Principles of Economics - 3e Chapter 11 Monopoly and Antitrust Policy

Monopoly and st Policy FIGURE Oligopoly versus Competitors in the Marketplace Large corporations , such as the natural gas producer Kinder Morgan , can bring economies of scale to the marketplace . Will that consumers , or is more competition better ?

Credit of Aerial view of Kinder Morgan Terminal by Creative Commons , Public Domain ) CHAPTER OBJECTIVES In this chapter , you will learn about Corporate Mergers Regulating Behavior Regulating Natural Monopolies The Great Deregulation Experiment Introduction to Monopoly and Antitrust Policy BRING IT HOME More than Cooking , Heating , and Cooling If you live in the United States , there is a slightly better than chance your home is heated and cooled using natural gas . You may even use natural gas for cooking . However , those uses are not the primary uses of natural gas in the . In late 2021 , according to the US . Energy Information Administration , home heating , cooling , and cooking accounted for nearly 20 of natural gas usage . What accounts forthe rest ?

The greatest uses for natural gas are the generation of electric power ( almost 37 ) and in industry ( 30 ) Together these three uses for natural gas touch many areas of our lives , so why would there be any opposition to a merger of two natural gas ?

After all , a merger could mean increased and reduced costs to people like you and me . In October 2011 , Kinder Morgan and El Paso Corporation , two natural gas , announced they were merging . The announcement stated the combined would link nearly every major production region with markets , cut costs by eliminating duplication in pipelines and other assets , and that the savings could be passed on to The objection ?

The billion deal would give Kinder Morgan control of more than miles of pipeline , new the third largest energy producer in North America . and the public wondered 260 11 Monopoly and Antitrust Policy new conglomerate really would pass on cost savings to consumers , or would the merger give Kinder Morgan a strong oligopoly position in the natural gas marketplace ?

That brings us to the central questions this chapter poses What should the balance be between corporate size and a larger number of competitors in a marketplace , and what role should the government play in this balancing act ?

The previous chapters on the theory of the three important lessons First , that competition , by providing consumers with lower prices and a variety of innovative products , is a good thing second , that large scale production can dramatically lower average costs and third , that markets in the real world are rarely perfectly competitive . As a consequence , government must determine how much to intervene to balance the potential of production against the potential loss of competition that can occur when businesses grow in size , especially through mergers . For example , in 2006 , AT and proposed a merger . At the time , there were very few mobile phone service providers . Both the Justice Department and the blocked the proposal . The two companies argued that the merger would consumers , who would be able to purchase better telecommunications services at a cheaper price because the newly created would take advantage of economies of scale and eliminate duplicate investments . However , a number of activist groups like the Consumer Federation of America and Public Knowledge expressed fears that the merger would reduce competition and lead to higher prices for consumers for decades to come . In December 2006 , the federal government allowed the merger to proceed . By 2009 , the new AT was the eighth largest company by revenues in the United States , and by that measure the largest telecommunications company in the world . Economists have spent and will still spend years trying to determine whether the merger of AT and , as well as other smaller mergers of telecommunications companies at about this same time , helped consumers , hurt them , or did not make much difference . This chapter discusses public policy issues about competition . How can economists and governments determine when mergers of large companies like AT and should be allowed and when they should be blocked ?

The government also plays a role in policing behavior other than mergers , like prohibiting certain kinds of contracts that might restrict competition . In the case of natural monopoly , however , trying to preserve competition probably will not work very well , and so government will often resort to regulation of price quantity of output . In recent decades , there has been a global trend toward less government intervention in the price and output decisions of businesses . Corporate Mergers LEARNING OBJECTIVES By the end of this section , you will be able to Explain antitrust law and its Calculate concentration ratios Calculate the Index ( Evaluate methods of antitrust regulation A corporate merger occurs when two formerly separate combine to become a single . When one purchases another , it is called an acquisition . An acquisition may not lookjust like a merger , since the newly purchased may continue to operate under its former company name . Mergers can also be lateral , where two of similar sizes combine to become one . However , both mergers and acquisitions lead to two formerly separate operating under common ownership , and so they are commonly grouped together . Regulations for Approving Mergers Since a merger combines two into one , it can reduce the extent of competition between . Therefore , when two announce a merger or acquisition where at least one of the is above a minimum size Access for free at

