1. Antitrust, Regulation, and Deregulation
Chapter 13
Antitrust, Regulation, and Deregulation

2. Chapter Objectives The goals of U.S. regulatory and antitrust policies
The legal framework for U.S. antitrust policy
How governments enforce antitrust policy
How the government gauges the effect of mergers on competition
How antitrust laws are interpreted and enforced
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3. The Government’s Role in Promoting Efficiency
Up to this point, we have studied the effects of the various market structures and government policy (taxes, price controls) on economy efficiency (deadweight loss).
Now, we turn to the role of government in promoting economic efficiency when there is market failure (the unregulated market is inefficient).
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4. Why the Government Might Intervene
Three main reasons why the government would intervene in a market:
To promote productive efficiency
Resources are employed at the lowest cost.
To promote innovation
Creation and application of new technology
To promote allocative efficiency
Resources are distributed in the way that society values most.
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5. Why the Government Might Intervene (cont’d)
Most economists agree that the best way to achieve efficiency and promote innovation is through competition.
However, competitive markets do not always arise naturally, and may even be undesirable in some cases. (market failure)
Too few competitors / barriers to entry
Externalities (costs/benefits not price in market)
Assymetric information
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6. Natural and Optimal Market Structures
The natural structure of a market is the degree of competition that would occur in the absence of government intervention.
The optimal structure of a market is the degree of competition that maximizes allocative efficiency.
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7. Natural and Optimal Market Structures (cont’d)
The government will tend to intervene if the natural structure differs significantly from the optimal structure.
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8. The Perfect Competition Benchmark
The efficiency of a market is measured by comparing the existing price and output to the price and output that would result from marginal cost pricing in a perfectly competitive market.
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9. Figure 13.1 Consumer and Producer Surplus With Competitive and Monopoly Pricing
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10. U.S. Antitrust Policy Legal Framework
The history of U.S. antitrust policy dates back to the mid-1860s, when a few very large firms came to dominate the steel, railroad, and oil industries.
These trusts came under fire for unethical business practices that drove competitors out of business.
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11. 3 Major Pieces of Legislation to address Anti-Competitive Markets
Sherman Anti-trust Act (1890)
Anti-competitive behavior, mergers
Clayton Act (1914)
Price discrimination (simple)
Tie-in sales
Robinson-Putman (1936)
More detailed/complex definition of price discrimination
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12. Sherman Anti-trust Act
As explained by the U.S. Supreme Court in Spectrum Sports, Inc. v. McQuillan,
“ The purpose of the [Sherman] Act is not to protect businesses from the working of the market; it is to protect the public from the failure of the market. The law directs itself not against conduct which is competitive, even severely so, but against conduct which unfairly tends to destroy competition itself
The law attempts to prevent the artificial raising of prices by restriction of trade or supply.[4]
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13. The Sherman Antitrust Act of 1890
The basis of much of U.S. antitrust policy, the Sherman Act outlaws:
Trusts and restraint of trade
Trusts allowed 1 company to own shares in another; thus getting around prohibition of collusive agreements
Monopolies or attempts to monopolize an industry
Standard Oil: Predatory Pricing
Dropping price < ATC to drive out competitors
McGee: found SO offered P = P(monopoly) (higher than competitive value)
Mergers that are anti-competive
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14. Sherman Anti-Trust Act
Divided into three sections.
Sec 1 delineates and prohibits specific means of anticompetitive conduct, (e.g., contracts/agreements)
Sec 2 deals with end results that are anticompetitive in nature. (actual pricing tactics, or non-compete)
Sec 3 simply extends the provisions of Section 1 to U.S. territories and the District of Columbia.
