Regulation of Market Structure, Supply, and Price

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Regulation of Market Structure, Supply, and Price
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Theoretical Background Concept of a MARKET

• What is the relevant market?
• A market is a collection of firms, each of which
  is supplying products that have some degree of
  substitutability to the same potential buyers

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Theoretical BackgroundConcept of MARKET

• Important characteristics
• Product type and substitutability
• practical nature of the good
• substitutes
• complements
• cross-price elasticity of demand
• change in Q of good 2 / change in P of good
  1
• Geography
• Time

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Marginal Cost

• Marginal cost per unit is a rough measure of the
  opportunity costs to society of the resources
  being used to produce that unit of a good
• PMC
• P
• PMC

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Model of Perfect Competition

• Conditions that must hold
• large of buyers and sellers
• homeogeneous product
• barriers to entry minimal or nonexistent (free
  entry and exit)
• perfect mobility of resources
• sellers and buyers have perfect information

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Model of Pure Competition Short Run
Assumptions 1. price taker 2. D AR curve
and MR curve 3. Price dictated by interaction
of supply and demand forces
P
MC
AC
P1
DARMR
Q
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Model of Pure Competition Short Run

• Firm produces output that will maximize their
  profits
• Marginal Costs Average Cost and thus firm earns
  an economic or abnormal profit
• Economic profit is one that exceeds the costs of
  producing the good plus a fair rate of return
  to investors capital
• If this occurs, over the long run, new firms are
  encouraged to enter the market

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Perfect Competition Long Run
With an economic profit, other firms enter
market, increasing output to entire market and
lowering price. Reach a breakeven point
where firms earn a normal profit. PMC
P
LRAC
LRMC
P1
P2
DARMR
P3
Q
MRARLRMCLRAC
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Perfect Monopoly

• One seller in market
• Ability to influence price quantity
• Produces a differentiated product

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Perfect Monopoly
SRMC LRMC
P
Short-run and long-run the same since there is
no entry MRMC downward sloping demand
curve PMC
A
P1
LRAC
B
C
D
MR
Q
Q1
Q2
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Long Run Outcome under Perfect Monopoly

• Three inefficiences
• PMC underallocation of resources
• operates a less than optimal scale of plant
• Underutilizes that plant

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Comparison between competition and monopoly

• Compared to firms in a purely competitive
  industry, a monopolist will
• produce a smaller level of output
• charge a higher price for product
• operate a less than optimal scale of plant
• underutilize that plant
• benefit from barriers to entry
• underallocate resources

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Monopolist Competition

• Markets where rivals have some degree of control
  over price and quantity
• Two important characteristics
• product differentiation
• ease of entry and exit

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Oligopoly

• Market with few sellers of the same product
• Mutual interdependence
• Product can be homogeneous or heterogeneous
• Reaction to other sellers

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Economic Effects of Market Power

• Loss of Consumer Surplus
• Nonallocative Inefficiency (X-inefficiency)
• Redistribution of income and welfare

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Consumer Surplus Loss
Consumer Surplus difference between what a
consumer would have been willing to pay for the
good and what he/she actually paid, added over
all consumers
P
A
B
PM
C
D
PC
MCAC S in C
D
MR
QC
QM
Q
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Antitrust Protections

• protect and preserve competition
• lower prices and choice
• fair competition

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The Sherman Act of 1890

• Section 1
• Intended to make illegal arrangements that reduce
  competition or firms acting independently (trusts
  and cartels)
• Section 2
• Intended to punish attempts to gain control of
  market (monopoly)
• Enforced by the Department of Justice

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Monopolizing Sherman Act Section 2 Cases (pp.
87-92)

• Northern Securities
• Standard Oil
• US Steel
• Alcoa
• United Shoe Machinery

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Clayton Act of 1914 Outlawed four specific
practices

• Section 2 price discrimination
• Section 3 tying contracts
• Section 7 mergers
• None of the prohibitions were absolute only when
  their effect may be to substantially lessen
  competition or tend to create a monopoly
• Section 8 interlocking directorates

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Subsequent Antitrust Legislation

• 1914 Federal Trade Commission Act
• Section 5. Made illegal unfair methods of
  competition in commerce. (term unfair not
  defined)
• 1936 Robinson-Patman Amendment to Clayton Act

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Subsequent Antitrust Legislation

• 1938 Wheeler - Lea Act
• Section 3 Unfair and deceptive acts
• 1950 Celler - Kefauver act
• Section 1 Anti-merger
• 1976 Hart-Scott-Rodino Act

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Subsequent Antitrust Legislation

• 1994 International Antitrust Enforcement
  Assistance Act
• mutual assistance agreements with foreign
  antitrust authorities

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Departures from Antitrust Exemptions

• Much local and statewide activity
• Labor unions
• Local utilities and urban services
• Social services and health services schools
• Public enterprises
• Farm and fishery cooperatives
• Many military suppliers
• Baseball, and to a lesser degree, other
  professional sports
• Newspapers joint publishing arrangements in many
  cities

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Departures from AntitrustPolicies that Reduce
Competition

• Tariffs and other barriers to international trade
• Patents
• Banking regulation that prevent new entry in many
  banking markets
• Price raising for certain farm products (USDA)
• Shipbuilding and shipping (price fixing is
  permitted by the FMC

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Antitrust Tools

• incentive for private individuals to enforce the
  laws
• breaking up firms that dominate an industry
• preventing mergers that would adversely affect
  competition
• government action against price-fixing
• investigates
• consent agreements - (cease and desist)
• if do not cease and desist - lawsuit - fines and
  criminal sanctions

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Monopolizing Sherman ActSection 2 cases (pp.
87-92)

• First Wave -- 1904-1920 - Testing the Law
• Standard Oil (85 of market)
• US Steel (90 of market)
• Second Wave --1938-1953 - Trying Again
• Alcoa (90 of market)
• United Shoe Machinery (95 of market)

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Monopolizing Sherman ActSection 2 cases (pp.
87-92)

• Third Wave -- 1968-1982 - Refining the Law
• IBM (70 of market)
• Cereals (collusion)
• ATT (83 of market)
• Antitrust virtually stops in the 1980s

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The Microsoft Case

• Charged with
• unfairly bundling its products
• unfairly extending its monopoly
• polluted the Java programming language which
  poses the greatest current threat to Microsofts
  monopoly

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Mergers Clayton Act, 1914 and Celler-Kefauver

• Three types of mergers
• Horizontal
• Vertical
• Conglomerate

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Cases Mergers

• Horizontal mergers
• Du Pont-General Motors
• Proposed AOL/Time Warner merger
• Barnes Noble / Ingram Book
• Conglomerate Mergers
• Proctor Gamble (1967)

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Herfindahl-Hirschman Index

• Herfindahl-Hirschman Index
• takes into the number and the inequality of
  market shares
• sum of squares of individual market shares of
  firms in the market

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Cases Price Fixing and Resale Price Maintenance

• Price Fixing
• Addyston Pipe and Steel Company (1899)
• Trenton Potteries
• Socony-Vacuum
• Resale Price Maintenance (vertical price fixing)
• Sharp

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Criteria for Evaluating Firms Behavior

• Defining the market
• Do consumers have relevant substitutes?
• Will firms gain dominant market share?
• What is the geographic market?
• Has there been abusive conduct?
• Will there be efficiencies due to the merger?
• Are there precedents?