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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 4 Regulating a Natural Monopoly Government – Increase social welfare – Lower P, expand Q Public utilities – Government-owned monopoly – Government regulated monopoly LO2 Chapter 15 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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) Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 13 Case Study LO3 Airline Regulation and Deregulation Chapter 15 Fierce competition Mergers Disappeared Bankrupt Lower wages Lower fares More flights Saving lives Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 17 Antitrust Enforcement Antitrust division of the U.S. Justice Department FTC Consent decree Court trial Judge decides LO4 Chapter 15 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 21 LO5 Exhibit 3 U.S. Merger Waves in the Past Century Chapter 15 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 25 LO6 Exhibit 4 Competitive Trends in the U.S. Economy: 1939 to 2000 Chapter 15 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 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 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 29 Problems with Antitrust Policy Competition may not require that many firms Abuse of antitrust Growth of international markets LO6 Chapter 15 Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 30