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Chapter 13

Chapter 13. Antitrust and Regulation. Economic Principles. Regulating a natural monopoly “Fair” price Marginal cost pricing Laissez-faire Nationalization. Economic Principles. The theory of contestable markets The theory of countervailing power The theory of creative destruction.

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Chapter 13

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  1. Chapter 13 Antitrust and Regulation Gottheil — Principles of Economics, 7e

  2. Economic Principles • Regulating a natural monopoly • “Fair” price • Marginal cost pricing • Laissez-faire • Nationalization Gottheil — Principles of Economics, 7e

  3. Economic Principles • The theory of contestable markets • The theory of countervailing power • The theory of creative destruction Gottheil — Principles of Economics, 7e

  4. Economic Principles • Patents • Antitrust legislation Gottheil — Principles of Economics, 7e

  5. Paradise Lost To many economists, perfect competition is the closest thing on earth to paradise. Gottheil — Principles of Economics, 7e

  6. Paradise Lost Under perfect competition, market prices are at their lowest levels, all goods are produced at the minimum point on their average cost curves, and the quantities supplied are greater than would be forthcoming under any other market condition. Gottheil — Principles of Economics, 7e

  7. Paradise Lost Unfortunately, perfect competition does not exist in the real world. Gottheil — Principles of Economics, 7e

  8. Paradise Lost The real world is one of monopoly, monopolistic competition and oligopoly. Gottheil — Principles of Economics, 7e

  9. Learning to Cope Without Perfect Competition There are several competing views among economists regarding what we should do about monopolies and oligopolies. Gottheil — Principles of Economics, 7e

  10. EXHIBIT 1 WHAT TO DO ABOUT MONOPOLY Gottheil — Principles of Economics, 7e

  11. Learning to Cope without Perfect Competition 1. Regulating monopoly: Monopolies are inevitable and undesirable. Use government regulation to make monopoly price conform more closely to the price that would exist if the markets were competitive. Gottheil — Principles of Economics, 7e

  12. Learning to Cope without Perfect Competition 2. Nationalizing the industry: Monopolies are inevitable and undesirable. Government should take over the monopolies. Gottheil — Principles of Economics, 7e

  13. Learning to Cope without Perfect Competition 3. Laissez-faire: Monopolies are inevitable, but not necessarily undesirable. Government policy of nonintervention in market outcomes. Translated, it means “leave it be.” Gottheil — Principles of Economics, 7e

  14. Learning to Cope without Perfect Competition 4. Encouraging concentration: Monopolies are inevitable and desirable. Government should promote less-competitive markets because they are technically superior, generate low prices and benefit society. Gottheil — Principles of Economics, 7e

  15. Learning to Cope without Perfect Competition 5. Splitting up monopoly: Monopolies are neither inevitable nor desirable. Government should promote anti-monopoly legislation, break monopolies into fragments and prevent their restoration. Gottheil — Principles of Economics, 7e

  16. The Economics of Regulation How does government regulation of monopoly work? • It separates monopoly pricing from monopolies and the price-making function is taken over by a government-appointed regulatory commission or agency. Gottheil — Principles of Economics, 7e

  17. The Economics of Regulation Regulation • Although the ownership of the regulated firm remains in private hands, pricing and production decisions of the firm are monitored by a regulatory agency directly responsible to the government. Gottheil — Principles of Economics, 7e

  18. EXHIBIT 2 THE CITY BUS COMPANY Gottheil — Principles of Economics, 7e

  19. Exhibit 2: The City Bus Company 1. Using the MR = MC rule, what fare and passenger capacity maximizes profit in Exhibit 1? • Profit is maximized at a fare of $5.00 and service to 80,000 passengers. Gottheil — Principles of Economics, 7e

  20. Exhibit 2: The City Bus Company 2. What is the profit of the bus company at a price of $5.00 and service to 80,000 passengers? • Profit = (Price × Number of passengers) - (Average cost per passenger × Number of passengers) • Profit = ($5.00 × 80,000) – ($3.00 × 80,000) = $160,000 Gottheil — Principles of Economics, 7e

  21. Exhibit 2: The City Bus Company 3. What fare would lead to zero economic profit for the bus company? • The company would achieve zero economic profit where price equals average total cost (P = ATC). • P = ATC at $1.00 Gottheil — Principles of Economics, 7e

  22. Exhibit 2: The City Bus Company 4. Why is zero economic profit considered a “fair” price? • The price is considered “fair” because the company is entitled to cover its costs, as well as enjoy normal profit, and passengers enjoy a lower bus fare. Gottheil — Principles of Economics, 7e

  23. The Economics of Regulation Benefits of government regulation of the bus service include: • Lower bus fares • Increased number of passengers Gottheil — Principles of Economics, 7e

  24. The Economics of Regulation Concerns with bus company regulation include: • The possibility that the ATC will begin to shift upward. Since price is set at ATC, when ATC goes up, bus fare also goes up. Under this scenario, there is little incentive to try to control ATC. Gottheil — Principles of Economics, 7e

  25. The Economics of Regulation Government commissions regulating markets must be vigilant in monitoring cost drift and keeping costs under control. Gottheil — Principles of Economics, 7e

  26. The Economics of Regulation Marginal cost pricing • A regulatory agency’s policy of pricing a good or service produced by a regulated firm at the firm’s marginal cost, P = MC. Gottheil — Principles of Economics, 7e