Corporate Mergers 261 of sales ( a threshold that moves up gradually over time , and was at 101 million in 2022 ) or certain other conditions are met , they are required under law to notify the Federal Trade Commission ( The left hand panel of Figure ( a ) shows the number of mergers submitted for review to the each year from 1999 to 2012 . Mergers follow the business cycle , falling after the 2001 recession , peaking in 2007 as the Great Recession struck , and then rising since 2009 . The panel of Figure ( shows the distribution of those mergers submitted for review in 2015 as measured by the size of the transaction . It is important to remember that this total leaves out many small mergers under 50 million , which companies only need to report in certain limited circumstances . In 2012 , 26 percent of all reported merger and acquisition transactions exceeded 500 million , while 11 percent exceeded billion . 350 300 . 250 as 200 150 100 50 Boo 00 ( Lao ( Ego 9390 960 . Size of Transaction ( a ) Number of mergers submitted for review by the Federal Trade ( Size of transaction for mergers submitted for Commission , review in 2012 ( in millions ) FIGURE Number and Size of Mergers ( a ) The number of mergers grew from 2003 to 2007 , then fell dramatically during the Great Recession , before recovering since . In 2012 , the greatest number of mergers submitted for review by the Federal Trade Commission was for transactions between 150 million . The laws that give government the power to block certain mergers , and even in some cases to break up large into smaller ones , are called antitrust laws . Before a large merger happens , the antitrust regulators at the and the US . Department ofJustice can allow the merger , prohibit it , or allow it if certain conditions are met . One common condition is that the merger will be allowed if the agrees to sell off certain parts . For example , in 2006 , Johnson Johnson bought the known brands like mouthwash and cold medicine . As a condition of allowing the merger , Johnson Johnson was required to sell off six brands to other , including heartburn relief medication , cream , and diaper rash medication , to preserve a greater degree of competition in these markets . consumer health division , which included The government approves most proposed mergers . In a economy , have the freedom to make their own choices . Private generally have the freedom to expand or reduce production set the price they choose open new factories or sales facilities or close them hire workers or to lay them off start selling new products or stop selling existing ones If the owners want to acquire a or be acquired , or to merge with another , this decision is just one of many that are free to make . In these conditions , the managers of private will sometimes make mistakes . They may close down a factory which , it later turns out , would have been . They may start selling a product that ends up losing money . A merger between two companies can sometimes lead to a clash

262 11 Monopoly and Antitrust Policy of corporate personalities that makes both worse off . However , the fundamental belief behind a oriented economy is that , not governments , are in the best position to know if their actions will lead to attracting more customers or producing more . Government regulators agree that most mergers are to consumers . As the Federal Trade Commission has noted on its website ( as of November , 2013 ) Most mergers actually competition and consumers by allowing to operate more . At the same time , the recognizes , Some mergers are likely to lessen competition . That , in turn , can lead to higher prices , reduced availability of goods or services , lower quality of products , and less innovation . Some mergers create a concentrated market , while others enable a single to raise The challenge for the antitrust regulators at the and the Department of Justice is to out when a merger may hinder competition . This decision involves both numerical tools and some judgments that are to quantify . The following Clear It Up explains the origins of antitrust law . CLEAR IT UP What is antitrust law ?

In the closing decades of the , many industries in the economy were dominated by a single that had most of the sales for the entire country . Supporters of these large argued that they could take advantage of economies of scale and careful planning to provide consumers with products at low prices . However , critics pointed out that when competition was reduced , these were free to charge more and make permanently higher , and that without the goading of competition , it was not clear that they were as or innovative as they could be . In many cases , these large were organized in the legal form of a trust , in which a group of formerly independent were consolidated by mergers and purchases , and a group of trustees then ran the companies as if they were a single . Thus , when the government sought to limit the power of these trusts , it passed the Sherman Antitrust Act in 1890 the nation antitrust law . In an early demonstration of the law power , the Supreme Court in 1911 upheld the government right to break up Standard Oil , which had controlled about 90 of the country oil , into 34 independent , including , Mobil , and Chevron . In 1914 , the Clayton Antitrust Act outlawed mergers and acquisitions ( where the outcome would be to substantially lessen competition in an industry ) price discrimination ( where different customers are charged different prices for the same product ) and tied sales ( where purchase of one product commits the buyer to purchase some other product ) Also in 1914 , the Federal Trade Commission ( was created to more what competition was unfair . In 1950 , the Act extended the Clayton Act by restricting vertical and conglomerate mergers . A vertical merger occurs when two or more , operating at different levels within an industry supply chain , merge operations . A conglomerate merger is a merger between that are involved in totally unrelated business activities . In the century , the and the Department of Justice continue to enforce antitrust laws . The Concentration Ratio Regulators have struggled for decades to measure the degree of monopoly power in an industry . An early tool was the concentration ratio , which measures the combined market share ( or percent of total industry sales ) which is accounted for by the largest ( typically the top four to eight ) For an explanation of how high market concentrations can create in an economy , refer to Monopoly . Say that the market for replacing broken automobile windshields in a certain city has 18 with the market shares in Table , where the market share is each proportion of total sales in that market . We calculate the concentration ratio by adding the market shares of the four largest in this case , 16 10 40 . We do not consider this concentration ratio especially high , because the largest four have less than half the market . Access for free at

Corporate Mergers If the market shares for replacing automobile windshields are Smooth as Glass Repair Company 16 of the market The Auto Glass Doctor Company 10 of the market Your Car Shield Company of the market Seven firms that each have of the market 42 of the market , combined Eight firms that each have of the market 24 of the market , combined Then the concentration ratio is 16 10 40 . TABLE Calculating Concentration Ratios from Market Shares The concentration ratio approach can help to clarify some of the fuzziness over deciding when a merger might affect competition . For instance , if two of the smallest in the hypothetical market for repairing automobile windshields merged , the concentration ratio would not implies that there is not much worry that the degree of competition in the market has notably diminished . However , if the top two merged , then the concentration ratio would become 46 ( that is , 26 ) While this concentration ratio is modestly higher , the concentration ratio would still be less than half , so such a proposed merger might barely raise an eyebrow among antitrust regulators . LINK up Visit this website ( Google ) to read an article about Google with the . The Index A concentration ratio is a simple tool , which may reveal only part of the story . For example , consider two industries that both have a concentration ratio of 80 . However , in one industry each control 20 of the market , while in the other industry , the top holds 77 of the market and all the other have each . Although the concentration ratios are identical , it would be reasonable to worry more about the extent of competition in the second the largest is nearly a in the . Another approach to measuring industry concentration that can distinguish between these two cases is called the Index ( We calculate by summing the squares of the market share of each in the industry , as the following Work It Out shows . Calculating Step . Calculate the for a monopoly with a market share of 100 . Because there is only one , it has 100 market share . The is 1002 . Step . For an extremely competitive industry , with dozens or hundreds of extremely small competitors , the value might drop as low as 100 or even less . Calculate the for an industry with 100 firms that each have of the market . In this case , the is 100 ( 12 ) 100 . Step . Calculate the for the industry in Table . In this case , the is 162 102 82 ( 62 ) 32 ) 744 . 263

