Chapter 13/Limiting Market Power: Regulation and Antitrust
CHAPTER 13
LIMITING MARKET POWER: REGULATION
AND ANTITRUST
Part 1 of Chapter 13 deals with the regulation of firm and the other principal tool the government
has to confront the problem of excessive market power, antitrust policy. Part 2 of Chapter 13
CHAPTER OUTLINE
THE PUBLIC INTEREST ISSUE: MONOPOLY POWER VERSUS MERE
SIZE
Firms that possess monopoly power may threaten the public interest.
The abuse of monopoly power is undesirable because:
1. high prices reduce the wealth of consumers
PART 1: ANTITRUST LAWS AND POLICIES
Antitrust policies are put into place by the government to preclude the deliberate creation of
monopoly and prevent powerful firms from engaging in related “anticompetitive practices.”
MEASURING MARKET POWER: CONCENTRATION
Concentration: Definition and Measurement—The Herfindahl-Hirschman Index
The four-firm concentration ratio is a common, but flawed, measure of industry
concentration.
The Herfindahl-Hirschman Index is a more accurate measure of industry concentration and is
used by the Department of Justice in analyzing potential mergers.
Three conclusions are widely accepted:
1. If an industry has a very low concentration ratio, then its firms are very unlikely to
Chapter 13/Limiting Market Power: Regulation and Antitrust
Evidence on Concentration in Reality
Although concentration varies from industry to industry, the concentration ratios have not
increased in the United States in the 20th century.
A CRUCIAL PROBLEM FOR ANTITRUST: THE RESEMBLANCE OF
MONOPOLIZATION AND VIGOROUS COMPETITION
It is often a challenge for the antitrust authorities to distinguish between vigorous
competition and acts that undermine competition and support monopoly power.
ANTICOMPETITIVE PRACTICES AND ANTITRUST
Predatory Pricing
One principle widely followed by the courts holds that prices are predatory only if they are
below either marginal or average variable costs.
Even in cases where prices are below marginal or average variable costs, they may be held to
be predatory only under two conditions:
1. If there is evidence that the low price would have been profitable only if it succeeded
The Microsoft Case: Bottlenecks, Bundling, and Network Externalities
The Microsoft antitrust case raises many issues, two of which are discussed here as
illustrations.
1. Abuse via Bottlenecks. Microsoft Windows, an operating system that runs about 90
percent of all personal computers, is a prime example of a bottleneck. The bottleneck
problem arises because Microsoft itself supplies not only Windows, but also many
Chapter 13/Limiting Market Power: Regulation and Antitrust
USE OF ANTITRUST LAWS TO PREVENT COMPETITION
A serious concern is the potential misuse of the antitrust laws to prevent competition.
Firm that try to protect themselves in this way always claim that their rivals have not
achieved success through superior ability but, rather, by means that they call
“monopolization.”
PART 2: REGULATION
WHAT IS REGULATION?
Government regulation of industry in the United States is designed to watch over industries
possessing monopoly power. Regulation is regularly criticized for the inefficiencies it creates
SOME OBJECTIVES OF REGULATION
The purposes of regulation include:
1. control of market power resulting from economies of scale and scope
2. universal service and rate averaging
TWO KEY ISSUES THAT FACE REGULATORS
Setting Prices to Protect Consumers’ Interests and Allow Regulated Firms to Cover
Their Costs
1. Prices intended to promote the public interest may cause financial problems for firms.
Marginal versus Average Cost Pricing
In many regulated industries, firms would go bankrupt if prices were set equal to marginal
cost because:
1. Many regulated industries exhibit significant economies of scale.
2. In an industry with economies of scale, the long-run average cost curve is downward
sloping.
Chapter 13/Limiting Market Power: Regulation and Antitrust
Preventing Monopoly Profit but Keeping Incentives for Efficiency and Innovation
When regulators control profits, they face the danger of removing the useful incentive effects
of profits.
Price Caps as Incentives for Efficiency
An adjusting price cap is a way of controlling profits yet retaining some of the incentive
effects of profits.
THE PROS AND CONS OF “BIGNESS”
Bigness in industry may benefit the general public:
1. economies of large size: where small-scale operation is inefficient
2. required scale for innovation
DEREGULATION
The Effects of Deregulation
1. Effects on prices: generally lower prices
2. Effects on local services: some communities have been hurt, some have benefited
PUZZLE RESOLVED: WHY REGULATORS OFTEN PUSH PRICES
UPWARD
Regulators sometimes increase prices when they want to prevent firms from going out of
business.
CONCLUDING OBSERVATIONS
Most economists believe that by the 1970s, government intervention had clearly gone too far
in some respects and that deregulation was thus in the public interest. However, the general
issue is still open to considerable debate.
Chapter 13/Limiting Market Power: Regulation and Antitrust
MARGIN DEFINITIONS
Economies of Scale: savings that are obtained through increases in quantities produced.
