit laws –Increase recycling Recycling: imposes environmental costs –Curbside recycling Trucks –Newsprint De-inked 49

50. Positive Externalities Beneficial externalities Education –Personal benefits –Benefits to society Positive externality Public policy –To increase quantity beyond private optimum 50

51. Exhibit 7 Education and positive externalities 51 E 0 E’ Quantity of education per period Dollars per unit D Marginal private benefit D’ Marginal social benefit S Marginal cost e’ e No government intervention: equilibrium quantity of education (E); marginal private benefit of education equals the marginal cost as reflected by the supply curve. Education also confers a positive externality on the rest of society, so the social benefit exceeds the private benefits. At E, the marginal social benefit exceeds the marginal cost, so more education increases social welfare. In this situation, government tries to increase education to E’, where the marginal social benefit equals the marginal cost.