264 11 Monopoly and Antitrust Policy Step . Note that the gives greater weight to large . Step . Considerthe earlier example , comparing one industry where each have 20 of the market with an industry where one has 77 and the other 23 have each . The two industries have the same concentration ratio of 80 . However , the for the industry is ( while the for the second industry is much higher at 772 23 ( 12 ) Step . Note that the in the second industry drives up the measure of industrial concentration . Step Review Table which gives some examples of the concentration ratio and the in various industries in 2016 . You can market share data from multiple industry sources . Data in the table are from ( for wireless ) The Wall ( for automobiles ) for computers ) and the Bureau of Transportation Statistics ( for airlines ) Industry Ratio Wireless 98 Largest , AT , Sprint , US Cellular Personal Computers 76 Largest , Dell , Apple , Airlines 69 Largest American , Southwest , Delta , United , Automobiles 58 Largest Ford , Chrysler , TABLE Examples of Concentration Ratios and in the Economy , 2016 In the , the followed these guidelines If a merger would result in an of less than , the would probably approve it . If a merger would result in an of more than , the would probably challenge it . If a merger would result in an between and , then the would scrutinize the plan and make a decision . However , in the last several decades , the antitrust enforcement authorities have moved away from relying as heavily on measures of concentration ratios and to determine whether they will allow a merger , and instead they carry out more analysis on the extent of competition in different industries . New Directions for Antitrust Both the concentration ratio and the index share some weaknesses . First , they begin from the assumption that the market under discussion is , and the only question is measuring how sales are divided in that market . Second , they are based on an implicit assumption that competitive conditions across industries are similar enough that a broad measure of concentration in the market is enough to make a decision about the effects ofa merger . These assumptions , however , are not always correct . In response to these two problems , the antitrust regulators have been changing their approach in the last decade or two . Access for free at

Corporate Mergers 265 a market is often controversial . For example , in the early had a dominant share of the software for computer operating systems . However , in the total market for all computer software and services , including everything from games to programs , the share was only about 14 in 2014 . A narrowly market will tend to make concentration appear higher , while a broadly market will tend to make it appear smaller . In recent decades , there have been two especially important shifts affecting how we markets one centers on technology and the other centers on globalization . In addition , these two shifts are interconnected . With the vast improvement in communications technologies , including the development of the internet , a consumer can order books or pet supplies from all over the country or the world . As a result , the degree of competition many local retail businesses face has increased . The same effect may operate even more strongly in markets for business supplies , where websites can allow buyers and suppliers from anywhere in the world to each other . Globalization has changed the market boundaries . As recently as the , it was common for measurements of concentration ratios and to stop at national borders . Now , many industries that their competition comes from the global market . A few decades ago , three companies , General Motors , Ford , and Chrysler , dominated the auto market . By 2014 , however , production of these three accounted for less than half of auto sales , although by 2021 , with the emergence of , the three accounted for essentially half of auto sales . The three face competition from car manufacturers such as , Honda , Volkswagen , and . When analysts calculate with a global perspective , concentration in most major lower than in a purely domestic context . Because attempting to a particular market can be and controversial , the Federal Trade Commission has begun to look less at market share and more at the data on actual competition between businesses . For example , in February 2007 , Whole Foods Market and Wild Oats Market announced that they wished to merge . These were the two largest companies in the market that the government as premium natural and organic supermarket chains . However , one could also argue that they were two relatively small companies in the broader market for all stores that sell groceries or specialty food products . Rather than relying on a market , the government antitrust regulators looked at detailed evidence on and prices for stores in different cities , both before and after other competitive stores entered or exited . Based on that evidence , the Federal Trade Commission decided to block the merger . After two years of legal battles , the eventually allowed the merger in 2009 under the conditions that Whole Foods sell off the Wild Oats brand name and a number of individual stores , to preserve competition in certain local markets . For more on the of markets , refer to . This new approach to antitrust regulation involves detailed analysis of markets and companies , instead of a market and counting up total sales . A common starting point is for antitrust regulators to use statistical tools and evidence to estimate the demand curves and supply curves the proposing a merger face . A second step is to specify how competition occurs in this industry . Some possibilities include competing to cut prices , to raise output , to build a brand name through advertising , and to build a reputation for good service or high quality . With these pieces of the puzzle in place , it is then possible to build a statistical model that estimates the likely outcome for consumers if the two are allowed to merge . These models do require some degree of subjective judgment , and so they can become the subject of legal disputes between the antitrust authorities and the companies that wish to merge .