Monopoly Power: (or market power): the ability of a business firm to raise the prices of its
products above competitive levels and to keep those prices high for a substantial amount of time.
Antitrust Policy: programs and laws that preclude the deliberate creation of monopoly and
prevent powerful firms from engaging in related “anticompetitive practices.”
Concentration of an Industry: measures the share of the total sales or assets of the industry in
the hands of its largest firms.
MAJOR IDEAS
1. Government regulation of firms is intended to prevent abuses that harm the public, but
many observers believe that it often leads to avoidable inefficiencies.
2. Among the major reasons given for regulation are: a) economies of scale and economies
of scope; b) the universal service goal.
Chapter 13/Limiting Market Power: Regulation and Antitrust
8. Predatory pricing is pricing that threatens to drive a competitor out of the market and
enables the firm to charge prices well above competitive levels.
9. There are conflicting opinions about the circumstances under which large firms harm the
public interest.
ON TEACHING THE CHAPTER
It is useful to go back to the microeconomic models of the firm that were developed in previous
chapters, and show how they can be used to analyze policy questions. The discussion of marginal
cost pricing in the presence of economies of scale is a good example.
This is a good place to emphasize that the microeconomic models of the firm are not just
mechanical constructs. They embody strong assumptions about optimization. The section entitled
“Preventing Monopoly Profit but Keeping Incentives for Efficiency and Innovation” is
particularly interesting in this respect. If regulation is done in such a way as to ensure a profit
The material in this chapter can capture students’ imagination. The movement for regulation
in the United States has idealistic origins, in the populist, progressive, and New Deal eras. In
each case, regulation was intended to protect the public against an exploitative private sector. But
the more recent movement for deregulation is intended to protect the public also, by allowing the
unseen hand of economic competition, which has been studied in this course, to work its magic.
Proponents of deregulation argue that, whatever the intentions of the regulators, the effects of
Chapter 13/Limiting Market Power: Regulation and Antitrust
PROBLEMS
1. Ace Monopoly has a widget plant in Eastville that is the sole supplier of widgets in
Eastville, and it has an identical plant in Westville that is the sole supplier in Westville.
There is no trade between Eastville and Westville, so the monopoly status of each plant is
secure. The Widget Regulatory Administration (WRA) regulates Ace. The following table
shows the total costs associated with different levels of output in each (identical) plant,
and it also shows the maximum price that can be charged for different quantities of output
in each city.
Maximum Price that Can be Charged
Output Total Cost in Eastville in Westville
4,000 $68,000 $18.00 $30.00
4,500 74,250 16.50 27.00
5,000 80,000 15.00 24.00
5,500 85,250 13.50 21.00
6,000 90,000 12.00 18.00
6,500 94,250 10.50 15.00
7,000 98,000 9.00 12.00
7,500 101,250 7.50 9.00
8,000 104,000 6.00 6.00
8,500 106,250 4.50 3.00
9,000 108,000 3.00 0.00
a) The WRA initially takes the view that the price of widgets should be the same in both
cities, and that it should be just sufficient to cover Ace’s marginal costs. What would
be the price and output of widgets in each city, under this rule?
b) On what grounds does Ace protest to WRA? (Note what Ace’s profits would be.)
c) WRA relents, and allows Ace to set a price in each city equal to its average cost in
that city. What will the price and output be in each city? Explain why there has been a
bigger reduction in output in one city than in the other.
d) Show how the rule adopted in c) has created inefficiency in the widget market. In
which city is the inefficiency more serious?
e) Ace has now come to an agreement with WRA such that it is guaranteed not to have
economic losses. What would you predict will happen to its cost schedule over time?
Is there anything that WRA can do to prevent this?
Solution:
a) Price and quantity of output are $6 and 8,000 units, respectively.
b) Ace’s protest to WRA would be on the basis of the loss it incurs at this price. Its total
Chapter 13/Limiting Market Power: Regulation and Antitrust
DISCUSSION QUESTIONS
1. Regulatory agencies sometimes set price floors for the output of firms in their industries.
Distinguish between reasons for such price floors that are valid in terms of protecting the
long-term interests of consumers, and reasons that are invalid.
Suggested Answer: The market price of a product will become higher than its equilibrium
price if the government sets a price floor. It will give an incentive for the suppliers to
2. Why have airline unions generally been skeptical about the value of deregulation in their
industry?
Suggested Answer: Students should discuss the effects of deregulation. Normally, unions
act as a monopoly that is aimed at the welfare of the employees. Usually, unions oppose
any move by the authorities to deregulate any industry that they think may harm their
3. Many people argue that the regulation of American business has gone much too far, with
the consequence that inefficiencies and high costs are rampant. There is widespread
support for deregulation in many areas. How would you evaluate regulation now? Do you
think the movement for deregulation has gone too far, not far enough, just about the right
distance? Why?
