Chapter Objectives The goals of U.S. regulatory and antitrust
policies The legal framework for U.S. antitrust policy How
governments enforce antitrust policy How the government gauges the
effect of mergers on competition How antitrust laws are interpreted
and enforced Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-2
Slide 3
The Governments Role in Promoting Efficiency Up to this point,
we have studied the effects of the various market structures and
government policy (taxes, price controls) on economy efficiency
(deadweight loss). Now, we turn to the role of government in
promoting economic efficiency when there is market failure (the
unregulated market is inefficient). Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-3
Slide 4
Why the Government Might Intervene Three main reasons why the
government would intervene in a market: To promote productive
efficiency Resources are employed at the lowest cost. To promote
innovation Creation and application of new technology To promote
allocative efficiency Resources are distributed in the way that
society values most. Copyright 2006 Pearson Addison-Wesley. All
rights reserved.13-4
Slide 5
Why the Government Might Intervene (contd) Most economists
agree that the best way to achieve efficiency and promote
innovation is through competition. However, competitive markets do
not always arise naturally, and may even be undesirable in some
cases. (market failure) Too few competitors / barriers to entry
Externalities (costs/benefits not price in market) Assymetric
information Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-5
Slide 6
Natural and Optimal Market Structures The natural structure of
a market is the degree of competition that would occur in the
absence of government intervention. The optimal structure of a
market is the degree of competition that maximizes allocative
efficiency. Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-6
Slide 7
Natural and Optimal Market Structures (contd) The government
will tend to intervene if the natural structure differs
significantly from the optimal structure. Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-7
Slide 8
The Perfect Competition Benchmark The efficiency of a market is
measured by comparing the existing price and output to the price
and output that would result from marginal cost pricing in a
perfectly competitive market. Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-8
Slide 9
Figure 13.1 Consumer and Producer Surplus With Competitive and
Monopoly Pricing Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-9
Slide 10
U.S. Antitrust Policy Legal Framework The history of U.S.
antitrust policy dates back to the mid-1860s, when a few very large
firms came to dominate the steel, railroad, and oil industries.
These trusts came under fire for unethical business practices that
drove competitors out of business. Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-10
Slide 11
3 Major Pieces of Legislation to address Anti-Competitive
Markets Sherman Anti-trust Act (1890) Anti-competitive behavior,
mergers Clayton Act (1914) Price discrimination (simple) Tie-in
sales Robinson-Putman (1936) More detailed/complex definition of
price discrimination Copyright 2006 Pearson Addison-Wesley. All
rights reserved.13-11
Slide 12
Sherman Anti-trust Act As explained by the U.S. Supreme Court
in Spectrum Sports, Inc. v. McQuillan,Spectrum Sports, Inc. v.
McQuillan The purpose of the [Sherman] Act is not to protect
businesses from the working of the market; it is to protect the
public from the failure of the market. The law directs itself not
against conduct which is competitive, even severely so, but against
conduct which unfairly tends to destroy competition itself The law
attempts to prevent the artificial raising of prices by restriction
of trade or supply. [4] [4] Copyright 2006 Pearson Addison-Wesley.
All rights reserved.13-12
Slide 13
The Sherman Antitrust Act of 1890 The basis of much of U.S.
antitrust policy, the Sherman Act outlaws: Trusts and restraint of
trade Trusts allowed 1 company to own shares in another; thus
getting around prohibition of collusive agreements Monopolies or
attempts to monopolize an industry Standard Oil: Predatory Pricing
P < ATC to drive out competitors McGee: SO offered P =
P(monopoly) (higher than competitive value) Mergers that are
anti-competive Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-13
Slide 14
Sherman Anti-Trust Act Divided into three sections. Sec 1
delineates and prohibits specific means of anticompetitive conduct,
(e.g., contracts/agreements) Sec 2 deals with end results that are
anticompetitive in nature. (actual pricing tactics, or non-compete)
Sec 3 simply extends the provisions of Section 1 to U.S.
territories and the District of Columbia. Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-14
Slide 15
Sherman Anti-Trust Act Section 1: "Every contract, combination
in the form of trust or otherwise, or conspiracy, in restraint of
trade or commerce among the several States, or with foreign
nations, is declared to be illegal." [13] trust [13] Section 2:
"Every person who shall monopolize, or attempt to monopolize, or
combine or conspire with any other person or persons, to monopolize
any part of the trade or commerce among the several States, or with
foreign nations, shall be deemed guilty of a felony [... ]" [14 [14
Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-15
Slide 16
The Federal Trade Commission Act of 1914 Created the Federal
Trade Commission (FTC), the agency that identifies and pursues
antitrust cases Department of Justice (DOJ), agency for attorneys
that prosecute the cases Copyright 2006 Pearson Addison-Wesley. All
rights reserved.13-16
Slide 17
Enforcement of Antitrust Policy The Department of Justice (DOJ)
and the Federal Trade Commission (FTC) have the power to sue firms
in order to: Force violators to stop anticompetitive practices
Break up existing firms into smaller ones Divestiture of AT&T
and Baby Bells Prevent the formation of very large firms T-Mobile
and AT&T Impose fines on firms that violate antitrust
legislation Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-17
Slide 18
Changes in Enforcement Since the Sherman Act of 1890,
enforcement of antitrust legislation has become less stringent.