266 11 Monopoly and Antitrust Policy Regulating Behavior LEARNING OBJECTIVES By the end of this section , you will be able to Analyze restrictive practices Explain tying sales , bundling , and predatory pricing Evaluate a situation of possible and restrictive practices The antitrust laws reach beyond blocking mergers that would reduce competition to include a wide array of practices . For example , it is illegal for competitors to form a cartel to collude to make and output decisions , as if they were a monopoly . The Federal Trade Commission and the Department of Justice prohibit from agreeing to prices or output , rigging bids , or sharing or dividing markets by allocating customers , suppliers , territories , or lines of commerce . the late , for example , the antitrust regulators prosecuted an international cartel of vitamin manufacturers , including the Swiss , the German , and the French . These reached agreements on how much to produce , how much to charge , and which would sell to which customers . Firms like General Mills , Mills , and Proctor and Gamble bought the vitamins , which pushed up the prices more . pleaded guilty in May 1999 and agreed both to pay a of 500 million and to have at least one top executive be incarcerated for our months . antitrust laws , monopoly itself is not illegal . If a has a monopoly because of a newly patented invention , for example , the law explicitly allows a to earn for a time as a reward for innovation . achieves a large share of the market by producing a better product at a lower , such behavior is not prohibited by antitrust law . Restrictive Practices Antitrust law includes rules against restrictive that do not involve outright agreements to raise price or to reduce the quantity produced , but that might have the effect of reducing competition . Antitrust cases involving restrictive practices are often controversial , because they delve into contracts or agreements between that are allowed in some cases but not in others . For example , an exclusive dealing agreement between a manufacturer and a dealer can be legal or illegal . It is legal if the purpose of the contract is to encourage competition between dealers . For example , it is legal for the Ford Motor Company to sell its cars to only Ford dealers , and for General Motors to sell to only dealers , and so on . However , exclusive deals may also limit competition . If one large retailer obtained the exclusive rights to be the sole distributor of televisions , computers , and audio equipment made by a number of companies , then this exclusive contract would have an effect on other retailers . Tying sales happen when a customer is allowed to buy one product only if the customer also buys a second product . Tying sales are controversial because they force consumers to purchase a product that they may not actually want or need . Further , the additional , required products are not necessarily advantageous to the customer . Suppose that to purchase a popular , the store required that you also purchase a certain portable model . These products are only loosely related , thus there is no reason to make the purchase of one contingent on the other . Even if a customer were interested in a portable , the tying to a particular model prevents the customer from having the option of selecting one from the numerous types available in the market . A related , but not identical , concept is bundling , where a sells two or more products as one . Bundling typically offers an advantage for consumers by allowing them to acquire multiple products or services for a better price . For example , several cable companies allow customers to buy products like cable , internet , and a phone line through a special price available through bundling . Customers are also welcome to purchase these Access for free at

Regulating Behavior 267 products separately , but the price of bundling is usually more appealing . In some cases , we can view tying sales and bundling as . However , in other cases they may be legal and even common . It is common for people to purchase season tickets to a sports team or a set of concerts so as to guarantee tickets to the few contests or shows that are most popular and likely to sell out . Computer software manufacturers may often bundle a number of different programs , even when the buyer wants only a few . Think about the software that is included in a new computer purchase , for example . Recall from the chapter on Monopoly that predatory pricing occurs when the existing ( or ) reacts to a new by dropping prices very low , until the new is driven out of the market , at which point the existing raises prices again . This pattern of pricing is aimed at deterring new from entering the market . However , in practice , it can be hard to out when pricing is predatory . Say that American Airlines is between two cities , and a new airline starts between the same two cities , at a lower price . If American Airlines cuts its price to match the new entrant , is this predatory pricing or is itjust market competition at work ?

A commonly proposed rule is that ifa is selling for less than its average variable is , at a price where it should be shutting there is evidence for predatory pricing . However , calculating in the real world what costs are variable and what costs are is often not obvious , either . The antitrust case embodies many of these gray areas in restrictive practices , as the next Clear It Up shows . CLEAR IT UP Did engage in and restrictive practices ?

The most famous restrictive practices case of recent years was a series of lawsuits by the government against that some of competitors encouraged . All sides admitted that Windows program had a position in the market for the software used in general computer operating systems . All sides agreed that the software had many satisfied customers and that the computer software capabilities were compatible with Windows . Software that and other companies produced had expanded dramatically in the 19905 . Having a monopoly or a is not necessarily illegal in and of itself , but in cases where one company controls a great deal of the market , antitrust regulators look at any allegations of restrictive practices with special care . The antitrust regulators argued that had gone beyond from its software innovations and its dominant position in the software market for operating systems , and had tried to use its market power in operating systems software to take over other parts of the software industry . For example , the government argued that had engaged in an form of exclusive dealing by threatening computer makers that , if they did not leave another firm software off their machines ( Internet browser ) then would not sell them its operating system software . Government antitrust regulators accused of tying together its Windows operating system software , where it had a monopoly , with its Internet Explorer browser software , where it did not have a monopoly , and thus using this bundling as an tool . The government also accused of a form of predatory pricing namely , giving away certain additional software products for free as part of Windows , as a way of driving out the competition from other software makers . In April 2000 , a federal court held that behavior had crossed the line into unfair competition , and recommended that the company be split into two competing . However , the court overturned that penalty on appeal , and in November 2002 reached a settlement with the government that it would end its restrictive practices . The concept of restrictive practices is continually evolving , as seek new ways to earn and government regulators what is permissible . A situation where the law is evolving and changing is always somewhat troublesome , since laws are most useful and fair when know what they are in advance . In

268 11 Monopoly and Antitrust Policy addition , since the law is open to interpretation , competitors who are losing out in the market can accuse successful of restrictive practices , and try to win through government regulation what they have failed to accomplish in the market . at the Federal Trade Commission and the Department of Justice are , of course , aware of these issues , but there is no easy way to resolve them . Regulating Natural Monopolies LEARNING OBJECTIVES By the end of this section , you will be able to Evaluate the appropriate competition policy for a natural monopoly Interpret a graph of regulatory choices Contrast and price cap regulation Most true monopolies today in the US . are regulated , natural monopolies . A natural monopoly poses a challenge for competition policy , because the structure of costs and demand makes competition unlikely or costly . A natural monopoly arises when average costs are declining over the range that market demand . This typically happens when costs are large relative to variable costs . As a result , one is able to supply the total quantity demanded in the market at lower cost than two or more splitting up the natural monopoly would raise the average cost of production and force customers to pay more . Public utilities , the companies that have traditionally provided water and electrical service across much of the United States , are leading examples of natural monopoly . It would make little sense to argue that a local water company should be divided into several competing companies , each with its own separate set and water supplies . Installing four or identical sets of pipes under a city , one for each water company , so that each household could choose its own water provider , would be terribly costly . The same argument applies to the idea of having many competing companies for delivering electricity to homes , each with its own set of wires . Before the advent of wireless phones , the argument also applied to the idea of many different phone companies , each with its own set of phone wires running through the neighborhood . The Choices in Regulating a Natural Monopoly What then is the appropriate competition policy for a natural monopoly ?

Figure illustrates the case of natural monopoly , with a market demand curve that cuts through the portion of the average cost curve . Points A , and i lustrate four of the main choices for regulation . Table outlines the regulatory choices for dealing with a natural monopoly . 10 Price Quantity FIGURE Regulatory Choices in Dealing with Natural natural monopoly will maximize by producing at the quantity where marginal revenue ( equals marginal costs ( and by then looking to the market demand curve to see what price to charge forthis quantity . This monopoly will produce at point A , with a quantity of and a price of . If antitrust regulators split this company exactly in half , then each half would Access for free at

Regulating Natural Monopolies 269 produce at point , with average costs of and output of . The regulators might require the to produce where marginal cost crosses the market demand curve at point However , if the is required to produce at a quantity of and sell at a price of , the will incur losses . The most likely choice is point , where the is required to produce a quantity of and charge a price of . Quantity Price Total Revenue Marginal Revenue Average Cost TABLE Regulatory Choices in Dealing with Natural Monopoly ( We obtain total revenue by multiplying price and quantity . However , we have rounded some of the price values in this table for ease of presentation . The possibility is to leave the natural monopoly alone . In this case , the monopoly will follow its normal approach to maximizing . It determines the quantity where , which happens at point at a quantity of . The then looks to point A on the demand curve to that it can charge a price of for that quantity . Since the price is above the average cost curve , the natural monopoly would earn economic . A second outcome arises if antitrust authorities decide to divide the company , so that the new can compete . As a simple example , imagine that the company is cut in half . Thus , instead of one large producing a quantity of , two each produce a quantity of . Because of the declining average cost curve ( AC ) the average cost of production for each of the companies producing , as point shows , would be , while the average cost for a larger producing would only be . Thus , the economy would become less productively , since the good is produced at a higher average cost . In a situation with a average cost curve , two smaller will always have higher average costs of production than one larger for any quantity of total output . In addition , the antitrust authorities must worry that splitting the natural monopoly into pieces may be only the start of their problems . If one of the two grows larger than the other , it will have lower average costs and may be able to drive its competitor out of the market . Alternatively , two in a market may discover subtle ways of coordinating their behavior and keeping prices high . Either way , the result will not be the greater competition that was desired . A third alternative is that regulators may decide to set prices and quantities produced for this industry . The regulators will try to choose a point along the market demand curve that both consumers and the broader social interest . Point illustrates one tempting choice the regulator requires that the produce the quantity of output where marginal cost crosses the demand curve at an output of , and charge the price of

270 11 Monopoly and Antitrust Policy , which is equal to marginal cost at that point . This rule is appealing because it requires price to be set equal to marginal cost , which is what would occur in a perfectly competitive market , and it would assure consumers a higher quantity and lower price than at the monopoly choice A . In fact , allocation of resources would occur at point , since the value to the consumers of the last unit bought and sold in this market is equal to the marginal cost of producing it . Attempting to bring about point through force of regulation , however , runs into a severe . At point , with an output of , a price of is below the average cost , which is , so if the charges a price of , it will be suffering losses . Unless the regulators or the government offer the an ongoing public subsidy ( and there are numerous political problems with that option ) the will lose money and go out of business . Perhaps the most plausible option for the regulator is point that is , to set the price where AC crosses the demand curve at an output of and a price of . This plan makes some sense at an intuitive level let the natural monopoly charge enough to cover its average costs and earn a normal rate of , so that it can continue operating , but prevent the from raising prices and earning abnormally high monopoly , as it would at the monopoly choice A . Determining this level of output and price with the political pressures , time constraints , and limited information of the real world is much harder than identifying the point on a graph . For more on the problems that can arise from a centrally determined price , see the discussion of price and price ceilings in Demand and Sup . versus Price Cap Regulation Regulators of public utilities for many decades followed the general approach of attempting to choose a point like in Figure . They calculated the average cost of production for the water or electricity companies , added in an amount for the normal rate of the should expect to earn , and set the price for consumers accordingly . This method was known as regulation . regulation raises of its own . receive reimbursement for their costs , plus a bit more , then at a minimum , producers have less reason to be concerned with high they canjust pass them along in higher prices . Worse , under regulation even have an incentive to generate high costs by building huge factories or employing many staff , because what they can charge is linked to the costs they incur . Thus , in the and , some public utility regulators began to use price cap regulation , where the regulator sets a price that the can charge over the next few years . A common pattern was to require a price that declined slightly over time . If the can ways of reducing its costs more quickly than the price caps , it can make a high level of . However , if the can not keep up with the price caps or suffers bad luck in the market , it may suffer losses . A few years down the road , the regulators will then set a new series caps based on the performance . Price cap regulation requires delicacy . It will not work if the price regulators set the price cap low . It may not work if the market changes dramatically so that the is doomed to incurring losses no matter what it , if energy prices rise dramatically on world markets , then the company selling natural gas or heating oil to homes may not be able to meet price caps that seemed reasonable a year or two ago . However , if the regulators compare the prices with producers of the same good in other areas , they can , in effect , pressure a natural monopoly in one area to compete with the prices charged in other areas . Moreover , the possibility of earning greater or experiencing of having an average rate of locked in every year by provide the natural monopoly with incentives for and innovation . With natural monopoly , market competition is unlikely to take root , so if consumers are not to suffer the high prices and restricted output of an unrestricted monopoly , government regulation will need to play a role . In attempting to design a system of price cap regulation with and incentive , government regulators do Access for free at

The Great Deregulation Experiment not have an easy task . The Great Deregulation Experiment LEARNING OBJECTIVES By the end of this section , you will be able to Evaluate the effectiveness regulation and antitrust policy Explain regulatory capture and its Governments at all levels across the United States have regulated prices in a wide range of industries . In some cases , like water and electricity that have natural monopoly characteristics , there is some room in economic theory for such regulation . However , once politicians are given a basis to intervene in markets and to choose prices and quantities , it is hard to know where to stop . Doubts about Regulation of Prices and Quantities Beginning in the , it became clear to of all political leanings that the existing price regulation was not working well . The United States carried out a great policy deregulation that we discussed in government controls over prices and quantities produced in airlines , railroads , trucking , intercity bus travel , natural gas , and bank interest rates . The Clear It Up discusses the outcome of deregulation in one industry in . CLEAR IT UP What are the results of airline deregulation ?

Why did the pendulum swing in favor of deregulation ?

Consider the airline industry . In the early days of air travel , no airline could make a just by flying passengers . Airlines needed something else to carry and the Postal Service provided that something with airmail . Thus , the first government regulation of the airline industry happened through the Postal Service , when in 1926 the Postmaster General began giving airlines permission to fly certain routes based on mail delivery the airlines took some passengers along forthe ride . In 1934 , the antitrust authorities charged the Postmaster General with colluding with the major airlines of that day to monopolize the nation airways . In 1938 , the government created the Civil Aeronautics Board ( CAB ) to regulate and routes instead . For 40 years , from 1938 to 1978 , the CAB approved all fares , controlled all entry and exit , and specified which airlines could fly which routes . There was zero entry of new airlines on the main routes across the country for 40 years , because the CAB did not think it was necessary . 1978 , the Airline Deregulation Act took the government out of the business of determining and schedules . The new law shook up the industry . Famous old airlines like Pan American , Eastern , and went and disappeared . Some new airlines like People Express were then vanished . The greater competition from deregulation reduced by about over the next two decades , saving consumers billions of dollars a year . The average flight used to take off with just half its seats full now it is full , which is far more efficient . Airlines have also developed systems , where planes all fly into a central hub city at a certain time and then depart . As a result , one can fly between any of the spoke cities with just one there is greater service to more cities than before deregulation . With lower fares and more service , the number of air passengers doubled from the late to the start of the increase that , in urn , doubled the number ofjobs in the airline industry . Meanwhile , with the watchful oversight of government safety inspectors , commercial air travel has continued to get safer over time . The airline industry is far from perfect . For example , a string of mergers in recent years has raised concerns over wow competition might be compromised . One with government price regulation is what economists call regulatory capture , in which the

272 11 Monopoly and Antitrust Policy that are supposedly regulated end up playing a large role in setting the regulations that they will follow . When the airline industry was regulated , for example , it suggested appointees to the regulatory board , sent lobbyists to argue with the board , provided most of the information on which the board made decisions , and offered to at least some of the people leaving the board . In this situation , it is easy for regulators to poorly represent consumers . The result of regulatory capture is that government price regulation can often become a way for existing competitors to work together to reduce output , keep prices high , and limit competition . The Effects of Deregulation Deregulation , both of airlines and of other industries , has its negatives . The greater pressure of competition led to entry and exit . When went bankrupt or contracted substantially in size , they laid off workers who had to . Market competition is , after all , a sport . A number of major accounting scandals involving prominent corporations such as , International , and led to the Act in 2002 . The government designed to increase in information provided by public corporations to protect investors from accounting fraud . The Great Recession , which began in late 2007 , was caused at least in part by a global crisis , which began in the United States . The key component of the crisis was the creation and subsequent failure of several types of unregulated assets , such as collateralized mortgage obligations ( a type of backed security ) and credit default swaps ( insurance contracts on assets like that provided a payoff even if the holder of the did not own the ) Private credit rating agencies such as Standard , Moody , and Fitch rated many of these assets very safe . The collapse of the markets for these assets precipitated the crisis and led to the failure of Brothers , a major investment bank , numerous large commercial banks , such as , and even the Federal National Mortgage Corporation ( Mae ) which had to be is , taken over by the federal government . One response to the crisis was the Act , which majorly attempted to reform the system . The legislation purpose , as noted on is To promote the stability of the United States by improving accountability and transparency in the system , to end too big to fail , to protect the American taxpayer by ending bailouts , and to protect consumers from abusive services practices . All economies operate against a background of laws and regulations , including laws about enforcing contracts , collecting taxes , and protecting health and the environment . The government policies that we discussed in this blocking certain mergers , ending restrictive practices , imposing price cap regulation on natural monopolies , and the role of government to strengthen the incentives that come with a greater degree of competition . BRING IT HOME More than Cooking , Heating , and Cooling What did the Federal Trade Commission ( decide on the Kinder Morgan El Paso Corporation merger ?

After careful examination , federal officials decided there was only one area of overlap that might provide the merged with strong market power . The approved the merger , provided Kinder Morgan divest itself of the overlap area . purchased Kinder Morgan Interstate Gas Transmission , Pipeline , two processing facilities in Wyoming , and Kinder Morgan 50 percent interest in the Rockies Express Pipeline to meet the requirements . The was attempting to strike a balance between potential cost reductions resulting from economies of scale and concentration of market power . Access for free at

The Great Deregulation Experiment Did the price of natural gas decrease ?

Yes , rather . In 2010 , the wellhead price of natural gas was per thousand cubic foot . In 2012 the price had fallen to just . Was the merger responsible for the large drop in price ?

The answer is uncertain . The larger contributor to the sharp drop in price was the overall increase in the supply of natural gas . Increasingly , more natural gas was able to be recovered by fracturing shale deposits , a process called fracking . Fracking , which is controversial for environmental reasons , enabled the recovery of known reserves of natural gas that previously were not economically feasible to tap . Kinder Morgan control of miles of pipeline likely made gas from to end users smoother and allowed for an even greater from the increased supply .

274 11 Key Terms Key Terms acquisition when one purchases another antitrust laws laws that give government the power to block certain mergers , and even in some cases to break up large into smaller ones bundling a situation in which multiple products are sold as one concentration ratio an early tool to measure the degree of monopoly power in an industry measures what share of the total sales in the industry are accounted for by the largest , typically the top four to eight regulation when regulators permit a regulated to cover its costs and to make a normal level of exclusive dealing an agreement that a dealer will sell only products from one manufacturer concentration ratio the percentage of the total sales in the industry that are accounted for by the largest four Index ( approach to measuring market concentration by adding the square of the market share of each in the industry market share the percentage of total sales in the market two formerly separate combine to become a single minimum resale price maintenance agreement an agreement that requires a dealer who buys from a manufacturer to sell for at least a certain minimum price price cap regulation when the regulator sets a price that a can not exceed over the next few years regulatory capture when the supposedly regulated end up playing a large role in setting the regulations that they will follow and as a result , they capture the people usually through the promise ofa job in that regulated industry once their term in government has ended restrictive practices practices that reduce competition but that do not involve outright agreements between to raise prices or to reduce the quantity produced tying sales a situation where a customer is allowed to buy one product only if the customer also buys another product Key Concepts and Summary Corporate Mergers A corporate merger involves two private joining together . An acquisition refers to one buying another . In either case , two formerly independent become one . Antitrust laws seek to ensure active competition in markets , sometimes by preventing large from forming through mergers and acquisitions , sometimes by regulating business practices that might restrict competition , and sometimes by breaking up large into smaller competitors . A concentration ratio is one way of measuring the extent of competition in a market . We calculate it by adding the market is , the percentage of total the four largest in the market . A Index ( is another way of measuring the extent of competition in a market . We calculate it by taking the market shares of all in the market , squaring them , and then summing the total . The forces of globalization and new communications and information technology have increased the level of competition that many face by increasing the amount of competition from other regions and countries . Regulating Behavior Antitrust block authorities from openly colluding to form a cartel that will reduce output and raise prices . Companies sometimes attempt to other ways around these restrictions and , consequently , many antitrust cases involve restrictive practices that can reduce competition in certain circumstances , like sales , bundling , and predatory pricing . Access for free at

11 Questions Regulating Natural Monopolies In the case ofa natural monopoly , market competition will not work well and so , rather than allowing an unregulated monopoly to raise price and reduce output , the government may wish to regulate price output . Common examples of regulation are public utilities , the regulated that often provide electricity and water service . regulation refers to government regulating a which sets the price that a can charge over a period of time by looking at the firms accounting costs and then adding a normal rate of . Price cap regulation refers to government regulation of a where the government sets a price level several years in advance . In this case , the can either earn high if it manages to produce at lower costs or sell a higher quantity than expected or suffer low or losses if costs are high or it sells less than expected . The Great Deregulation Experiment The economy experienced a wave in the late and early , when the government eliminated a number of regulations that had set prices and quantities produced in a number of industries . Major accounting scandals in the early and , more recently , the Great Recession have spurred new regulation to prevent similar occurrences in the future . Regulatory capture occurs when the regulated industries end up having a strong over what regulations exist . Questions . Is it true that a merger between two that are not already in the top four by size can affect both the concentration ratio and the Index ?

