CHAPTER 17 PROMOTING MORE EFFICIENT MARKETS

I. CHAPTER OVERVIEW Government has three major roles to play in supporting a modern domestic economy: maintain efficiency, promote macroeconomic stability and growth, and establish a fair distribution of income. This chapter concentrates on one of governments primary challenges in exercising its efficiency roleperforming a watchdog function to prevent excessive abuse of market power. Also, the chapter focuses your attention on the two major tools employed by the U.S. government to put some teeth into its careful monitoring of business activity: regulation and antitrust activity. Regulation is often employed when economies of scale are so significant in a production process that a monopoly is the only efficient solution. Government agencies are organized to monitor the behavior of the monopolist and to protect the interests of consumers. Antitrust legislation is designed to prevent monopolies from forming and to attack anticompetitive abuses. The Sherman Antitrust Act and the Clayton Act form the backbone of antitrust policies; the Federal Trade Commission Act established the FTC as the agency in charge of monitoring and enforcing the legislation. Of course, as with any laws, the courts ultimately interpret their meaning, and a century of legal precedent defines the meaning of these statutes. II. LEARNING OBJECTIVES After you have read Chapter 17 in your text and completed the exercises in this Study Guide chapter, you should be able to: 1. Distinguish between two brands of regulation: economic and social. List examples of each. 2. List and explain three major public-interest justifications for regulation. Understand the difference between these and interest-group theories of regulation. 3. Describe the process of regulating natural monopolies, particularly in the provision of public utilities. 4. Review the history of regulated industries in the U.S. in the past several decades. 5. Summarize the major pieces of antitrust legislation in the U.S. and explain their historical significance. 6. Review recent antitrust cases and explain the importance of these decisions in establishing a new industrial landscape in the U.S. 7. Understand the difference between horizontal and vertical mergers, and the merger guidelines that are used by the antitrust authorities. III. REVIEW OF KEY CONCEPTS Match the following terms from column A with their definitions in column B. A B __ Command and 1. Join together unrelated businesses. control __ Market 2. Established a regulatory agency to prohibit unfair methods of competition and incentives to warn against anticompetitive mergers. __ Natural 3. Regulatory strategy in which price is set such that a firms total costs are monopoly distributed to each product sold. __ Economies of 4. A group of firms, usually in the same industry, that combine together by a scope legal agreement to regulate production, prices, or other industrial conditions. __ Average-cost 5. Government commands people to undertake or desist from certain activities pricing through government regulation. __ Marginal-cost 6. Means that only unreason able restraints of trade come within the scope of the pricing Sherman Act and are considered illegal. __ Two-part tariff 7. Involves charging different prices to different customers when there is no difference in the cost of delivering the product. __ Trust 8. Harnessing of market forces to achieve regulatory goals. __ Sherman 9. Occurs when companies in the same industry combine.

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Antitrust Act __ Clayton Act __ FTC Act __ Per se prohibitions __ Rule of reason __ Predatory pricing __ Tying contracts __ Price discrimination __ Bell doctrine __ Vertical mergers __ Horizontal mergers __ Conglomerate mergers

10. Means that there is no defense that will justify a set of actions. 11. Arrangements whereby a firm will sell product A only if the purchaser also buys product B. 12. Occurs when the most efficient way of organizing production in an industry is through a single firm. 13. Regulatory strategy in which the firms price is set equal to its marginal cost. 14. Establishes the fact that monopolies are illegal and that the attempt to monopolize is illegal. 15. Occur when two firms at different stages of the production process come together. 16. Pricing strategy in which a firm charges a fixed fee to cover the overhead costs and then adds a variable cost to cover the marginal costs. 17. Occurs when a firm sells its output for a price that is less than the costs of production, presumably to drive competitors out of business. 18. Passed to clarify and strengthen the Sherman Act by detailing specific illegal behavior. 19. Arise when a number of different products can more efficiently be produced by a single firm than by separate firms. 20. Stated that regulated monopoly and competition should not be mixed.

