Microeconomics: Principles, Applications, and Tools

Transcription

1 Microeconomics: Principles, Applications, and Tools NINTH EDITION Chapter 13 Controlling Market Power: Antitrust and Regulation

2 Learning Objectives 13.1 Define a natural monopoly and explain the averagecost pricing policy List three features of antitrust policy.

3 13.1 NATURAL MONOPOLY 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.

4 13.1 NATURAL MONOPOLY Picking an Output Level Because of the indivisible input (the pipe system), the long-run averagecost 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).

5 13.1 NATURAL MONOPOLY Will a Second Firm Enter? The entry of a second water utility 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.

6 13.1 NATURAL MONOPOLY 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 $1.20 per consumer. Regulation decreases the price and increases the quantity.

7 APPLICATION 1 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 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.

8 APPLICATION 2 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

9 13.2 ANTITRUST POLICY 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.

10 Anti-Trust Cases American Tobacco Company James B Duke s employed advertising & limit pricing to encourage competition to join consortium (trust) of companies % cigarette production, 80% all tobacco products in US 1911 Supreme Court decision broke company into four smaller companies Standard Oil John D. Rockefeller & Henry Flagler Formed in 1870 as refining operation, expanded into all facets of oil industry aggressive pricing, secret transport deals/discounts discouraged competition 1911 Supreme Court decision broke company into 34 smaller companies American Telephone & Telegraph (Bell System) Formed in 1877 as American Bell Telephone Co, acquired by AT&T 1899 AT&T Long Lines Western Electric Bell Laboratories Bell Companies Challenged 1914; broken up 1983, forming 11 smaller companies

11 13.2 ANTITRUST POLICY 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.

12 13.2 ANTITRUST POLICY 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.

13 13.2 ANTITRUST POLICY Merger Remedy for Wonder Bread In some cases, the government allows a merger to happen but imposes restrictions on the new company. TABLE 13.1 A Merger Increases Prices Wonder Brand Interstate Brand Total Before Merger After Merger Before Merger After Merger >0 $1.50 $1.50 $1.50 $1.50 Price $2.00 $2.00 $2.00 $2.20 Before Merger After Merger Quantity Profit $ 50 $ 55 $ 50 $ 49 $100 $104

14 13.2 ANTITRUST POLICY Regulating Business Practices Price-fixing A cooperative agreement among firms to collude rather than compete 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.

15 13.2 ANTITRUST POLICY A Brief History of U.S. Antitrust Policy TABLE 13.2 Key Antitrust Legislation Law Date Enacted Regulation Enacted Sherman Act 1890 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 stockpurchase 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.

16 APPLICATION 3 THE MERGER OF PENZOIL AND QUAKER 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 3 and 7 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.

17 APPLICATION 4 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.

18 Learning Objectives 13.1 Define a natural monopoly and explain the averagecost pricing policy List three features of antitrust policy.

19 KEY TERMS Merger Predatory pricing Tie-in sales Trust

20 Questions?