Economics of Regulation and Antitrust

7/27/2019 Economics of Regulation and Antitrust

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E C O N O M I C S O F R E G U L A T I O N A N D A N T I TR U S TSecond Edition

W. K ip ViscusiJohn M . VernonJoseph E. Harrington, Jr.

The MIT PressCambridge, MassachusettsLondon, England


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Contents

Preface to the Second Edition xxiIntroduction 1

The Rationale for Regulation and An titrust Policies 2Antitrust Regulation 4

The Changing Ch aracter of Antitrust Issues 4Reasoning behind Antitrust Regulations 5

Economic Regulation 5Development of Econom ic Regulation 6Factors in Setting Rate Regulations 6

Health, Safety, and Environm ental Regu lation 8Role of the Courts 9

Criteria for Assessment 10Questions and Problems 11Recomm ended Reading 11Appendix 12

The Making of a Regulation 13State versus Federal Regulation: The Federalism Debate 14Advan tages of Federalism 15

Advantages of Nation al Regulations 16The Overlap of State and Federal Regu lations 17

The Characte r of the Rulemaking Process 18The Chrono logy of New Regulations 19

Nature of the Regulatory Oversight Process 23The Nixon and Ford Adm inistrations 24The Carter Adm inistration 25The Reagan Adm inistration 27The Bush Adm inistration 28The Clinton Administration 28

The Criteria Applied in the Oversight Process 29Regulatory Success Stories 29Prom otio n of Cost-Effective Regulation 30Distortion of Benefit and Cost Estimates 30The Regulatory Role of Price and Quality 32The Imp act of the Oversight Process 32The Cost of Regulation 33Other Measures of the Size of Regu lation 33The Ch aracter of Regulatory Oversight Actions 36

W hat D o Regulators Maximize? 38


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viii Contents

The Capture TheoryOther Theories of Infiuence PatternsComprehensive Models of Regulatory Objectives

ConclusionQuestions and ProblemsNotesAppendix. Trends in R egulatory Agency Budgets and Staff

ANTITRUSTIntroduction to Antitrust

Industrial O rganization A nalysisConcentrationEntry BarriersProduct Differentiation

AntitrustEnforcement and RemediesExemptions from AntitrustSummary and Overview of Part I

NotesAppendix. Antitrust Statutes

Sherman ActClayton ActFederal Trade Commission Act

Efficiency and Technical ProgressEconomic EfficiencyPartial Equilibrium Weifare Tools

M onopoly versus Competition ExampleOil Industry ApplicationSome C omplicationsX-InefficiencyMonopoly-Induced WasteEstimates of the Weifare Loss from Monopoly

Technical ProgressImpo rtance of Technological ChangeAn R & D Rivalry Model

SummaryQuestions and ProblemsNotes


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Contents

Oligopoly, Collusion, and Antitrust 97Gam e Theory 97Example 1: Advertising Com petition 97

Exam ple 2: Compatibility of Standards 99The Strategie Form of a Gam e 100Nash Equilibrium 101

Oligopoly Theory 102The Courno t Solution 102Other Models of Oligopoly 108Pro duct Differentiation 109Collusion 112A Theory of Collusion 113Cartel Problems 117Collusion: Ra ilroads in the 1880s 121

Antitrust Law toward Price Fixing 122Economic Analysis of Legal Categories 123Per Se Rule Cases 125Conscious Parallelism 129Summary 132

Questions and Problems 134Notes 135Appendix A 138

Game Theory: Fo rm al Definitions 138Appendix B 139

The Addyston Pipe Case 139The Opinion of the Court 141Market Structure and Strategie Competition 145

M arke t Structure 145Concentration 145Scale Econom ies 152Entry Conditions 155

Dominant Firm Theory 164Static Analysis 164Dynam ic Analysis: Limit Pricing 166Strategie Competition 171Limit Pricing 171Investment in Cost-Reducing Ca pital 179Raising Rivals' Costs 183


