International Economic Lecture 3
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Transcript of International Economic Lecture 3
Lecture 3July 12th 2010Saksarun (Jay) Mativachranon
Regulation and Antitrust Policy in Globalized Economy
Key learning objectives
•Distinguish between economic regulation and social regulation
•Recognize practical difficulties that arise when regulating the prices charged by natural monopolies
•Identify potential benefits and possible negative side effects of social regulation
•Understand the foundations of antitrust laws and regulations
Forms of Industry Regulation
•Two basic types of Government Regulations▫Economic Regulation of natural monopolies
and nonmonopolistic industries▫Social Regulation of all industries
•The US government began regulating both types early in the nation’s history
•The amount of government regulation began increasing in the 20th century
Regulation on the Rise
Regulation of Natural Monopolies
•Initially, most economic regulation in the US was aimed at controlling prices in industries considered natural monopolies
•Overtime, federal and state government have sought to influence products and processed of firms in a variety of industries
•Definition of Natural Monopoly:▫A natural monopoly exists in an industry
where a single firm can produce output such as to supply the market at a lower per unit-cost than can two or more firms.
•Ex.▫Electricity and Water supply industries are
often natural monopolies
Why Regulate Natural Monopoly?•The need to avoid duplication of facilities•The need to prevent industries from
earning monopoly profits
Profit Maximization and Regulation Through Marginal Cost Pricing
Quantity per Time period
Un
it
Pri
ce
LMC
LAC
Demand
MRQm
PmF
Point F• Profit maximizing point for natural monopolist• Price (Pm) where consumers willing to pay for the quantity (Qm)
Profit Maximization and Regulation Through Marginal Cost Pricing
Quantity per Time period
Un
it
Pri
ce
LMC
LAC
Demand
MR Q1
AC1
Point B• Regulated price = Long-term Marginal Cost, Quantity (Q1) = Demand• Average Cost (AC1) > Price (P1), natural monopolist is losing money = Area (Losses)• Regulatory commission will have to subsidize the cost
LossesP1
B
Average Cost Pricing
Quantity per Time period
Un
it
Pri
ce
LMC
LAC
Demand
MR Q1
AC1
Point C• Regulators cannot always force marginal cost pricing• Enforcing Cost-of-service regulation or Rate-of-return regulation
LossesP1 B
Q2
CP2
Regulating Nonmonopolistic Industries•To provide a coordinated system of
safeguarding the interests of citizens•Two common rationales for government
involvement▫Market Failure▫Asymmetric information
Regulating Nonmonopolistic Industries (cont.)•Lemons Problem
▫Potential asymmetric information problem bring about a general decline in product quality Example: Used car market, pharmaceuticals,
etc.•Implementing consumer protection
regulation▫Liability laws and government licensing▫Direct economic and social regulation
Social Regulation
•Social Regulations apply to all firms in the economy
•Designed to improve the functioning of the markets
•Almost all cases, increased regulation results in higher production cost, and those increment cost are ultimately absorbed by the consumer
•Strict regulation prevent smaller firms to enter the market
Social Regulation (cont.)
•Usually benefit the society in the long run▫Safer products▫Safer workplaces▫Clean environment▫Etc.
Incentives and costs of Regulation
Incentives and Costs of Regulation
•Capture Hypothesis▫Predicts that the regulators will eventually
be captured by the special interests of the industry being regulated
Incentives and Costs of Regulation•Share-the-Gains, Share-the-Pains Theory
▫The regulators must take account of the demands of three groups; Legislators Regulated industries Consumers
Incentives and Costs of Regulation•Benefits of regulation
▫Regulation offers many potential benefits▫Actual benefits are more difficult to
measure•Costs of regulation
▫Government uses taxes to pay for the cost of regulation
▫US has over 190,000 employees in regulatory agencies
Incentives and Costs of Regulation•Total cost of regulation (US)
▫Cost of compliance estimated to be around $500 billion - $600 billion per year
▫Opportunity cost of complying with regulations is as high as $270 billion
Antitrust Policy
Antitrust Policy
•To promote business competitions•US congress enacted 4 key antitrust laws
▫The most important is the Sherman Act.
