Econ 204 week 12 outline

Prepared By Brock Williams
Chapter 13
Controlling Market
Power:
Antitrust and
Regulation
In 1997, a U.S. court blocked the
proposed merger of Staples and
Office Depot, the nation’s two
largest office- supply retailers.

Copyright ©2014 Pearson Education, Inc. All rights reserved. 13-2
Learning Objectives
1. Define a natural monopoly and explain the
average-cost pricing policy.
2. List three features of antitrust policy.

Picking an Output Level
M A R G I N A L P R I N C I P L E
Increase the level of an activity as long as its marginal benefit exceeds its
marginal cost. Choose the level at which the marginal benefit equals the
marginal cost.
13.1 NATURAL MONOPOLY

 FIGURE 13.1
A Natural Monopoly Uses the
Marginal Principle to Pick
Quantity and Price
Because of the indivisible input of
cable service (the cable system),
the long-run average-cost curve is
negatively sloped.
The monopolist chooses point a,
where marginal revenue equals
marginal cost.
The firm serves 70,000
subscribers at a price of $27 each
(point b) and an average cost of
$21 (point c). The profit per
subscriber is $6 ($27 – $21).
Picking an Output Level
13.1 NATURAL MONOPOLY (cont.)

Will a Second Firm Enter?
 FIGURE 13.2
Will a Second Firm Enter the
Market?
The entry of a second cable
firm would shift the demand
curve of the typical firm to the
left.
After entry, the firm’s demand
curve lies entirely below the
long-run average-cost curve.
No matter what price the firm
charges, it will lose money.
Therefore, a second firm will
not enter the market.

Price Controls for a Natural Monopoly
 FIGURE 13.3
Regulators Use Average-Cost
Pricing to Pick a Monopoly’s
Quantity and Price
Under an average-cost pricing
policy, the government chooses
the price at which the demand
curve intersects the long-run
average-cost curve—$12 per
subscriber.
Regulation decreases the price
and increases the quantity.

In the early part of the nineteenth century in Great Britain, water was distributed by
local government.
▪ The Industrial Revolution led to rapid urban growth.
▪ Lacking taxing power the local governments could not keep up with the demand
and water distribution changed to private industry.
▪ Problems with water distribution eventually led to Parliament to change back to
public waterworks.
▪ Water is a natural monopoly and multiple companies could not earn enough
profit to stay in business and offer adequate services.
PUBLIC VERSUS PRIVATE WATERWORKS
APPLYING THE CONCEPTS #1: What is the rationale
for regulating a natural monopoly?
A P P L I C A T I O N 1

In 2008, the nation’s only two satellite radio providers, Sirius Satellite Radio and XM
Satellite Radio, announced plans to merge into a single firm. Together the two firms had
14 million subscribers, each paying $13 per month. Both firms were losing money as
they struggled to get enough subscribers to cover their substantial fixed costs.
▪ The proposed merger needed to be approved by the U.S. Department of
Justice and the Federal Communication Commission.
▪ The key question is whether the elimination of competition between the two
firms would lead to higher prices, and how large any price hike would be.
▪ In evaluating the merits of the proposed merger, government regulators
grappled
with the trade-offs between saving costs by avoiding duplication and possible price
hikes.
▪ The merger eventually led to greater options and lower costs to subscribers
SATELLITE RADIO AS A NATURAL MONOPOLY
APPLYING THE CONCEPTS #2: When does a natural
monopoly occur?

● trust
An arrangement under which the
owners of several companies
transfer their decision-making
powers to a small group of trustees.
Breaking Up Monopolies
One form of antitrust policy is to break up a monopoly into several
smaller firms. The label “antitrust” comes from the names of the early
conglomerates that the government broke up.
13.2 ANTITRUST POLICY

Blocking Mergers
● merger
A process in which two or more firms
combine their operations.
• A horizontal merger involves two firms producing a similar
product, for example, two producers of pet food.
• A vertical merger involves two firms at different stages of the
production process, for example, a sugar refiner and a candy
producer.
13.2 ANTITRUST POLICY (cont.)

Blocking Mergers
 FIGURE 13.4
Pricing by Staples in Cities
with and without
Competition
Using the marginal principle,
Staples picks the quantity at
which its marginal revenue
equals its marginal cost.
In a city without a competing
firm, Staples picks the
monopoly price of $14.
In a city where Staples
competes with Office Depot,
the demand facing Staples is
lower, so the profit-
maximizing price is only $12.

Merger Remedy for Wonder Bread
In some cases, the government allows a merger to happen
but imposes restrictions on the new company.
 FIGURE 13.1
A Merger Increases Prices

Regulating Business Practices
● tie-in sales
A business practice under which a
business requires a consumer of
one product to purchase another
product.
● predatory pricing
A firm sells a product at a price
below its production cost to drive
a rival out of business and then
increases the price.

A Brief History of U.S. Antitrust Policy
 FIGURE 13.2
Key Antitrust Legislation

• In 1998, Pennzoil Motor Oils purchased Quaker State Motor oils in an
acquisition valued at $1 billion. The merger brought together two of the five
brands of premium motor oil, with a combined market share of 38% (29% for
Pennzoil and 9% for Quaker State).
• The antitrust agencies approved the merger without any modifications. A recent
study of the merger concludes that the new company increased the price of the
Quaker State products by roughly 5%, but did not change the price of Pennzoil
products. The market share of Pennzoil products increased, while the market
shares of Quaker State products decreased.
• The study also examines the price effects of four other mergers. In three of four
cases, the merger increased prices, with price hikes between 3 and 7 percent.
The authors note that the modest price effects might be surprising to (1) people
who expect relatively large positive price effects as firms exploit their greater
market power and (2) people who expect negative price effects as the firms
become more efficient.
THE MERGER OF PENZOIL AND QUARTER STATE
APPLYING THE CONCEPTS #3: How does a merger
affect prices?

The Federal Trade Commission (FTC) is responsible for enforcing laws against
predatory pricing. Consider the following FAQ dialog from the FTC web site.
Q: The gas station down the street offers a discount program that gives
members cents off every gallon purchased. I can't match those prices because they
are below my costs. If I try to compete at those prices, I will go out of business. Isn't
this illegal?
A: Pricing below a competitor's costs occurs in many competitive markets and
generally does not violate the antitrust laws. Sometimes the low-pricing firm is simply
more efficient. Pricing below your own costs is also not a violation of the law unless it
is part of a strategy to eliminate competitors, and when that strategy has a dangerous
probability of creating a monopoly for the discounting firm so that it can raise prices
far into the future and recoup its losses. In markets with a large number of sellers,
such as gasoline retailing, it is unlikely that one company could price below cost long
enough to drive out a significant number of rivals and attain a dominant position.
FAQ ABOUT PREDATORY PRICING FROM THE FTC
APPLYING THE CONCEPTS #4: What is predatory pricing?

merger
predatory pricing
tie-in sales
trust
K E Y T E R M S

Econ 204 week 12 outline

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Econ 204 week 12 outline