Chapter 28 Regulation and Antitrust Policy in a Globalized

Copyright ©2011 by Pearson Education, Inc.All rights reserved.

Chapter 28

Regulation and Antitrust Policyin a Globalized Economy

28-2Copyright © 2011 Pearson Education, Inc. All rights reserved.

Introduction

The term sticker shock has come into widespread use to describe a consumer’s surprise and dismay about higher-than-anticipated prices of an item.

Today, consumers also have to deal with document-fee shock.

As you will learn in this chapter, auto-dealer document fees are just one example of a cost of government regulation.


Learning Objectives

• Distinguish between economic regulation and social regulation

• Recognize the practical difficulties in regulating the prices charged by natural monopolies

• Explain the main rationales for government regulation of industries that are not inherently monopolistic


Learning Objectives (cont'd)

• Identify alternative theories aimed at explaining the behavior of regulators

• Understand the foundations of antitrust laws and regulations

• Discuss basic issues in enforcing antitrust laws


Chapter Outline

• Forms of Industry Regulation• Regulating Natural Monopolies • Regulating Nonmonopolistic Industries• Incentives and Costs of Regulation• Antitrust Policy• Antitrust Enforcement


Did You Know That...

• A recent estimate indicates that the gross costs of complying with government rules regulating U.S. health care at about $339 billion per year?

• The estimated dollar value of the benefits from these regulations is $170 billion, leaving a net cost to society of $169 billion, or about $1,500 per household.

• Firms in the U.S. health care industry are highly regulated. Before you can study the economic effects of regulation, it is important to understand the various ways in which the government oversees the activities of U.S. businesses.


Forms of Industry Regulation

• The U.S. government began regulating social and economic activity early in the nation’s history.

• The amount of government regulation began increasing in the twentieth century.


Figure 28-1 Regulation on the Rise

Sources: Institute for University Studies; Federal Register, various issues.


Forms of Industry Regulation (cont'd)

• There are two basic types of government regulation.

1. Economic regulation of natural monopolies and nonmonopolistic industries

2. Social regulation which covers all industries



• Economic regulation of natural monopolies

– Initially, most economic regulation in the United States was aimed at controlling prices in industries considered natural monopolies.

– Over time, federal and state governments have sought to influence products and processes of firms in a variety of industries.



• Economic regulation of nonmonopolistic industries

– Securities (SEC)

– Banking (Fed, FDIC, Comptroller)

– Transportation (FAA)

– Communications (FCC)



• Social regulation

– The aim is better quality of life

• Improved products

• Less pollution

• Better working conditions


Table 28-1 Federal Agencies Engaged in Social Regulation


Regulating Natural Monopolies

• The theory of natural monopoly regulation includes our understanding of:

– Unregulated natural monopoly

– Impracticality of marginal cost pricing

– Average cost pricing


Regulating Natural Monopolies (cont'd)

• Recall

– Natural monopoly is a monopoly arising from the peculiar production characteristics in an industry.

– It usually arises when there are large economies of scale relative to the industry’s demand.

– One firm can produce at a lower average cost than can be achieved by multiple firms.


Figure 28-2 Profit Maximization and Regulation Through Marginal Cost Pricing, Panel (a)

Max profits at point Awhere marginal cost equals marginal revenue


28-17

Figure 28-2 Profit Maximization and Regulation Through Marginal Cost Pricing, Panel (b)

Losses eventually drive the natural monopolist out of business



• Methods of rate regulation

– Cost-of-Service Regulation• Regulation based on allowing prices to reflect only the

actual cost of production and no monopoly profits

– Rate-of-Return Regulation• Regulation that seeks to keep the rate of return in the

industry at a competitive level by not allowing excessive prices to be charged



• Natural Monopolies No More?– Are natural monopolies a thing of the past?

• Before answering this question, consider:

– Electricity and natural gas: separating production from delivery

– Telecommunications services meet the Internet


Regulating Nonmonopolistic Industries

• Protecting consumer interests has been the main rationale for governmental regulatory functions.

