Market Economies, Competition, Free Enterprise and Regulation

1
Market Economies, Competition, Free Enterprise
and Regulation

• Parker-Economics

2
3 Economic Questions

• What to produce
• How to produce it
• For whom to produce
• Basically, how are the four factors of production
  land, labor, capital and entrepreneurship
  allocated in a society?

3
Economic Systems

• Traditional
• What to produce, how to produce and for whom to
  produce determined by custom or tradition. Roles
  usually passed from generation to generation
• Command
• Economic questions answered by government
  officials
• Market
• Economic questions answered by individuals
  consumers and producers interacting in the market

4
Market Structures

• Pure Competition
• Monopolistic Competition
• Oligopoly
• Monopoly

5
Free Enterprise versus Socialism
6
Prices in Free Enterprise

• Equilibrium exists in a market when quantity of
  goods demanded is equal to the quantity of goods
  sellers are willing to produce and offer for sale
• Equilibrium price price at which a good is
  bought and sold in a market that is in
  equilibrium
• Shortage condition where quantity demanded is
  greater than quantity supplied
• Surplus quantity supplied is greater than
  quantity demanded

7
History of Industrialization and Emergence of
Market Economy in the U.S.

• Industrial Revolution began in Britain in late
  18th century.
• Industrialization in United States began in 19th
  century.
• Several large US manufacturers were known
  world-wide by mid 19th century.
• McCormick reaper
• Colt revolvers
• Singer sewing machines

Source Hughes, Jonathon and Louis P. Cain,
American Economic History, 5th ed., Addison
Wesley, 1998, pg. 327. http//www.sieu.edu/BUSINE
SS/depart/econfin/courses/econ112/Sullivan/Lecture
Notes/antitrust20regulation.ppt
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Industrialization

• The industrial manufacturing process typically
  relied on large machines and the energy to run
  them (e.g., steam engines).
• For example the steel industry utilized the
  Bessemer converter (invented in 1856 and first
  used by Andrew Carnegie) the Siemens
  open-hearth furnace (which replaced it by the
  early 20th century).

Source Hughes, Jonathon and Louis P. Cain,
American Economic History, 5th ed., Addison
Wesley, 1998, pg. 335-6. http//www.sieu.edu/BUSI
NESS/depart/econfin/courses/econ112/Sullivan/Lectu
reNotes/antitrust20regulation.ppt
9
Industrialization Economies of Scale

• The large machines required a huge investment,
  yet allowed extremely low average costs.
• Large economies of scale encouraged mergers and
  expansion of existing companies.
• It no longer is possible, to do business on the
  basis of high profits for comparatively small
  tonnage. Elbert H. Gary, head of Illinois Steel
  during the late 19th century.

Source Hughes, Jonathon and Louis P. Cain,
American Economic History, 5th ed., Addison
Wesley, 1998, pg. 336 http//www.sieu.edu/BUSINES
S/depart/econfin/courses/econ112/Sullivan/LectureN
otes/antitrust20regulation.ppt .
10
Industrial Consolidation

• Many industries began consolidating to take
  advantage of these economies of scale.
• Example
• Steel Carnegie Steel Works and then United
  States Steel
• Meat Packing Swift and Armour
• Oil Standard Oil
• http//www.sieu.edu/BUSINESS/depart/econfin/course
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Entrepreneurial Power

• The leaders of these large corporations were
  admired for their creativity, power and
  philanthropy. Yet, also, feared and resented.
• Andrew Carnegie (Carnegie Steel Works)
• J.P. Morgan (United States Steel)
• John D. Rockefeller (Standard Oil)
• Edward Harriman (Union Pacific Railroad)
• Jay Gould (several railroads)
• http//www.sieu.edu/BUSINESS/depart/econfin/course
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Entrepreneurial Power

• Many of these corporate leaders were extremely
  clever in using their near-monopoly power.
• They utilized price fixing, output controls and
  pooling of voting stock of competitive firms.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

13
John D. RockefferRobber Baron or Captain of
Industry?

• As we view the achievements of aggregate
  capital, we discover the existence of trusts,
  combinations, and monopolies, while the citizen
  is struggling far in the rear, or is trampled to
  death beneath an iron heel. Corporations, which
  should be the carefully restrained creatures of
  the law and the servants of the people, are fast
  becoming the peoples masters. President
  Grover Cleveland (1888).

Source Hughes, Jonathon and Louis P. Cain,
American Economic History, 5th ed., Addison
Wesley, 1998, pg. 359.
14
Robber Barons or Captains of Industry?