  27. The Economics of Regulation Marginal cost pricing • P = MC indicates society’s optimal use of resources. • The value that people place on a service is indicated by the price they are willing to pay. Gottheil — Principles of Economics, 7e

  28. The Economics of Regulation Marginal cost pricing • At P = ATC, or a $0.90 fare, the price people are willing to pay for the service is higher than the cost to produce the service ($0.40). • In other words, P = ATC > MC. Gottheil — Principles of Economics, 7e

  29. Exhibit 2: The City Bus Company 5. What are price and quantity when P = MC in Exhibit 1? • At P = MC, price is $0.30. Quantity is 180,000. Gottheil — Principles of Economics, 7e

  30. Exhibit 2: The City Bus Company 6. Why must the city subsidize bus transportation if price is regulated at P = MC? • At P = MC, revenue for the bus company = ($0.30 × 180,000) = $54,000. • Average total cost is $0.70. Gottheil — Principles of Economics, 7e

  31. Exhibit 2: The City Bus Company 6. Why must the city subsidize bus transportation if price is regulated at P = MC? • Total cost for the firm = ($0.70 × 180,000) = $126,000. • At P = MC the bus company suffers a loss of $(126,000 – 54,000) = $72,000. Gottheil — Principles of Economics, 7e

  32. The Economics of Regulation • Who makes up a regulatory commission, and what interests they represent, is a delicate matter. • Sometimes regulatory commissions end up protecting the monopolies they are supposed to regulate. Gottheil — Principles of Economics, 7e

  33. The Economics of Regulation Deregulation • The process of converting a regulated firm into an unregulated firm. Gottheil — Principles of Economics, 7e

  34. The Economics of Nationalization Nationalization • Government ownership of a firm or industry. Price and production decisions are made by an administrative agency of the government. Gottheil — Principles of Economics, 7e

  35. The Economics of Nationalization Governments can nationalize industries by either buying out the shares held by the shareholders or by simply confiscating the property. Gottheil — Principles of Economics, 7e

  36. The Economics of Nationalization • Governments typically buy firms by exchanging their own bonds for the nationalized firm’s shares. • Assessing the firm’s net worth can be a problem, but governments have generally been generous when nationalizing a firm. Gottheil — Principles of Economics, 7e

  37. The Economics of Nationalization What pricing options does the government have, once it has nationalized a firm? • The options available to the government are exactly the same as those available to the regulatory commission under regulation. Gottheil — Principles of Economics, 7e

  38. The Economics of Nationalization What pricing options does the government have, once it has nationalized a firm? • The government can act as a profit-maximizing firm and follow the MR = MC rule, it can set price at ATC, or it can set price at MC. Gottheil — Principles of Economics, 7e

  39. The Economics of Nationalization • Some people believe that the government-run industries are inherently inefficient. • One reason government may appear inefficient is that it often takes over industries that were struggling in the first place. Gottheil — Principles of Economics, 7e

  40. The Economics of Nationalization • Another reason for the fear of inefficiency is that governments cannot go bankrupt. • While private firms cannot absorb large losses over the long term, governments can continue to subsidize failing industries indefinitely. Gottheil — Principles of Economics, 7e

  41. The Economics of Nationalization • It is virtually impossible to distinguish ownership on the basis of performance, however. • There are many examples of government-run industries which perform well, including airlines, colleges, and football teams. Gottheil — Principles of Economics, 7e

  42. The Economics of Laissez-Faire • Some economists are not at all disturbed by monopolies. • They believe that even with considerable industry concentration, there is still enough competition to generate acceptable price and output levels. Gottheil — Principles of Economics, 7e

  43. The Economics of Laissez-Faire Three theories try to explain why monopolies are not undesirable: 1. Contestable markets 2. Countervailing power 3. Creative destruction Gottheil — Principles of Economics, 7e

  44. The Economics of Laissez-Faire Contestable market • A market in which prices in highly concentrated industries are moderated by the potential threat of firms entering the market. Gottheil — Principles of Economics, 7e

  45. The Economics of Laissez-Faire According to this theory, does there actually need to be competitors in a market in order to moderate prices? • No. There only needs to be a potential threat of competition in order to moderate prices. Gottheil — Principles of Economics, 7e

  46. The Economics of Laissez-Faire • Critics of the contestable market theory find the argument compelling, but the applicability limited. • They argue that in reality, barriers to entry and the cost of shifting resources make the market uncontestable. Gottheil — Principles of Economics, 7e

  47. The Economics of Laissez-Faire Countervailing power • The exercise of market power by an economic bloc is ultimately counteracted by the market power of a competing bloc, so that no bloc exercises undue market power. Gottheil — Principles of Economics, 7e

  48. The Economics of Laissez-Faire The countervailing power theory argues that while competition may not exist among firms within a highly concentrated industry, it may still exist among highly concentrated industries. Gottheil — Principles of Economics, 7e

  49. The Economics of Laissez-Faire What are the four competing power blocs, according to the countervailing power theory? • The four competing blocs power are industrial, labor, agricultural and retail. Gottheil — Principles of Economics, 7e

  50. The Economics of Laissez-Faire For example, in the canned food industry, the oligopoly power of industrial producers of canned food is checked by the oligopoly power of the major retail grocery stores. Gottheil — Principles of Economics, 7e

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