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Chapter 27 Regulation and Antitrust Policyin a Globalized Economy
Introduction Congress has assigned the U.S. Department of Agriculture (USDA) and the Food and Drug Administration (FDA) to enforce new food-labeling regulations for large supermarkets and restaurant chains. In this chapter, you will learn about both the costs and benefits of government regulation, such as those new regulations enforced by the USDA and FDA.
Learning Objectives Distinguish between economic regulation and social regulation Recognize the practical difficulties in regulating the prices charged by natural monopolies Explain the main rationales for government regulation of industries that are not inherently monopolistic
Learning Objectives (cont'd) Identify alternative theories aimed at explaining the behavior of regulators Understand the foundations of antitrust laws and regulations Discuss basic issues in enforcing antitrust laws
Chapter Outline Forms of Industry Regulation Regulating Natural Monopolies Regulating Nonmonopolistic Industries Incentives and Costs of Regulation Antitrust Policy Antitrust Enforcement
Did You Know That ... In a recent year not only did 285 laws enacted by the U.S. Congress go into effect, but U.S. federal agencies also imposed 3,830 new regulatory rules? While many of these rules are intended to promote greater economic efficiency and benefit consumers, some critics have estimated that the annual cost of complying with these regulations exceeds $1 trillion. In this chapter, you will study the economic effects of regulation.
Forms of Industry Regulation The U.S. government began regulating social and economic activity early in the nation’s history. The amount of government regulation began increasing in the twentieth century.
Figure 27-1 Regulation on the Rise Sources: Institute for University Studies; Federal Register, various issues.
Forms of Industry Regulation (cont'd) Two basic types of government regulation: Economic regulation of natural monopolies and nonmonopolistic industries Social regulation which covers all industries
Forms of Industry Regulation (cont'd) Economic regulation of natural monopolies Initially, most economic regulation in the United States was aimed at controlling prices in industries considered natural monopolies Over time, federal and state governments have sought to influence products and processes of firms in a variety of industries
Forms of Industry Regulation (cont'd) Economic regulation of nonmonopolistic industries Securities (SEC) Banking (Fed, FDIC, Comptroller) Transportation (FAA) Communications (FCC)
Forms of Industry Regulation (cont'd) Social regulation The aim is better quality of life Improved products Less pollution Better working conditions
Regulating Natural Monopolies The theory of natural monopoly regulation includes our understanding of: Unregulated natural monopoly Impracticality of marginal cost pricing Average cost pricing
Regulating Natural Monopolies (cont'd) Recall Natural monopoly is a monopoly arising from the peculiar production characteristics in an industry It usually arises when there are large economies of scale relative to the industry’s demand One firm can produce at a lower average cost than can be achieved by multiple firms
Figure 27-2 Profit Maximization and Regulation Through Marginal Cost Pricing, Panel (a) Max profits at point A where marginal cost equals marginal revenue
Figure 27-2 Profit Maximization and Regulation Through Marginal Cost Pricing, Panel (b) Losses eventually drive the natural monopolist out of business
Regulating Natural Monopolies (cont'd) Methods of rate regulation Cost-of-Service Regulation Regulation based on allowing prices to reflect only the actual cost of production and no monopoly profits Rate-of-Return Regulation Regulation that seeks to keep the rate of return in the industry at a competitive level by not allowing excessive prices to be charged
Regulating Natural Monopolies (cont'd) Natural monopolies no more? Are natural monopolies a thing of the past? Before answering this question, consider: Electricity and natural gas: separating production from delivery Telecommunications services meet the Internet
Regulating Nonmonopolistic Industries Protecting consumer interests has been the main rationale for governmental regulatory functions The Latin phrase caveat emptor, “let the buyer beware,” was once the operative principle, but no more
Regulating Nonmonopolistic Industries (cont'd) Rationales for government oversight in nonmonopolistic industries Market failure arising from externalities The need for consumer protection arising from asymmetric information
Regulating Nonmonopolistic Industries (cont'd) The Lemons Problem The potential for asymmetric information to bring about a general decline in product quality in an industry Credence goods such as pharmaceuticals, health care, and professional services are vulnerable to the lemons problem.
Regulating Nonmonopolistic Industries (cont'd) Implementing consumer protection regulation Liability laws and government licensing Direct economic and social regulation
Incentives and Costs of Regulation Abiding by government regulations can be costly Consequently, businesses engage in activities intended to avoid intent or to change regulations agencies establish
Incentives and Costs of Regulation (cont'd) Creative response and feedback effects: Results of regulation Creative Response Behavior on the part of a firm that allows it to comply with the letter of the law but violates the spirit, significantly lessening the law’s effects
Incentives and Costs of Regulation (cont'd) Creative response and feedback effects: Results of regulation Feedback effect Changing behavior after the regulation that offset the regulation Example HOV lanes added to combat air pollution have higher accident rates
Policy Example: Food Makers Respond to Regulation by Replacing Trans Fats Because trans fats—fats created when hydrogen is added to vegetable oil—induce the human body to boost production of unhealthful cholesterol, the FDA has decided to require companies to disclose the amounts of trans fats in their food products. In response, companies have replaced the trans fats with equally unhealthful ingredients of saturated fats, such as coconut oil and palm oil, so that the total fat content of the food remained the same but with no trans fats.
Incentives and Costs of Regulation (cont'd) The Capture Hypothesis Predicts that the regulators will eventually be captured by the special interests of the industry being regulated
Policy Example: The Tobacco Industry Sees Benefits in Regulation Tobacco firms are among the strongest supporters of the new legislation that grants the FDA the authority to regulate the tobacco industry. Why? While the new regulation does not permit the FDA to ban existing tobacco products, it would eliminate threats of entry by new competitors as the FDA is unlikely to approve any new tobacco products. The FDA would now be required to stop the distribution of counterfeit cigarettes, so that another source of competition would be removed.
Incentives and Costs of Regulation (cont'd) The Share-the-Gains, Share-the-Pains Theory States that regulators must take account of the demands of three groups: legislators, members of the regulated industry, and consumers of the regulated industry’s product or service
Incentives and Costs of Regulation (cont'd) The benefits and costs of regulation Regulation offers many potential benefits Actual benefits are more difficult to measure
Incentives and Costs of Regulation (cont'd) Direct costs to taxpayers Taxpayers pay more than $40 billion per year Agencies employ more than 250,000 employees
Incentives and Costs of Regulation (cont'd) The total social cost of regulation Explicit costs of compliance in the United States is estimated to be between $500 billion and $600 billion per year Economists estimate the opportunity cost of complying with federal regulations may be as high as $270 billion Add state and municipal regulations, and consider all implicit and explicit costs, and we are over $1 trillion in total
Antitrust Policy An expressed aim of the U.S. government is to foster competition This is the general idea behind antitrust legislation Congress has enacted four key antitrust laws, seen in Table 27-2 The most important of these laws is the Sherman Act
Antitrust Policy (cont'd) Sherman Antitrust Act of 1890 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 hereby declared to be illegal.
Antitrust Policy (cont'd) Sherman Antitrust Act of 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… shall be guilty of a misdemeanor.
Antitrust Policy (cont'd) The Clayton Act of 1914 Passed to remove the vagueness of the Sherman Act Federal Trade Commission Act in 1914 Established the Federal Trade Commission to investigate unfair trade practices and enumerated certain business practices that involved overly aggressive competition. An amendment in 1938 expressly prohibited “unfair or deceptive acts or practices in commerce”
Antitrust Policy (cont'd) The Robinson-Patman Act of 1936 Amended Section 2 of the Clayton Act Designed to protect independent retailers and wholesalers from “unfair discrimination” by chain stores
Antitrust Policy (cont'd) Exemptions from antitrust laws All labor unions Public utilities – electric, gas, and telephone Professional baseball Cooperative activities among U.S. exporters
Antitrust Policy (cont'd) Exemptions from antitrust laws Hospitals Public transit and water systems Suppliers of military equipment Joint publishing arrangement in a single city by two or more newspapers
International Policy Example: Antitrust Authorities Fine Intel for Its Low Prices Recently, Advanced Micro Devices (AMD)—the second largest global producer of microprocessors, which power computer and other computing devices—filed an antitrust in Europe against Intel—the largest microprocessor producer—for setting its prices of microprocessors below the average total costs of Intel’s competitors in order to induce them to exit the market. Soon after Intel paid a $1.45 billion fine and then another $1.25 billion to AMD as part of a legal settlement, consumers were paying higher prices for microprocessors.
Antitrust Policy (cont'd) International Discord in Antitrust Policy As more U.S. firms seek to merge with companies in other countries, the international dimensions of antitrust policy become more important In the European Union, there are restrictions against any business combination that would enhance the market dominance of one firm
Antitrust Enforcement Monopolization The possession of monopoly power in the relevant market and the willful acquisition or maintenance of that power As distinguished from growth or development as a consequence of a superior product, business acumen, or historical accident
Antitrust Enforcement (cont'd) Market Share Test The percentage of a market that a particular firm supplies; used as the primary measure of monopoly power
Antitrust Enforcement (cont'd) The relevant market The relevant product market The relevant geographic market
Antitrust Enforcement (cont'd) A particular problem in U.S. antitrust enforcement is determining whether a firm has engaged in “willful acquisition or maintenance” of market power What appears as good business to some may look like antitrust violations to others
Why Not … outlaw all mergers between firms that sell similar items? While some mergers lead to reductions in quantities and increases in market prices, a number of mergers in fact result in the combined firm incurring lower marginal cost than the individual firms incurred before their merger. Thus, in many markets in which mergers occur, the mergers result in higher production and lower equilibrium prices.
Antitrust Enforcement (cont'd) Versioning Selling a product in slightly altered forms to different groups of consumers An example is selling software in “professional” and “standard” versions