Economics NINTH EDITION Chapter 28 Controlling Market Power: Antitrust and Regulation Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved Learning Objectives 28.1 Define a natural monopoly and explain the average-cost pricing policy 28.2 List three features of antitrust policy Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.1 NATURAL MONOPOLY (1 of 4) Picking an Output Level MARGINAL PRINCIPLE Increase the level of an activity as long as its marginal benefit exceeds its marginal cost Choose the level at which the marginal benefit equals the marginal cost Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.1 NATURAL MONOPOLY (2 of 4) Picking an Output Level Because of the indivisible input (the pipe system), the long-run average-cost curve is negatively sloped The monopolist chooses point a, where marginal revenue equals marginal cost The firm sells 70 million units of water at a price of $2.70 each (point b) and an average cost of $2.10 (point c) The profit per subscriber is $0.60 ($2.70 – $2.10) Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.1 NATURAL MONOPOLY (3 of 4) Will a Second Firm Enter? The entry of a second cable firm would shift the demand curve of the typical firm to the left After entry, the firm’s demand curve lies entirely below the long-run average-cost curve No matter what price the firm charges, it will lose money Therefore, a second firm will not enter the market Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.1 NATURAL MONOPOLY (4 of 4) Price Controls for a Natural Monopoly Under an average-cost pricing policy, the government chooses the price at which the demand curve intersects the long-run average-cost curve— $12 per subscriber Regulation decreases the price and increases the quantity Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION PUBLIC VERSUS PRIVATE WATERWORKS APPLYING THE CONCEPTS #1: What is the rationale for regulating a natural monopoly? In the early part of the nineteenth century in Great Britain, water was distributed by local government The Industrial Revolution led to rapid urban growth Lacking taxing power the local governments could not keep up with the demand and water distribution changed to private industry Problems with water distribution eventually led to Parliament to change back to public waterworks Water is a natural monopoly and multiple companies could not earn enough profit to stay in business and offer adequate services Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION SATELLITE RADIO AS A NATURAL MONOPOLY APPLYING THE CONCEPTS #2: When does a natural monopoly occur? In 2008, the nation’s only two satellite radio providers, Sirius Satellite Radio and XM Satellite Radio, announced plans to merge into a single firm Together the two firms had 14 million subscribers, each paying $13 per month Both firms were losing money as they struggled to get enough subscribers to cover their substantial fixed costs The proposed merger needed to be approved by the U.S Department of Justice and the Federal Communication Commission The key question is whether the elimination of competition between the two firms would lead to higher prices, and how large any price hike would be In evaluating the merits of the proposed merger, government regulators grappled with the trade-offs between saving costs by avoiding duplication and possible price hikes The merger eventually led to greater options and lower costs to subscribers Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.2 ANTITRUST POLICY (1 of 6) Trust An arrangement under which the owners of several companies transfer their decision-making powers to a small group of trustees Breaking Up Monopolies One form of antitrust policy is to break up a monopoly into several smaller firms The label “antitrust” comes from the names of the early conglomerates that the government broke up Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.2 ANTITRUST POLICY (2 of 6) Blocking Mergers Merger A process in which two or more firms combine their operations A horizontal merger involves two firms producing a similar product, for example, two producers of pet food A vertical merger involves two firms at different stages of the production process, for example, a sugar refiner and a candy producer Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.2 ANTITRUST POLICY (3 of 6) Blocking Mergers Using the marginal principle, Staples picks the quantity at which its marginal revenue equals its marginal cost In a city without a competing firm, Staples picks the monopoly price of $14 In a city where Staples competes with Office Depot, the demand facing Staples is lower, so the profit- maximizing price is only $12 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.2 ANTITRUST POLICY (4 of 6) Merger Remedy for Wonder Bread In some cases, the government allows a merger to happen but imposes restrictions on the new company TABLE 28.1 A Merger Increases Prices Wonder Brand Interstate Brand Total Before After Before After Before After Merger Merger Merger Merger Merger Merger >0 $1.50 $1.50 $1.50 $1.50 Price $2.00 $2.00 $2.00 $2.20 Quantity 100 110 100 70 200 180 Profit $ 50 $ 55 $ 50 $ 49 $100 $104 Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.2 ANTITRUST POLICY (5 of 6) Regulating Business Practices Tie-in sales A business practice under which a business requires a consumer of one product to purchase another product Predatory pricing A firm sells a product at a price below its production cost to drive a rival out of business and then increases the price Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved 28.2 ANTITRUST POLICY (6 of 6) A Brief History of U.S Antitrust Policy Table 28.2 Key Antitrust Legislation Law Date Enacted Sherman Act 1890 Regulation Enacted Made it illegal to monopolize a market or to engage in practices that result in a restraint of trade Clayton Act 1914 Outlawed specific practices that discourage competition, including tie-in sales contracts, price discrimination for the purpose of reducing competition, and stock-purchase mergers that would substantially reduce competition Federal Trade Commission Act 1914 Created a mechanism to enforce antitrust laws Robinson – Patman Act 1936 Prohibited selling products at “unreasonably low prices” with the intent of reducing competition Celler-Kefauver Act 1950 Outlawed asset-purchase mergers that would substantially reduce competition Hart-Scott-Rodino Act 1980 Extended antitrust legislation to proprietorships and partnerships Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION THE MERGER OF PENZOIL AND QUARTER STATE APPLYING THE CONCEPTS #3: How does a merger affect prices? In 1998, Pennzoil Motor Oils purchased Quaker State Motor oils in an acquisition valued at $1 billion The merger brought together two of the five brands of premium motor oil, with a combined market share of 38% (29% for Pennzoil and 9% for Quaker State) The antitrust agencies approved the merger without any modifications A recent study of the merger concludes that the new company increased the price of the Quaker State products by roughly 5%, but did not change the price of Pennzoil products The market share of Pennzoil products increased, while the market shares of Quaker State products decreased The study also examines the price effects of four other mergers In three of four cases, the merger increased prices, with price hikes between and percent The authors note that the modest price effects might be surprising to (1) people who expect relatively large positive price effects as firms exploit their greater market power and (2) people who expect negative price effects as the firms become more efficient Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved APPLICATION MERGER OF OFFICE DEPOT AND OFFICEMAX APPLYING THE CONCEPTS #4: What is the role of competition in the regulation of mergers? In 2013 the Federal Trade Commission (FTC) approved the merger of Office Depot and OfficeMax The FTC concluded that the merger of the second and third largest office supply superstores was unlikely to substantially reduce competition in the office supplies market Other competition comes from general superstores such as Wal-Mart and Target and club stores such as Costco and Sam’s Club In addition, there is competition from Amazon and other Internet suppliers Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved KEY TERMS Merger Predatory pricing Tie-in sales Trust Copyright © 2015, 2012, 2009 Pearson Education, Inc All Rights Reserved ...Learning Objectives 28. 1 Define a natural monopoly and explain the average-cost pricing policy 28. 2 List three features of antitrust policy Copyright © 2015,... water was distributed by local government The Industrial Revolution led to rapid urban growth Lacking taxing power the local governments could not keep up with the demand and water distribution... approved by the U.S Department of Justice and the Federal Communication Commission The key question is whether the elimination of competition between the two firms would lead to higher prices, and