IV. SUMMARY AND CHAPTER OUTLINE This section summarizes the key concepts from the chapter. A. Business Regulation: Theory and Practice 1. In the United States, regulation is the most popular mechanism with which governments at all levels protect their citizens from potential abuses of market power, particularly when a natural monopoly is under scrutiny. Regulation, in its broadest context, includes all rules and laws designed to change or control the operation of an economic enterprise. There are, in fact, two major categories within that context: economic and social. Economic regulation can be accomplished by controlling prices, production, standards, and exit and entry conditions. Social regulation is directed at correcting (negative) externalities. 2. There are several reasons to regulate industry. First, government may want to contain market power and encourage competition in markets. However, when natural monopolies exist, regulatory agencies are established to protect consumer interests while allowing the monopoly to operate. Second, information failures may need to be remedied. In some cases, consumers may have insufficient information on products. Before the government began to take on this task, the markets cried out, Let the buyer beware!implying that it was the consumers responsibility to make sure that products were safe and effective. Now the government protects consumers by overseeing the production and distribution of many products, from food to infant car seats. Third, government may want to diminish the severity of externalities. For example, the Environmental Protection Agency is a regulator whose main activity is to design and enforce pollution control strategies. Finally, government may choose to step into an industry when the regulators have been captured by the regulated. This happens when the regulators actually begin to protect the firms best interest rather than the consumers. 3. The next logical question is, how do regulators set industrial standard? Several alternative strategies exist. With average-cost pricing, regulated firms are allowed to set price equal to the average total costs of production. That is, the firm takes all its costs and distributes them to each product sold. This brings them to a solution that is similar to the long-run perfectly competitive solution that has firms producing at minimum average total costs. With marginal-cost pricing, the firm is restricted to setting price equal to marginal cost. This again brings them to a solution that is similar to perfect competition. However, particularly when economies of scale are significant, this may lead to losses for the firm. For example, many municipal transportation systems exist as regulated natural monopolies. (Running several subway systems in the same city hardly seems practical.) Equity considerations imply that these companies hold their prices to a bare minimum as a service to commuters and working people. Because these firms cannot generate enough revenues to cover costs at this price, they are often subsidized by the city government.