• Main Entry robber baronFunction nounDate
  1878 an American capitalist of the latter part
  of the 19th century who became wealthy through
  exploitation (as of natural resources,
  governmental influence, or low wage scales)

Source http//www.m-w.com/cgi-bin/dictionary?book
Dictionaryvarobber20baron
15

• Captain 'kæptinnoun. . . 6  a person in
  command over a group, organization, etc.
  leaderexample a captain of industry. . .
• http//www.wordreference.com/English/definition.as
  p?encaptain

16
Accomplishments ofStandard Oil

• Rockefeller entered oil industry in 1860s
• Used technology to cut costs and lower prices
• From 1873 to 1883, gross margins on refined oil
  dropped by 7.3 cents a gallon to .9 cents a
  gallon
• Between 1870 and 1911, prices plummeted and
  output soared. In 1911, Supreme Court ruled that
  Standard Oil violated the antitrust laws.

17
Refined Oil
In cents Millions of 42-gallon barrels of
refined oil From Greed. Stoessel in the
Classroom. The Palmer R. Chitester Fund, Inc.
2002. Page 7.
18
Rockefeller Robber Baron or Captain of
Industry???

• Read the articles distributed in class (also on
  website)
• Draw a T-chart was Rockefeller a good guy or
  did he exploit others?

19
Robber Barons or Captains of Industry?

• Society is more apt to think of them as robber
  barons than captains of industry. Only when
  the American steel industry in the 1970s needed a
  new Carnegie and the automobile industry needed a
  new Henry Ford and no one stepped forward did
  we begin to worry about entrepreneurship, call
  conferences, make government grants to study the
  problem and otherwise sound the alarm.

Source Hughes, Jonathon and Louis P. Cain,
American Economic History, 5th ed., Addison
Wesley, 1998, pg. 344. http//www.sieu.edu/BUSINES
S/depart/econfin/courses/econ112/Sullivan/LectureN
otes/antitrust20regulation.ppt
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Standard Oil Company of NJ vs. United States

• May 15, 1911 Ten years after the case was first
  introduced, the US Supreme Court ruled that
  Standard Oil must be broken into seven smaller
  companies (Standard, Mobil, Chevron, Amoco,
  Exxon, etc.).
• 1987 British Petroleum (BP) buys Standard
• 1998 BP merges with Amoco
• 1999 Exxon and Mobil merged
• 2001 Chevron merged with Texaco
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
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21
The Rule of Reason

• First articulated in the Standard Oil case.
• An evolving standard by which antitrust cases are
  decided.
• Requires not only the existence of monopoly power
  (per se rule), but also the intent to restrict
  trade.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Recap Robber or Captain?

• True or False Rockefeller did not mean to
  create benefits for the less fortunate, so it
  should not count.
• I have never known much good done by those who
  affected to trade for the public good. Adam
  Smith

23
Government Regulation and Free Enterprise

• The natural effort of every individual to
  better his own condition is so powerful a
  principle, that it is alone, and without
  assistance, not only capable of carrying on the
  society to wealth and prosperity, but of
  surmounting a hundred impertinent obstructions
  with which the folly of human laws too often
  encumber everyone. Adam Smith (Wealth of
  Nations. p. 508.

24
The Invisible Hand
Adam Smith believed that competition, along with
the free market system would act as an Invisible
hand. This invisible hand would guide resources
to their most productive use. With competition,
individuals acting in their own self-interest
and government intervention would be
unnecessary. Laissez-faire no
government Intervention in economic affairs
25
Adam Smith

• Every individual necessarily labours to render
  the annual revenue of the society as great as he
  can. He generally neither intends to promote the
  public interest, nor knows how much he is
  promoting it.He intends only his own gain, and
  he is in this, as in many other cases, led by an
  invisible hand to promote an end which was no
  part of his intention. Nor is it always the
  worse for society that it was no part of his
  intention. By pursuing his own interest, he
  frequently promotes that of the society
  more effectually than when he really intends to
  promote it. I have never known much good done by
  those who affected to trade for the public good.

26
Antitrust Policy

• Antitrust policies are government actions
  designed to promote competition among firms in
  the economy.
• They are also known as competition policy or
  antimonopoly policy.

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Important Trust Acts

• 1890 Sherman Antitrust Act
• 1914 Clayton Antitrust Act
• 1914 Federal Trade Commission Act
• 1936 Robinson-Patman Act
• 1938 Wheeler-Lea Act

28
Sherman Antitrust Act 1890

• Named after Senator John Sherman (R-Ohio), who
  had introduced similar bills in 1888 and 1889.

