Transcript O`Sullivan Sheffrin Peres 6e

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Economics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.
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Economics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
6/e.
O’Sullivan, Sheffrin, Perez
Economics: Principles, Applications, and Tools
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.
PREPARED BY
FERNANDO QUIJANO, YVONN QUIJANO,
AND XIAO XUAN XU
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Economics: Principles, Applications, and Tools
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C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
APPLYING THE CONCEPTS
1
How does a decrease in demand affect the price of a
regulated monopoly?
A Decrease in Demand Increases the Price of Cable TV
2
What are the trade-offs with a merger?
Satellite Radio Merger
3
4
Does competition between the second- and third-largest
firms matter?
Heinz and Beech-Nut Battle for Second Place
How does a merger affect prices?
Xidex Recovers Its Acquisition Cost in Two Years
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28.1
NATURAL MONOPOLY
Economics: Principles, Applications, and Tools
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Controlling Market Power:
Antitrust and Regulation
Picking an Output Level
 FIGURE 28.1
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).
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28.1
NATURAL MONOPOLY
Picking an Output Level
Economics: Principles, Applications, and Tools
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C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
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28.1
NATURAL MONOPOLY
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Controlling Market Power:
Antitrust and Regulation
Will a Second Firm Enter?
 FIGURE 28.2
Will a Second Cable 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.
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28.1
NATURAL MONOPOLY
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Controlling Market Power:
Antitrust and Regulation
Price Controls for a Natural Monopoly
 FIGURE 28.3
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.
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APPLICATION
1
A DECREASE IN DEMAND INCREASES THE PRICE OF
CABLE TV
APPLYING THE CONCEPTS #1: How does a decrease
in demand affect the price of a regulated monopoly?
When the population of a city decreases, the demand for all sorts of goods
decreases. The decrease in the demand for housing decreases the price of housing.
In contrast, the price of cable TV service increases. A higher price for cable service
seems to defy the laws of supply and demand. What explains the puzzling increase
in price?
The key to solving this puzzle is that cable TV is a regulated natural monopoly, with a
price equal to the average cost of providing cable service.
• A decrease in the number of subscribers will cause the cable company to move
upward along its negatively sloped average-cost curve to a higher average cost
and a higher regulated price.
• In graphical terms, the demand curve for cable service shifts to the left, so it will
intersect the negatively sloped average-cost curve at a higher average cost.
• There are fewer subscribers to share the large fixed cost of the cable system, so
each subscriber must pay more.
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28.2
ANTITRUST POLICY
Economics: Principles, Applications, and Tools
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C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
● 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.
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28.2
ANTITRUST POLICY
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Controlling Market Power:
Antitrust and Regulation
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..
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ANTITRUST POLICY
Blocking Mergers
 FIGURE 28.4
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 profitmaximizing price is only $12.
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O’Sullivan, Sheffrin, Perez
C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
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28.2
ANTITRUST POLICY
Merger Remedy for Wonder Bread
In some cases, the government allows a merger to happen
but imposes restrictions on the new company.
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Controlling Market Power:
Antitrust and Regulation
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APPLICATION
2
SATELLITE RADIO MERGER
APPLYING THE CONCEPTS #2: What are the trade-offs
with a merger?
In 2007, 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 for dozens of channels, most
of which are free of advertisements. 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. Only the future can reveal what will happen to prices.
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28.2
ANTITRUST POLICY
Economics: Principles, Applications, and Tools
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C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
Regulating Business Practices: Price-Fixing, Tying, and
Cooperative Agreements
● 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.
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28.2
ANTITRUST POLICY
The Microsoft Cases
In recent years, the most widely reported antitrust actions have
involved Microsoft Corporation, the software giant.
In the case of United States v. Microsoft Corporation, the judge
concluded that Microsoft stifled competition in the software industry.
