Antitrust, Regulation,
and Deregulation
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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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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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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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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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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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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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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Figure 13.1 Consumer and Producer Surplus With
Competitive and Monopoly Pricing
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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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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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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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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
 P < ATC to drive out competitors
 McGee: SO offered P = P(monopoly) (higher than
competitive value)
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 Mergers Copyright
that are
anti-competive
rights reserved.
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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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Sherman Anti-Trust Act
 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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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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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

Divestiture of AT&T and Baby Bells
 Prevent the formation of very large firms

T-Mobile and AT&T
 Impose fines on firms that violate
antitrust legislation
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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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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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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
20
Attempts to Measure
Market Concentration
 four-firm concentration ratio is often utilized to
characterize/determine whether a market is an
oligopoly.
 market share of the four largest firms in an industry
 Herfindahl index,
 also known as Herfindahl-Hirschman Index or HHI,
 widely applied in competition law and antitrust.
 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.
21
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.
22
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
23
Figure 12.11 Four-Firm Concentration Ratio
(CR4) for Selected Industries in 1997
24
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
25
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
26
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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Non-competitive Oligopolies
 Non-competitive/collusive behavior (cooperative
oligopolies)
 Cartels: firms may collude to raise prices and restrict production in
the same way as a monopoly. Where there is a formal agreement for
such collusion, this is known as a cartel.
 Dominant Firm/Price Leader:


collude in an attempt to stabilize unstable markets, so as to reduce the
risks inherent in these markets for investment and product development.
does not require formal agreement



although for the act to be illegal there must be a real communication between
companies
for example, in some industries, there may be an acknowledged market leader
which informally sets prices to which other producers respond, known as price
leadership.
Stackleberg price-leader model
28
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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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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Natural
Monopolies
And
Regulation
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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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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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Figure 13.2 Natural Monopoly in the
Telecommunications Industry
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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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Figure 13.3 Choosing a Price for a Natural
Monopolist
US
French
Economic Loss
or Subsidy
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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 Copyright
– industry’s
average productivity (incentive for tech.
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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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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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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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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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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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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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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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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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Summary (cont’d)
 Deregulation of an industry may be appropriate
because of changes in technology and globalization.
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Table 13.1 Excerpts From Section 1
and 2 of the Sherman Antitrust Act
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Table 13.2 Summary of Key U.S. Antitrust
Legislation
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