Public Policy in Private Markets

1. Public Policy in Private Markets Understanding Public Policy

2. Announcements • Feb. 2 • i>clicker starts counting • Deadline for group formation (if not opting out of it)

3. Today • Why public policy? • Class overview • What prompts public policy?

4. Why Public Policy? • Rationales for government intervention: • Dominant belief: US favors free enterprise • Regulation: Why alter the operation of markets? • What is done when there is unhappiness about market outcomes? • Extent of government intervention varies with cycles (politics) • Government regulation is often criticized (e.g. mortgage crisis); how should things work? • However, regulation remains in place and is continuously growing and evolving

5. Why Public Policies in Private Markets? • In the US, we value perfectly competitive markets: • Effectively executes large # of decisions • Most transactions can be handled by markets • Government burden is reduced • But, in real world, markets are not perfectly competitive • Focus of public policy: how well do markets work compared with perfect competition?

6. Example: The NFL • Professional and College sports exempt from antitrust law (controversial) • Prior to ‘93: If drafted, player belonged to team • Blocking linemen lowest paid players • After ‘93: Players become free agents (after a few years) and negotiate with other teams. • Blocking linemen are the second most highly paid players in the NFL (after QB’s) • Why? Free markets are, under certain conditions, able to bring about efficient prices.

7. Example: Cartel • Example: Vitamin Cartel (1990’s) • Cartel involved vitamins, A, B, C and folic acid • Firms involved: Roche, BASF, Aventis, Solvay, Merck, Daiichi, Esai and Takeda • Firms admitted to participating in worldwide price fixing conspiracy over 10 years • 1999: in US, Canada and Australia, Roche & BASF pay $750 million in fines to settle suit. • 2001: in EU 8 companies pay approx. 1.2 bill

8. Why Public Policies in Private Markets? • Private Sector • Individual decision making (max π) • Example: should a firm adopt an exclusive dealing policy? Discussion • Government sector • Group decision making, among (often disagreeing) individuals (maximize: social welfare, equity?) • Example: Should we allow a merger because it brings about efficiency (good for everyone) or should we block it because it brings about higher prices (bad for consumers)?

9. Class Overview: Competition Policies • Antitrust laws: • how firms compete with each other (rules of the game) • What is legal? What is illegal? • What are the economics behind government intervention? • Focus: market power and its use in detriment of buyers and consumers

10. Example: Vitamin Cartel • Legal issues • Why was this illegal? • How did they conspire? • How did they get caught? • Economic issues • How are damages calculated?

11. Example: AT&T – T-Mobile merger

12. Example: ATT + T-Mobile • Customers nationwide: • Verizon: 102 million • ATT: 97 • Spring: 49 • T-Mobile: 33 • Will this merger be challenged?

13. Example: ATT + T-Mobile • Arguments for merger: • Synergies, better call quality, better service • Easier roll out of new 4G network (most powerful in terms of data transmission) – priority for Obama administration

14. Example: ATT + T-Mobile • Arguments against merger: • More concentrated industry: main concern is less competitive pressure • Higher prices? • Less variety? • Decreased customer service? • High barriers to entry

15. ATT + T-Mobile • What is main issue antitrust authorities should look at: • Risk of less competitive pressure (i.e. higher prices, less innovation, etc.) • Benefits of enhanced efficiency (i.e. greater coverage, less infrastructure overlap) • Higher barriers to entry (potential entrants are less likely to emerge) • Increased bargaining power against suppliers (lower prices for consumers)

16. ATT + T-Mobile • Should this merger be challenged? • Yes • No • Will it be challenged? • Yes • No

17. Class Overview (time permitting) • Information Policies • How much information is needed? What format should this information have? • E.g. Nutrition labeling: recent proposals to have traffic lights on nutrition labels • Product Quality • Safety: crash ratings for cars, pesticide levels, etc. • What are the processing standards? Do we need this? (cost-benefit analysis)

18. Class Overview: Types of regulation 2. Information Policies: • Regulation on how products are presented to consumers • E.g.: advertisement, labeling, unit pricing • How much information is needed? • What format should this information have? • E.g. Nutrition labeling: new proposal to have traffic lights on nutrition labels

19. What prompts Public Policy? • Market imperfections (markets work but not so well) • Market Failure (markets do not work) • Ethical Criteria (we want markets to consider certain aspects)

20. What prompts Public Policy? • Market imperfections • Monopoly/oligopoly • One or several structural requirements are violated: #small number of sellers, differentiated products, blocked or difficult entry • Examples of high concentration (possibly large market power) • RTE cereal industry: CR4=90% • Soft drinks: CR2=70% • Microsoft: >90% of PC’s are Windows compatible

21. 1. Market Imperfections • Why regulate monopolies/oligopolies? • Market can be influenced by few firms’ decisions on pricing (e.g. collusion) • Allocative inefficiency: P>MC, output is depressed and prices increase • X-inefficiency: Less competition may reduce incentives to minimize costs

22. 1.A Monopoly, Oligopoly • Note of caution: Sources of market power • Natural/Legal: e.g. large economies of scale (electricity), network effects (iPod, Windows), or simply a “successful business model” • Artificial/Illegal (abuse): collusion, predatory pricing, limit pricing, price discrimination. • Response: Antitrust laws, trade regulation

23. 1.B Information Inadequacies • Market imperfections B. Information inadequacies • Perfect information of PC model is violated • People and/or firms lack complete information • Best decisions are not made (e.g. persuasive advertising) • Responses: • Information regulation (product labeling) • Product regulation (standards)

24. 2. Market Failures • Externalities: positive and negative

25. Externalities Which of the following is a positive externality: • Consuming a California apple gives you 40 calories • Consuming a California apple increases your ability to fight colds (vitamin C intake) • Consuming a California apple increases carbon footprint (compared to a locally produced one) • Consuming a California apple is better than consuming a candy bar

26. 2. Market Failures • Externalities: positive and negative • Positive: price/market does not reflect all societal benefits of the product. Examples?

27. 2. Market Failures • Externalities • Positive: price/market does not reflect all benefits of the product. Examples? • Fiber in food (reduced heart disease) • Hybrid cars (lower air pollution)

28. 2. Market Failures • Externalities • Positive: price/market does not reflect all benefits of the product. Examples? • Negative: price/market does not reflect all costs of the product. Examples? • Fiber in food (reduced heart disease,) • Hybrid cars (lower air pollution)

29. 2. Market Failures • Externalities • Positive: price/market does not reflect all benefits of the product. Examples? • Negative: price/market does not reflect all costs of the product. Examples? • Fiber in food (reduced heart disease,) • Hybrid cars (lower air pollution) • Alcohol consumption: increased traffic accidents, health risks • SUV’s: increased pollution, larger damages to other cars in crashes

30. 2. Market Failures B. Public Goods?

31. 2. Market Failures B. Public Goods • Examples: national defense, clean air, public parks, highways • Ideally: joint efforts to provide good (e.g. neighbors get together to build a park) • Problem: free riding on others’ efforts (contributions) • In short: you can get it even if you don’t pay, and you might not get it even if you pay

32. 3. Ethical criteria • Do markets yield fair and equitable treatment of people? • Response: tax code, equal opportunity, non-discrimination laws, etc.