Economics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
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28.2
ANTITRUST POLICY
A Brief History of U.S. Antitrust Policy
Economics: Principles, Applications, and Tools
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C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
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Antitrust and Regulation
APPLICATION
3
HEINZ AND BEECH-NUT BATTLE FOR SECOND PLACE
APPLYING THE CONCEPTS #3: Does competition
between the second- and third-largest firms matter?
In 2001, H.J. Heinz Company announced plans to buy Milnot Holding Company’s
Beech-Nut for $185 million. The merger would combine the nation’s second- and
third-largest sellers of baby food, with a combined market share of 28 percent. The
combined company would still be less than half the size of the market leader,
Gerber, with its 70 percent market share.
The FTC successfully blocked the merger, based on two observations:
• Most retailers stock only two brands of baby food, Gerber and either
Heinz or Beech-Nut. After the merger, the Heinz brand would
disappear, leaving Beech-Nut as a secure second brand on the shelves
next to Gerber. The elimination of competition for second place would
lead to higher prices.
• The smaller the number of firms in an oligopoly, the easier it is to
coordinate pricing. In a market with two firms instead of three, it would
be easier for the baby-food manufacturers to fix prices.
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Controlling Market Power:
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APPLICATION
4
XIDEX RECOVERS ITS ACQUISITION COST IN TWO YEARS
APPLYING THE CONCEPTS #4: How does a merger affect prices?
In 1981, the FTC brought an antitrust suit against Xidex Corporation for its earlier
acquisition of two rivals in the microfilm market. By acquiring Scott Graphics, Inc., in
1976 and Kalvar Corporation in 1979, Xidex increased its market share of the U.S.
microfilm market from 46 to 71 percent. As a result, the price of microfilm increased:
• The price of one type of microfilm (diazo) increased by 11 percent, and the price
of a second type (vesicular) increased by 23 percent.
• These price hikes were large enough that Xidex recovered the cost of acquiring its
two rivals ($4.2 million for Scott Graphics and $6 million for Kalvar) in less than
two years.
To settle the antitrust lawsuit, Xidex agreed to license its microfilm technology—at
bargain prices—to other firms.
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28.3
DEREGULATION: AIRLINES,
TELECOMMUNICATIONS, AND
ELECTRICITY
Deregulation of Airlines
Before 1978, the Civil Aeronautics Board (CAB) regulated interstate air travel by
limiting entry into the market and controlling prices. The Airline Deregulation Act of
1978 eliminated most of the entry restrictions and price controls, and the CAB
eventually disappeared.
Deregulation led to lower prices, which fell by about 28 percent, on average. By
1998, deregulation had generated $24 billion in savings for passengers. Here are the
factors that contributed to the lower prices and the percentage of savings for each:
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28.3
Economics: Principles, Applications, and Tools
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6/e.
C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
DEREGULATION: AIRLINES,
TELECOMMUNICATIONS, AND
ELECTRICITY
Deregulation of Telecommunication Services
The Telecommunications Act of 1996 established new rules to promote
competition among firms that transmit video, voice, and data. Several
provisions of the act affect the Regional Bell Operating Companies (the Baby
Bells) that were formed as a result of the breakup of AT&T in 1982. Here are
the most important provisions of the act:
• Local telephone service.
• Cable TV service.
• Long-distance service.
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28.3
DEREGULATION: AIRLINES,
TELECOMMUNICATIONS, AND
ELECTRICITY
Deregulation of Electricity
The electricity industry has been regulated as a natural monopoly since its
early days.
In the 1990s, there was growing pressure to deregulate the electricity market
for two reasons:
• First, technological innovations reduced the economies of scale in
electricity generation, so generation was no longer a true natural
monopoly.
• A second factor in the pressure to deregulate was the substantial
variation in electricity prices across states.
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KEY TERMS
merger
predatory pricing
tie-in sales
trust
Economics: Principles, Applications, and Tools
O’Sullivan, Sheffrin, Perez
6/e.
C H A P T E R 28
Controlling Market Power:
Antitrust and Regulation
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