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X Contents

Preemption and Brand ProliferationSummaryQuestions and ProblemsNotes

MergersAntitrust Laws and Merger TrendsReasons for Mergers

MonopolyEconomiesReducing Management InefficienciesOther Motives

Horizontal MergersBenefits and CostsCases1992 Merger Guidelines

Conglomerate MergersPotential BenefitsAnticompetitive Effects and Cases


Vertical Mergers and RestrictionsVertical Mergers

BenefitsAnticompetitive EffectsExtension of Monopoly: Fixed ProportionsExtension of Monopoly: Variable Prop ortionsCases

Vertical RestrictionsResale Price MaintenanceTerritorial RestraintsExclusive DealingTyingSummary

Questions and ProblemsNotes

Monopolization and Price DiscriminationThe Possession of Monopoly Power


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XI Contents

Intent to Monopolize 270Cases 2711890-1940: Standa rd Oil and Un ited States Steel 271

1940-1970: Alcoa and Un ited Shoe Machinery 2751970 to Present: Ko dak, Cereals, IBM , and Others 280

Predato ry Pricing: Proposed Legal Definitions 283The ATC Rule 285The Outpu t Restriction Rule 286Joskow-K levorick Two-Stage Rule 289

Price Discrimination and the Robinson-P atman Act 290Systematic Discrim ination 290Unsystematic Discrim ination 295

Cases 296Summary 298Questions and Problems 298Notes 300

ECONOM IC REGULATION 30510 Introduction to Economic Regulation 307

W hat Is Econom ic Regulation? 307Instrum ents of Regu lation 308

Co ntrol of Price 308Con trol of Qu antity 309Control of Entry and Exit 309Control of Oth er Variables 310

Brief History of Econom ic Regu lation 311Formative Stages 311Trends in Regu lation 312

The Regulatory Process 317Overview of the Regu latory Process 317Regulatory Legislation 318Independent Regu latory Commissions 319Regulatory Procedures 321

The Theory of Regu lation 322Norm ative Analysis as a Positive Theory 323Cap ture Theory 327Econom ic Theory of Regu lation 328Taxicab Regulation 342


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Contents

Summ ary and Overview of Par t II 345Questions and Problems 346Notes 347

Theory of Natural Monopoly 351The Na tural Monopoly Problem 351

Permanent and Temporary Na tural Monopoly 351Subadditivity and M ultiproduct Monopoly 353

Alternative Policy Solutions 358Ideal Pricing 358Franchise Bidding 370Actual Solutions 370Regulation 370

Public Enterprise 371Summary 372Questions and Problem s 372Notes 375

Natural Monopoly Regulation 377The Rate Case 378Accounting Equ ation 378Regulatory Lag 379

The Rate Level 381Rate Base Valuation 381Cost of Equ ity Capital 383The Sliding Scale Plan 385Price Caps and Performance Standards 386Averch-Johnson Effect 387

Rate Structure 391FD C Pricing 392Un due Discrimination 394

Peak -Load Pricing 396Costs of Power Produc tion 396Peak-L oad Pricing Model 399

Reg ulation/Deregu lation of Electric Power 403Effectiveness of Price Regulation 403Trend toward Com petition 404

Summary 407Questions and Problems 407Notes 409


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Contents

Franchise Bidding and Cable Television 413Theory of Franchise Bidding 413Competition at the Bidding Stage 414

Co ntractual Arrangements for the Postbidd ing Stage 424Assessment of Franchise Bidding 428

Cable Television 429Historical/Regulatory Background 429Cable Television as a Na tura l Monopoly 432Franchising Process 437Assessment of Franchise Bidding 438Is Governmen t Intervention Welfare-Improving? 446


Public Enterprise 453General Background 454Positive Theory of Public Enterprise 456

M anagerial Model of a Firm 456M anagerial Model of a Priva te Enterprise 458M anagerial M odel of a Public Enterprise 459Com parison of Public and Private Enterprise 462

