Regulation and Antitrust Law

Regulation and Antitrust Law

Chapter

CHAPTER OUTLINE

I. Explain the effects of regulation of natural monopoly and oligopoly. A. The Changing Scope of Regulation B. The Regulatory Process C. Economic Theory of Regulation

1. Public Interest Theory 2. Capture Theory

D. Natural Monopoly E. Public Interest or Private Interest Regulation?

1. Marginal Cost Pricing 2. Average Cost Pricing 3. Rate of Return Regulation 4. Price Cap Regulation

F. Oligopoly Regulation

2. Describe U.S. antitrust law and explain three antitrust policy debates. A. The Antitrust Laws B. Three Antitrust Policy Debates

1. Resale Price Maintenance 2. Tying Arrangements 3. Predatory Pricing

C. A Recent Antitrust Showcase: The United States Versus Microsoft 1. The Case against Microsoft 2. Microsoft’s Response 3. The Outcome

D. Merger Rules

CHAPTER ROADMAP

What’s New in this Edition? Chapter 17 is lightly revised. The Eye on the U.S. economy now discusses airline deregulation.

424 Part 5 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE

Where We Are Chapter 17 is the last chapter devoted to studying industry structure. In this chapter, we investigate different types of regulation imposed by the government. We also review the history of antitrust law and current topics in antitrust cases.

Where We’ve Been In the previous four chapters we’ve reviewed four types of market structure and studied how firms in each market structure selected their profit‐maximizing output and price. We’ve compared the efficiency of the outcomes generated by each market structure. This chapter builds on the previous work because those chapters explained why competition is desirable, which is the thrust of the antitrust laws. In addi‐tion, Chapter 14 briefly examined natural monopolies, a topic re‐examined in depth in this chapter.

Where We’re Going The next chapter leaves behind the industry structure and the output side of firms to begin a two‐chapter unit studying input markets and the distribution of income. Chapter 18 leads off by examining the different types of factors (labor, capital, land, and entrepreneurship) and discussing, as well as analyzing, the markets in which these factors are traded.

IN THE CLASSROOM

Class Time Needed

You can complete this chapter in one session. If you want to spend more time, you can bring in current events, such as the situation in the California electricity market or perhaps some on‐going regulation or deregulation issue from your state. An estimate of the time per checkpoint is: • 17.1 Regulation—25 to 35 minutes • 17.2 Antitrust Law—15 to 30 minutes

Chapter 17 . Regulation and Antitrust Law 425

CHAPTER LECTURE

17.1 Regulation Regulation consists of rules administered by a government agency to influence economic activity by determining prices, product standards and types, and the conditions under which new firms may enter an industry.

The Changing Scope of Regulation and the Regulatory Process • The Interstate Commerce Commission, the first federal regulatory agency, was organized

in 1887 to regulate interstate railroads. Since the 1930s, the number of regulatory agencies greatly increased (at both the state and federal levels). By the 1970s, almost one quarter of all industry was regulated. In the last 25 years, there has been a tendency for deregula‐tion, which is the process of removing restrictions on prices, product standards and types, and entry conditions.

• The regulatory agencies are run by bureaucrats. Each agency adopts a set of rules and practices designed to control the prices and other aspects of economic behavior in the in‐dustry it is assigned to regulate. Regulated firms generally are free to choose the level of technology and quantities of inputs but they generally are not free to set their own prices.

Economic Theory of Regulation • The public interest theory of regulation maintains that regulation seeks an efficient allo‐

cation of resources. • The capture theory of regulation maintains that regulation helps producers maximize

their economic profit. The producers “capture” the regulators and so the regulators do what is best for the producers. It assumes that the cost of regulation is high, and as a re‐sult, regulation will increase the surplus of small, easily identifiable groups with low or‐ganization costs.

Be sure to point out the tension between getting competent regulators to represent the interests of the consumers and the motivations surrounding these regulatory analysts. Emphasize that the information necessary to efficiently regulate an industry is vast and complex. Production costs, for example, are typically very difficult to estimate without highly specialized knowledge of the industry. Who is more likely to have this type of specialized knowledge than people hired from the ranks of the firms that are being regulated? These people have the requisite knowledge but they might retain some allegiance to and empathy for the managers that they recently worked with or firms that they worked for. This point means the loyalties of the regulators might be sur‐reptitiously swayed by their past personal relationships.