• The Latin phrase caveat emptor, “let the buyer beware,” was once the operative principle, but no more.


Regulating Nonmonopolistic Industries (cont'd)

• Rationales for government oversight in nonmonopolistic industries

– Market failure arising from externalities

– The need for consumer protection arising from asymmetric information



• The Lemons Problem

– The potential for asymmetric information to bring about a general decline in product quality in an industry

• Credence goods such as pharmaceuticals, health care, and professional services are vulnerable to the lemons problem.



• Implementing consumer protection regulation

– Liability laws and government licensing

– Direct economic and social regulation


Policy Example: Trying to Satisfy One Regulation Can Violate Another Regulation

• Under federal transportation laws, drivers of trucks with weights exceeding 10,000 pounds must be able to hear. Nevertheless, a federal appeals court recently supported an Equal Employment Opportunity Commission (EEOC) claim that United Parcel Service’s refusal to allow a deaf individual to drive a 20,000-pound truck violated the 1990 Americans with Disabilities Act.

• Separately, the EEOC is also citing age discrimination regulations in trying to force some firms to permit people over the age of 60 to fly airplanes. The EEOC is pursuing this claim even though a federal law prohibits people over 60 from piloting commercial passenger planes.

• As shown in these examples, regulations can often come into conflict.


Incentives and Costs of Regulation

• Abiding by government regulations can be costly.

– Consequently, businesses engage in activities intended to avoid intent or to change regulations agencies establish.


Incentives and Costs of Regulation (cont'd)

• Creative response and feedback effects: Results of regulation

– Creative Response

• Behavior on the part of a firm that allows it to comply with the letter of the law but violates the spirit, significantly lessening the law’s effects



• Creative response and feedback effects: Results of regulation

– Feedback effect• Changing behavior after the regulation that offset the

regulation

– Example• HOV lanes added to combat air pollution have higher

accident rates


Policy Example: The Feedback Effect of Warning-Label Overkill

• Warning labels are common on many products.

• Studies indicate that consumers typically read a single, briefly worded warning sticker that offers guidance about key safety risks associated with using a product.

• When confronted with numerous warning labels, however, consumers opt not to take the time to read any of the warnings at all.



• The Capture Hypothesis

– Predicts that the regulators will eventually be captured by the special interests of the industry being regulated



• The Share-the-Gains, Share-the-Pains Theory

– States that regulators must take account of the demands of three groups: legislators, members of the regulated industry, and consumers of the regulated industry’s product or service



• The Benefits and Costs Of Regulation

– Regulation offers many potential benefits.

– Actual benefits are more difficult to measure.



• Direct costs to taxpayers

– Taxpayers pay more than $40 billion per year.

– Agencies employ more than 250,000 employees.


Figure 28-3 The Distribution of Federal Regulatory Spending



• The total social cost of regulation

– Explicit costs of compliance in the United States is estimated to be between $500 billion and $600 billion per year.

– Economists estimate the opportunity cost of complying with federal regulations may be as high as $270 billion.

– Add state and municipal regulations, and consider all implicit and explicit costs, and we are over $1 trillion in total.


Antitrust Policy

• An expressed aim of the U.S. government is to foster competition.

• This is the general idea behind antitrust legislation.

• Congress has enacted four key antitrust laws, seen in Table 28-2. The most important of these laws is the Sherman Act.


Table 28-2 Key U.S. Antitrust Laws


Antitrust Policy (cont'd)

• 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.



• 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.



• The Clayton Act of 1914– Passed to remove the vagueness of the Sherman Act

• Federal Trade Commission Act in 1914– Established the Federal Trade Commission to investigate

unfair trade practices and enumerated certain business practices that involved overly aggressive competition.

