Government Regulation Chapter 17

1. Government RegulationChapter 17 • Corporations are legal entities which exist only because governments allow them to exist. • Governments impose many restrictions on firms: mergers, patents, licensing, or subsidies. • The stated intention of governments is set restrictions that promote social welfare, but they sometimes benefit particular groups or individuals. 2005 South-Western Publishing

2. Market Structure, Conduct, and Performance Fundamental Market and Environmental Conditions MARKET STRUCTURE Feedback Effects Feedback Effects MARKET CONDUCT MARKET PERFORMANCE

3. Good Market PerformanceDepends on: • Efficient resource allocation • Technologically progressive • Promote full employment • Equitable distribution of income • Resource conservation • Satisfactory product performance and safety characteristics.

4. Market Conduct • Pricing behavior • Product policy • Sales promotion and advertising strategies • R&D and innovation strategies • Legal tactics with regard to entry

5. Market Structure • Seller and buyer concentration • Actual or imaginedProduct differentiation. • Entry conditions. • Vertical Integration • Diversification or conglomeration • Contestability

6. Types of Barriers to Entry open 1.Product differentiation • Advertising, patent control, distributional control 2. Absolute cost advantages • Superior techniques, control of inputs, superior access to financing 3. Scale Economies • Capital intensive technology, high start-up costs 4. Limited access to distribution channels closed

7. SUPPLY Location of ownership of raw materials Product durability Technology Labor organization DEMAND Price elasticity Cross price elasticity Growth prospects Type of product Method of purchase Fundamental Market and Environmental Conditions

8. Determining Industry Structure • A market is a group of economic agents that interact in a buyer-seller relationship. The nature of that relationship is affected by the number and size distribution of the buyers and sellers. • A popular measure of seller concentration is the percentage of an industry comprised of the top 4 firms. • Similarly, the top 4 buyers is a popular measure of buyer concentration.

9. Market Concentration Ratios • The size distribution of firms is measured by the percentage of the top four firms (or buyers) • .22 • .18 • .10 • .08 • … shares of market listed in descending order • Similar concentration of occur for 8-firm, 20-firm, and 50-firm ratios • The Bureau of Census provides data on industries by SIC (Standard Industrial Classification) or its equivalent 58% of market is controlled by top 4 firms

10. Industrial and firm classifications • North American Industrial Classification System (NAICS) of the US Department of Commerce replaced SIC’s in 1997. Industry Classifications • 2-digit sectors: 32 Manufacturing sector • 3-digit sub-sectors: • 322Paper Manufacturing Sub-sector • 4-digit industry groups: • 3221 Pulp, Paper, and Paperboard Mills • 5-digit industry in North America: • 32212 Paper Mills • 6-digit industry in US, Canada, or Mexico: • 322121 Paper Mills in the US except newsprint To compare NAICS to SIC see: http://www.census.gov/epcd/naics/naicstb1.txt

11. Incomplete Measures of Concentration • Providing all the market shares can reveal too much • Partial measures use only some of the market shares • 4, 8, 20 & 50 firm Concentration Ratios • Share of top 4 firms, as in 4CR = 60 • Problem of two industries A has shares of 60, 10, 5 & 5 B has shares of 20, 20, 20 & 20 • The knowledge of each share is hidden in partial measures of concentration in an industry Both are 4CR=80

12. Other Market Concentration Measures • Complete Measures • Know the market shares of all firms • Herfindahl-Hirschman Index:HHI = S si2 • Example: Baby Food • 70% for Gerber • 16% for Beech-Nut • 14% for Heinz • So the 4CR = 100% • And the HHI = (70)2 + (16)2 + (14)2 = 5352 • The maximum HHI is (100)2 = 10,000 for a pure monopoly • With 100 firms, each with 1% of the market, HHI=100

13. Antitrust: Government Regulation of Market Conduct and Structure • In trusts, the voting rights to the several firms are conveyed to a legal trust to manage the group of firms as if it were one firm. This tends to create monopolization of an industry. • The Sherman Antitrust Act (1890) outlawed monopolies per se and attempted monopolization.

14. The Clayton Act • The Clayton Act (1914) extended the list of conduct that was anti-competitive: a. price discrimination. (section 2) b. tying contracts force customers to buy added products with one product. (section 3) c. purchasing shares of competing firms as an anti-merger section. (section 7) d. corporate directorship interlocks occur when the same people are in directorships of competing firms. (section 8) • The Federal Trade Commissionwas established in 1914 to prohibit unfair methods of competition.

15. Robinson-Patman Act of 1936 Section 2(a) prohibits price discrimination which "substantially lessen competition". Section (2b) provides a cost justification for price discrimination. Section (2c) prohibits some kinds of brokerage commissions. Sections (2d-2e)prohibits discounts to buyers not afforded to other customers. • TheHart-Scott-Rodino Antitrust Improvement Act(1976) requires notification by large firms to the Justice Department of impending mergers.

16. Antitrust Prohibitionsof Selected Business Decisions • Collusion to fix prices (airlines and grocery stores have been penalized) • Mergers that substantially lessen competition (mergers raise 4CR and the HHI) • If HHI > 1,800, mergers are usually challenged • If 1,000 < HHI < 1,8000, mergers challenged if raise the HHI by more than 100 points • If HHI < 1,000, most mergers are not challenged • Monopolization(attempted monopolization is a violation of the Sherman Antitrust Act) • Wholesale Price Discrimination (forms of price discrimination that injured other competitors, not necessarily customers) • Penguin Books sold books at lower prices to Barnes & Noble than to other bookstores • Refusals to Deal (when not based on legitimate business justifications)

17. Palladium Metal-Casting Industry • The Palladium Metal-Casting numerical example uses a simple monopoly model (pages 780-781) • P = 15,000 - .3 Q and TC = 100,000,000 +6Q +.05Q2 • Solution: P=$8,574 & ROI = 7.2% • Adding an additional fixed cost ($150 million to reduce smoke) lowers profit and ROI (return on investment) without changing the price. • Solution: same price and ROI = 5.4% • If the operating controls raise variable costs, then the output and price changes in the directions you would expect: higher prices and lower output. • Solution: P = $9,378 & ROI = 3%

18. The Deregulation Movement • Airline and trucking have been deregulated. • They are no longer "infant industries". • Deregulation of long-distance occurred due in large part to technological changes in transmitting phone messages by microwave.

19. Government Protection of Business • Governments historically have helped some companies by restricting or eliminating competition. • Examples • Licensing of professions (or businesses) • Patents of ideas or processes restricts use of the idea • Import quotas

20. Trade Restrictions on US Sugar Markets S D • Ignoring tariffs, lets look only at quotas. • D & S are domestic demand and supply • At world price Pw, the US grows 6.14 and imports the rest to 19.18 (imports of 13.04) • With a quota on of imports, price rises to Pquota, and quantity consumed declines and local production grows Pquota imports A B C D E F G H Pw imports before quota 6.14 12.10 18.06 19.18 Quantity in billions of pounds

21. Welfare Impacts of Quotas • Consumers • Pay more after quotas. • Consumer surplus declines by areas A+B+C+D • Domestic Producers of Sugar • Receive more after quotas • Producer surplus rises by area A • Foreign Producers of Sugar • Receive more after quotas • Foreign producer surplus is area C • No one gets areas B + D, this is called excess burden or deadweight social loss