Natural Monopoly • A natural monopoly is an industry in

which one firm can supply the entire market at a lower price than two or more firms can. The figure shows a natural monopoly. The definition of a natural monopoly means that the firm’s ATC curve falls throughout the relevant range of production. As a re‐sult, the firm’s MC curve is below its ATC curve when the MC curve crosses the firm’s demand curve.

• A marginal cost pricing rule sets price equal to marginal cost, P = MC. In the figure, the firm sets a price of Pmc and produces Qmc. • The rule leads to the efficient

level of production in the indus‐try, so it maximizes the total surplus in the industry. It is in the public interest. But the firm incurs an economic loss because P < ATC.

• An average cost pricing rule sets price equal to average total cost, P = ATC. In the figure, the firm sets a price of Patc and produces Qatc.. • The rule leads to an inefficient level of production so there is a deadweight loss. But

the firm earns a normal profit because P = ATC. • Implementing pricing rules is difficult because the regulator does not know the firm’s

true costs. So regulators often use two practical pricing rules: • Rate of return regulation is regulation that sets the price at a level that allows the

regulated firm to earn a specified target percent return on its capital. When this pol‐icy is used, the managers of the regulated firm have the incentive to inflate its costs for beneficial amenities that do not promote efficiency but instead give the managers more amenities.

• A price-cap regulation is a regulation that specifies the highest price that a firm is permitted to set—a price ceiling. Price cap regulation gives managers an incentive to minimize costs because if the firm decreases its costs and earns an economic profit, the firm will be allowed to keep all (or part) of the profit. Typically price cap regula‐tion also requires earnings sharing regulation, under which profits that rise above a target level must be shared with the firm’s customers.

Oligopoly Regulation A cartel is a collusive agreement among a number of firms that is designed to restrict output and achieve a higher profit for cartel members. Cartels are illegal in the United States but still might arise in oligopoly industries. Regulation in these industries can be in the social interest—in which


case the price and quantity equal their competitive levels and the outcome is efficient—or the regulators might be captured—in which case the firms earn an economic profit and the regula‐tion acts against the social interest.

17.2 Antitrust Law Antitrust law provides an alternative way in which the government may influence resource allo‐cation in the marketplace. Antitrust law regulates or prohibits certain kinds of market behavior, such as monopoly and monopolistic practices.

The Antitrust Laws • The Sherman Act was the first antitrust law and was passed in 1890.

• Section 1 outlawed any “combination, trust, or conspiracy that restricts interstate trade.”

• Section 2 prohibited the “attempt to monopolize.” • The Clayton Act was passed in 1914. It made illegal specific business practices if the prac‐

tices “substantially lessen competition or create monopoly.” Practices outlawed include price discrimination, tying arrangements, requirements contacts, exclusive dealing, terri‐torial confinement, acquiring a competitor’s shares or assets, or becoming a director of a competing firm.

• The Federal Trade Commission was formed in 1914 to look for “unfair methods of com‐petition and unfair or deceptive business practices.”

Three Antitrust Policy Debates • Price fixing is always illegal. But other practices generate debates:

• Resale price maintenance occurs when a manufacturer agrees with a distributor on the price at which the product will be resold. Agreements between a manufacturer and distributors are illegal but it is legal for a manufacturer to force a distributor to accept guidance. This practice is inefficient if it allows retailers of the goods to operate a cartel and charge the monopoly price. It is efficient if it allows manufacturers to in‐duce dealers to provide the efficient standard of service when selling the product.

• A tying arrangement is an agreement to sell one product only if the buyer agrees to buy another, different product. A tying arrangement sometimes allows manufactur‐ers to price discriminate.

• Predatory pricing is setting a low price to drive competitors out of business with the intention of setting a monopoly price when the competition is gone. Economists are skeptical that predatory pricing occurs frequently because, unless there is some bar‐rier to entry, the predatory firm is unable to charge a monopoly price after the com‐petition is eliminated.

A Recent Antitrust Showcase: The United States Versus Microsoft • In 1998 the U.S. Department of Justice began a trial in which it said that Microsoft pos‐

sessed monopoly power, used predatory pricing and tying arrangements to establish Internet Explorer, and used other anti‐competitive practices.