Municipal Electric Utilities 463Pricing Behavior 463Allocative Efficiency Comparison 464Produc tive Efficiency Comparison 467Assessment of Private versus Public Utilities 468Airlines 468


Dynamic Issues in Natural Monopoly Regulation:Telecommunications 475

Transformation of a Na tural Monopoly 475Basis for N atural Monopoly Regulation 476Sources of Na tural M onopoly Transformation 478Regulatory Response 483Intercity Telecomm unications M arke t 486Local-Exchange Telecommunications M arke t 498


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Contents

Separation of Regulated Monopolies and CompetitiveMarkets 500Benefits and Costs of Separation 501

Breakup of AT&T 503Telecommunications and Com puters 505

The Future of the Telecommunications Industry: DigitalConvergence 507

Industry Forces 508Technology and Regulation 510Policy Issues 511Summary 513

Questions and Problems 514Notes 515

The Regulation of Potentially Competitive Markets: Theory andEstimation Methods 519

Theory of Price and Entry/Exit Regulation 520Direct Effects of Price and Entry/Exit Regulation:The Competitive Model 520Direct Effects of Price and Entry/Exit Regulation:The Imperfectly Competitive Model 525Some Indirect Effects of Price and Entry Regulation 528Some Indirect Effects of Price and Exit Regulation 532Regulation and Innovation 533

Methods for Estimating the Effects of Regulation 537Overview of Estimation M ethods 537Intertemporal Approach 537Application: New York Stock Exchange 539Intermarket Approach 540Application: Advertising of Eyeglasses 541Counterfactual Approach 542Application: State Usury Laws 544


Economic Regulation of Transportation: Surface Freight andAirlines 551

Transp ortation Industry 551Surface Freight Transportation 553

Regulatory History 553


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Contents

Description of Regulatory PracticesEffects of RegulationAirlinesRegulatory HistoryDescription of Regulatory PracticesEffects of RegulationCompetition and Antitrust Policy after Deregulation

SummaryQuestions and ProblemsNotesEconomic Regulation of Energy: Crude Oil and Natural GasThe Theory of Price CeilingsPrice and Qu antity Regulation of the Crude Oil Industry

Regulatory HistoryOil Prorationing

Regulatory PracticesRationale for ProrationingSolutions to the Common Pool ProblemEffects of Prorationing

Mandatory Oil Import ProgramRegulatory PracticesEffects of Regulation

Crude Oil Price ControlsRegulatory PracticesEffects of Price Regulation

Price Regulation of the Natu ral Gas IndustryRegulatory HistoryRegulatory PracticesEffects of Price Regulation


557560574574576578589597597598603606610613615615617621623624624624626626628636637639641648649650

HEALTH, SAFETY, AN D ENVIRONMENTALREGULATION 653Introduction: The Emergence of Health, Safety, andEnvironmental Regulation 655

Risk in Perspective 656The Infeasibility of a No-Risk Society 658


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XVI Contents

Wealth and Risk 660Irrationality and Biases in Risk Percep tion 661Policy Evaluation 663Regulatory Standards 664M argina l Analysis 667The Role of Heterogeneity 668Discounting Deferred Effects 670Present Value 670

Uncertainty and Conservatism 672The Role of Risk Am biguity 675The Role of Political Factors 676Economic Models of Environm ental Policies 676Voting Patte rns 679

Summ ary and Overview of Pa rt III 680Questions and Problems 682Recommended Reading 683Notes 683

20 Valning Life and Other Nonmonetary Benefits 683Policy Evaluation Principles 686WiUingness-to-Pay versus Other Approaches 688Variations in the Value of Life 691The Labor M arket Model 693Em pirical Estimates of the Value of Life 697Value of Life for Regulatory Policies 699Survey Approaches to Valuing Policy Effects 701

