Market Failure: Public Policy to Promote Competition

1. Market Failure:Public Policy to Promote Competition AP Economics Mr. Bordelon

2. Antitrust Policy • The Department of Justice’s Antitrust Division describes the goals of antitrust laws as: • protecting competition • ensuring lower prices • promoting the development of new and better products. • DOJ-AD believes that firms in competitive markets attract consumers by cutting prices and increasing the quality of products or services. • Competition and profit opportunities also stimulate businesses to find new and more efficient production methods. • Acting anti-competitively stops this efficiency.

3. Sherman Antitrust Act of 1890 • The Sherman Antitrust Act of 1890 has two important provisions that outlaw a particular type of anti-competitive activity. • 1. It is illegal to create a contract, combination, or conspiracy that unreasonably restrains interstate trade • 2. It is illegal to monopolize any part of interstate commerce. • Beyond this, the Act itself was vague, but allowed the government broad powers to enforce antitrust policy.

4. Clayton Antitrust Act of 1914 • The Clayton Act clarifies the Sherman Act somewhat and specifically prohibits four firm behaviors. • 1. Price Discrimination. It is illegal to charge different prices to different people for the same product. There are obvious exceptions like discounted movie theatre tickets for children. • 2. Anticompetitive practices of exclusive dealing and tying arrangements. • 3. Anticompetitive mergers. If Coca-Cola and Pepsi Cola were going to merge into one ginormous soda company, this would probably be judged as illegal under the Clayton Act. The government would look at what such a merger would do to the market power (recall concentration ratio, HHIfrom a while ago). • 4. Interlocking Directorates. Two companies cannot share members of the board of directors.

5. Federal Trade Commission Act of 1914 • Prohibits unfair methods of competition in interstate commerce and created the Federal Trade Commission (FTC). • The FTC Act outlaws unfair competition, including “unfair or deceptive acts.” The FTC Act also outlaws some of the same practices included in the Sherman and Clayton Acts. • In addition, it specifically outlaws • price fixing (including the setting of minimum resale prices), • output restrictions • actions that prevent the entry of new firms • The FTC’s goal is to promote lower prices, higher output, and free entry—all characteristics of competitive markets.

6. Natural Monopolies A natural monopoly occurs when economies of scale make it efficient to have only one firm in a market. Generally there are two options: Marginal cost pricing. The firm must operate where P=MC. This is an outcome consistent with perfect competition and zero DWL, but this creates economic losses for the firm. Government would need to subsidize theses losses with taxpayer dollars. Not the first choice.

7. Natural Monopolies In the graph, where P=MC, the natural monopoly is operating below ATC, and thus taking a loss. Average cost pricing. More favored. Firm must operate where P=ATC. Here, the natural monopoly will earn a normal profit, but not at the most efficient level of output. Some DWL will exist.

8. Natural Monopolies In the graph, where P=ATC, the natural monopoly makes a normal profit. When ATC=Q1, would the natural monopoly would operate? Why?

9. Natural Monopolies Here’s another way to look at it. Without regulation, the natural monopoly would operate at Qm, making a substantial profit because it can control quantity. If at QC, we’d be at a perfectly competitive outcome, but at a loss because we’re below our costs. Finally, if at Qr, the natural monopoly would earn at least a little profit, but not as much if unregulated.