• However, Microsoft countered that it has not violated antitrust law. Microsoft said that Windows was vulnerable to competition because there are no barriers to entry and that incorporating Internet Explorer into Windows is an attempt to increase customer value of the operating system software, rather than trying to monopolize the browser software market.

• The final court decision found Microsoft was in violation of the anti‐trust laws and or‐dered Microsoft to disclose details of its operating systems software to other software developers so they could more effectively compete against it.

Merger Rules The Department of Justice uses guidelines to determine which mergers to examine and possibly block. The Herfindahl‐Hirschman Index (HHI) (introduced in Chapter 15) is one of those guide‐lines. If the original HHI is less than 1,000, a merger is not challenged. If the original HHI is be‐tween 1,000 and 1,800, any merger that raises the HHI by 100 or more is challenged. If the origi‐nal HHI is greater than 1,800, any merger that raises the HHI by more than 50 is challenged.


Lecture Launchers 1. I (Maggy Shannon) like to give the students the historical background be‐

hind many economic issues. Antitrust law is a natural for this approach. I explain how absent regulation, the post‐Civil War U.S. railroad industry consolidated as firms sought to maximize profit. The first landmark federal antitrust legislation, the Sherman Act (1890), was a direct reaction to this consolidation. In Standard Oil Co. of New Jersey v. United States (1911) Jus‐tice John Harlan explained “All who recall the condition of the country in 1890 will remember that there was everywhere, among the people gener‐ally, a deep feeling of unrest. The Nation had been rid of human slavery ‐‐ fortunately, as all now feel ‐‐ but the conviction was universal that the country was in real danger from another kind of slavery sought to be fas‐tened on the American people, namely, the slavery that would result from aggregations of capital in the hands of a few individuals and corporations controlling, for their own profit and advantage exclusively, the entire busi‐ness of the country, including the production and sale of the necessaries of life. Such a danger was thought to be then imminent, and all felt that it must be met firmly and by such statutory regulations as would adequately protect the people against oppression and wrong.” While Justice Harlan’s opinion is both a concurring and dissenting one, his explanation of the need for the Sherman Act illustrates the basic principle of regulation and anti‐trust law: that capitalism unrestrained can devolve into harmful monopoly. Consequently, some trade must be restrained so that the greater part may remain free. (The complete text of Mr. Justice Harlan’s opinion is at http://supct.law.cornell.edu/supct/html/historics/USSC_CR_0221_0001_ZX.html )

2. Some students are familiar with the government’s case against Microsoft or, if not with the details, with the fact that the government had filed suit. When you discuss this case, be sure to point out that many expert witnesses were called at Microsoft’s trial. And, of course, each side brought its own economists…some of whom were paid over $1,000 an hour! More seriously, you can emphasize the tension between combining formerly separate goods into a product as a monopolizing action (tying agreements) and combining goods as a form of technological advancement to enhance consumer sur‐plus (product innovation). The Microsoft defense to antitrust charges al‐luded to the inevitable combining of web browsers into computer operating system software. Microsoft could be truly enhancing its product but it also could be using its market power in one market to capture market power in another, more competitive market. If students are not sympathetic to Mi‐crosoft’s argument, ask them if when they buy a car, they also expect to get tires installed by the manufacturer. Challenge them about this point—aren’t there independent tire companies? Why is the tire tied to purchase of the


automobile? If students object that “you need a tire for the car to run,” quickly ask them if a radio should be tied to the purchase of the car? Why shouldn’t the purchase of a radio be an independent decision? You don’t need to take sides with this discussion. Just point out to your students that arguments aren’t always as clear cut as they might seem initially. Also, after your lectures on the chapter have concluded, you can ask your students if they think that the outcome of the Microsoft case was efficient or equitable.

3. Get your students to go to Federal Register Web site, located at www.archives.gov/federal_register/the_federal_register/indexes.html. They (and you) will be amazed at the volume and detail of regulatory activity, almost all of which has an economic dimension and impact.

There is no free lunch in regulating firms and industries that embody mar‐ket power. Make the issue of industry regulation intriguing for the students by emphasizing the following countervailing opportunity costs that arise in regulating the firms in those industries that are creating a market failure.