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4. For the past two decades, a significant trend toward deregulation has been spreading across the economy. From airlines to trucking to banking to electricity, many industries have shed the yoke of regulation and entered the world of free competition. Most of these industries have emerged stronger and more competitive than they were under regulation. B. Antitrust Policy 1. Antitrust policy exists to limit the excesses of imperfect competition. Unregulated monopoly power allows firms to operate at socially inefficient levels, charging too much for too little product. Monopolists charge a price that is greater than marginal cost, and often greater than average costs, allowing them to earn economic profits into the long run. This means that the monopoly solution yields a distribution of resources that is not allocatively efficient. Imperfect competition can emerge due to the existence of economies of scale. If the technology in an industry is such that output can be produced efficiently only when a single firm exists, we have a natural monopoly. 2. Of course, antitrust policy is written with full knowledge that imperfect competition has both a good and a bad side. Unbridled exploitation of market power can, on the one hand, depress output and generate excessive prices and profits. On the other hand, however, there do exist economies of scale that should not be sacrificed simply for the sake of having many firms instead of few. There is, moreover, a demonstrable correlation between market concentration and research into discovery and development of new products and new processes. In light of this dichotomy of properties, it is the primary lesson of this chapter that antitrust activity should (1) keep the barriers to competition low, (2) tolerate bigness when size is determined by technology, and (3) be vigilant against anticompetitive practices whenever they occur. 3. The three most significant pieces of antitrust legislation in the United States are the Sherman Antitrust Act, the Clayton Act, and the Federal Trade Commission Act. The Sherman Act declares contracts, combinations, and conspiracies in restraint of trade illegal and further states that attempting to monopolize is illegal. The Clayton Act outlines specific anticompetitive behaviors that are illegal, such as price discrimination, tying contracts, and interlocking directorates. The Clayton Act also limits corporate mergers that would lessen competition; horizontal mergers are the most troublesome in this regard. The FTC Act established a commission whose duty is to prohibit unfair methods of competition and to warn against anticompetitive activity. 4. The application of these antitrust laws is not an easy task. It is often difficult to know if any illegal behavior exists or to determine exactly what a firms intent might be. Thus, on the basis of conduct, it is hard to know whether or not firms are behaving illegally. In addition, it is often difficult to know exactly how to define a market or how to define competitors. For example, consider the automobile industry. Is it oligopolistic, consisting of just three big firms (Ford, Chrysler, GM) in the United States, or is it perfectly competitive, consisting not only of Ford, Chrysler, and GM but also of Honda, Toyota, BMW, Mazda, etc.? How do we define markets, and, once we define them, how can we describe the behavior of firms relative to one another? On the basis of structure, it is hard to know whether or not firms are operating in an illegal fashion. 5. Recent antitrust activity has, in fact, focused on promoting efficiency in business practices and not on attacking bigness per se. The notion underlying this concentration on conduct rather than structure, in an economy that is facing increasing competition from around the world, is that collusive agreements that try to fix prices are the most troublesome source of inefficiency. Large firms that can exploit decreasing costs as they compete internationally can be a source of economic strength as long as they do indeed compete. V. HELPFUL HINTS 1. Figure 17-2 in your text is complicated, so we have reproduced it here as Figure 17-1. First, notice the shape and position of the average and marginal cost curves. Because they are everywhere downward-sloping, this looks like a natural monopoly. The larger the firm gets, the lower its per unit costs. Given a market demand and marginal revenue curve, the profit-maximizing firm will produce where marginal cost is equal to marginal revenue and set the highest price it possibly can. This leads to PM and QM as industry price and output.

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Figure 17-1 Notice further the inefficiencies inherent in this solution. At QM price is greater than average costs, and it is greater than marginal costs. This opens the door to regulators, who would like to make some adjustments. Remember that regulators, in theory, are charged with the duty of protecting consumer interests. This means they should be fighting to establish prices and output levels that come closer to the competitive ideal. Average-cost pricing moves in that direction by setting price equal to average costs, allowing the firm to cover its opportunity costs (R). Marginal-cost pricing often pushes prices below the firms average costs, forcing the firm to incur a loss (I). No monopolist will remain in business given this sort of price, unless they are subsidized by another government agency. 2. When an industry is deregulated, several events may occur. First, supply might increase as the number of competing firms increases. (Examples include telephone service and airlines.) This increase in supply should lower prices for consumers. Along with this increase in supply comes increased competition, which often takes the form of advertising. Advertising may increase consumer demand, expanding the size of the market for all competitors. This chain of events seems to reflect both the market for telephone service and the market for airline travel. Deregulation led to tremendous increases in supply, followed by a barrage of advertising as competitors scrambled for market share. The resulting increase in demand has enlarged opportunities for all firms. 3. There are many reasons for firms to pursue conglomerate mergers. One of the most appealing has to do with risk and uncertainty. A firm that acquires subsidiaries in other industries is able to spread its risk across a greater number of options, limiting the uncertainty it faces in the marketplace. For example, Philip Morris, a large producer of cigarettes, purchased the Kraft food chain several years ago. As the market for cigarettes became increasingly risky, the firm began searching for ways to diversify its holdings. It achieved this diversification, in part, by purchasing relatively safe product lines. VI. MULTIPLE CHOICE QUESTIONS These questions are organized by topic from the chapter outline. Choose the best answer from the options available. A. Business Regulation: Theory and Practice Which of the following would be considered a form of economic regulation? a. OSHA regulations designed to ensure safety in the workplace. b. EPA regulations designed to improve air quality.

1.

