Regulation and Antitrust Law

1
Regulation and Antitrust Law

• Principles of Microeconomic Theory, ECO 284
• John Eastwood
• CBA 247
• 523-7353
• e-mail address John.Eastwood_at_nau.edu

2
Learning Objectives

• Define regulation and antitrust law
• Distinguish between the public interest and
  capture theories of regulation
• Explain how regulation affects prices, outputs,
  profits, and the distribution of the gains from
  trade between consumers and producers

3
Learning Objectives (cont.)

• Explain how antitrust law has been applied in a
  number of landmark cases
• Explain how antitrust law is used today

4
Learning Objectives

• Define regulation and antitrust law
• Distinguish between the public interest and
  capture theories of regulation
• Explain how regulation affects prices, outputs,
  profits, and the distribution of the gains from
  trade between consumers and producers

5
Market Intervention

• Government intervention in the monopolistic and
  oligopolistic markets
• Regulation
• Antitrust law

6
Market Intervention

• Regulation
• Rules administered by a government agency to
  influence economic activity
• Antitrust Law
• Laws that regulate and prohibit certain kinds of
  market behavior

7
Learning Objectives

• Define regulation and antitrust law
• Distinguish between the public interest and
  capture theories of regulation
• Explain how regulation affects prices, outputs,
  profits, and the distribution of the gains from
  trade between consumers and producers

8
Economic Theory of Regulation

• Four Factors Affecting the Demand for Regulation
• Consumer surplus per buyer
• Number of buyers
• Producer surplus per firm
• Number of firms

9
Economic Theory of Regulation

• Three Factors Affecting the Supply of Regulation
• Consumer surplus generated per buyer
• Producer surplus generated per firm
• The number of voters benefited

10
Economic Theory of Regulation

• Political Equilibrium
• The amount of regulation is such that no interest
  group finds it worthwhile to press for changes
  and no group of politicians finds it worthwhile
  to offer different regulations.

11
Economic Theory of Regulation

• Political Equilibrium
• Public Interest Theory
• Regulations are supplied to satisfy the demand of
  consumers and producers to maximize total surplus
• Capture Theory
• Regulations are supplied to satisfy the demand of
  producers to maximize producer surplus--maximize
  economic profit.

12
Regulation and Deregulation

• Numerous regulatory agencies have been developed
  since 1887.
• Since 1977, industry has been going through a
  gradual process of deregulation.

13
Regulation and Deregulation

• The Regulatory Process
• Bureaucrats are appointed
• Agencies adopt a set of practices and rules
• Agency grant certification to a company
• Price and Quantity Regulation

14
Regulation and Deregulation

• Natural Monopoly
• Industry in which one firm can supply the entire
  market at a lower cost than two or more firms can

15
Regulation and Deregulation

• Marginal Cost Pricing Rule
• Sets price equal to marginal cost
• If the Firm Incurs a Loss
• Price discrimination
• Two-part tariff
• Subsidy

16
Learning Objectives

• Define regulation and antitrust law
• Distinguish between the public interest and
  capture theories of regulation
• Explain how regulation affects prices, outputs,
  profits, and the distribution of the gains from
  trade between consumers and producers

17
Natural MonopolyMarginal Cost Pricing
30
25
Price Cost (dollars per household per month)
20
15
ATC
10
MC
D
0
2
4
6
10
8
Quantity (millions of households)
18
Natural MonopolyMarginal Cost Pricing
30
Total surplus
25
Price Cost (dollars per household per month)
20
Loss per household
15
ATC
10
MC
D
0
2
4
6
10
8
Quantity (millions of households)
19
Regulation and Deregulation

• Average Cost Pricing Rule
• Sets price equal to average total cost
• Firm Earns a Normal Profit

20
Natural MonopolyAverage Cost Pricing
30
25
Price Cost (dollars per household per month)
20
15
ATC
10
MC
D
0
2
4
6
10
8
Quantity (millions of households)
21
Natural MonopolyAverage Cost Pricing
30
25
Price Cost (dollars per household per month)
20
Consumer surplus
15
ATC
Producer surplus
10
MC
Deadweight loss
D
0
2
4
6
10
8
Quantity (millions of households)
22
Regulation and Deregulation

• Capturing the Regulator
• Maximizes profit

23
Natural MonopolyProfit Maximization
30
25
Price Cost (dollars per household per month)
20
18
15
ATC
10
MC
D
MR
0
2
4
6
10
8
Quantity (millions of households)
24
Natural MonopolyProfit Maximization
30
Consumer surplus
25
Deadweight loss
Price Cost (dollars per household per month)
20
18
15
ATC
Economic profit
10
MC
D
MR
0
2
4
6
10
8
Quantity (millions of households)
25
Regulation and Deregulation

• How do agencies determine a regulated price?
• Answer Rate of Return Regulation

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Regulation and Deregulation

• Rate of Return Regulation
• Sets price that enables the firm to earn a
  specific percent of return on its capital
• Inflating Costs
• Firms will be motivated report costs as high as
  possible.

27
Natural MonopolyInflating Costs
30
25
Price Cost (dollars per household per month)
20
18
ATC (inflated)
15
ATC
10
MC
D
MR
0
2
4
6
10
8
Quantity (millions of households)
28
Natural MonopolyInflating Costs
30
Profit is maximized
25
Price Cost (dollars per household per month)
20
18
ATC (inflated)
15
ATC
Economic profit
10
MC
D
MR
0
2
4
6
10
8
Quantity (millions of households)
29
Regulation and Deregulation

• Incentive Regulation Schemes
• Gives a firm an incentive to operate efficiently
  and keep costs under control.
• Public Interest or Capture?
• Not completely clear which one
• Both predict Price exceeds MC
• Except for local phone service

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Rate of Return inRegulated Monopolies
Years Industry 196269 19707
7

• Electricity 3.2 6.1
• Gas 3.3 8.2
• Railroad 5.1 7.2
• Average of above 3.9 7.2
• Economy Average 6.6 5.1

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Gains from DeregulatingNatural Monopolies

• Consumer Producer Total
• surplus surplus surplus
• Industry (billions of 1990 dollars)

Railroads 8.5 3.2 11.7 Telecommunications 1.2 0.0
1.2 Cable television 0.8 0.0 0.8 Total 10.5 3.2 13
.7
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Regulation and Deregulation

• Cartel Regulation
• Place an output limit on each firm in the
  industry.
• Prevent cheating
• Regulation - Which One is Used?
• Public interest
• Capture theory

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Collusive Oligopoly
50
Producer interest regulation
MC
40
Price Cost (dollars per trip)
30
Public interest regulation
20
10
D
MR
0
100
200
300
500
400
Quantity (number of trips)
34
Rates of Return in Regulated Oligopolies
Years Industry 196269 19707
7

• Airlines 12.8 3.0
• Trucking 13.6 8.1
• Economy Average 6.6 5.1

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Gains from Deregulating Oligopolies

• Consumer Producer Total
• surplus surplus surplus
• Industry (billions of 1990 dollars)

Airlines 11.8 4.9 16.7 Trucking 15.4 -4.8 10.6 Tot
al 27.2 0.1 27.3
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Regulation and Deregulation

• Making Predictions
• Why were the transportation and
  telecommunications industries deregulated?
• Economists became more confident and vocal
• We can expect to see more deregulation.

37
Learning Objectives (cont.)

• Explain how antitrust law has been applied in a
  number of landmark cases
• Explain how antitrust law is used today

38
Antitrust Laws
Year Name of law Passed What the
law prohibits

• Sherman Act
  1890 Combination, trust or conspiracy to
  restrict interstate or international
  trade.
• Monopolization or attempt to monopolize
  interstate or international trade
• Clayton Act 1914 Price
  discrimination if the effect is to
  Robinson-Patman 1936 substantially
  lessen competition or create Amendment
  monopoly and if such discrimination is not
  Cellar-Kefauver 1950 justified
  by cost differences
• Amendment Contracts force other goods to be
  bought from same firm
• Acquisition of competitors shares or assets
• Interlocking directorships among competing
  firms

39
Antitrust Laws
Year Name of law Passed What the
law prohibits

• Federal Trade 1914 Unfair methods of
  competition and
• Commission Act unfair or deceptive business
  practices

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Landmark Antitrust Cases

• Federal Trade Commission was established in 1914
  to enforce the antitrust laws.
• Rule of reason
• Monopolies arising from mergers and agreements
  are not necessarily illegal.
• Vertical and Horizontal Integration were found to
  be illegal

41
Landmark Antitrust Cases
Case Year Verdict and consequence

• American Tobacco 1911
  Guilty Ordered to divest themselves of
• and Standard Oil Co. Large holdings in other
  companies rule
• of reason enunciated--only unreasonable
• combinations guilty under Sherman Act.
• U.S. Steel Co. 1920
  Not Guilty U.S. Steel had a very large
  market share (near monopoly), mere size alone
  is not an offense application of the rule of
  reason.
• Socony-Vacuum Oil Co. 1940 Guilty
  Combination was formed for price fixing no
  consideration of
• reasonableness applied.

42
Landmark Antitrust Cases
Case Year Verdict and consequence

• Alcoa 1945
  Guilty Too big--had too large a share of
  the
• market end of rule of reason.
• General Electric, 1961
  Guilty Price-fixing conspiracy executives
• Westinghouse others fined and jailed
• Brown Shoe 1962
  Guilty Ownership of Kinney, a retail chain,
• reduced competition ordered to sell Kinney
  shoes, (Brown supplied 8 percent of Kinney's and
  Kinney sold 2 percent of nations shoes)
• Vons Grocery 1965
  Guilty Merger of two supermarkets in
• Los Angeles would restrain competition
  (the merged firm would have had 7.5 percent of
  the L.A. market).

43
Landmark Antitrust Cases
Case Year Verdict and consequence

• IBM
  1982 Case dismissed as being without merit.
• ATT
  1983 Agreement between ATT and
• government that the company would
• divest itself of all local telephone
  operating companies --80 of its assets.

44
Learning Objectives (cont.)

• Explain how antitrust law has been applied in a
  number of landmark cases
• Explain how antitrust law is used today

45
Landmark Antitrust Cases

• Three Recent Antitrust Cases
• IBM
• ATT
• Microsoft

46
Landmark Antitrust Cases

• Current Merger Rules
• The Department of Justice uses the
  Herfindahl-Hirschmand (HHI) to evaluate mergers.
• Less than 1,000 competitive
• 1,000 to 1,800 moderately concentrated
• challenged if merger would increase the index by
  100 points
• above 1,800 concentrated market
• challenged if merger would increase the index by
  50 points

47
The HHI Merger Guidelines
48
Proposed Mergers (1986)

• Market definition
• Narrow carbonated soft drinks HHI gt 2400
  highly concentrated
• Coke 39
• PepsiCo 28
• Dr Pepper 7
• 7-Up 6
• RJR 5

• Market definition
• Broad carbonated soft drinks, fruit juices and
  bottle water sold by these four companies
• HHI 120 highly competitive
• Dept. of Justice chose the narrow definition
  blocked both mergers

49
Landmark Antitrust Cases

• Is the public interest served?
• Original intent was to protect and pursue the
  public interest
• However, the interest of the producer sometimes
  comes into play.
• Is our court system more likely to serve the
  public interest than our regulators?