Emphasize the tension between the potential for efficiency in production inherent with a natural monopoly and the inefficiency potential from the firm exercising its inherent market power. Be sure the students understand that economies of scale or scope enable the unregulated natural monopoly to provide products and services at the lowest possible cost, but the lack of competition also enables the firm to increase producer surplus at the ex‐pense of consumer surplus and creates a significant deadweight loss to so‐ciety.

Land Mines

1. To help present the differences between marginal cost pricing and average cost pricing, draw matching graphs side‐by‐side. Show students the prices that will be allowed by regulators. Ask students which regulation is “bet‐ter.” Be sure to show your students that marginal cost pricing generates an economic loss even though output is at the competitive level.

2. A large percentage of students read the Clayton Act as always prohibiting the activities listed, such as price discrimination or exclusive deals. Ask your students why airlines and movie theaters can price discriminate even though it is outlawed by the Clayton Act. Ask them why Coke and McDon‐ald’s are allowed to have an exclusive deal so that only Coke products can be purchased at McDonald’s while Pepsi and KFC have similar exclusive deal. The objective is to force the students to understand that the business practices mentioned in the Clayton Act are illegal only if they substantially lessen competition or create monopoly. You can state this qualifying phrase as often as you like but real‐life, specific examples are necessary to hammer the point home!


ANSWERS TO CHECKPOINT EXERCISES

CHECKPOINT 17.1 Regulation

1a. The firm produces 200,000 cans, which is the quantity at which marginal cost equals marginal revenue.

1b. The firm sets a price of $0.30 a can, which, as the demand curve shows, is the maximum price at which consumers are willing to buy the 200,000 cans produced.

1c. If the monopoly can capture the regulator, the firm gets the regulator to al‐low it to maximize its economic profits. This outcome occurs when 200,000 cans are produced.

1d. The monopoly’s goal is to produce 200,000 cans. When it is producing 200,000 cans, its price is $0.30 a can. And when 200,000 cans are produced, the company’s average fixed cost is $0.15 a can and its average variable cost is equal to its marginal cost, $0.10 a can. So average total cost is $0.25 a can, which is $0.05 below its price of $0.30 a can. So the maximum excess aver‐age total cost the company would claim is $0.05 a can.

1e. Only if the regulated monopoly produces 400,000 cans (where demand equals marginal cost) does it produce an efficient outcome.

CHECKPOINT 17.2 Antitrust Law

1. From the FTC website, BP Amoco PLC and ARCO were required to divest: (1) all of ARCO’s assets and interests related to and primarily used with or

in connection with ARCO’s Alaska businesses; (2) all of ARCO’s assets related to its Cushing, Oklahoma crude oil business. In particular, the FTC said “Proposed Respondents will divest all of

ARCO’s Alaska assets to Phillips Petroleum Company (ʺPhillipsʺ), an ap‐proved up‐front buyer. The vast majority of these assets must be divested to Phillips within 30 days of the signing of the Proposed Consent Order. Some of the ARCO Alaska assets require third‐party or governmental ap‐provals and Proposed Respondents have up to six (6) months to divest those particular assets. Proposed Respondents will divest the Cushing as‐sets to an acquirer or acquirers that receive the prior approval of the Com‐mission and in a manner approved by the Commission. They must divest the Cushing assets within four (4) months of signing the Proposed Consent Order.”

2. The Standard Oil Company was broken up years ago because the courts be‐lieved that it was restraining trade to an unreasonable level. In recent years, some of these individual firms have merged. These actions are a result of the market changing. This outcome would be analogous to the government allowing fragmented portions of the old AT&T to merge. The communica‐


tions market has changed and new types of competitors have developed. In the petroleum industry, the government has decided that the merged firms now represent a more efficient operation and that they face sufficient com‐petition to restrain their behavior.