– An amendment in 1938 expressly prohibited “unfair or deceptive acts or practices in commerce”



• The 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



• Exemptions from antitrust laws

– All labor unions

– Public utilities – electric, gas, and telephone

– Professional baseball

– Cooperative activities among U.S. exporters



• Exemptions from antitrust laws

– Hospitals

– Public transit and water systems

– Suppliers of military equipment

– Joint publishing arrangement in a single city by two or more newspapers


E-Commerce Example: The Justice Department Focuses on Flash Memory Price Fixing

• In the early 2000s, officials representing four companies—Elpida Memory, Hunix Semiconductor, Infineon Technologies, and Samsung—colluded in the setting of prices of dynamic random-access memory (DRAM) microchips.

• In 2006, The U.S. Justice Department secured convictions under the Sherman Antitrust Act.

• Why does the fact that higher prices could result from either higher market demand or from collusive efforts to monopolize a market complicate efforts to determine whether a Sherman Act violation may have occurred?



• International Discord in Antitrust Policy

– As more U.S. firms seek to merge with companies in other countries, the international dimensions of antitrust policy become more important.

– In the European Union, there are restrictions against any business combination that would enhance the market dominance of one firm.


Antitrust Enforcement

• Monopolization

– The possession of monopoly power in the relevant market and 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


Antitrust Enforcement (cont'd)

• Market Share Test

– The percentage of a market that a particular firm supplies; used as the primary measure of monopoly power



• The relevant market

– The relevant product market

– The relevant geographic market



• A particular problem in U.S. antitrust enforcement is determining whether a firm has engaged in “willful acquisition or maintenance” of market power.

• What appears as good business to some may look like antitrust violations to others.



• Versioning

– Selling a product in slightly altered forms to different groups of consumers

– An example is selling software in “professional”and “standard” versions



• Bundling

– Offering two or more products for sale as a set



• Tie-In Sales

– Purchases of one product that are permitted by the seller only if the consumer buys another good or service from the same firm


Issues and Applications: The Latest in Spiraling Regulation Costs: “Doc Fees”

• The costs of finalizing transactions involving vehicle purchaseshave increased considerably in recent years. The reason for this is that a variety of regulations have expanded the range of legally required documents.

• Until the 1990s, document processing fees associated with vehicle purchases rarely exceeded $50 per transaction.

• Since the early 1990s, many state legislatures have enacted laws establishing regulations requiring auto sellers to provide detailed documents to purchasers verifying features that are both present and absent in buyers’ vehicles.


Issues and Applications: The Latest in Spiraling Regulation Costs: “Doc Fees”(cont’d)

• A consequence of this kind of regulation has been the creation of more documents to be processed at the time of transfer.

• During the 2000s, a new wave of document requirements came about as state and federal governments began subjecting vehicle sales transactions to various requirements related to social regulation.


Issues and Applications: The Latest in Spiraling Regulation Costs: “Doc Fees”(cont’d)

• These and other laws have pushed up doc fees in many states. Average doc fees in most states today are close to $500.

• How does requiring an auto seller to prepare additional documents affect the marginal cost that the seller faces in completing a vehicle transaction?


Summary Discussion of Learning Objectives

• Government regulation of business– Includes economic and social

• Practical difficulties in regulating the prices charged by natural monopolies– Marginal cost pricing results in losses.

– Regulation aims at zero economic profit.


Summary Discussion of Learning Objectives (cont'd)

• Rationales for regulating nonmonopolistic industries

– Market failure

– Asymmetric information



• Regulators’ incentives and the costs of regulation

– Capture hypothesis

– Share-the-gains, share-the-pains



• Foundations of antitrust

– Sherman Act (1890)

– Clayton Act (1914)

– Federal Trade Commission Act (1914)

– Robinson-Patman Act (1936)



• Issues in enforcing antitrust laws

– Enforcement is through Supreme Court interpretations.

– Authorities use market share test and determine “relevant market.”

Documents

Chapter 28 Regulation and Antitrust Policy in a Globalized