CHAPTER
14
Market Power and Public
Policy: Antitrust Policy
and Deregulation
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
1
Antitrust Policy

The purpose of antitrust policy is to
promote competition among firms.
Competition leads to lower prices and
better products.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Antitrust Policy
Under federal antitrust rules, the government
can:
 Break up of monopolies into several
smaller companies.

Prevent corporate mergers that would
reduce competition.

Regulate business practices.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Brief History of Antitrust Legislation
1890
Sherman Act: made it illegal to monopolize a market or to engage
in practices that resulted in a restraint of trade.
1914
Clayton Act: outlawed specific practices that discourage
competition, including tying contracts, price discrimination for the
purpose of reducing competition, and stock-purchase mergers that
would substantially reduce competition.
1914
Federal Trade Commission: established to enforce antitrust laws.
1936
Robinson-Patman Act: prohibited selling products at
“unreasonably low prices” with the intent of reducing competition.
1950
Celler-Kefauver Act: outlawed asset-purchase mergers that would
substantially reduce competition.
1980
Hart-Scott-Rodino Act: extended antitrust legislation to
proprietorships and partnerships.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Breaking Up Monopolies

A trust is an arrangement under which
the owners of several companies transfer
their decision-making powers to a small
group of trustees. Firms in a trust act as
a single firm.

The label “antitrust” comes from early
cases involving the breakup of trusts.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Blocking Mergers

A merger occurs when two firms combine their
operations.

Because a merger decreases the number of
firms in a market, it is likely to lead to higher
prices.

A possible benefit from a merger is that the new
firm could combine production, marketing, or
administrative operations, and thus produce its
products at a lower average cost.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Blocking Mergers

New guidelines developed by the Justice
Department and the Federal Trade Commission
allow companies involved in a proposed merger
to present evidence that the merger would
reduce costs and lead to lower prices, better
products, or better service.

The analysis of proposed mergers today
focuses less on counting the number of firms in
a market, and more on how a merger would
affect price.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Impact of Mergers on Price and
Profits

Suppose that initially there
are two separate firms in
the bread market. Each
firm serves half of the
market demand, and faces
the same structure of costs
as the other.

When firms act
independently, the profit of
each firm equals $250.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Impact of Mergers on Price and
Profits


Suppose that after a
merger, the firm will keep
the price of Wonder
bread constant at $1.50,
but increase the price of
Interstate bread to $1.60.
An increase in the price of
Interstate bread will
decrease quantity sold,
and profit from the sale of
Interstate decreases by
$10, from $250 to $240.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Impact of Mergers on Price and
Profits

The increase in the price
of Interstate bread will
increase the demand for
Wonder bread.

Profit from the sale of
Wonder bread increases
by $30, from $250 to $280.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Impact of Mergers on Price and
Profits
Conclusion:

In this case, the good news (more profit on
Wonder bread) outweighs the bad news (less
profit on Interstate bread), thus it is possible for
a merger of two firms selling close substitutes to
lead to higher prices and have a net increase
in profit.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Competition and Pricing in Different
Cities

A 1997 study by the Federal Trade
Commission found that the prices
charged by Staples, an office supply
chain, were lower in cities where its
competitor, Office Depot, also had a store.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Competition and Pricing in Different
Cities

The profit-maximizing price is higher in the city
without competition.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Competition and Pricing in Different
Cities

The Federal Trade Commission used this
logic to convince the court that the
proposed merger of Staples and Office
Depot would lead to higher prices.
14
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Regulating Business Practices


The government may intervene when
specific business practices increase
market concentration.
Among those practices are:



Price fixing
Tying, or forcing consumers of one product
to purchase another
Price discrimination that reduces competition
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Predatory Pricing

Predatory pricing is the selling of
products at “unreasonably low prices”
with the intent of reducing competition.

Predatory pricing is a profitable strategy if
the firm can charge the monopoly price
long enough to offset the losses from
driving its rival out of business.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Microsoft Case

In the case of the United States versus
Microsoft Corporation, the government
alleged that Microsoft stifled competition
in several ways.
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Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Microsoft Case

Microsoft threatened Compaq
Corporation, a computer manufacturer,
with the loss of the license to install the
Microsoft operating system in their
computers after Compact announced
plans to substitute Netscape’s Navigator
for Explorer.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Microsoft Case

Microsoft prohibited computer
manufacturers from altering the Windows
desktop by removing Microsoft’s desktop
links to the Internet.
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Economics: Principles and Tools, 2/e
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The Microsoft Case

Microsoft’s bundling of Explorer with
Windows 95 and its inclusion as part of
Windows 98 involves tying the operating
system with the browser.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
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The Microsoft Case

The government claimed that Microsoft
used its virtual monopoly in operating
systems to gain a monopoly in the
browser market.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
The Microsoft Case

The government also claimed that
Microsoft used illegal practices to protect
its monopoly in the market for operating
systems.
22
© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Deregulation of Airlines and
Telecommunications

The purpose of deregulation in the airlines
and telecommunications industries was to
increase competition and decrease
prices.

In the airline industry, deregulation caused
some firms to go out of business and
others to merge.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Deregulation of Airlines and
Telecommunications


Some mergers resulted in lower
production costs and prices, but others
reduced competition and led to higher
fares.
The consensus among economists is that
deregulation generated net benefits for
consumers. On average, fares
decreased about 33% in real terms.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Deregulation of Airlines and
Telecommunications

The Telecommunications Act of 1996
established new rules for the transmission
of video, voice and data.

The basic idea was to promote
competition in the markets for
telecommunication services.
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin
Deregulation of Airlines and
Telecommunications
Among the provisions of the act were:

To open local telephone service to new firms
that would compete with the Baby Bells

To eliminate price controls for cable TV and
allow the phone companies to enter the cable
market

To allow the Baby Bells to enter the market for
long-distance service once there is sufficient
competition in local telephone service
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© 2001 Prentice Hall Business Publishing
Economics: Principles and Tools, 2/e
O’Sullivan & Sheffrin