ANSWERS TO CHAPTER CHECKPOINT EXERCISES

1. The first federal antitrust law, the Sherman Act, was passed in 1890. The second major law, the Clayton Act, was passed in 1914. Section 1 of the Sherman Act prohibits “every contract, … or conspiracy in restraint of trade.” Section 2 makes illegal “attempts to monopolize.” The Clayton Act, along with its two amendments, the Robinson‐Patman Act (1936) and the Celler‐Kefauver Act (1950), prohibit specific business practices “only if they substantially lessen competition or create monopoly.” The practices are • Price discrimination • Tying arrangements • Requirements contracts • Exclusive dealing • Territorial confinement • Acquiring a competitor’s shares or assets • Becoming a director of a competing firm

These practices are outlawed because they lead to an inefficient use of re‐sources. Firms that gain monopoly power restrict their output and boost their prices, which harms consumers and creates a deadweight loss.

2a. The meetings are definitely illegal under Section 1 of the Sherman Act. The firms want to fix their prices such that they will earn an economic profit.

2b. The proposed merger is likely illegal under Section 2 of the Sherman Act and/or the Clayton’s Act prohibition of acquiring a competitor’s shares or assets. Amazon wants to merge to gain the market power to raise its price and earn an economic profit.

2c. This is probably legal, especially if the pharmaceutical manufacturer does not require that the drug stores buy all of its drugs from only the one com‐pany. If the manufacturer does impose this requirement, the action might be prohibited as a requirements contract under the Clayton Act. But even in this case, it would be illegal only if it substantially lessened competition.

2d. The action is almost certainly legal. It does not run afoul of the Clayton Act’s prohibition of tying contracts because it seems very unlikely to sub‐stantially lessen competition or create monopoly.

2e. The video store is imposing a tying contract. This action is illegal under the Clayton Act only if it substantially lessens competition or creates monop‐oly. If there is enough competition in the video rental market, this action would be legal.


3. Figure 17.1 illustrates the case of Hawaii Cable. 4. Figure 17.2 illustrates the situation when Ha‐

waii Cable is unregulated. Hawaii Cable pro‐duces the quantity at which marginal revenue equals marginal cost, so it serves 20,000 house‐holds. The price is $60 a month. The economic profit, consumer surplus, and deadweight loss are indicated.

5. Figure 17.3 illustrates the situation when Ha‐waii Cable is regulated in the public interest. Hawaii Cable produces the quantity at which the marginal cost curve intersects the demand curve, so it serves 40,000 households. The price is $20 a month. The consumer surplus is illus‐trated. There is no deadweight loss. There also is no economic profit. Hawaii Cable incurs an economic loss.


6. Figure 17.4 illustrates the situation when Hawaii Cable is regulated using a price cap. The price cap is set at $40 a month. If Hawaii Cable serves 30,000 households and the price is $40 a month. The consumer surplus and deadweight loss are illustrated. Because the price cap is set equal to Hawaii Cable’s average total cost, there is no economic profit. Hawaii Cable earns a normal.

7. If the price cap for Hawaii Cable is set too low for the firm to earn normal profit, then the firm is incurring an economic loss. If the regulator refuses to raise the price cap, Hawaii Cable would go out of business.

8a. If the firms behave as a cartel, they select the monopoly quantity, where MR = MC, and set the monopoly price. Figure 17.5 illustrates that the monopoly quantity is 30,000 calls a day and the price is 15¢ a call.

8b. If the firms are regulated in the public interest, they produce the quantity at which the marginal cost curve intersects the demand curve. Figure 17.5 illustrates that the quantity is 40,000 calls a day and the price is 13.3¢ a call.

8c. If the companies capture the regulator, the output and price is the monopoly output and price, 30,000 calls a day and a price of 15¢ a call.

8d. The deadweight loss when the firms capture the regulator is illustrated in Figure 17.5

9a. Marginal cost pricing leads to resource use being efficient. 9b. Efficient regulation sets the price equal to the marginal cost. Marginal cost

pricing would not lead to the firms incurring an economic loss because the price, which is determined by where the marginal cost curve intersects the demand curve, is greater than the average total cost.


9c. Figure 17.6 illustrates an efficient price cap regulation The price cap is set at 13.3¢ a call, the same as with marginal cost pricing. The number of calls is the efficient quantity, 40,000 calls a day.

9d. Because the regulation is efficient, there is no deadweight loss.

10. Land Line might be able to drive Cellular City out of business if it sets a low enough price. But to do so Land Line would incur an economic loss. If Land Line did manage to drive Cellular City out of business and then Land Line set the monopoly price and quantity, the economic profit Land Line earns gives a new competitor the incentive to enter the market. And, if there are no barriers to entry, Land Line cannot block the entry of a new competitor. So any economic profit Land Line manages to earn might be very short lived.