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c. Public utility regulations designed to promote efficient and equitable pricing of electricity. d. FDA regulations designed to ensure the safety of new drugs. e. All the above. 2. Which of the following would be considered a form of social regulation? a. Product quality standards designed to protect consumers. b. Public utility regulations designed to promote efficient and equitable pricing of cable television. c. NRC regulations designed to ensure the safe operation of nuclear power plants. d. Insurance regulations designed to promote premiums that are fair and economically justifiable. e. All the above. 3. Rather than command firms to comply with regulatory standards, government agencies have recently begun to use market incentives. These types of programs: a. allow the market to operate freely, with no regulation. b. bribe firms to behave in the proper manner by offering rewards for good behavior. c. harness the forces of supply and demand to achieve regulatory goals. d. encourage firms to capture regulators. e. none of the above. 4. Which of the following represents a reason for suspecting that a natural monopoly might best serve a particular market? a. A tariff structure that allows domestic pricing above the world price. b. The presence of increasing returns to scale throughout a range of output which covers the entire market. c. The invention of a new product that is covered by a 17-year patent. d. The creation of monopoly power by an act of government which restricts market entry e. All the above. The diagram in Figure 17-2 describes cost and demand conditions in the market for a product. Use it to answer questions 5 through 10.

Figure 17-2 5. An unregulated monopolist would operate by producing an amount that would clear the market at what price? a. $1. b. $2. c. $3. d. $4. e. $5. 6. Which price would be the ideal regulated price for the monopolist represented above? a. $1. b. $2.

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c. $3. d. $4. e. $5. 7. How much output would the monopolist in Figure 17-2 produce if regulated by average-cost pricing? a. 9 units. b. 7 units. c. 5 units. d. 4 units. e. 1 unit. 8. If the monopolist whose cost and demand conditions are given in Figure 17-2 were to face an ideal price regulation, how much of a subsidy would be required, per unit, to sustain his or her activity? a. Exactly $5 per unit. b. Exactly $4 per unit. c. More than $2 per unit but less than $4 per unit. d. More than $1 per unit but less than $2 per unit. e. Exactly $1 per unit. 9. Net of the subsidy (judged to be $1.25 per unit), how much consumer surplus would be gained over the unregulated case if the monopolist in Figure 17-2 were to face ideal price regulation? a. $16.00. b. $10.00. c. $7.75. d. $4.50. e. Zero; the subsidy exhausts the entire gain. 10. Which answers to question 7 should have been correct if that question had referred to marginal-cost price regulation? a. 9 units. b. 7 units. c. 5 units. d. 4 units. e. 1 unit 11. Regulation restrains the unfettered market power of firms. What are the legitimate reasons why government might choose to override the decisions made in free markets? a. To prevent abuses of market power by monopolies or oligopolies. b. To remedy informational failures. c. To correct externalities. d. A and B. e. A, B, and C. B. Antitrust Policy 12. Imperfect competition is inefficient because it yields: a. less output than a perfectly competitive industry. b. higher prices than a perfectly competitive industry. c. lower output and lower profits than a perfectly competitive industry. d. lower prices and lower profits than a perfectly competitive industry e. a and b. 13. The Sherman Antitrust Act: a. outlaws contracts, combinations, and conspiracies in restraint of trade. b. specifies that price discrimination is illegal. c. established the FTC to oversee competitive behavior in markets. d. encourages firms to exploit economies of scale to their fullest. e. a and d. 14. Which of the following made price discrimination not based on cost differentials illegal? a. The Sherman Antitrust Act. b. The Humphrey-Hawkins Act. c. The Clayton Antitrust Act. d. The Gramm-Rudman Act. e. The Federal Trade Commission Act.