Valuation of Air Quality 703Explora tory Nature of the Survey Approach 704

Sensitivity Analysis and Cost Effectiveness 704Risk-Risk Analysis 705Establishing Prices for H ealth, Safety, and Environm entalRegulation 706Questions and Problems 707Notes 708

21 Environmental Regulation 711The Coase Theorem for Externalities 711

The Coase Theorem as a Bargaining Gam e 713A Pollution Example 715Long-Run Efficiency Concerns 716Transactions Costs and Oth er Problems 716


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Smoking Externah ties 718Special Fea tures of Environm ental Contexts 720Selecting the Optimal Policy: Stand ards versus Fines 721Setting the Pollution Tax 723The Role of Heterogeneity 724The Role of Uncertainty 726Pollution Taxes 727Cost Heterogeneity for W ater Pollution Control 729

Curren t M arket Trading Policies 730The Fu ture of M arket Approaches 731Global W arming and Irreversible Env ironmental Effects 733Assessing the Merits of Global-Warming Policies 734How Should We React to Uncertainty? 735

Multiperson Decisions and Group Externalities 737The Prisoner's Dilemma 737The N-P erson Prisoner's Dilemma 737Applications of the Prisoner's Dilemm a 738

The Enforcement and Performance of EnvironmentalRegulation 740Enforcement Options 740Enforcement Trends 741Environmental Outcom es and Enterprise Decisions 742

Summary 746Questions and Problem s 747Notes 748

Product Safety 751Emergence of Pro duc t Safety Regu lations 751Current Safety Decisions 752Changing Emphasis of Prod uct Regulation 755

Prem anufactunng Screening: The Case of Pharm aceuticals 755Weighing the Significance of Side Effects 756Drug Approval Strategies 757

The Behavioral Response to Produc t Safety Regulation 761Consumer's Po ten tial for M uting Safety Device Benefits 762

The Costs of Product Safety Regulation: The AutomobileIndustry Case 767Trends in M otor Vehicle and Hom e Accident Dea ths 769

The Decline of Accident Rates 772


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xvm Contents

The Rise of Pro duct Liability 774The Negligence Standard 775The Strict Liability Standard 776Events Study Evidence on Liability Costs 777Escalation of Dam ages 779

Risk Information and Hazard W arnings 781Self-Certification of Safe Products 782Governm ent De termination of Safety 782Alternatives to Direct Com mand and Control Regulation 783

The Fu ture of Pro duc t Safety Policy 785Questions and Problems 787Notes 788

23 Regulation of Workplace Health and Safety 791The Po ten tial for Inefficiencies 793

How M arkets Can Prom ote Safety 793Com pensating Wage Differential Theory 795Risk Information 797On-the-Job Experience and Worker Quit Rates 799Inadequacies in the M arke t 800

Informational Problem s and Irrationalities 800Externalities 802

OSH A's Regulatory Approach 802Setting OSH A Stand ard Levels 803The Nature of OSHA Standards 805The Reform of OSHA Standards 807Regulatory Reform Initiatives 807

Changes in OSHA Standards 808OSHA 's Enforcement Strategy 811Inspection Policies 812Trivial Violations 813OSH A Penalties 814Enforcement Targeting 815

The Imp act of OSH A Enforcement on W orker Safety 816OSH A Regulations in Different Situations 818OSH A and Other Fac tors Affecting Injuries 819

Agenda for Policy Reform Efforts 825Questions and Problems 826Notes 827


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Contents

Patents and Pharmaceuticals 831Econom ics of Invention and Pa tents 831Background on Paten ts 833

Incentives to Invent: M onopo ly versus Com petition 834Weifare Analysis of Pa ten ts 837

Pharm aceuticals and the Role of Paten ts 847Industry Structure 847The 1984 Drug Price Competition and PatentRestora tion Act 855Other Policies Th at Affect R& D Incentives 858Summary 863

Questions and Problems 864Notes 865Na me Index 871Subject Index 877

Economics of Regulation and Antitrust

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