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15. Section 1: "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal."[13]
Section 2: "Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony [. . . ]"[14
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16. The Sherman Antitrust Act of 1890
Trusts and restraint of trade
Trust: ownership of another company’s stock
Marketing agreements/non-compete
Monopolies or attempts to monopolize an industry
Standard Oil: Predatory Pricing
Dropping price < ATC to drive out competitors
See McGee’s correction
Mergers that are anti-competive
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17. The Sherman Antitrust Act of 1890 (cont’d)
Under the Sherman Act, courts may:
Break monopolies up into smaller firms
Divestiture – divest the company of its smaller firms
1980 – AT&T break-up
Prohibit certain business practices
Predatory pricing: P < min ATC to drive competitors out
Supposedly Standard Oil in the 30’s
Price fixing: setting P > MC and agreeing not to compete
Eastern/American Airlines
Not compete: geographic/product lines
Impose fines on firms
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18. The Clayton Act of 1914 The Clayton Act prohibits:
Price discrimination that reduces competition
Product tie-ins
Required purchase of another more elastic good to be able to purchase monopoly good
IBM and computer cards
The purchase of stock issued by competing companies
Serving on the board of directors of a competing company
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19. The Clayton Act of 1914 (cont’d)
Established treble damages
Plaintiffs can recover three times the actual damage.
Exempted labor unions from antitrust law
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20. The Federal Trade Commission Act of 1914
Created the Federal Trade Commission (FTC), the agency that identifies and pursues antitrust cases
Department of Justice (DOJ), agency for attorneys that prosecute the cases
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21. The Robinson-Patman Act of 1936
Clarified the definition of price discrimination
discrimination in price;
on at least 2 consummated sales;
from the same seller;
to 2 different purchasers;
of "commodities" of like grade and quality;
the effect may be "substantially to lessen competition or tend to create a monopoly in any line of commerce."
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22. Enforcement of Antitrust Policy
The Department of Justice (DOJ) and the Federal Trade Commission (FTC) have the power to sue firms in order to:
Force violators to stop anticompetitive practices
Break up existing firms into smaller ones
Prevent the formation of very large firms
Impose fines on firms that violate antitrust legislation
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23. Changes in Enforcement
Since the Sherman Act of 1890, enforcement of antitrust legislation has become less stringent.
Technological change and globalization have lead to increased competition. (contestable markets)
Telecomm – wireless and landlines
Music – record manufacturers and ITunes
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24. Mergers
In addition to enforcing antitrust laws, the FTC may try to block or alter a merger.
A merger occurs when two firms combine to form a single firm.
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25. Types of Mergers Conglomerate Merger Vertical Merger Horizontal Merger
Firms in unrelated industries merge.
Vertical Merger
A firm buys another firm that is either above it or below it in the supply chain.
Horizontal Merger
A combination of two firms that are in the same industry
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26. The Government’s Position on Mergers
The government’s position on mergers has changed over the years, from preventing the merger of relatively small firms to allowing the merger of large companies.
Bush(43) – focused only on horizontal mergers
Obama – returned to review both horizontal and vertical mergers (Ticketmaster)
In general, a merger that results in a Herfindahl-Hirschman Index of less than will not be challenged.
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27. Natural Monopolies And Regulation
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28. Natural Monopolies
Economies of Scale continue to occur at so large a scale that is it is “productively efficient” (least cost) to have only 1 provider
Natural state and optimal state is a monopoly
typically high fixed costs and low variable costs
electric, natural gas, water, telecommunications (land) and tv cable
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29. Regulation
If a natural monopoly arises due to scale economies, the government may prefer to regulate the monopoly.
Breaking the firm up may reduce efficiency
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30. Figure 13.2 Natural Monopoly in the Telecommunications Industry
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31. Government Regulation of Price and Output
The government cannot require that a natural monopolist set price equal to marginal cost.
Because marginal cost is less than average cost, two options:
1. Government subsidizes the loss (Euro approach)
No deadweight loss, but requires taxes on other goods
2. Average Cost Pricing (or Rate of Return (ROR)): government sets price equal to average total cost. (US solution)
Leads to some deadweight loss, but less than a monopoly
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32. Figure 13.3 Choosing a Price for a Natural MonopolistUS
French
Economic Loss or Subsidy
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33. Government Regulation of Price and Output
Two methods of regulating price and output:
Rate of Return Regulation—the firm is allowed to earn a pre-specified amount of profit in a given time period.