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15. Which answer to question 13 would have been correct if that question had referred to making the formation of a monopoly a felony? a. outlaws contracts, combinations, and conspiracies in restraint of trade. b. specifies that price discrimination is illegal. c. established the FTC to oversee competitive behavior in markets. d. encourages firms to exploit economies of scale to their fullest. e. a and d. 16. Which answer to question 13 would have been correct if that question had referred to making unfair and deceptive business practices unlawful? a. outlaws contracts, combinations, and conspiracies in restraint of trade. b. specifies that price discrimination is illegal. c. established the FTC to oversee competitive behavior in markets. d. encourages firms to exploit economies of scale to their fullest. e. a and d. 17. Current thinking about the application of antitrust legislation looks most critically upon: a. horizontal mergers. b. multinational mergers. c. vertical mergers. d. conglomerate mergers. e. mergers of any kind. 18. Firms which exercise market power charge prices above marginal cost because: a. profits are maximized where marginal revenue equals marginal cost, and downward-sloping demand places marginal revenue below price. b. such firms never operate in the elastic region of demand where marginal revenue is negative. c. the effective demand curve which they face is horizontal, indicating an ability to charge prices which exceed the market-clearing level. d. profits are maximized where price equals marginal cost, and downward-sloping demand places marginal revenue above price. e. increasing returns to scale and their associated declining average costs mean that marginal cost and price always exceed average cost. 19. The most important class of per se illegal conduct is: a. predatory pricing. b. tying contracts. c. price discrimination. d. price fixing. e. none of the above. VII. PROBLEM SOLVING The following problems are designed to help you apply the concepts that you learned in this chapter. A. Business Regulation: Theory and Practice 1. Place (E) or (S) in the blanks provided to indicate whether each of the following regulatory activities is an example of an economic regulation or a social regulation: ___ a. Restraints on price-setting practices among firms ___ b. Clean air policy ___ c. Limits on the rates of return earned by utilities ___ d. Drug testing by the FDA ___ e. Requirement to provide electricity to every one who asks for it ___ f. Constraints on entry into and exit from given markets 2. Price controls are frequently mentioned as a possible means of controlling the potential abuses of monopoly power. Pervasive use of price controls to limit monopoly power can, however, cause a plethora of economic problems. In the blanks provided, check off those effects that might appear in a list of possible difficulties existing with price controls: ___ a. Alienation of business and government ___ b. International trade problems

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___ e. ___ d. ___ e. Consult Shortages and surpluses Absence of necessary flexibility in relative prices Increased unemployment Figure 17-3.

3.

Figure 17-3 a. For the indicated demand and cost curves, it is clear that the unregulated monopolist would produce ___ units of output for sale at a price of $___. Excess pure economic profits of $___ would then be earned. b. Regulation to the point of zero profits would meanwhile require a price specification of $___, at which ___ units of output would be expected. Consumer surplus would, in this case, increase from the unregulated monopoly level of $18 to $___. c. Ideal price regulation to the point where efficiency conditions were satisfied would, meanwhile, require a price specification of $___, with ___ units of output expected only if the monopolists losses in the amount of $___ were covered. Consumer surplus would rise further to $___ but would actually equal $___ if the subsidy to cover the losses just noted were deducted. This (would / would not) represent an improvement over the average-cost pricing alternative. B. Antitrust Policy a. Imperfect competition is undesirable from an economic standpoint mainly because of the (excess profits generated by the exploitation of price and quantity / distortions that it produces in the allocation of resources). b. For a monopolist, the equality of marginal benefit and marginal cost does not result from selfmotivated profit maximization. Since price is always (greater than / equal to / less than) marginal revenue, profit maximization requires that marginal cost be maintained at a level that is (higher than / equal to / lower than) the going price. Why? Because profits are maximized where marginal cost equals marginal revenue, and marginal revenue is less than price. Price ratios still reflect ratios of marginal utility, though, so monopoly power yields marginal cost that is (higher than / equal to / lower than) marginal benefit. Total welfare (cannot / can) then be improved by rearranging resources. How? In a way which (brings resources into / moves resources out of) the monopolists markets to (increase / decrease) their output. Based on the efficiency properties of the perfectly competitive market, it is clear that the marginal utility derived from consuming the monopolists product is (greater than / less than / equal to) the marginal cost of producing the good in question. Consult Figure 17-4. The long-run competitive output and price for a market with the indicated cost structure must equal __ units and $__, respectively. If this market is monopolized, an unregulated, profitmaximizing monopolist would sell ___ units at a price of $___. The result would be a reduction in

4.