11. The antitrust authorities blocked the merger between PepsiCo and 7‐Up and between Coca‐Cola and Dr. Pepper because the authorities believed that these mergers would significantly lessen competition in the market for soft drinks. Based on the pre‐merger HHI, the market before any of the mergers occurred already was concentrated. These mergers would make the market even more concentrated and less competitive, so the antitrust authorities, behaving in the public interest, blocked the mergers.

12a. OPEC would definitely be in violation of Section 1 of the Sherman Act be‐cause OPEC is fixing the price of petroleum and seeking to restrict trade.

12b. If OPEC was made to behave competitively, the price of oil would tumble. The quantity would increase and consumer surplus would increase. The deadweight loss would decrease. OPEC’s producer surplus would de‐crease.

13a. If Land Line and Cellular City merge, they would become a monopoly. The price of a local call would rise and the quantity would decrease.


13b. Once Land Line and Cellular City are a monopoly, the higher price and decreased quantity decreases consumer surplus, increases producer sur‐plus, and creates a deadweight loss.

13c. The antitrust authorities would move to block this merger because it would create a monopoly.

14a. The merger is not in the public interest. The merged firm, Super Burger Chain, would eliminate competition in the fast food market. It would have significant market power, would raise the price of a burger, and would re‐sult in an inefficient use of resources.

14b. The price of a burger would rise. The Super Burger Chain would have a large share of the market for fast food hamburgers and would be able to use its market power to raise the price of a burger.

14c. Consumer surplus would decrease, producer surplus would increase, and a deadweight loss would be created.

14d. The antitrust authorities would block the merger because it would raise the HHI well beyond the threshold necessary for them to take action.

14e. The merger is in the interest of the firms because the Super Burger Chain would limit competition and have significant market power. Almost cer‐tainly Super Burger Chain would be able to raise the price of a fast food hamburger and earn an economic profit.


Critical Thinking

15a. Your students’ answers will vary. One issue they might discuss concerns the point that there would be a massive public outcry if the government tries to regulate the Internet. In addition, it is not obvious that price and quantity regulation are needed for the Internet because, at least currently, the Internet appears competitive with relatively easy entry into many as‐pects of it. However, if a few firms such as AOL or Google grow extremely large the government in the future might consider some sort of economic regulation.

15b. Again, your students’ answers will vary. Some points they might mention include the fact that there are many special interest groups strongly op‐posed to taxing e‐commerce, such as firms engaged in e‐commerce and consumers who are heavy buyers of products sold by e‐commerce. In addi‐tion, imposing the tax would be difficult, at least at the state level. If one state moved to tax e‐commerce sales from firms located within that state, the firm could easily move to another state.

15c. Your students’ answers will vary. But there seem to be no specially diffi‐cult aspects of antitrust law when it comes to the Internet.

15d. Your students’ answers will vary. But there do not seem to be an immense number of new antitrust issues created by the Internet. Attempts to mo‐nopolize are as difficult as always to prove. And the Clayton Act prohibi‐tion of acquiring a competing firm if it substantially lessens competition also remains difficult to prove.

16a. Your students’ answers will vary. Those students who believe that Micro‐soft attempted to monopolize the market will assert that Microsoft used predatory pricing and tying agreements to drive out competitors, such as Netscape and IBM. Those students who disagree will assert that Microsoft was being innovative and through this innovation kept prices low for con‐sumers.

16b. Your students’ answers will vary. Those who agree that Microsoft engaged in predatory pricing will point to the zero price of Internet Explorer and then suggest that if Microsoft had been allowed to keep Internet Explorer a separate piece of software that the price would be significantly higher now. Those who disagree will point to the fact that Internet Explorer is now bundled with Windows and will assert that its price remains zero.

16c. Your students’ answers will vary. Those who agree that Microsoft engaged in an illegal tying arrangement will assert that there is no natural reason for bundling Internet Explorer with Windows. For instance, they might point out that Word is not bundled with Windows because similarly, there is no natural reason for including the two pieces of software together. Those who disagree will assert that a browser is needed for an operating


system to be complete. They might use an analogy, for instance, a battery is included when a car is purchased because without the battery the car would not operate.