Suggested Answer: Student answers will vary. After collecting adequate information on
4. In recent years there has been a movement in many countries away from nationalized
industries and toward privatization. It seems clear to many people that government-run
industries are inherently inefficient. But if this is so clear, why was nationalization once
so popular? Are there no good reasons for a government’s taking over large companies
that have extensive market power?
Suggested Answer: Some believe that public ownership will help people to exercise
Chapter 13/Limiting Market Power: Regulation and Antitrust
5. Some people argue that there is no need for government regulation in the area of health
and safety. Agencies like the Food and Drug Administration and the Occupational Safety
and Health Administration are redundant, they say. Competition among firms for
customers and for labor will compel them to have safe products and safe working
conditions—if not, they would quickly lose their sales and their work force. Do you agree
with this argument?
Suggested Answer: These are vital as far as society is concerned. Competition sometimes
makes firms adopt unethical practices. Cost-cutting pressures may tempt companies to
6. Is there any valid reason for a regulatory agency actually preventing a competitive firm
from entering a market?
Suggested Answer: Students could come up with various reasons like national security,
7. Some people argue that one of the biggest faults of the regulatory system is the extensive
time delay. When conditions in an industry change, the regulatory agency may take
months and even years to change its rules and regulations. The process of public hearings
and administrative cases is overly cumbersome and time consuming. Others argue that
the time delays are beneficial. For example, a company may know that eventually the
agency will act to remove any excess profits, but in the meantime any efficiencies it can
achieve will cause its profits to rise, and so it has an incentive to manage its resources
carefully. Do you agree that regulatory agencies should be in no hurry to come to new
decisions?
Suggested Answer: Some may agree with this line of thought. Nevertheless, the power of
the government or another firm to haul a company into court on antitrust charges is an
8. How may firms collude in the setting of prices and the carving up of markets, without
their representatives actually getting together and talking?
Suggested Answer: Tacit collusion, where firms, without ever meeting, try to do undo
competition by maintaining prices near monopoly levels and hoping their competitors do
9. Some people argue that monopolies hinder innovation, because without competition,
firms are under no pressure to improve their products and services. Others argue that
monopoly promotes innovation because the prospect of monopoly profits is what gives
people the incentive to invest in risky, innovative ventures. How do you assess this
argument?
Suggested Answer: Student answers will vary. A monopoly firm may see no need for
reducing the cost through innovation, as there are no rivals in the market. Therefore, the
Chapter 13/Limiting Market Power: Regulation and Antitrust
10. Do you think that technological progress in the United States at the beginning of the 21st
century is tending to produce more or less concentrated industries? Why?
Suggested Answer: Over the course of the 20th century, concentration in individual U.S.
industries has shown little tendency to increase. Some argue that the size of firms has
11. Many professions restrict the entrance of newcomers to their trade by means of extensive
training programs and licensing. The medical profession, for example, requires many
years of training, plus rigorous certification examinations. The legal profession requires
not only completion of a law degree but also success at the bar examination. Similar
restrictions apply to accountants, real estate agents, electricians, and plumbers. Why
should these practices not be considered restraints on trade, established for the principal
purpose of raising incomes in their respective professions, and be deemed illegal under
American antitrust laws?
Suggested Answer: Extensive training and licensing is aimed at improving the quality of
12. Should a court admit evidence on the question of whether a market is contestable when
deciding whether a firm is guilty of antitrust violations?
Suggested Answer: It is important to note that the issue of evidence presentation in a
court about the antitrust activities conducted by a company is relative. It can be stated
that the company against which allegations have been made is actually engaging in
13. Antitrust legislation is intended to ensure that American firms are competitive. Explain
how antitrust laws can actually be used in some cases to reduce competition.
Suggested Answer: The misuse of antitrust laws to prevent competition is quite common.
There are many firms that seek protection from courts against their successful
Chapter 13/Limiting Market Power: Regulation and Antitrust
14. “Antitrust laws are at best irrelevant, and at worst harmful. Large firms (including
monopolies) exist only when there are long-run economies of scale—because if there
were no economies of scale, smaller firms could outsell larger firms. But when there are
economies of scale, the public is best served by fewer, larger firms. So industrial structure
is generally determined by the shape of the cost curves, not by legislation. And if the
courts actually do interfere with natural economic forces, by requiring firms to be broken
up in cases in which there are economies of scale, the public will be harmed because of
higher average costs. If the public is worried about excessive market power, it should
regulate large firms, but it should never attempt to break them up.” Discuss.
Suggested Answer: Scale economies mean that in a competition between a small firm and
a large firm, the large firm usually wins. If the courts actually interfere with natural
15. Discuss the Microsoft antitrust case. Do you think that the enormous costs incurred by
both the U.S. government and Microsoft outweighs the benefits to society? What are the
opportunity costs involved in the government’s decision to pursue this case?
Suggested Answer: This case is probably a good illustration of the difficulty in
differentiating between extremely competitive behavior and violation of antitrust