Public Policy in Private
Markets
Understanding Public Policy
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Feb. 2
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Today
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Why public policy?
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Class overview
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What prompts public policy?
Why Public Policy?
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Rationales for government intervention:
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Dominant belief: US favors free enterprise
Regulation: Why alter the operation of markets?
What is done when there is unhappiness about
market outcomes?
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Extent of government intervention varies with cycles
(politics)
Government regulation is often criticized (e.g. mortgage
crisis); how should things work?
However, regulation remains in place and is
continuously growing and evolving
Why Public Policies in Private Markets?
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In the US, we value perfectly competitive
markets:
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Effectively executes large # of decisions
Most transactions can be handled by markets
Government burden is reduced
But, in real world, markets are not perfectly
competitive
Focus of public policy: how well do markets
work compared with perfect competition?
Example: The NFL
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Professional and College sports exempt from
antitrust law (controversial)
Prior to ‘93: If drafted, player belonged to team
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After ‘93: Players become free agents (after a
few years) and negotiate with other teams.
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Blocking linemen lowest paid players
Blocking linemen are the second most highly paid
players in the NFL (after QB’s)
Why? Free markets are, under certain
conditions, able to bring about efficient prices.
Example: Cartel
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Example: Vitamin Cartel (1990’s)
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Cartel involved vitamins, A, B, C and folic acid
Firms involved: Roche, BASF, Aventis, Solvay,
Merck, Daiichi, Esai and Takeda
Firms admitted to participating in worldwide
price fixing conspiracy over 10 years
1999: in US, Canada and Australia, Roche &
BASF pay $750 million in fines to settle suit.
2001: in EU 8 companies pay approx. 1.2 bill
Why Public Policies in Private Markets?
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Private Sector
 Individual decision making (max π)
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Example: should a firm adopt an exclusive
dealing policy? Discussion
Government sector
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Group decision making, among (often disagreeing)
individuals (maximize: social welfare, equity?)
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Example: Should we allow a merger because it
brings about efficiency (good for everyone) or
should we block it because it brings about higher
prices (bad for consumers)?
Class Overview: Competition Policies
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Antitrust laws:
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how firms compete with each other (rules of
the game)
What is legal? What is illegal?
What are the economics behind government
intervention?
Focus: market power and its use in detriment
of buyers and consumers
Example: Vitamin Cartel
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Legal issues
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Why was this illegal?
How did they conspire?
How did they get caught?
Economic issues
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How are damages calculated?
Example: AT&T – T-Mobile merger
Example: ATT + T-Mobile
Customers nationwide:
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Verizon: 102 million
ATT: 97
Spring: 49
T-Mobile: 33
Will this merger be challenged?
Example: ATT + T-Mobile
Arguments for merger:
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Synergies, better call quality, better service
Easier roll out of new 4G network (most powerful in
terms of data transmission) – priority for Obama
administration
Example: ATT + T-Mobile
Arguments against merger:
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More concentrated industry: main concern is less
competitive pressure
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Higher prices?
Less variety?
Decreased customer service?
High barriers to entry
ATT + T-Mobile
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What is main issue antitrust authorities should
look at:
A.
Risk of less competitive pressure (i.e. higher prices,
less innovation, etc.)
B.
Benefits of enhanced efficiency (i.e. greater
coverage, less infrastructure overlap)
C.
Higher barriers to entry (potential entrants are less
likely to emerge)
D.
Increased bargaining power against suppliers (lower
prices for consumers)
ATT + T-Mobile
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Should this merger be challenged?
A.
Yes
B.
No
Will it be challenged?
A.
Yes
B.
No
Class Overview (time permitting)
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Information Policies
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How much information is needed? What
format should this information have?
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E.g. Nutrition labeling: recent proposals to
have traffic lights on nutrition labels
Product Quality
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Safety: crash ratings for cars, pesticide
levels, etc.
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What are the processing standards? Do we
need this? (cost-benefit analysis)
Class Overview: Types of regulation
2. Information Policies:
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Regulation on how products are presented
to consumers
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E.g.: advertisement, labeling, unit pricing
How much information is needed?
What format should this information have?
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E.g. Nutrition labeling: new proposal to have
traffic lights on nutrition labels
What prompts Public Policy?
1.
Market imperfections (markets work but
not so well)
2.
Market Failure (markets do not work)
3.
Ethical Criteria (we want markets to
consider certain aspects)
What prompts Public Policy?
1.
Market imperfections
A.
Monopoly/oligopoly
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One or several structural requirements are violated:
#small number of sellers, differentiated products,
blocked or difficult entry
Examples of high concentration (possibly large
market power)
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RTE cereal industry: CR4=90%
Soft drinks: CR2=70%
Microsoft: >90% of PC’s are Windows compatible
1. Market Imperfections
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Why regulate monopolies/oligopolies?
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Market can be influenced by few firms’
decisions on pricing (e.g. collusion)
Allocative inefficiency: P>MC, output is
depressed and prices increase
X-inefficiency: Less competition may
reduce incentives to minimize costs
1.A Monopoly, Oligopoly
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Note of caution: Sources of market
power
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Natural/Legal: e.g. large economies of scale
(electricity), network effects (iPod, Windows),
or simply a “successful business model”
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Artificial/Illegal (abuse): collusion,
predatory pricing, limit pricing, price
discrimination.
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Response: Antitrust laws, trade regulation
1.B Information Inadequacies
1.
Market imperfections
B. Information inadequacies
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Perfect information of PC model is violated
People and/or firms lack complete information
Best decisions are not made (e.g. persuasive
advertising)
Responses:
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Information regulation (product labeling)
Product regulation (standards)
2. Market Failures
A.
Externalities: positive and negative
Externalities
Which of the following is a positive
externality:
A. Consuming a California apple gives you
40 calories
B. Consuming a California apple increases
your ability to fight colds (vitamin C
intake)
C. Consuming a California apple increases
carbon footprint (compared to a locally
produced one)
D. Consuming a California apple is better
than consuming a candy bar
2. Market Failures
A.
Externalities: positive and negative
1.
Positive: price/market does not reflect all
societal benefits of the product.
Examples?
2. Market Failures
A.
Externalities
1.
Positive: price/market does not reflect all
benefits of the product. Examples?
• Fiber in food (reduced heart disease)
• Hybrid cars (lower air pollution)
2. Market Failures
A.
Externalities
1.
Positive: price/market does not reflect all
benefits of the product. Examples?
• Fiber in food (reduced heart disease,)
• Hybrid cars (lower air pollution)
2.
Negative: price/market does not reflect
all costs of the product. Examples?
2. Market Failures
A.
Externalities
1.
Positive: price/market does not reflect all
benefits of the product. Examples?
• Fiber in food (reduced heart disease,)
• Hybrid cars (lower air pollution)
2.
Negative: price/market does not reflect
all costs of the product. Examples?
• Alcohol consumption: increased traffic
accidents, health risks
• SUV’s: increased pollution, larger
damages to other cars in crashes
2. Market Failures
B. Public Goods?
2. Market Failures
B. Public Goods
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Examples: national defense, clean air,
public parks, highways
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Ideally: joint efforts to provide good (e.g.
neighbors get together to build a park)
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Problem: free riding on others’ efforts
(contributions)
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In short: you can get it even if you don’t
pay, and you might not get it even if you
pay
3. Ethical criteria
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Do markets yield fair and equitable
treatment of people?
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Response: tax code, equal
opportunity, non-discrimination laws,
etc.