Antitrust Policy
•Sherman Antitrust Act of 1890▫Section 1
Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is hereby declared to be illegal
Antitrust Policy
•Sherman Antitrust Act of 1890▫Section 2
Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons to monopolize any part of the trade or commerce …. shall be guilty of a misdemeanor
Antitrust Policy
•Clayton Act of 1914▫Passed to remove the vagueness of the
Sherman Act•Robinson-Patman Act of 1936
▫Amended Section 2 of the Clayton Act▫Designed to protect independent retailers
and wholesalers from “unfair discrimination” by chain stores
Antitrust Policy
•Microsoft’s 2001 antitrust lawsuit
Antitrust Policy
•Exemptions from antitrust laws (US)▫All labor unions▫Public utilities▫Professional baseball▫Cooperative activities among US exporters▫Hospitals▫Public transit and water systems▫Supplier of military equipment▫Joint publishing arrangement in a single
city by two or more newspaper
International Antitrust Policy
•More firms across the borders are merging
•The European Union put restrictions against merging of any business that would enhance the market dominance of one firm
Antitrust Enforcement
Antitrust Enforcement
•Monopolization▫The possession of monopoly power in
relevant market▫The willful acquisition or maintenance of
that power, as distinguished from growth or development as a consequence of a superior product, business acumen, or historical accident
Monopoly power and the Relevant market•Monopoly is not just company size•Usually look at percentage of share in the
relevant market▫A firm is usually considered to have
monopoly power if share > 70%•Ex:
▫Being the “only” liquor store on a popular resort town (loosely)
Monopoly power and the Relevant market•Relevant market consists of 2 elements
▫Product market All items produced by different firms in the
market have identical attributes, this includes substitutable products
▫Geographic market Geographic boundaries include all area that
items are sold
Antitrust Enforcement
•Product Versioning▫Selling a product with altered forms or
functionalities to different groups of consumers
•Product Bundling▫Offering two or more products for sale as a
set
Product Versioning
•Software version▫Professional and Standard edition?
Product Bundling
•Microsoft Windows and Internet Browser software
Issues in Enforcing antitrust
•Enforcement is through Supreme Court interpretations
•Authorities use market share test and determine “relevant market”
International Trade
Basics of trade – what you should know•The principle of comparative advantage•The effect of tariffs•The effect of quotas•How restrictions on trade decrease the
wealth of a country•Know who gains and who loses from trade
restrictions
Comparative advantage
•Comparative advantage refers to the lowest opportunity cost to produce a product
•The ability to produce a good or service at a lower opportunity cost compared with producers
Comparative advantageItaly USA
Computer 8 1
Wine 2 2
Table indicates the unit cost of product.
Italy – a unit of Wine costs 2 hours of work and a unit of computer costs 8 hours of work
USA – a unit of Wine costs 2 hours of work and a unit of computer costs 1 hour of work
The USA has Absolute Advantage in producing both Wine and Computer. Should the US trade with Italy?
Comparative advantageItaly USA
Computer 8 1
Wine 2 2
Why not produce both computer and Wine in the US??
Comparative advantageItaly USA
Computer 8 1
Wine 2 2
Let’s look at computer perspective:• To make 1 wine, the US sacrifices 2 computers. While Italy sacrifices 0.25 computer to make 1 wine.
Comparative advantageItaly USA
Computer 8 1
Wine 2 2
Let’s look at wine perspective:• To make 1 computer, the US sacrifices 0.5 wine. While Italy sacrifices 4 wines to make 1 computer.
Comparative Advantage
•To make 1 wine, the US sacrifices 2 computers. While Italy sacrifices 0.25 computer to make 1 wine.
•To make 1 computer, the US sacrifices 0.5 wine. While Italy sacrifices 4 wines to make 1 computer.
Comparative advantageComputer Wine Hours
USA 1 2 5
Italy 2 4 24
Total consumption 3 6
Computer Wine Hours
USA 3 0 3
Italy 0 6 12
Total consumption 3 6