2. 1 C H A P T E R 14 1 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin Market Power and Public Policy: Antitrust Policy and Deregulation

3. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 2 Antitrust Policy  The purpose of antitrust policy is to promote competition among firms. Competition leads to lower prices and better products.

4. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 3 Antitrust Policy  Break up of monopolies into several smaller companies.  Prevent corporate mergers that would reduce competition.  Regulate business practices. Under federal antitrust rules, the government can:

5. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 4 Brief History of Antitrust Legislation 1890Sherman Act: made it illegal to monopolize a market or to engage in practices that resulted in a restraint of trade. 1914Clayton Act: outlawed specific practices that discourage competition, including tying contracts, price discrimination for the purpose of reducing competition, and stock-purchase mergers that would substantially reduce competition. 1914Federal Trade Commission: established to enforce antitrust laws. 1936Robinson-Patman Act: prohibited selling products at “unreasonably low prices” with the intent of reducing competition. 1950Celler-Kefauver Act: outlawed asset-purchase mergers that would substantially reduce competition. 1980Hart-Scott-Rodino Act: extended antitrust legislation to proprietorships and partnerships.

6. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 5 Breaking Up Monopolies  A trust is an arrangement under which the owners of several companies transfer their decision-making powers to a small group of trustees. Firms in a trust act as a single firm.  The label “antitrust” comes from early cases involving the breakup of trusts.

7. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 6 Blocking Mergers  A merger occurs when two firms combine their operations.  Because a merger decreases the number of firms in a market, it is likely to lead to higher prices.  A possible benefit from a merger is that the new firm could combine production, marketing, or administrative operations, and thus produce its products at a lower average cost.

8. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 7 Blocking Mergers  New guidelines developed by the Justice Department and the Federal Trade Commission allow companies involved in a proposed merger to present evidence that the merger would reduce costs and lead to lower prices, better products, or better service.  The analysis of proposed mergers today focuses less on counting the number of firms in a market, and more on how a merger would affect price.

9. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 8 The Impact of Mergers on Price and Profits  Suppose that initially there are two separate firms in the bread market. Each firm serves half of the market demand, and faces the same structure of costs as the other.  When firms act independently, the profit of each firm equals $250.

10. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 9 The Impact of Mergers on Price and Profits  An increase in the price of Interstate bread will decrease quantity sold, and profit from the sale of Interstate decreases by $10, from $250 to $240.  Suppose that after a merger, the firm will keep the price of Wonder bread constant at $1.50, but increase the price of Interstate bread to $1.60.

11. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 10 The Impact of Mergers on Price and Profits  Profit from the sale of Wonder bread increases by $30, from $250 to $280.  The increase in the price of Interstate bread will increase the demand for Wonder bread.

12. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 11 The Impact of Mergers on Price and Profits  In this case, the good news (more profit on Wonder bread) outweighs the bad news (less profit on Interstate bread), thus it is possible for a merger of two firms selling close substitutes to lead to higher prices and have a net increase in profit. Conclusion:

13. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 12 Competition and Pricing in Different Cities  A 1997 study by the Federal Trade Commission found that the prices charged by Staples, an office supply chain, were lower in cities where its competitor, Office Depot, also had a store.

14. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 13 Competition and Pricing in Different Cities  The profit-maximizing price is higher in the city without competition.

15. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 14 Competition and Pricing in Different Cities  The Federal Trade Commission used this logic to convince the court that the proposed merger of Staples and Office Depot would lead to higher prices.

16. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 15 Regulating Business Practices  The government may intervene when specific business practices increase market concentration.  Among those practices are: Price fixing Tying, or forcing consumers of one product to purchase another Price discrimination that reduces competition

17. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 16 Predatory Pricing  Predatory pricing is the selling of products at “unreasonably low prices” with the intent of reducing competition.  Predatory pricing is a profitable strategy if the firm can charge the monopoly price long enough to offset the losses from driving its rival out of business.

18. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 17 The Microsoft Case  In the case of the United States versus Microsoft Corporation, the government alleged that Microsoft stifled competition in several ways.

19. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 18 The Microsoft Case  Microsoft threatened Compaq Corporation, a computer manufacturer, with the loss of the license to install the Microsoft operating system in their computers after Compact announced plans to substitute Netscape’s Navigator for Explorer.

20. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 19 The Microsoft Case  Microsoft prohibited computer manufacturers from altering the Windows desktop by removing Microsoft’s desktop links to the Internet.

21. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 20 The Microsoft Case  Microsoft’s bundling of Explorer with Windows 95 and its inclusion as part of Windows 98 involves tying the operating system with the browser.

22. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 21 The Microsoft Case  The government claimed that Microsoft used its virtual monopoly in operating systems to gain a monopoly in the browser market.

23. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 22 The Microsoft Case  The government also claimed that Microsoft used illegal practices to protect its monopoly in the market for operating systems.

24. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 23 Deregulation of Airlines and Telecommunications  The purpose of deregulation in the airlines and telecommunications industries was to increase competition and decrease prices.  In the airline industry, deregulation caused some firms to go out of business and others to merge.

25. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 24 Deregulation of Airlines and Telecommunications  Some mergers resulted in lower production costs and prices, but others reduced competition and led to higher fares.  The consensus among economists is that deregulation generated net benefits for consumers. On average, fares decreased about 33% in real terms.

26. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 25 Deregulation of Airlines and Telecommunications  The Telecommunications Act of 1996 established new rules for the transmission of video, voice and data.  The basic idea was to promote competition in the markets for telecommunication services.

27. © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eO’Sullivan & Sheffrin 26 Deregulation of Airlines and Telecommunications  To open local telephone service to new firms that would compete with the Baby Bells  To eliminate price controls for cable TV and allow the phone companies to enter the cable market  To allow the Baby Bells to enter the market for long-distance service once there is sufficient competition in local telephone service Among the provisions of the act were: