1. Chapter 15
Economic Regulations and Antitrust

2. Types of Government Regulation
• Market power: the ability of a firm to raise its
price without losing all its customers to rival
firms
– Firms with downward sloping demand curves
– The assumption is that a monopoly or firms acting
like a monopoly will restrict output to charge a
higher price.
• Less social welfare is provided

3. Types of Government Regulation
• Three kinds of government policies are
designed to alter or control firm behaviors
– Social regulation
– Economic regulation
– Antitrust regulations

4. Social regulation
• Social regulation tries to improve health and
safety
– It has economic consequences
– Improvements in safety of workers

5. Economic regulation
• It aims to control the price, output, the entry
of new firms, and the quality of service in
industries in which monopoly appears
inevitable or even desirable.
– Government controls over natural monopolies
• Phone
• Electricity
• Subway Stations

6. Antitrust regulation
• Antitrust policy outlaws attempts to
monoplize, or cartelize, markets in which
competition is desirable.
– It is pursued in the courts

7. Regulating a Natural Monopoly
• Unregulated Profit Maximization
– The price-output combination is inefficient in
terms of social welfare.
– Consumers pay a price that is much higher than
the marginal cost of providing the service.

8. LO2 Exhibit 1
Regulating a Natural Monopoly
a
Natural monopoly maximizes profit: MR=MC,
per trip
Dollars
q=50, p=$4. Inefficient: p>MC.
Demand
Efficient output rate: set p=$0.50, then
c b q=105 efficient outcome. But the firm:
$4.00 economic loss; requires subsidy.
Profit Alternative: set p=$1.50;
2.50 then q=90, the firm breaks
1.50 h g even (p=average cost);
1.25 LRAC earns normal profit.
f Loss e
0.50 Long-run MC
MR
0 50 90 105 Trips per month (millions)
Social welfare could still be increased by expanding output as long as the
price >MC; but that would result in an economic loss, requiring a subsidy.

9. What can the government do?
• They can either operate the monopoly itself,
or government can regulate a privately owned
monopoly.
• Government-owned or government-
regulation monopolies are called public
utilities.

10. What are some of these regulations?
• Setting Price Equal to Marginal Cost
– The monopolist is operating at a loss
– In the L-R, the monopolist will go out of business
rather than endure such a loss
• Subsidizing the Natural Monopolist
– The Government can cover the loss by subsidizing
the firm to earn a normal profit
• Amtrak’s $30 billion over the last three decades

11. What are some of these regulations?
• Setting Price Equal to Average Cost
– A “fair return”
– The monopoly can stay in business without a
subsidy

12. Why do governments regulate certain
industries?
• Why not let market forces allocate resources?
• Two views of government regulation:
– Public interest
– Special interest of producers
• Restricting entry into the market
• Capture theory of regulation: producers’ political
power and strong stake in the regulatory outcome lead
them, in effect, to “capture” the regulating agency and
prevail on it to serve producer interests.

13. LO3 Airline Regulation and Deregulation
 1938 Civil Aeronautics Board
 Regulated interstate airlines
Case Study
 40 years: No new interstate airline
 Fixed prices among the 10 major airlines
 Blocked new entry
 Labor unions
 Higher wages
 Pilots worked 2
weeks/month
 High price

14. LO3 Airline Regulation and Deregulation
 1978 Deregulation
 Price competition
Case Study
 New entry
 Price: one quarter below regulated price
 More efficient airlines
 FAA regulates quality
and safety
 Accident rates declines by
10-45%
 More people fly (passenger
miles tripled)

15. LO3 Airline Regulation and Deregulation
 Fierce competition
 Mergers
Case Study
 Disappeared
 Bankrupt
 Lower wages
 Lower fares
 More flights
 Saving lives

16. Origins of Antitrust Policy
• Antitrust is the government’s attempt to
reduce anticompetitive behavior and promote
a market structure that leads to greater
competition.
– They attempt to promote socially desirable
market performance

17. Origins of Antitrust Policy
• Two important developments were:
– Technological breakthrough that lead to a larger
optimal plant size in manufacturing and
– The rise of the railroad from 9,000 miles of track
in 1850 to 167,000 miles by 1890
• Economies of scale and cheaper transport costs
extended the geographical size of markets, so firms
grew larger to serve this bigger market.

18. Antitrust
• Before the Civil War, industries were made up
of small firms and monopoly power was not
very prevalent at the time.
• After the Civil War, things began to change
– 1870s and 1880s with many new inventions, such
as the railroads and the telegraph the country was
becoming more linked.
– These technology changes allowed firms to
expand into national markets
– They began to form “trust.”

19. Trust
• A trust is a combination or cartel consisting of
firms that place their assets in the custody of a
board of trustees.
– This allows firms that have not merged to form a
cartel that will control an industry in order to
charge monopoly prices and earn higher profits.
• Today, these guys are no longer legal
• Examples: Iron Trust, Sugar Trust, Cooper Trust, and
Steel Trust

20. Predatory Pricing
• One practice that the trust use to run smaller
competitors out of the market was known as
“predatory pricing.”
– Def: Predatory pricing is the practice of one or
more firms temporarily reducing prices in order to
eliminate competition and then raising prices.

21. The Sherman Act
• So, how should we stop this behavior.
• In the late 1890s, the government and the
country in general grew tired of this behavior,
as a result the next 50 years or so would lead to
several antitrust laws. The most famous and the
first of these actions is “The Sherman Act."

22. The Sherman Act
• The Sherman Act of 1890 is the federal
antitrust law that prohibits monopolization
and conspiracies to restrain trade.
– This is still used today as the cornerstone of
antitrust legislation.
– Section 1- made trust illegal (i.e. no cartels)
– Section 2- no monopolization of an industry
http://www.stolaf.edu/people/becker/antitrust/

23. The Clayton Act
• The Clayton Act of 1914 is an amendment that
strengthened the Sherman Act by making it
illegal for firms to engaged in certain
anticompetitive business practices.
– Made these things illegal when they “substantially
lessen competition or tend to create a monopoly.”
• Price discrimination
• Exclusive dealing
• Tying Contracts
• Stock Acquisition of Competing Companies
• Interlocking Directories.

24. The Federal Trade Commission
• The Act established the Federal Trade
Commission (FTC) to investigate unfair
competitive practices of firms.
• Today’s concerns:
– Enforcing consumer protection legislation
– Prohibiting deceptive advertising
– Preventing collusion
• How does it work?

25. The Federal Trade Commission
• This law can block horizontal and vertical
mergers.
– Horizontal merger: the merging of firms that
produce the same product
• Wells Fargo and Wachovia
– Vertical merger: the merging of firms where one
supplies inputs to the other or demands output
from the other.
• Coke and a sugar farm

26. How to enforce them?
• Three ways:
– Antitrust Division of the Department of Justice
– FTC
• Enforces through voluntary understanding or formal
commission order
– Private proceedings
• Lawsuits for damage

27. Per Se Illegality and the Rule of Reason
• Per Se Illegality: In antitrust law, business
practices deemed illegal regardless of their
economic rational or their consequences.
– The courts examine the firm’s behavior
• Rule of Reason: Before ruling on the legality of
certain business practices, a court examines
why they were undertaken and what effect
they have on competition.

28. Key Antitrust Cases
• The Standard Oil Case (1911)
– Established the rule of reason
• The Alcoa Case (1945)
– Established per s e rule
• The IBM Case (1982)
• The AT& T Case (1982)
• The MIT Case (1992)
• The Microsoft Case (2001)

29. Mergers and Public Policy
• In determining possible harmful effects that a
merger might have on competition, one
important consideration is its impact on the
share of sales accounted for by the largest
firms in the industry.
• A few firms account for a relatively large share
of sales, the industry is said to be
“concentrated.”

30. Mergers and Public Policy
• As a measure of sales concentration, the
Justice Department uses the “Herfindahl-
Hirschman Index” (HHI)
– A measure of market concentration that squares
each firms percentage share of the market then
sums these squares
– Pure Monopoly= 10,000= 100 squared

31. LO5 Exhibit 2
Herfindahl-Hirschman Index (HHI) Based on
Market Share in Three Industries
Each of the three industries has 44 firms. The HHI is found by squaring each firm’s market
share then summing the squares. Only the market share of the top four firms differ across
industries; the remaining 40 firms have 1% market share each.
The HHI for Industry III is nearly triple that for each of the other two industries.

32. Mergers and Public Policy
• The Justice Department generally challenges
any merger in an industry that meets two
conditions:
– The post merger HHI exceeds 1,800
– The merger increases the index by more than 100
points

33. Merger Waves
• 1887-1904- Horizontal Mergers
• 1916-1929- Vertical Mergers
• 1948-1969- Conglomerate Mergers
– A merger of firms in different industries
• 1982-present- Horizontal and Vertical Mergers

34. Competitive Trends in
the US Economy
1. Pure monopoly
– One firm controls the market
– Block entry
2. Dominant firm
– One firm: more than half market share
– No close rival
LO6

35. Competitive Trends in
the U.S. Economy
3. Tight oligopoly
– Top 4 firms: more than 60% of market
output
– Evidence of cooperation
4. Effective competition
– Low concentration
– Low barriers to entry
– Little or no collusion
LO6

36. Competition over Time
• The Growth in competition from 1958 to
2000:
– Competition from imports
– Deregulation
– Antitrust policy

37. LO6 Competitive Trends in the U.S. Economy:
1939 to 2000
Exhibit 4

38. Problems with
Antitrust Policy
 Competition may not
require that many
firms
 Abuse of antitrust
 Growth of international
markets
 Bailing Out Trouble
Industries
LO6