Micro
McEachern
ECON
2008-2009
15
CHAPTER
Designed by
Amy McGuire, B-books, Ltd.
Chapter 15
Economic
Regulation and
Antitrust Policy
Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved
1
Types of Government Regulation

Market power
– Raise the price
• Without losing all
sales to rivals
– Firms
• Downward-sloping
demand curve
LO1
Chapter 15
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2
Types of Government Regulation

Government regulations
– Social regulations
• Improve health and safety
– Economic regulations
• Control: price, output, entry of new
firms, quality of service
– Desirable monopolies
• Control natural monopolies
– Antitrust policy
LO1 • Outlaws monopolies and cartels
Chapter 15
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3
Regulating a Natural Monopoly
 Natural monopoly
– Downward-sloping LRAC curve
 Unregulated profit maximization
– MR=MC
– Economic profit
– Consumer surplus
– P>MC, higher social welfare if
output expanded
LO2
Chapter 15
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4
Regulating a Natural Monopoly
 Government
– Increase social welfare
– Lower P, expand Q
 Public utilities
– Government-owned
monopoly
– Government regulated
monopoly
LO2
Chapter 15
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5
Regulating a Natural Monopoly
 Setting P=MC
– Where D intersects MC
– Higher consumer surplus
– Monopolist: economic loss
– In long-run: monopolist
exits the market
– Needs subsidizing
LO2
Chapter 15
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6
Regulating a Natural Monopoly
 Subsidizing the natural monopolist
– Government covers the loss
– Firm: earn normal profit
– Drawback: government must raise
taxes, forgo public spending
 Setting P=average cost
– ‘Fair return’: normal profit
• Stay in business without a subsidy
2 – Higher social welfare (than unregulated)
LO
Chapter 15
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7
Regulating a Natural Monopoly
 Setting P=MC or P=average cost
– Reduce P
– Increase output
– Erase economic profit
– Increase consumer surplus
– Increase social welfare
LO2
Chapter 15
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8
Regulating a Natural Monopoly
 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
LO2 • No socially optimal allocation
Chapter 15
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9
LO2 Exhibit 1
Regulating a Natural Monopoly
a
Dollars
per trip
Natural monopoly maximizes profit: MR=MC,
q=50, p=$4. Inefficient: p>MC.
Demand
c
$4.00
Efficient output rate: set p=$0.50, then
q=105 efficient outcome. But the firm:
economic loss; requires subsidy.
b
Profit
2.50
h
1.50
1.25
0.50
0
f
Loss
g
e
MR
LRAC
Alternative: set p=$1.50;
then q=90, the firm breaks
even (p=average cost);
earns normal profit.
Long-run MC
50
90 105 Trips per month (millions)
Social welfare could still be increased by expanding output as long as the
price >MC; but that would result in an economic loss, requiring a subsidy.
Chapter 15
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10
LO3
Alternative Theories:
Economic Regulation
 Economic regulation
 Public interest, promotes social welfare
 Special interest of producers
 ‘Capture theory of regulation’
 Producer groups
 Expect to gain
 Persuade public officials to impose restrictions
 Consumers have no special interest
 Reduce competition
 Increase prices
Chapter 15
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11
Case Study
LO3 Airline Regulation and Deregulation
Chapter 15
 1938 Civil Aeronautics Board
 Regulated interstate airlines
 40 years: No new interstate airline
 Fixed prices among the 10 major airlines
 Blocked new entry
 Labor unions
 Higher wages
 Pilots worked
2 weeks/month
 High price
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12
Case Study
LO3 Airline Regulation and Deregulation
Chapter 15
 1978 Deregulation
 Price competition
 New entry
 Price: one quarter below regulated price
 More efficient airlines
 FAA regulates quality
and safety
 Accident rates
declines by 10-45%
 More people fly
(passenger miles
tripled)
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13
Case Study
LO3 Airline Regulation and Deregulation
Chapter 15
 Fierce competition
 Mergers
 Disappeared
 Bankrupt
 Lower wages
 Lower fares
 More flights
 Saving lives
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14
Antitrust Law and Enforcement
 Antitrust policy
– Reduce anticompetitive behavior
– Promote competition
 Origins of antitrust policy
