Economics principles tools and applications 9th by sullivan sheffrin perez chapter 28

Economics

NINTH EDITION

Chapter 28

Controlling Market
Power:
Antitrust and
Regulation
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Learning Objectives

28.1 Define a natural monopoly and explain the average-cost pricing policy.
28.2 List three features of antitrust policy.

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28.1 NATURAL MONOPOLY (1 of 4)

Picking an Output Level
MARGINAL PRINCIPLE
Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the
marginal cost.

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28.1 NATURAL MONOPOLY (2 of 4)

Picking an Output Level
Because of the indivisible input (the pipe system), the long-run
average-cost curve is negatively sloped.
The monopolist chooses point a, where marginal revenue equals
marginal cost.
The firm sells 70 million units of water at a price of $2.70 each
(point b) and an average cost of $2.10 (point c). The profit per
subscriber is $0.60 ($2.70 – $2.10).

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28.1 NATURAL MONOPOLY (3 of 4)

Will a Second Firm Enter?
The entry of a second cable firm would shift the demand curve of the
typical firm to the left.
After entry, the firm’s demand curve lies entirely below the long-run
average-cost curve.
No matter what price the firm charges, it will lose money. Therefore, a
second firm will not enter the market.

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28.1 NATURAL MONOPOLY (4 of 4)

Price Controls for a Natural Monopoly

Under an average-cost pricing policy, the government chooses the price
at which the demand curve intersects the long-run average-cost curve—
$12 per subscriber.
Regulation decreases the price and increases the quantity.

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APPLICATION 1

PUBLIC VERSUS PRIVATE WATERWORKS
APPLYING THE CONCEPTS #1: What is the rationale for regulating a natural monopoly?
In the early part of the nineteenth century in Great Britain, water was distributed by local government.
The Industrial Revolution led to rapid urban growth.
Lacking taxing power the local governments could not keep up with the demand and water distribution changed to private industry.
Problems with water distribution eventually led to Parliament to change back to public waterworks.
Water is a natural monopoly and multiple companies could not earn enough profit to stay in business and offer adequate services.

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APPLICATION 2

SATELLITE RADIO AS A NATURAL MONOPOLY
APPLYING THE CONCEPTS #2: When does a natural monopoly occur?
In 2008, the nation’s only two satellite radio providers, Sirius Satellite Radio and XM Satellite Radio, announced plans to merge into a single firm. Together the
two firms had 14 million subscribers, each paying $13 per month. Both firms were losing money as they struggled to get enough subscribers to cover their
substantial fixed costs.
The proposed merger needed to be approved by the U.S. Department of Justice and the Federal Communication Commission.
The key question is whether the elimination of competition between the two firms would lead to higher prices, and how large any price hike would be.

In evaluating the merits of the proposed merger, government regulators grappled with the trade-offs between saving costs by avoiding duplication and possible price
hikes.
The merger eventually led to greater options and lower costs to subscribers

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28.2 ANTITRUST POLICY (1 of 6)

Trust
An arrangement under which the owners of several companies transfer their decision-making powers to a small group of trustees.

Breaking Up Monopolies
One form of antitrust policy is to break up a monopoly into several smaller firms. The label “antitrust” comes from the names of the early conglomerates that the
government broke up.

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28.2 ANTITRUST POLICY (2 of 6)

Blocking Mergers
Merger
A process in which two or more firms combine their operations.
A horizontal merger involves two firms producing a similar product, for example, two producers of pet food.
A vertical merger involves two firms at different stages of the production process, for example, a sugar refiner and a candy producer.

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28.2 ANTITRUST POLICY (3 of 6)

Blocking Mergers
Using the marginal principle, Staples picks the quantity at
which its marginal revenue equals its marginal cost.
In a city without a competing firm, Staples picks the
monopoly price of $14.

In a city where Staples competes with Office Depot, the
demand facing Staples is lower, so the profit- maximizing
price is only $12.

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28.2 ANTITRUST POLICY (4 of 6)

Merger Remedy for Wonder Bread
In some cases, the government allows a merger to happen but imposes restrictions on the new company.

TABLE 28.1 A Merger Increases Prices
Wonder Brand

Interstate Brand

Total

1

2

3

4

5

6

Before

After

Before

After

Before

After

Merger

Merger

Merger

Merger

Merger

Merger

>0

$1.50

$1.50

$1.50

$1.50

Price

$2.00

$2.00

$2.00

$2.20

Quantity

100

110

100

70

200

180

Profit

$ 50

$ 55

$ 50

$ 49

$100

$104

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28.2 ANTITRUST POLICY (5 of 6)

Regulating Business Practices
Tie-in sales
A business practice under which a business requires a consumer of one product to purchase another product.

Predatory pricing
A firm sells a product at a price below its production cost to drive a rival out of business and then increases the price.

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28.2 ANTITRUST POLICY (6 of 6)

A Brief History of U.S. Antitrust Policy
Table 28.2 Key Antitrust Legislation
Law

Date Enacted

Sherman Act

1890

Regulation Enacted
Made it illegal to monopolize a market or to engage in practices that result in a restraint of
trade.

Clayton Act

1914

Outlawed specific practices that discourage competition, including
tie-in sales contracts, price discrimination for the purpose of reducing competition, and
stock-purchase mergers that would substantially reduce competition.

Federal Trade Commission Act

1914

Created a mechanism to enforce antitrust laws.

Robinson – Patman Act

1936

Prohibited selling products at “unreasonably low prices” with the intent of reducing
competition.

Celler-Kefauver Act

1950

Outlawed asset-purchase mergers that would substantially reduce competition.

Hart-Scott-Rodino Act

1980

Extended antitrust legislation to proprietorships and partnerships.

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APPLICATION 3

THE MERGER OF PENZOIL AND QUARTER STATE
APPLYING THE CONCEPTS #3: How does a merger affect prices?
In 1998, Pennzoil Motor Oils purchased Quaker State Motor oils in an acquisition valued at $1 billion. The merger brought together two of the five brands of
premium motor oil, with a combined market share of 38% (29% for Pennzoil and 9% for Quaker State).
The antitrust agencies approved the merger without any modifications. A recent study of the merger concludes that the new company increased the price of the
Quaker State products by roughly 5%, but did not change the price of Pennzoil products. The market share of Pennzoil products increased, while the
market shares of Quaker State products decreased.
The study also examines the price effects of four other mergers. In three of four cases, the merger increased prices, with price hikes between 3 and 7 percent.
The authors note that the modest price effects might be surprising to (1) people who expect relatively large positive price effects as firms exploit their
greater market power and (2) people who expect negative price effects as the firms become more efficient.

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APPLICATION 4

MERGER OF OFFICE DEPOT AND OFFICEMAX
APPLYING THE CONCEPTS #4: What is the role of competition in the regulation of mergers?
In 2013 the Federal Trade Commission (FTC) approved the merger of Office Depot and OfficeMax.
The FTC concluded that the merger of the second and third largest office supply superstores was unlikely to substantially reduce competition in the office
supplies market.
Other competition comes from general superstores such as Wal-Mart and Target and club stores such as Costco and Sam’s Club. In addition, there is
competition from Amazon and other Internet suppliers.

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KEY TERMS

Merger

Predatory pricing
Tie-in sales
Trust

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