Technological change and globalization have lead to increased
competition. (contestable markets) Telecomm wireless and landlines
Music record manufacturers and ITunes Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-18
Slide 19
Mergers In addition to enforcing antitrust laws, the FTC may
try to block or alter a merger. A merger occurs when two firms
combine to form a single firm. Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-19
Slide 20
20 How do we tell? Market concentration refers to the size and
distribution of firm market shares and the number of firms in the
market. Economists use two measures of industry concentration:
Four-firm Concentration Ratio The Herfindahl-Hirschman Index
Slide 21
21 Attempts to Measure Market Concentration four-firm
concentration ratio is often utilized to characterize/determine
whether a market is an oligopoly. four-firm concentration ratio
market share of the four largest firms in an industry Herfindahl
index, also known as Herfindahl-Hirschman Index or HHI, widely
applied in competition law and antitrust.competition lawantitrust
sum of the squares of the market shares of each individual firm.
Decreases in the Herfindahl index generally indicate a loss of
pricing power and an increase in competition, whereas increases
imply the opposite.
Slide 22
22 Four-Firm Concentration Ratio The four-firm concentration
ratio (CR4) measures market concentration by adding the market
shares of the four largest firms in an industry. If CR4 > 60,
then the market is likely to be oligopolistic.
Slide 23
23 Example FirmMarket Share Nike62% New Balance15.5% Asics10%
Adidas4.3%
Slide 24
24 Figure 12.11 Four-Firm Concentration Ratio (CR4) for
Selected Industries in 1997
Slide 25
25 The Herfindahl-Hirschman Index The Herfindahl-Hirschman
index (HHI) is found by summing the squares of the market shares of
all firms in an industry. Advantages over the CR4 measure: Captures
changes in market shares Uses data on all firms
Slide 26
26 Example FirmMarket Share Nike62% New Balance15.5% Asics10%
Adidas4.3%
Slide 27
27 Example (contd) FirmMarket Share Nike22.95% New
Balance22.95% Asics22.95% Adidas22.95% What happens if market
shares are evenly distributed?
Slide 28
28 Non-competitive Oligopolies Non-competitive/collusive
behavior (cooperative oligopolies) Cartels: firms may collude to
raise prices and restrict production in the same way as a monopoly.
Where there is a formal agreement for such collusion, this is known
as a cartel.colludemonopolycartel Dominant Firm/Price Leader:
collude in an attempt to stabilize unstable markets, so as to
reduce the risks inherent in these markets for investment and
product development. collude does not require formal agreement
although for the act to be illegal there must be a real
communication between companies for example, in some industries,
there may be an acknowledged market leader which informally sets
prices to which other producers respond, known as price
leadership.price leadership Stackleberg price-leader model
Slide 29
Types of Mergers Conglomerate Merger Firms in unrelated
industries merge. Vertical Merger A firm buys another firm that is
either above it or below it in the supply chain. Horizontal Merger
A combination of two firms that are in the same industry Copyright
2006 Pearson Addison-Wesley. All rights reserved.13-29
Slide 30
The Governments Position on Mergers The governments position on
mergers has changed over the years, from preventing the merger of
relatively small firms to allowing the merger of large companies.
Bush(43) focused only on horizontal mergers Obama returned to
review both horizontal and vertical mergers (Ticketmaster) In
general, a merger that results in a Herfindahl-Hirschman Index of
less than 1800 will not be challenged. Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-30
Slide 31
Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-31 Natural Monopolies And Regulation
Slide 32
Natural Monopolies Economies of Scale continue to occur at so
large a scale that is it is productively efficient (least cost) to
have only 1 provider Natural state and optimal state is a monopoly
typically high fixed costs and low variable costs electric, natural
gas, water, telecommunications (land) and tv cable Copyright 2006
Pearson Addison-Wesley. All rights reserved.13-32
Slide 33
Regulation If a natural monopoly arises due to scale economies,
the government may prefer to regulate the monopoly. Breaking the
firm up may reduce efficiency Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-33
Slide 34
Figure 13.2 Natural Monopoly in the Telecommunications Industry
Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-34
Slide 35
Government Regulation of Price and Output The government cannot
require that a natural monopolist set price equal to marginal cost.