16d. Your students answers will vary. Those who think that code sharing will lead to efficiency will assert that the code sharing will keep the market competitive. Those who disagree might suggest that Microsoft will come up with new ways to hinder its competition and retain significant market power.


Web Exercises

17a. Intel is probably not a natural monopoly. 17b. From the Web site, in 1998 “The FTC alleged that Intel illegally used its

market power when it denied three of its customers continuing access to technical information necessary to develop computer systems based on In‐tel microprocessors, and took other steps to punish them for refusing to li‐cense key patents on Intel’s terms. … Over the years, Intel has promoted and marketed its microprocessors by providing customers with technical information in advance of the official commercial release of new micro‐processor products. This makes it possible for computer makers to have computers based on new Intel microprocessors ready to sell at the time of the official commercial release of the microprocessors, or shortly after‐wards. … This is part of the mutually beneficial relationship between Intel and its customers. Intel benefits because its customers—computer systems manufacturers—commit resources to designing new computer products that incorporate the new Intel microprocessors. The customers benefit be‐cause they are able to introduce “leading edge” computer products with the latest microprocessor technology on a timely basis, the complaint states. The FTC alleged that on at least three occasions, Intel has termi‐nated or threatened to terminate its mutually beneficial relationships in a selective, targeted fashion to retaliate against the firms that sought to pro‐tect or assert patent rights in rival microprocessor technologies or that re‐fused to license such rights to Intel. This retaliation has primarily taken the form of cutting off access to technical information needed to design com‐puter systems based on soon‐to‐be‐released Intel microprocessors. By its actions, Intel sought to injure the customer until that customer surrendered the patent licenses Intel desired.”

17c. Intel agreed to make its chips more widely available and to allow other companies to enforce their patents. This agreement will increase the quan‐tity of chips, lower the price, and increase consumer surplus.

17d. Intel’s agreement should increase the quantity of chips and lower the price. It should increase consumer surplus and decrease producer surplus.

18a. Before 1996, electric utilities in California were regulated as they had been for many previous years. Prices were set by the state and the companies owned their own generating plants as well as their transmission and dis‐tribution networks.

18b. The 1996 deregulation required that the transmission lines be transferred to a non‐profit organization, the Independent System Operator. Utilities continued to own the distribution networks but they were required to sell their generating plants to independent, unregulated private firms. As a re‐sult, the wholesale price of electricity was deregulated, though the retail


price remained regulated by the state. Further, the utilities were not al‐lowed to sign long‐term contracts with the private power producers. Rather the utilities were required to buy power each day.

18c. The retail price of electricity has remained regulated; the electric utility companies have not been allowed to sign long‐term contracts with private power producers; the electric utilities have not been allowed to own their own generating plants.

18d. When the equilibrium price exceeds the price cap, the price cap becomes binding. The quantity of electricity generated and offered for sale is less with the price cap than if the price were allowed to reach its equilibrium. Shortages of electricity are the result.

18e. If the state had used an earnings‐sharing plan, at first consumers would have benefited because initially the policy created profits for the electricity utility companies. But after 2000 consumers would have been hit by rap‐idly rising prices. Quite likely there would be fewer rolling blackouts, but the price of electricity would be higher.

19a. Your students’ answers will vary because there are literally hundreds of different cases.

19b. Your students’ answers will vary, depending on the case they select. For instance, in U.S. v Greyhound Lines, Inc. Greyhound was alleged to violate Section 1 of the Sherman Act because Greyhound prohibited local bus companies from selling tickets for intercity bus transportation via other companies within a 25‐mile radius of Greyhound’s terminals. It was al‐leged that the effect of this provision was to restrict competition in the provision of intercity bus transportation service.

19c. The price of intercity bus travel rose and the quantity of intercity bus travel decreased. Consumer surplus decreased, producer surplus increased, and a deadweight loss was created.

19d. The outcome was that Greyhound agreed to eliminate this practice. 19e. The price of intercity bus travel fell and the quantity of intercity bus travel

increased. Consumer surplus increased, producer surplus decreased, and the deadweight loss decreased.