Set prices to recover average cost + normal rate of return
How do you determine normal ROR?
Incentive for regulated firm to “pad” its costs (Averech-Johnson effect)
Price Cap—government sets the maximum price or the maximum rate of price increase.
After rate setting process: future rates can be raised by rate of inflation – industry’s average productivity (incentive for tech. iinnov.)
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34. Deregulation
The current trend is for the government to remove regulation and allow market forces to determine prices, output, profits, and industry structure.
Factors favoring deregulation:
Difficulty in determining a regulatory strategy
Advances in technology that have lead to increased competition
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35. Life Lessons Two wrongs don’t make a right.
In the 1930s many states passed “Fair Trade” laws that effectively outlawed low prices.
Fair trade – same price in each market
Doesn’t reflect different supply/costs (or demand)
As a result, consumers faced higher prices and retail stores were protected from bankruptcy.
These laws were eliminated in 1975.
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36. Reasons For Deregulation
In deciding to deregulate an industry, the government must be confident that private market outcomes will be more efficient than regulated outcomes.
Will deregulation affect product safety or reliability?
Will deregulation eliminate service for some customers?
Will the benefits of deregulation accrue to only a few customers?
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37. Application: Deregulation of the Airline Industry
In 1978, the U.S. Airline Deregulation Act removed regulations on prices, the number of carriers and route assignments.
(some) Passengers have benefited from the resulting price competition among air carriers.
FAA set similar rates for flights of similar difference, regardless of destination (and demand in large/small cities)
“legacy” losses and gains
Smaller cities saw higher prices and fewer flight
Larger cities: lower prices, more flights
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38. Application: Deregulation of theTelecommunications
In 1980, AT&T and the “Baby Bells” were broken up into 8 different companies
AT&T could offer only long distance service and had to compete with MCI and Sprint (no longer a monopoly)
Baby Bells’ customer could choose their LD provider
Took several years for AT&T market share to drop below 80%
Colbert video – “it’s all back together again”
FCC missed that there were economies of scale – led to mergers to reduce costs
1996 Congress passed the Telecommunications Act
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39. Application: Deregulation of theTelecommunications
1996 Congress passed the Telecommunications Act
Required Baby Bells and GTE to open their local markets to all competitors
Established prices that Bells could charge competitors for “renting” their lines and switching equipment
Prices were set below incurred (or historical) costs
Decreased incentive to maintain and update existing equipment
Previously business line rates set higher than costs to subsidize residential phone service
New entrants targeted business customers and high long distance usage customers (winners)
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40. Strategy and Policy
The Department of Justice takes on Cingular–AT&T Wireless merger
In 2004, Cingular agree to buy AT&T Wireless, creating a company with an HHI of 8,000 in some markets.
In 2005, the firm was required to divest the entire AT&T Wireless network in the 13 markets where concentration was highest.
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41. Summary
The U.S. government may intervene in the private sector to promote productive efficiency, innovation, or allocative efficiency.
U.S. antitrust policy is based on:
The Sherman Act, which forbids monopolies
The Clayton Act, which prohibits price discrimination
The Federal Trade Commission Act, which established the FTC
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42. Summary (cont’d)
Some actions are per se illegal; simply engaging in them is enough to establish guilt.
Conglomerate mergers are not usually challenged.
Vertical and horizontal mergers may be challenged if they reduce competition.
In the case of a natural monopoly, it may be preferable for the government to regulate the firm.
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43. Summary (cont’d)
Deregulation of an industry may be appropriate because of changes in technology and globalization.
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44. Table 13.1 Excerpts From Section 1 and 2 of the Sherman Antitrust Act
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45. Table 13.2 Summary of Key U.S. Antitrust Legislation
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