– Developments
• Technology: economies of scale
• Railroad: reduced transport costs
• Bigger firms, wider markets
LO4
Chapter 15
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15
Origins of Antitrust Policy
 1873-1883 sharp economic decline
– Competing firms formed a trust
• Sugar, tobacco, oil industries
• Widespread criticism
 Sherman Antitrust Act of 1890
– Trusts, restraint of trade, monopolization
 Clayton Act of 1914
– Price discrimination, tying contracts,
exclusive dealing
4
LO
Chapter 15
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16
Origins of Antitrust Policy
 Federal Trade Commission Act of 1914
– Federal Trade Commission
– Enforce antitrust laws
 Cellar-Kefauver Anti-Merger Act
– Horizontal mergers
– Vertical mergers
LO4
Chapter 15
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17
Antitrust Enforcement
 Antitrust division of the U.S.
Justice Department
 FTC
 Consent decree
 Court trial
 Judge decides
LO4
Chapter 15
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18
Per Se Illegality and
Rule of Reason
 Per se illegal
– Illegal regardless of the economic
rationale or consequences
– Firm’s behavior
 Rule of reason
– Reason and its effect on competition
– Firm’s behavior
– Market structure
LO4
Chapter 15
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19
Mergers and Public Policy
LO5
Chapter 15
 Antitrust division and FTC
– Approve/deny mergers and acquisitions
– Herfindahl-Hirschman Index (HHI)
• Sales concentration
• Horizontal mergers
– Firms in the same market
• Nonhorizontal mergers
– Challenged mergers if
• Post-merger HHI>1800
• Merger increases HHI by >100 points
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20
LO5 Exhibit 2
Herfindahl-Hirschman Index (HHI) Based on
Market Share in Three Industries
Each of the three industries has 44 firms. The HHI is found by squaring each firm’s market
share then summing the squares. Only the market share of the top four firms differ across
industries; the remaining 40 firms have 1% market share each.
The HHI for Industry III is nearly triple that for each of the other two industries.
Chapter 15
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21
LO5 Exhibit 3
U.S. Merger Waves in the Past Century
Chapter 15
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22
Merger Waves
 First wave
– Technological progress in transportation,
communication, and manufacturing
 Second wave
– Stock market boom of 1920s
 Third wave
– After WWII
 Fourth wave
– One-third: hostile takeovers
LO5
Chapter 15
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23
Competitive Trends in
the US Economy
1. Pure monopoly
– One firm controls the market
– Block entry
2. Dominant firm
– One firm: more than half market share
– No close rival
LO6
Chapter 15
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24
Competitive Trends in
the U.S. Economy
3. Tight oligopoly
– Top 4 firms: more than 60% of market
output
– Evidence of cooperation
4. Effective competition
– Low concentration
– Low barriers to entry
– Little or no collusion
LO6
Chapter 15
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25
LO6 Exhibit 4
Competitive Trends in the U.S. Economy: 1939 to 2000
Chapter 15
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26
Competitive Trends in
the U.S. Economy

Growth in competition (1958-2000)
– Competition from imports
• One-sixth
– Deregulation
• One-fifth
– Antitrust policy
• Two-fifths
LO6
Chapter 15
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27
Case Study
LO6 Microsoft on Trial
Chapter 15
 Charges
 Protect Windows monopoly (90%)
 Extend monopoly into Internet Explorer
 Internet Explorer’s integration into
Windows 98
 Microsoft: to make life easier for
customers
 Government: boost IE’s market share
 Predatory practices
 Anticompetitive behavior
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28
Recent Competitive
Trends
 Increased competition in U.S.
 Growing world trade
– Three major automakers
• 80% of U.S. market in 1970; only 54% by 2006
 Deregulation
– International phone service
• $0.88 a minute in 1997; under $0.10 by 2007
 Technological change
– Three major TV networks
• 90% in 1980; under 40% by 2007
LO6
Chapter 15
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29
Problems with
Antitrust Policy
 Competition may
not require that
many firms
 Abuse of antitrust
 Growth of
international
markets
LO6
Chapter 15
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30