Regulation and Antitrust Law

1. MICRO ECONOMICS Regulation and Antitrust Law

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

6. 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

7. 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

8. 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

9. 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.

10. Economic Theory of Regulation Political Equilibrium (cont.) 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.

11. Regulation and Deregulation • Numerous regulatory agencies have been developed since 1887. • 1977 - 2008, industry has been going through a gradual process of deregulation.

12. 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

13. 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.

14. 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

15. Price Discrimination Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider In a theoretical market with perfect information, perfect substitutes, and no transaction costs or prohibition on secondary exchange (or re-selling) to prevent arbitrage, price discrimination can only be a feature of monopolistic and oligopolisticmarkets,[3] where market power can be exercised.

16. Two - part tariff A two-part tariff is a price discrimination technique in which the price of a product or service is composed of two parts – (a) a lump-sum fee as well as a (b) per-unit charge. In general, price discrimination techniques only occur in partially or fully monopolisticmarkets. It is designed to enable the firm to capture more consumer surplus than it otherwise would in a non-discriminating pricing environment. Two-part tariffs may also exist in competitive markets when consumers are uncertain about their ultimate demand. Health club consumers, for example, may be uncertain about their level of future commitment to an exercise regime.

17. Subsidy • A subsidy (also known as a subvention) is a form of financial assistance paid to a business or economic sector. Most subsidies are made by the government to producers or distributors in an industry to prevent the decline of that industry (e.g., as a result of continuous unprofitable operations) or an increase in the prices of its products or simply to encourage it to hire more labor (as in the case of a wage subsidy). Examples are subsidies to encourage the sale of exports; subsidies on some foods to keep down the cost of living, especially in urban areas; and subsidies to encourage the expansion of farm production and achieve self-reliance in food production.[1] • Subsidies can be regarded as a form of protectionism or trade barrier by making domestic goods and services artificially competitive against imports. Subsidies may distort markets, and can impose large economic costs.[2] Financial assistance in the form of a subsidy may come from one's government, but the term subsidy may also refer to assistance granted by others, such as individuals or non-governmental institutions

18. 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

19. Loss per household ATC MC D Natural Monopoly:Marginal Cost Pricing 30 Total surplus 25 20 Price & Cost (dollars per household per month) 15 10 0 2 4 6 8 10 Quantity (millions of households)

20. Regulation and Deregulation Average Cost Pricing Rule • Sets price equal to average total cost • Firm Earns a Normal Profit

21. Consumer surplus ATC Producer surplus MC Deadweight loss D Natural Monopoly:Average Cost Pricing 30 25 20 Price & Cost (dollars per household per month) 15 10 0 2 4 6 8 10 Quantity (millions of households)

22. Regulation and Deregulation Capturing the Regulator • Maximizes profit

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

24. Regulation and Deregulation How do agencies determine a regulated price? Answer: Rate of Return Regulation

25. 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.

26. Profit is maximized ATC (inflated) Economic profit Natural Monopoly:Inflating Costs 30 25 20 18 Price & Cost (dollars per household per month) 15 ATC 10 MC MR D 0 2 4 6 8 10 Quantity (millions of households)

27. Regulation and Deregulation Incentive Regulation Schemes • Gives a firm an incentive to operate efficiently and keep costs under control. Public Interest of Capture? • Not completely clear which one • Price does not use the MC pricing rule

28. Rate of Return inRegulated Monopolies Years Industry 1962–69 1970–2007 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

29. Gains from DeregulatingNatural Monopolies in the USA 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

30. 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

31. Producer interest regulation MC Public interest regulation D MR Collusive Oligopoly 50 40 Price & Cost (dollars per trip) 30 20 10 0 100 200 300 400 500 Quantity (number of trips)

32. Rates of Return in Regulated Oligopolies Airlines 12.8 3.0 Trucking 13.6 8.1 Economy Average 6.6 5.1 Years Industry 1962–69 1970–2007

33. Gains from Deregulating Oligopolies in the USA 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 Total 27.2 0.1 27.3

34. 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.

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

36. Antitrust Law The Sherman Act, 1890 Section 1: Every contract, combination in the form or trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is hereby declared to be illegal.

37. Antitrust Law The Sherman Act, 1890 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.

38. Antitrust Law The Clayton Act and its Amendments Clayton Act 1914 Robinson-Patman Act 1936 Cellar-Kefauver Act 1950 These Acts prohibit the following practices only if they substantially lessen competition or create monopoly:

39. Antitrust Law The Clayton Act and its Amendments (cont.) 1. Price discrimination. 2. Contracts that require other goods to be bought from the same firm (called trying arrangements).

40. Antitrust Law The Clayton Act and its Amendments (cont.) 3. Contracts that require a firm to buy all its requirements of a particular item from a single firm (called requirements contracts.) 4. Contracts that prevent a firm from selling competing items (called exclusive dealing).

41. Antitrust Law The Clayton Act and its Amendments (cont.) 5. Contracts that prevent a buyer from reselling a product outside a specified area (called territorial confinement). 6. Acquiring competitor’s shares or assets. 7. Interlocking directorships among competing firms.

42. Landmark Antitrust Cases USA: 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.

43. Landmark Antitrust Cases Case Year Verdict and consequence 1. Price Fixing Socony-Vacuum Oil Co. 1940 Guilty: Combination was formed for purpose of price fixing; no consideration of “reasonableness” applied. General Electric, Westinghouse, and others 1961 Guilty: Price-fixing conspiracy; executives fined and jailed. Archer, Daniels, Midland 1996 Guilty: Price-fixing conspiracy; fined $100 million.

44. Landmark Antitrust Cases Case Year Verdict and consequence 2. Attempts to Monopolize 1911 American Tobacco and Standard Oil Co. Guilty: Ordered to divest themselves of 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.”

45. Landmark Antitrust Cases Case Year Verdict and consequence 2. Attempts to Monopolize (continued) Alcoa Guilty: Too big--had too large a share of the market; end of “rule of reason.” 1945 Brown Shoe Guilty: Ownership of Kinney, a retail chain, reduced competition; ordered to sell Kinney (Brown supplied 8 percent of Kinney's shoes, and Kinney sold 2 percent of nations shoes. 1962

46. Landmark Antitrust Cases Case Year Verdict and consequence 2. Attempts to Monopolize (continued) Von’s 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.

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

48. Antitrust Law Today The Case Against Microsoft 1. Possesses monopoly power in the market for PC operating systems. 2. Uses predatory pricing and trying agreements to achieve a monopoly in the market for Web browsers. 3. Uses other anti-competitive practices to strengthen its monopoly in these two markets.

49. Antitrust Law Today Microsoft’s Response • Microsoft challenges all these claims. • It says that although Windows dominates today, it is vulnerable to new operating systems. • It claims that integrating Internet Explorer with Windows 98 provides a product of greater consumer value.

50. EU vs. Microsoft • In 1993, Novell said that Microsoft was blocking its competitors out of the market through anti-competitive practices. The complaint centered on the license practices at the time which required royalties from each computer sold by a supplier of Microsoft's operating system, whether or not the unit actually contained the Windows operating system. Microsoft reached a settlement in 1994, ending some of its license practices.