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

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

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

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

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. 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. 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. 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. 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. Regulation and Deregulation
Numerous regulatory agencies have been developed since 1887.
Since 1977, industry has been going through a gradual process of deregulation.

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. 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. 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. 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. Natural Monopoly: Marginal Cost Pricing30 25
Price & Cost (dollars per household per month) 20 15
ATC 10 MC D 2 4 6 8 10
Quantity (millions of households)

18. Natural Monopoly: Marginal Cost Pricing30
Total
surplus 25
Price & Cost (dollars per household per month) 20
Loss per
household 15
ATC 10 MC D 2 4 6 8 10
Quantity (millions of households)

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

20. Natural Monopoly: Average Cost Pricing30 25
Price & Cost (dollars per household per month) 20 15
ATC 10 MC D 2 4 6 8 10
Quantity (millions of households)

21. Natural Monopoly: Average Cost Pricing30 25
Price & Cost (dollars per household per month) 20
Consumer
surplus 15
Producer
surplus
ATC 10 MC
Deadweight
loss D 2 4 6 8 10
Quantity (millions of households)

22. Regulation and Deregulation
Capturing the Regulator
Maximizes profit

23. Natural Monopoly Profit Maximization30 25
Price & Cost (dollars per household per month) 20 18 15
ATC 10 MC MR D 2 4 6 8 10
Quantity (millions of households)

24. Natural Monopoly Profit Maximization30
Consumer
surplus 25
Price & Cost (dollars per household per month) 20
Deadweight
loss 18 15
Economic
profit
ATC 10 MC MR D 2 4 6 8 10
Quantity (millions of households)

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

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. Natural Monopoly: Inflating Costs30 25
Price & Cost (dollars per household per month) 20 18
ATC (inflated) 15
ATC 10 MC MR D 2 4 6 8 10
Quantity (millions of households)

28. Natural Monopoly: Inflating Costs30
Profit is
maximized 25
Price & Cost (dollars per household per month) 20 18
ATC (inflated) 15
Economic
profit
ATC 10 MC MR D 2 4 6 8 10
Quantity (millions of households)

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. Rate of Return in Regulated Monopolies
Years
Industry 1962– –77
Electricity
Gas
Railroad
Average of above
Economy Average

31. Gains from Deregulating Natural Monopolies
Consumer Producer Total
surplus surplus surplus
Industry (billions of 1990 dollars)
Railroads
Telecommunications
Cable television
Total

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. Collusive Oligopoly 50 40 30 20 10 100 200 300 400 500 MC
Producer
interest
regulation MC 40
Price & Cost (dollars per trip) 30
Public
interest
regulation 20 10 D MR
100
200
300
400
500
Quantity (number of trips)

34. Rates of Return in Regulated Oligopolies
Years
Industry 1962– –77
Airlines
Trucking
Economy Average

35. Gains from Deregulating Oligopolies
Consumer Producer Total
surplus surplus surplus
Industry (billions of 1990 dollars)
Airlines
Trucking
Total

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

38. Antitrust Laws Year Name of law Passed What the law prohibits
Sherman Act *Combination, trust or conspiracy to restrict interstate or international trade.
* Monopolization or attempt to monopolize interstate or international trade
Clayton Act * Price discrimination if the effect is to Robinson-Patman substantially lessen competition or create Amendment monopoly and if such discrimination is not Cellar-Kefauver 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

39. Antitrust Laws Year Name of law Passed What the law prohibits
Federal Trade * Unfair methods of competition and
Commission Act unfair or deceptive business practices

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. Landmark Antitrust Cases
Case Year Verdict and consequence
American Tobacco 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.

42. Landmark Antitrust Cases
Case Year Verdict and consequence
Alcoa Guilty: Too big--had too large a share of the
market; end of “rule of reason.”
General Electric, Guilty: Price-fixing conspiracy; executives
Westinghouse & others fined and jailed
Brown Shoe 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 Guilty: Merger of two supermarkets in
Los Angeles would restrain competition (the merged firm would have had 7.5 percent of the L.A. market).

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

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

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. The HHI Merger Guidelines

48. Proposed Mergers (1986) Market definition 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. 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?