ADDITIONAL EXERCISES FOR ASSIGNMENT

Questions CHECKPOINT 17.1 Regulation 1. An unregulated natural monopoly cans

Mount Peak air, unique clean air that has no substitutes. The monopolyʹs total fixed cost is $120,000, and its marginal cost is 20 cents a can. Figure 17.7 illustrates the demand for Mount Peak air.

1a. How many cans of Mount Peak air does the monopoly sell?

1b. What is the price of a can of Mount Peak air? 1c. If the monopoly captures the regulator, how

might the monopoly be regulated? 1d. If the monopoly can mislead the regulator

about its costs, what is the maximum excess average total cost that it would claim?

1e. Would the regulated monopoly use resources efficiently?

CHECKPOINT 17.2 Antitrust Law 1. Two recently proposed mergers were WorldCom and MCI and Alcoa and

Reynolds Aluminum. The WorldCom/MCI merger would have raised the Herfindahl‐Hirschman Index (HHI) from 1,850 to 3,000 and the Al‐coa/Reynolds Aluminum merger would have raised the HHI from 1,270 to 1,800. What do you think the Department of Justice’s stance was on these mergers?

Answers

CHECKPOINT 17.1 Regulation 1a. The firm will produce 400,000 cans, which is the quantity at which marginal

cost equals marginal revenue. 1b. The firm sets the price at $0.60 a can, which, as the demand curve shows, is

the maximum price for which consumers are willing to buy the 400,000 cans produced.

1c. If the monopoly can capture the regulator, the firm gets the regulator to al‐low it to maximize economic profit. This outcome occurs when 400,000 cans a day are produced.

1d. The monopoly’s goal is to produce 400,000 cans. When it is producing 400,000 cans, its price is $0.60 a can. Now, when 400,000 cans are produced,


the company’s average fixed cost is $0.30 a can and its average variable cost is equal to its marginal cost, $0.20 a can. So the true average total cost is $0.50 a can, and the maximum excess average total cost the company would claim is an additional $0.10 a can.

1e. Only if the regulated monopoly produces 800,000 cans a day—the quantity at which the demand curve and the marginal cost curve intersect—does it produce an efficient outcome.

CHECKPOINT 17.2 Antitrust Law 1. The Department of Justice challenged both mergers. The outcome was that

neither merger occurred. When the HHI is between 1,000 and 1,800, a merger in this market that would increase the index by 100 points is chal‐lenged by the Department of Justice. And when the HHI is above 1,800, a merger in this market that would increase the index by 50 points is chal‐lenged.


USING EYE ON THE U.S. ECONOMY

Airline Deregulation

Complaints about flying are so commonplace today that they are hardly worth mentioning. Frequent fliers and even infrequent fliers decry the crowds and the delays. Ask your students about their complaints—is flying “fun”? Once you solicit a number of complaints, you can point out that these complaints actually point out the success of airline deregulation. Ask your students to recall any movies or film clips they have seen that feature people flying in the 1950s. At that time, flying was so expensive and so few people flew that travelers dressed up when they flew. Men wore suits and women formal dresses. Nowadays, of course, tank tops, t‐shirts, and shirts are common. Why the difference? Of course the answer is that today travel by airline is so inexpensive millions of people fly every week. As the data in the Eye’s figure shows, airline deregulation has helped lessen the price of flying. Since 1985, there has been a general downward trend in the price of flying. And, of course, there has been a massive upward trend in the number of miles flown. In terms of supply and demand, the demand has increased (with higher incomes and probably an increased preference to fly because of improvements in the safety record) and because of deregulation, sup‐ply has increased even more. You can point out to your students that without airline deregulation, there would be fewer complaints of overcrowding…but even far fewer people flying. You can discuss with your students whether they prefer being able to afford to fly frequently, even with the overcrowding, or be‐ing able to fly either infrequently or perhaps not at all.

Regulatory Roller Coaster

This story clearly shows how markets change and cause regulators to view com‐petition and efficient outcomes differently over time. You can have students dis‐cuss why prices have risen. Is it lack of regulation or demand for more channels? What kind of innovations can produce effective competition for cable firms? Why haven’t satellite dish systems produced this kind of competition?

Regulation and Antitrust Law

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Transcript of Regulation and Antitrust Law