Notes

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Notes

• Homework III due Friday, May 6, 5pm.
• Available on-line, or in room 322 Ag. Admin.
• Exam available to be picked up in room 322 Ag
  Admin.
• Average on exam only 74
• Class average so far 85
• Next Exam, May 13, in class

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Chapter 11 12 Game Theory, Antitrust
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Price Leadership

• The dominant firm establishes price in accordance
  with its profit maximizing objectives.
• Other firms take this prices as given, and will
  equate price with their respective marginal
  costs.
• Other firms are price takers.

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Why is there an incentive to cheat in an
Oligopoly (or Cartel)?

• Short term deviations from the agreement can be
  profitable.
• Producing a little more this period will have
  little impact upon price and not be noticeable
• Firms act strategically
• They try to guess what other firms will do.
• They often guess that other firms will cheat on
  the agreement, so.
• How can we analyze the potential outcomes of an
  oligopoly?

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Game Theory

• Game Theory a mathematical technique used to
  analyze the behavior of decision makers who
• Try to reach an optimal position through game
  playing or the use of strategic behavior.
• Are fully aware of the interactive nature of the
  process at hand.
• Anticipate the moves of other decision makers.

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Prisoners Dilemma Exhibit 8
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Cartels and Prisoners Dilemma Exhibit 9
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Characteristics and Consequences of Market
Structures
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Monopoly and Oligopoly as Market Failure

• Deviations from perfect competition cost
  consumers, and suggest market failure.
• Consequence is higher prices than we should
  have to pay.
• How do we know?
• Difficult to determine perfectly.
• Can use rules of thumb
• Number of firms in industry?
• Proportion of sales?
• 4 and 8 firm concentration ratios
• Herfindahl index.
• This area of economics and law has evolved, is
  evolving, and will continue to evolve over time

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Antitrust

• Antitrust Law legislation passed for the
  purpose of controlling monopoly power and
  preserving and promoting competition.
• Trust A combination of firms that come together
  to act as a monopolist

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The Sherman Act (1890)

• Every 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.
• Every person who shall monopolize, or attempt to
  monopolize, or combine or conspire with any other
  person or persons to monopolize any part of the
  trade or commerceshall be guilty of a
  misdemeanor.

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The Clayton Act (1914)

• The Following were made illegal by this act
• Price Discrimination
• Exclusive Dealing
• Tying Contracts
• Acquisition of competing companies stock if the
  acquisition reduces competition.
• Interlocking directorates an arrangement
  whereby the directors of one company sit on the
  board of directors of another company in the same
  industry

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Other Antitrust Acts

• Federal Trade Commission Act (1914)
• Robinson-Patman Act (1936)
• Wheeler-Lea Act (1938)
• Celler-Kefauver Antimerger Act (1950)

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Current Issues

• Justice Department
• Monitors business activity and practices to
  assess whether there is unfair competition
• Press Release Former Executive of Indiana Ready
  Mixed Concrete Producer Agrees to Plead Guilty to
  Price-Fixing Charge - Agrees to Serve Eight
  Months in Prison and to Pay a 70,000 Criminal
  Fine (04/28/2005)
• Press Release Korean Company--Hynix--Agrees to
  Plead Guilty to Price Fixing and Agrees to Pay
  185 Million Fine for Role in DRAM Conspiracy -
  Company Pays Third Largest Antitrust Criminal
  Fine in History (04/21/2005)
• Mergers Do they lead to unfair competitive
  advantages?
• Change in Herfindahl index could trigger an
  investigation.
• Examples USAir United (No) Boeing McDonnell
  Douglas (Yes) BP (Sohio) Amoco (Yes)
• Globalization presents challenges to assessing
  mergers.

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Mergers and Antitrust

• Horizontal Merger a merger between firms that
  are selling similar products in the same market
• Vertical Merger a merger between companies in
  the same industry, but at different stages of the
  production process.
• Conglomerate Merger a merger between companies
  in different industries.

Government looks most carefully at proposed
horizontal mergers because they are more likely
to change the degree of concentration or
competition in an industry
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Current Issues Innovation

• Department of Justice now takes innovation into
  account when assessing potential mergers
• Why?
• More than half of productivity gains from
  innovation and technical change.
• While increased competition lowers prices,
  monopoly power may yield more innovation.
• Patents are a form of monopoly power (at least
  for a time)

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Network Monopoly

• Network Good A good whose value increases as
  more people are attached to the network.
• Telephone service mail service.
• Airplane service to smaller cities.
• Internet.
• Regulation DoJ pays attention to how the network
  monopolist behaves
• Predatory pricing practices may lead to action.

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Natural Monopoly
Exhibit 2

• Economies of scale are so large
• Only one firm can produce more at lower price.
• Many utility services
• Costs of capital and distribution are very large.
• Often regulated
• PUCO

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Theories of Regulation

• Capture Theory regardless of the motive for the
  initial regulation and the establishment of the
  regulatory agency, eventually the agency will be
  captured by the special interests of the
  industry that is being regulated.
• Public Interest Theory regulators are seeking to
  do, and will do through regulation, what is in
  the best interest of the public or society at
  large.
• Public Choice Theory regulators are seeking to
  do, and will do through regulation, what is in
  their best interest (specifically, to enhance
  their power and the size and budget of their
  regulatory agencies).

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Current Issue Deregulation

• Many economists, basing their arguments on the
  capture and public choice theories of regulation,
  argued that regulation was actually promoting and
  protecting market power instead of reducing it.
• Deregulation has led to a decline in costs in
  various institutions.
• Since 1970s Airlines, trains, trucks,
  electricity, natural gas, cable, local telephone