Antitrust, Regulation,
and Deregulation
The Government’s Role
in Promoting Efficiency
 Studied the effects of the various market structures
and government policy (taxes, price controls) on
economy efficiency (deadweight loss).
 Now: role of government in promoting economic
efficiency when there is market failure (the
unregulated market is inefficient).
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13-2
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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13-3
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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13-4
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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13-5
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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13-6
The Sherman Antitrust Act of 1890
 The basis of much of U.S. antitrust policy, the Sherman
Act outlaws:
 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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13-7
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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13-8
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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13-9
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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13-10
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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13-11
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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13-12
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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13-13
Types of Mergers
 Conglomerate 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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13-14
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 1800
will not be challenged.
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13-15
Reviewing Mergers
 Primarily aimed at preventing mergers or acquisitions
that reduce competition
 FCC regulates communications media (newspapers, tv,
telecomm, radio)
 FTC and DOJ regulate the rest
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Where We’re Going
 How do we tell if a merger is anti-competitive?
 Market Concentration
 CR4: market share for the 4 largest firms
 Herfindahl Index (HHI): computed from the squares of the market
shares
 Strategic behavior (how do they behave in the
market place)
 Collusive: act together
 Non-collusive: act separately and/or stratgeicially
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How do we tell?
 Market concentration refers to the size and
distribution of firm market shares and the number of
firms in the market.
 Economists use two measures of industry
concentration:
 Four-firm Concentration Ratio
 The Herfindahl-Hirschman Index
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Four-Firm Concentration Ratio
 The four-firm concentration ratio (CR4) measures
market concentration by adding the market shares of
the four largest firms in an industry.
 If CR4 > 60, then the market is likely to
be oligopolistic.
19
Example
Firm
Nike
Market Share
62%
New Balance
15.5%
Asics
10%
Adidas
4.3%
CR 4 = 62 15.5 10  4.3  91.8
20
The Herfindahl-Hirschman
Index
 The Herfindahl-Hirschman index (HHI) is found by
summing the squares of the market shares of all firms
in an industry.
 Advantages over the CR4 measure:


Captures changes in market shares
Uses data on all firms
HHI > 1800
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Example
Firm
Market Share
Nike
62%
New Balance
15.5%
Asics
10%
Adidas
4.3%
HHI  62 15.5 10  4.3  4,202.74
2
2
2
2
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Example (cont’d)
What happens if market shares are evenly distributed?
Firm
Market Share
Nike
22.95%
New Balance
22.95%
Asics
22.95%
Adidas
22.95%
HHI  22.95 2  22.95 2  22.95 2  22.95 2  2,106.81
CR 4  91.8
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How do they determine whether a
merger reduces competition?
 Herfindahl-Hirschman Index or HHI,
 measure of the size of firms in relationship to the
industry
 Meant to be an indicator of the amount of competition
 sum of the squares of the market shares of each
individual firm.

decreases in the Herfindahl index generally indicate a loss of
pricing power and an increase in competition, whereas increases
imply the opposite
 DOJ guidelines
 Mergers resulting in HHI > 1800 can be challenged
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Figure 12.11 Four-Firm Concentration Ratio
(CR4) for Selected Industries in 1997
25
Are All Mergers Equal?
 Conglomerate
 Merger of firms in unrelated industries
 Vertical Merger
 Merger of firms upstream/downstream from each other in
production stream


FCC: ownership of more than 1 media type
Microsoft
 Horizontal Mergers
 Firms in the same industry

Telecomm industry


AT&T divestiture
Verizon/GTE merger; RBOC mergers
 Would the HHI be a valid measure of competitiveness?
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