Chapter 15
Professor Yuna Chen
Economic Regulation
and
Antitrust Policy
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1. Types of Government Regulation
Three types of government regulation
1.1 Social regulations
– Aimed at improving health and safety
• Control over
– Unsafe working conditions, dangerous products
• Health care reform
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1. Types of Government Regulation
1.2 Economic regulations
– Control: price, output, entry of new firms,
quality of service
– Control over natural monopolies
• Local electricity transmission, local phone
service
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1. Types of Government Regulation
1.3 Antitrust policy
– Preventing monopoly
– Fostering competition
– Outlaws monopolies and cartels
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2. Regulating a Natural Monopoly
Case study: Subway system: a natural
monopoly
– Average production cost is lowest when
a single firm supplies the market
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Exhibit 1
Dollars per trip
Regulating a Natural Monopoly
$40
a
Demand
c
b
Profit
25
15
12.50
f
5
0
h
Loss
g
e
50 MR
90 105
LRAC
Long-run MC
Trips per month
(millions)
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Regulating a Natural Monopoly
(1) Unregulated monopoly
Qm = 50
Pm = $40
TR = $200
TC = $
Profit =
Consumer surplus =
Result: inefficient in terms of social welfare
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Regulating a Natural Monopoly
(2) Setting P (marginal benefit)=MC
Q* =
P* =
TR =
TC =
Profit =
Consumer surplus =
Result: a. social welfare is maximized.
b. monopolist: economic loss
c. In long-run: monopolist exits the market
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Regulating a Natural Monopoly
(3) Possible solutions
a) Government-owned monopolies; use
tax revenue to cover the loss
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Regulating a Natural Monopoly
b) Subsidizing the natural monopolist
– Monopolist: produce where P=MC
– Government covers the loss
– Firm: earn normal profit
– Drawback: government either raise
taxes, or forgo public spending
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Regulating a Natural Monopoly
c) Setting P = average cost
– Breaking even
– normal profit
– Stay in business without a subsidy
– Higher social welfare than unregulated
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Regulating a Natural Monopoly
(4) The regulatory dilemma
– If P=MC
• Socially optimal allocation of resources
– Marginal benefit=MC
• Monopolists: loss
• Requires government subsidy
– If P=average cost
• Monopolist: normal profit
• Not a socially optimal allocation
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Alternative Theories
• Views of government regulation
– Economic regulation is in the public
interest
• Promotes social welfare by keeping prices
down
– Economic regulation is in the special
interest of producers
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Alternative Theories
• Producers’ special interest
– Well-organized producer groups
• Expect to gain from economic regulation
• Persuade public officials to impose
restrictions
– Reduce competition
– Increase prices
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Alternative Theories
• Capture theory of regulation
– Producers have
• Political power
• Strong stake in the regulatory outcome
– Leads them to “capture” the regulating
agency
• Prevail on it to serve producer interests
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Antitrust Law and Enforcement
• Antitrust policy
– Reduce anticompetitive behavior
– Promote competition
– Attempts to promote socially desirable
market performance
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Origins of Antitrust Policy
• 1873-1883 sharp economic decline
– Competing firms formed a trust
• Sugar, tobacco, oil industries
• Widespread criticism
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Origins of Antitrust Policy
• Sherman Antitrust Act of 1890
– First national legislation in the world
against monopoly
– Prohibited trusts, restraint of trade,
monopolization
– Vague and ineffective
• Allowed room for much anticompetitive
activity
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Origins of Antitrust Policy
• Clayton Act of 1914
– Improved the Sherman Act
– Outlawed certain anticompetitive practices not
prohibited by the Sherman Act
• Price discrimination
• Tying contracts
• Exclusive dealing
• Interlocking directorates
• Buying the corporate stock of a competitor
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Origins of Antitrust Policy
• Tying contract
– A seller of one good requires a buyer to
purchase other goods as part of the deal
• Exclusive dealing
– A supplier prohibits its customers from
buying from other suppliers
• Interlocking directorate
– A person serves on the boards of
directors of two or more competing firms
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Origins of Antitrust Policy
• Federal Trade Commission Act of 1914
– Federal trade commission (FTC)
– Enforce antitrust laws
• Cellar-Kefauver Anti-Merger Act
– Prevents one firm from buying physical
assets of another firm
• If the effect is to reduce competition
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Origins of Antitrust Policy
• Horizontal merger
– One firm combines with another firm
• That produces the same type of product
• Vertical merger
– One firm combines with another firm
• From which it had purchased inputs or to
which it had sold output
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Antitrust Enforcement
• Antitrust Division of the US Justice
Department or the FTC
– Charges a firm/group of firms with
breaking the law
– Acting on a complaint by a customer or a
competitor
– Accused
• Sign a consent decree
• Contest the charges: Court trial
– Judge decides
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Antitrust Enforcement
• Consent decree
– Accused party
• Without admitting guilt
• Agrees not to do whatever it was charged
with
• If the government drops the charges
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Per Se Illegality
• Per se illegal
– Business practices deemed illegal
– Regardless of their economic rationale or
their consequences
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Rule of Reason
• Rule of reason
– Reasons of the offending practice and its
effect on competition
– Focus on
• Firm’s behavior
• Market structure resulting from that behavior
• Predatory pricing
– Pricing tactics employed by a dominant
firm to drive competitors out of business
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Mergers and Public Policy
• Antitrust Division and FTC
– Approve/deny mergers and acquisitions
• Herfindahl-Hirschman Index, HHI
– Sales concentration
– Square the sales of each firm, then sum them
– Perfect competition: HHI closes to 0
– Monopoly: HHI = 10,000
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Mergers and Public Policy
• Antitrust Division and FTC
– Challenges any merger in an industry that
meets two conditions
• (1) the HHI exceeds 2,500
• (2) the merger increases the index by more
than 200 points
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Exhibit 2 Herfindahl-Hirschman Index (HHI) Based on
Market Share in Three Industries
Each of the three industries shown has 44 firms. The HHI is found by squaring each
firm’s market share then summing the squares. Under each industry, each firm’s market
share is shown in the left column and the square of the market share is shown in the
right column. For ease of exposition, only the market share of the top four firms differs
across industries. The remaining 40 firms have 1 percent market share each. The HHI
for Industry III is nearly triple that for each of the other two industries.
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Exhibit 3
U.S. Merger Waves in the Past Century
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Exhibit 4
Competitive Trends in the U.S. Economy: 1939 to 2000
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