5.

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consumer surplus from $___ to $___. Of that reduction, $___ would go to the monopolist in the form of excess profit, and $___ would represent lost welfare that would disappear (deadweight loss).

Figure 17-4 6. a. Suppose that the monopolist depicted in Figure 17-4 faces a lump-sum tax on profits of $8. The unregulated, profit-maximizing monopolist would then (increase the price above $8 / decrease the price below $8 / maintain the price at $8) to support a (larger / smaller / constant) level of production and sales. b. Suppose, instead, that government taxes the monopolists implicit return to capital and that the effective (constant) marginal cost of production thereby increases from $6 to $8 per unit. Output should (fall to / rise to / continue to remain fixed at) ___ units; price would (climb to / fall to / remain at) $___, representing an increase in price (equal to / less than / greater than) the $___ increase in unit costs. 7. The text notes three important pieces of antitrust legislation that laid the groundwork for subsequent antitrust activity: 1. The Sherman Antitrust Act (1890) (SA) 2. The Clayton Antitrust Act (1914) (CA) 3. The Federal Trade Commission Act (1914) (FTCA) Match each of the following provisions to its landmark legislation by recording SA, CA, or FTCA in the blanks provided; if none applies, write none: ___ a. Price discrimination that is not based upon cost differentials and is designed to lessen competition is declared illegal. ___ b. Unfair and deceptive business activities and practices are declared illegal. ___ c. No corporation can acquire another if such an acquisition would substantially reduce competition. ___ d. Forming a monopoly is declared a felony. ___ e. Lobbying for tariff protection against foreign competition is declared illegal. ___ f. Restraint of trade or commerce among states is declared illegal. ___ g. Restraint of trade or commerce with foreign nations is declared illegal. ___ h. Imposing a contract which prohibits the purchase of a competitors product is illegal. 8. One significant change in the way that the legal system of the United States deals with the potential problems of imperfect competition is found in the judicial attention paid to how business is actually conducted. According to this new view of how the law should be enforced, it is more important to attack behavior that signifies the abuse of market power than it is to concentrate on markets that display offensive industrial organization. These abusive methods of conducting business, including (a) price fixing, (b) output restraint, (c) market division, (d) predatory pricing, and (e) price discrimination, are not necessarily confined to the concentrated industries with extreme and potentially profitable market power. Some of them can appear in competitive markets as well. The following list contains examples of the five types of conduct just noted. Identify each example with the conduct that it represents, and record your answer in the space provided. a. An agreement between retailers and the manufacturer not to sell a certain doll for less than $25:

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b. c.

The pricing of computers below production costs to prevent entry by potential competitors: An agreement among suppliers of oil not to sell more than 1 million barrels per day:

d. A policy in which a particular firm sells hammers to hardware stores for $8.99 each and to the Defense Department for $410.22 each: e. f. g. An agreement among sugar retailers to sell only in specified geographical regions of the United States: An agreement among airlines to increase fares 20 percent over the weekend: The destruction of thousands of pounds of coffee beans before they get to market:

VIII. DISCUSSION QUESTIONS Answer the following questions, making sure that you can explain the work you did to arrive at the answers. 1. Why might regulation using market incentives be more efficient than regulation using command-andcontrol orders? 2. What major factors must be considered when deciding whether to regulate a monopolistic industry or break it up? What basic criteria might you establish to help make this decision? 3. What are economies of scope? How do they differ from economies of scale? 4. Why might a regulator choose to impose marginal-cost pricing for a monopoly? List and explain two different scenarios in which marginal-cost pricing might be appropriate. What will the effect be on the firm? 5. Review the three main pieces of antitrust legislation in the United States. What does each add to extend or clarify the nature of antitrust policy? 6. Review the path of antitrust policy as it has been interpreted by the courts during this century. 7. Around the world today, many countries have different attitudes toward antitrust. In Japan, for example, companies are encouraged to work together to gain a competitive edge over international competitors. The government maintains a careful process of subsidization of industry that helps to germinate young businesses and cushion the blows dealt by the business cycle. Given the nature of antitrust policy in the United States, can our firms expect to compete in the global economy? Has the Sherman Antitrust Act outlived its usefulness? 8. Do you think that the Bell doctrine, along with the recent decision against Microsoft, will discourage firms from innovation? IX. ANSWERS TO STUDY GUIDE QUESTIONS III. Review of Key Concepts 5 Command and control 8 Economic incentives 12 Natural monopoly 19 Economies of scope 3 Average-cost pricing 13 Marginal-cost pricing 16 Two-part tariff 4 Trust 14 Sherman Antitrust Act 18 Clayton Act 2 FTC Act 10 Per se prohibitions 6 Rule of reason 17 Predatory pricing 11 Tying contracts 7 Price discrimination

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20 15 9 1 Bell doctrine Vertical mergers Horizontal mergers Conglomerate mergers 3. 9. 15. C C A 4. 10. 16. B B E 5. 11. 17. E E A 6. 12. 18. B E A

VI. Multiple Choice Questions 1. C 2. C 7. C 8. D 13. A 14. C 19. D

l.

2. 3. 4. 5. 6. 7.

8.

VII. Problem Solving a. E b. S e. E d. S e. E or S f. E All these effects indicate difficulties with price controls. a. 6, $9, $6 b. $7, 8, $32 c. $5, 10, $10, $50, $40, would nonetheless a. distortions that it produces in the allocation of resources b. greater than, lower than, lower than, can, brings resources into, increase, greater than 8, $6, 4, $8, $16, $4, $8, $4 a. maintain the price at $8, constant b. fall to, 2, climb to, $9, less than, $2 a. CA b. FTCA e. CA d. SA e. none f. SA g. SA h. CA a. Price fixing b. Predatory pricing c. Output restraint d. Price discrimination e. Market division f. Price fixing g. Output restraint

VIII. Discussion Questions 1. Market incentives encourage firms to change their behavior as part of their own profit-maximizing strategy. Command-and-control orders require firms to make decisions in order to avoid penalty. Thus, market incentives may be more efficient. 2. Is the monopoly reasonable? Does the monopolist use unfair tactics to maintain monopoly power? Criteria might include the difference between price and marginal cost, and the difference between price and average costs. This would help us to determine how far the monopolist is from the competitive ideal. 3. Economies of scope exist when several products can be produced more efficiently by a single firm than by separate firms. Economies of scale exist when a firms long-run average costs decline as output increases. 4. A regulator might choose marginal-cost pricing for a monopoly if it desires an outcome that mirrors the competitive ideal. This holds prices low for customers. Marginal-cost pricing might be appropriate for a public transportation company or for public housing. In both these cases, regulators want to keep prices for consumers as low as possible. Firms would have to receive subsidies if they are to stay in business.

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5. The three important pieces of legislation are the Sherman Antitrust Act, the Clayton Act, and the Federal Trade Commission Act. Sherman is antimonopoly legislation, Clayton details illegal practices, and the FTC Act established a regulatory agency to oversee antitrust activity. 6. Key points include swings between the rule of reason and per se illegality during this century, as well as the existence of merger mania during the 1980s. 7. We may find that in order to compete internationally, U.S. firms must be allowed to work together in some ways. However, this runs counter to the path of antitrust policy as it has been enforced over the past 100 years. The Sherman Act will have outlived its usefulness if we are willing to admit that decreased competition among domestic producers is in the best interest of international competitiveness and consumer welfare. 8. Only time will tell. The returns to innovation are economic profits. Profitability is greater the longer the firm can hang onto its monopoly power. If the FTC seems intent on prosecuting firms that are monopolies, then the returns to innovation will fall!