Explain . Is it true that the concentration ratio puts more emphasis on one or two very large , while the Index puts more emphasis on all the in the entire market ?

Explain . Some years ago , two intercity bus companies , Greyhound Lines , and Transportation System , wanted to merge . One possible of the market in this case was the market for intercity bus service . Another possible was the market for intercity transportation , including personal cars , car rentals , passenger trains , and commuter air Which do you think the bus companies preferred , and why ?

As a result of globalization and new information and communications technology , Would you expect that the of markets that antitrust authorities use will become broader or narrower ?

Why would a choose to use one or more of the practices described in Regulating Behavior ?

276 11 Review Questions . Urban transit systems , especially those with rail systems , typically experience economies of scale in operation . Consider the transit system data in Table . Note that the quantity is in millions of riders . Demand Quantity 10 Price 10 10 Costs Marginal Cost 10 TABLE Draw the demand , marginal revenue , marginal cost , and average cost curves . Do they have the normal shapes ?

From the graph you drew to answer , would you say this transit system is a natural monopoly ?

Justify . Use the following information to answer the next three questions . In the years before wireless phones , when telephone technology required having a wire running to every home , it seemed plausible that telephone service had diminishing average costs and might require regulation like a natural monopoly . For most of the twentieth century , the national phone company was AT , and the company functioned as a regulated monopoly . Think about the deregulation of the telecommunications industry that has occurred over the last few decades . This is not a research assignment , but a thought assignment based on what you have learned in this chapter . What changes made the deregulation possible ?

What are some of the of the deregulation ?

10 . What might some of the negatives of deregulation be ?

Review Questions 11 . What is a corporate merger ?

What is an acquisition ?

12 . What is the goal of antitrust policies ?

13 . How do we measure a concentration ratio ?

What does a high measure mean about the extent of competition ?

14 . How do we measure a Index ?

What does a low measure mean about the extent of competition ?

15 . Why can it be to decide what a market is for purposes of measuring competition ?

16 . What is a minimum resale price maintenance agreement ?

How might it reduce competition and when might it be acceptable ?

17 . What is exclusive dealing ?

How might it reduce competition and when might it be acceptable ?

18 . What is a sale ?

How might it reduce competition and when might it be acceptable ?

19 . What is predatory pricing ?

How might it reduce competition , and why might it be to tell when it should be illegal ?

Access for free at 20 . 21 . 22 . 23 . 24 . 25 . 26 . 11 Critical Thinking Questions utilities are a natural monopoly , what would be the danger in them ?

utilities are a natural monopoly , what would be the danger in splitting them into a number of separate competing ?

What is regulation ?

What is price cap regulation ?

What is deregulation ?

Name some industries that have been deregulated in the United States . What is regulatory capture ?

Why does regulatory capture reduce the persuasiveness of the case for regulating industries for the benefit of consumers ?

Critical Thinking Questions 27 . 28 . 29 . 30 . 31 . 32 . 33 . 34 . Does either the concentration ratio or the directly measure the amount of competition in an industry ?

Why or why not ?

What would be evidence of serious competition between firms in an industry ?

Can you identify two highly competitive industries ?

Can you think of any examples of successful predatory pricing in the real world ?

Ifyou were developing a product ( like a web browser ) for a market with barriers to entry , how would you try to get your product into the market successfully ?

In the middle of the twentieth century , major cities had multiple competing city bus companies . Today , there is usually only one and it runs as a subsidized , regulated monopoly . What do you suppose caused the change ?

Why are urban areas willing to subsidize urban transit systems ?

Does the argument for subsidies make sense to you ?

Deregulation , like all changes in government policy , always has pluses and minuses . What do you think some of the minuses might be for airline deregulation ?

Do you think it is possible for government to outlaw everything that businesses could do wrong ?

If so , why does government not do that ?

If not , how can regulation stay ahead of rogue businesses that push the limits of the system until it breaks ?

278 11 Problems Problems 35 . Use Table to calculate the concentration ratio for the auto market . Does this indicate a concentrated market or not ?

19 Ford 17 14 Chrysler 11 TABLE Global Auto Manufacturers with Top Four Market Share , June 2013 ( Source ) 36 . Use Table and Table to calculate the Index for the auto market . Would the approve a merger between and Ford ?

Honda 10 Kia Subaru Volkswagen TABLE Global Auto Manufacturers with additional Market Share , June 2013 ( Source ) Access for free at Problems Use Table to answer the following questions . 37 . If the transit system were allowed to operate as an unregulated monopoly , what output would it supply and what price would it charge ?

38 . If the transit system were regulated to operate with no subsidy ( at zero economic ) what approximate output would it supply and what approximate price would it charge ?

39 . If the transit system were regulated to provide the most quantity of output , what output would it supply and what price would it charge ?

What subsidy would be necessary to ensure this provision of transit services ?