Source Hughes, Jonathon and Louis P. Cain,
American Economic History, 5th ed., Addison
Wesley, 1998, pg. 362. http//www.sieu.edu/BUSINES
S/depart/econfin/courses/econ112/Sullivan/LectureN
otes/antitrust20regulation.ppt
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Sherman Act Section 1

• Section 1 makes price fixing illegal
• Any contract, combination in the form of trust
  or otherwise, or conspiracy, in restraint of
  trade or commerce among the several states or
  with foreign nations is hereby declared to be
  illegal.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Sherman Act Section 2

• Section 2 addresses monopolies
• Every person who shall monopolize, or attempt to
  monopolize any part of the trade or commerce
  among the several states, or with foreign
  nations, shall be deemed guilty of a felony.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Theodore Roosevelt

• Roosevelt (US President 1901-1908) made his
  reputation as a trust buster by attacking
  various monopolies using the Sherman Act.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ
• 112/Sullivan/LectureNotes/antitrust20regulation.p
  pt

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William Howard Taft

• Taft (Roosevelts Vice President, and US
  President 1909-1912) continued these efforts.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Su
• llivan/LectureNotes/antitrust20regulation.ppt

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Antitrust Cases based upon Sherman

• 1911 American Tobacco Company forced to split
  with the British Imperial Tobacco Company.
• 1920 US Steel survived a breakup attempt, when
  the Supreme Court ruled that, based on the rule
  of reason, US Steel did not restrain competition.
• 1945 Alcoa Aluminum was found guilty when rule
  changed to allow efforts to maintain a monopoly
  as standard.
• 1969 Action brought against IBM. Subsequently
  dropped because of changes in the computer
  industry.
• 1970s 1980s ATT is forced to split their long
  distance and local companies.
• 1990s Action brought against Microsoft.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Clayton Antitrust Act

• 1914 US law aimed at preventing mergers that
  would create monopolies.
• Amended and clarified the Sherman Act.
• Drafted by Henry De Lamar Clayton.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Other Antitrust Legislation

• Federal Trade Commission Act
• 1914
• Robinson-Patman
• 1936
• Wheeler-Lea Act
• 1938

36
Federal Agencies Enforcing Antitrust Laws

• The Federal Trade Commission (FTC) was
  established in 1914 to help enforce antitrust
  laws in the US.
• The Antitrust Division of the Justice Department
  also enforces antitrust law.

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What is Considered When Approving a Merger?

• Concentration of industry
• Market Definition
• Horizontal versus Vertical Mergers
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Horizontal Merger

• A horizontal merger combines two firms that sell
  the same good or the same type of good.
• Always increases concentration

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Vertical Merger

• A vertical merger is the combining of two firms,
  one of which supplies the other.

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Anticompetitive Practices

• Predatory Pricing
• Price Fixing
• Vertical Restraints
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Predatory Pricing

• Predatory pricing is when a firm sets a price
  below the shutdown point, hoping to drive
  competitors out of business, after which theyll
  have a monopoly.
• Is illegal in the US, although it is difficult to
  prove because it is difficult to distinguish from
  normal competition.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Price Fixing

• Price fixing occurs when firms conspire to set
  prices for goods sold in the same market.
• Illegal under Section 1 of the Sherman Antitrust
  Act.
• Complaints can be brought forward by affected
  firms (more typical) or by the Justice
  Department.
• Individual firms can collect treble damages.
• Most famous case involved Westinghouse and
  General Electric in the 1950s.
• http//www.sieu.edu/BUSINESS/depart/econfin/course
  s/econ112/Sullivan/LectureNotes/antitrust20regula
  tion.ppt

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Vertical Restraints

• Exclusive Territories giving retailers or
  wholesalers exclusive rights to sell the product
  in an area (soft drinks beer).
• Exclusive Dealing requiring that retailers do
  not sell competing products.
• Resale Price Maintenance forbidding retailers
  from selling at a discount (common with
  electronic equipment).
• These strategies are not, in general, illegal.

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Regulating Monopolies

• Perhaps the best way to regulate monopolies is to
  break them up, or prevent them in the first
  place.
• What if a breakup is impractical or inefficient
  (e.g., a natural monopoly)?
• Regulation (such as by a utility commission)
• Marginal Cost Pricing
• Average Total Cost Pricing
• Incentive Regulation
• Government Ownership

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Government Ownership

• If all else fails, the government can take over
  the monopoly.
• This is relatively uncommon in the US.

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Deregulation

• Beginning in the late 1970s and continuing in the
  1980s, deregulation was an effort to reduce the
  regulations controlling prices and entry into
  industries.
• Examples
• Trucking
• Airlines
• Cable TV
• Oil gas
• Radio

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Credits/Bibliography

• Several pages of this presentation were taken
  from Antitrust Policy Regulation by Timothy
  S. Sullivan, Ph.D., Department of Economics
  Finance, Southern Illinois and are noted as such
  at the bottom of those pages with the website
• http//www.sieu.edu/BUSINESS/depart/econfin/cour
  ses/econ112/Sullivan/LectureNotes/antitrust20regu
  lation.ppt