Lecture 3 July 12th 2010 Saksarun (Jay) Mativachranon
Regulation and Antitrust Policy in Globalized Economy
Key learning objectives Distinguish between economic regulation and social regulation Recognize practical difficulties that arise when regulating the prices charged by natural monopolies Identify potential benefits and possible negative side effects of social regulation Understand the foundations of antitrust laws and regulations
Forms of Industry Regulation Two basic types of Government Regulations Economic Regulation of natural monopolies and nonmonopolistic industries Social Regulation of all industries The US government began regulating both types early in the nation’s history The amount of government regulation began increasing in the 20th century
Regulation of Natural Monopolies Initially, most economic regulation in the US was aimed at controlling prices in industries considered natural monopolies Overtime, federal and state government have sought to influence products and processed of firms in a variety of industries
Definition of Natural Monopoly: A natural monopoly exists in an industry where a single firm can produce output such as to supply the market at a lower per unit-cost than can two or more firms. Ex. Electricity and Water supply industries are often natural monopolies
Why Regulate Natural Monopoly? The need to avoid duplication of facilities The need to prevent industries from earning monopoly profits
Profit Maximization and Regulation Through Marginal Cost Pricing Point F
Profit maximizing point for natural monopolist
Price (Pm) where consumers willing to pay for the quantity (Qm)
Unit Price F Pm LMC LAC Demand Qm MR Quantity per Time period
Profit Maximization and Regulation Through Marginal Cost Pricing Point B
Regulators cannot always force marginal cost pricing
Enforcing Cost-of-service regulation or Rate-of-return regulation
Unit Price LMC C P2 LAC AC1 Losses P1 B Demand Q1 Q2 MR Quantity per Time period
Regulating Nonmonopolistic Industries To provide a coordinated system of safeguarding the interests of citizens Two common rationales for government involvement Market Failure Asymmetric information
Regulating Nonmonopolistic Industries (cont.) Lemons Problem Potential asymmetric information problem bring about a general decline in product quality Example: Used car market, pharmaceuticals, etc. Implementing consumer protection regulation Liability laws and government licensing Direct economic and social regulation
Social Regulation Social Regulations apply to all firms in the economy Designed to improve the functioning of the markets Almost all cases, increased regulation results in higher production cost, and those increment cost are ultimately absorbed by the consumer Strict regulation prevent smaller firms to enter the market
Social Regulation (cont.) Usually benefit the society in the long run Safer products Safer workplaces Clean environment Etc.
Incentives and Costs of Regulation Capture Hypothesis Predicts that the regulators will eventually be captured by the special interests of the industry being regulated
Incentives and Costs of Regulation Share-the-Gains, Share-the-Pains Theory The regulators must take account of the demands of three groups; Legislators Regulated industries Consumers
Incentives and Costs of Regulation Benefits of regulation Regulation offers many potential benefits Actual benefits are more difficult to measure Costs of regulation Government uses taxes to pay for the cost of regulation US has over 190,000 employees in regulatory agencies
Incentives and Costs of Regulation Total cost of regulation (US) Cost of compliance estimated to be around $500 billion - $600 billion per year Opportunity cost of complying with regulations is as high as $270 billion
Antitrust Policy To promote business competitions US congress enacted 4 key antitrust laws The most important is the Sherman Act.
Antitrust Policy Sherman Antitrust Act of 1890 Section 1 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
Antitrust Policy Sherman Antitrust Act of 1890 Section 2 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 commerce …. shall be guilty of a misdemeanor
Antitrust Policy Clayton Act of 1914 Passed to remove the vagueness of the Sherman Act Robinson-Patman Act of 1936 Amended Section 2 of the Clayton Act Designed to protect independent retailers and wholesalers from “unfair discrimination” by chain stores
Antitrust Policy Exemptions from antitrust laws (US) All labor unions Public utilities Professional baseball Cooperative activities among US exporters Hospitals Public transit and water systems Supplier of military equipment Joint publishing arrangement in a single city by two or more newspaper
International Antitrust Policy More firms across the borders are merging The European Union put restrictions against merging of any business that would enhance the market dominance of one firm
Antitrust Enforcement Monopolization The possession of monopoly power in relevant market The willful acquisition or maintenance of that power, as distinguished from growth or development as a consequence of a superior product, business acumen, or historical accident
Monopoly power and the Relevant market Monopoly is not just company size Usually look at percentage of share in the relevant market A firm is usually considered to have monopoly power if share > 70% Ex: Being the “only” liquor store on a popular resort town (loosely)
Monopoly power and the Relevant market Relevant market consists of 2 elements Product market All items produced by different firms in the market have identical attributes, this includes substitutable products Geographic market Geographic boundaries include all area that items are sold
Antitrust Enforcement Product Versioning Selling a product with altered forms or functionalities to different groups of consumers Product Bundling Offering two or more products for sale as a set
Product Versioning Software version Professional and Standard edition?
Product Bundling Microsoft Windows and Internet Browser software
Issues in Enforcing antitrust Enforcement is through Supreme Court interpretations Authorities use market share test and determine “relevant market”
Basics of trade – what you should know The principle of comparative advantage The effect of tariffs The effect of quotas How restrictions on trade decrease the wealth of a country Know who gains and who loses from trade restrictions
Comparative advantage Comparative advantage refers to the lowest opportunity cost to produce a product The ability to produce a good or service at a lower opportunity cost compared with producers
Comparative Advantage Food (tons) Country A’s Production Possibility Frontier Machines
Comparative advantage Table indicates the unit cost of product. Italy – a unit of Wine costs 2 hours of work and a unit of computer costs 8 hours of work USA – a unit of Wine costs 2 hours of work and a unit of computer costs 1 hour of work The USA has Absolute Advantage in producing both Wine and Computer. Should the US trade with Italy?
Comparative advantage Why not produce both computer and Wine in the US??
Comparative advantage Let’s look at computer perspective:
To make 1 wine, the US sacrifices 2 computers. While Italy sacrifices 0.25 computer to make 1 wine.
Comparative advantage Let’s look at wine perspective:
To make 1 computer, the US sacrifices 0.5 wine. While Italy sacrifices 4 wines to make 1 computer.
Comparative Advantage To make 1 wine, the US sacrifices 2 computers. While Italy sacrifices 0.25 computer to make 1 wine. To make 1 computer, the US sacrifices 0.5 wine. While Italy sacrifices 4 wines to make 1 computer.