Midterm 1

1
Midterm 1

• Rough guide to grading scale
• A 90 100 (12.8)
• B 76 89 (29.7)
• C 61 75 (35.3)
• D 46 60 (17.2)
• F 45 and below (4.8)
• Mean 72
• Standard deviation 14

2
Review

• We have started to learn about government
  interventions in the market economy when there is
  market failure (i.e., market outcome is
  inefficient).
• One example of market failure is the existence of
  market power. In the presence of market power,
  the market fails to allocate resources
  efficiently. Public policy can potentially remedy
  the problem and increase efficiency through
  regulations and antitrust laws.
• Monopoly and Oligopoly Regulations

3
Regulation of natural monopoliesMarginal Cost
pricing
Regulation in the social interest is achieved
total surplus, which is entirely consumer
surplus, is maximized. There is no deadweight
loss. However, the firm incurs a loss because
PMC lt ATC
4
Regulation of natural monopoliesAverage Total
Cost pricing

• One alternative is to set price equal to ATC.
• Firm earns zero economic profit when
• PATC.
• But ATC pricing leads to
• DWL.
• In practice
• Rate of return regulation
• price-cap regulation

5
Social Interest Theory of Regulation
versusCapture Theory of Regulation

• Regulation of natural monopoly unclear which
  theory describes it the best
• Regulation of cartel capture theory
• Antitrust laws ?

6
Antitrust lawslaws to promote competition

• Trust an organized association of several
  companies for the purpose of reducing or
  defeating competition. Here the word trust is
  synonymous to monopolistic practices.
• Antitrust oppose and curb practices that may
  harm competition, such as monopolies or cartels.
• The Antitrust laws allow the government to
• - prevent mergers
• e.g. 1997, FTC blocked merger of Office Depot
  with Staples
• - break up companies
• e.g. 1984, ATT was split up into 8 smaller
  companies
• - prevent cartels

7
Antitrust lawslaws to promote competition

• The Sherman Antitrust Act (1890)
• - Outlawed monopolies and attempt to monopolize
• - Deemed agreements among oligopolists as
  criminal conspiracy
• The Clayton Act (1914)
• - Strengthened the antitrust laws
• - Authorized and encouraged private lawsuits
  against conspiring oligopolists
• The Federal Trade Commission (1914) set up to
  look for unfair method of competition, to bust
  the trusts. Over the years, Congress passed
  additional laws giving the agency greater
  authority to police anticompetitive practices

8
Controversies over Antitrust laws

• Price fixing is always illegal. But the antitrust
  laws have been used to condemn some business
  practices that may have legitimate purposes.
• e.g. Resale price maintenance
• Tying
• Required Reading Ch14,
  p335-336
• Bottom line Business practices that appear to
  reduce competition may in fact have legitimate
  purposes. This makes the application of the
  antitrust laws all the more difficult and policy
  makers need to be very careful when using the
  substantial power of the antitrust laws to place
  limits on firm behavior.

9
The U.S. versus Microsoft (1998-2002)

• Microsoft controls 80 of PC operating systems
  Main competitors are Apple Mac and Linux
• Microsoft argued potential new entrants make
  industry very competitive (no barriers to entry)
• Microsofts monopoly power comes from
• - network economies (I want to use the same
  operating system as you)
• - large fixed costs (software development)
• Specific complaint by the department of justice
  Microsoft was tying Internet Explorer into
  windows (free software drives out competitors)
• Microsoft argued this was making product more
  useful to customers (like putting a stereo in a
  car)
• Result of the suit
• - Microsoft not broken up, but IE was separated
  from windows
• - Microsoft requires to disclose details of its
  operating system to other developers so they
  could more effectively compete against it

10
Social Interest Theory of Regulation
versusCapture Theory of Regulation

• Regulation of natural monopoly unclear which
  theory describes it the best
• Regulation of cartel capture theory
• Antitrust laws The overall thrust of antitrust
  laws has been to protect consumers and pursue
  efficiency. But at times, the court
  interpretation of these laws has favored the
  interest of producers.

11

• Another example of market failure
• Externalities
• Refers to a cost of benefit that arises from
  production and falls on someone other than the
  producer, or a cost or benefit that arises from
  consumption that falls on someone other than the
  consumer.

12
Four types of externalities

• Negative production externalities
• e.g. air pollution produced by factories
• Positive production externalities
• e.g. technology spillovers in the market of
  industrial robot
• Negative consumption externalities
• e.g. smoking in a confined place
• Positive consumption externalities
• e.g. flu vaccination

13
Definitions

• Marginal private cost (MC) - the marginal cost
  personally borne by the producer
• Marginal external cost the marginal cost falls
  on people other than the producer
• Marginal social cost (MSC)
• MSC MC marginal external cost
• Marginal private benefit (MB) - the marginal
  benefit personally received by the consumer
• Marginal external benefit the marginal benefit
  enjoyed by people other than the consumer
• Marginal social benefit (MSB)
• MSB MB marginal external benefit

14
Negative Production Externality Pollution

• MSB lt MSC in the market equilibrium inefficient
  outcome.
• The efficient quantity is where MSB MSC
• The market overproduces and creates a deadweight
  loss.

15
Positive Consumption Externality Education

• Figure shows how a private market underproduces
  an item that generates an external benefit
• and creates a deadweight loss.