Because marginal cost is less than average cost, two options: 1.
Government subsidizes the loss (Euro approach) No deadweight loss,
but requires taxes on other goods 2. Average Cost Pricing (or Rate
of Return (ROR)): government sets price equal to average total
cost. (US solution) Leads to some deadweight loss, but less than a
monopoly Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-35
Slide 36
Figure 13.3 Choosing a Price for a Natural Monopolist Copyright
2006 Pearson Addison-Wesley. All rights reserved.13-36 US French
Economic Loss or Subsidy
Slide 37
Government Regulation of Price and Output Two methods of
regulating price and output: Rate of Return Regulationthe firm is
allowed to earn a pre-specified amount of profit in a given time
period. Set prices to recover average cost + normal rate of return
How do you determine normal ROR? Incentive for regulated firm to
pad its costs (Averech-Johnson effect) Price Capgovernment sets the
maximum price or the maximum rate of price increase. After rate
setting process: future rates can be raised by rate of inflation
industrys average productivity (incentive for tech. iinnov.)
Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-37
Slide 38
Deregulation The current trend is for the government to remove
regulation and allow market forces to determine prices, output,
profits, and industry structure. Factors favoring deregulation:
Difficulty in determining a regulatory strategy Advances in
technology that have lead to increased competition Copyright 2006
Pearson Addison-Wesley. All rights reserved.13-38
Slide 39
Reasons For Deregulation In deciding to deregulate an industry,
the government must be confident that private market outcomes will
be more efficient than regulated outcomes. Will deregulation affect
product safety or reliability? Will deregulation eliminate service
for some customers? Will the benefits of deregulation accrue to
only a few customers? Copyright 2006 Pearson Addison-Wesley. All
rights reserved.13-39
Slide 40
Application: Deregulation of the Airline Industry In 1978, the
U.S. Airline Deregulation Act removed regulations on prices, the
number of carriers and route assignments. (some) Passengers have
benefited from the resulting price competition among air carriers.
FAA set similar rates for flights of similar difference, regardless
of destination (and demand in large/small cities) legacy losses and
gains Smaller cities saw higher prices and fewer flight Larger
cities: lower prices, more flights Copyright 2006 Pearson
Addison-Wesley. All rights reserved.13-40
Slide 41
Application: Deregulation of theTelecommunications In 1980,
AT&T and the Baby Bells were broken up into 8 different
companies AT&T could offer only long distance service and had
to compete with MCI and Sprint (no longer a monopoly) Baby Bells
customer could choose their LD provider Took several years for
AT&T market share to drop below 80% Colbert video its all back
together again FCC missed that there were economies of scale led to
mergers to reduce costs 1996 Congress passed the Telecommunications
Act Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-41
Slide 42
Application: Deregulation of theTelecommunications 1996
Congress passed the Telecommunications Act Required Baby Bells and
GTE to open their local markets to all competitors Established
prices that Bells could charge competitors for renting their lines
and switching equipment Prices were set below incurred (or
historical) costs Decreased incentive to maintain and update
existing equipment Previously business line rates set higher than
costs to subsidize residential phone service New entrants targeted
business customers and high long distance usage customers (winners)
Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-42
Slide 43
Strategy and Policy The Department of Justice takes on
CingularAT&T Wireless merger In 2004, Cingular agree to buy
AT&T Wireless, creating a company with an HHI of 8,000 in some
markets. In 2005, the firm was required to divest the entire
AT&T Wireless network in the 13 markets where concentration was
highest. Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-43
Slide 44
Summary The U.S. government may intervene in the private sector
to promote productive efficiency, innovation, or allocative
efficiency. U.S. antitrust policy is based on: The Sherman Act,
which forbids monopolies The Clayton Act, which prohibits price
discrimination The Federal Trade Commission Act, which established
the FTC Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-44
Slide 45
Summary (contd) Some actions are per se illegal; simply
engaging in them is enough to establish guilt. Conglomerate mergers
are not usually challenged. Vertical and horizontal mergers may be
challenged if they reduce competition. In the case of a natural
monopoly, it may be preferable for the government to regulate the
firm. Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-45
Slide 46
Summary (contd) Deregulation of an industry may be appropriate
because of changes in technology and globalization. Copyright 2006
Pearson Addison-Wesley. All rights reserved.13-46
Slide 47
Table 13.1 Excerpts From Section 1 and 2 of the Sherman
Antitrust Act Copyright 2006 Pearson Addison-Wesley. All rights
reserved.13-47
Slide 48
Table 13.2 Summary of Key U.S. Antitrust Legislation Copyright
2006 Pearson Addison-Wesley. All rights reserved.13-48