Chapter 27
Regulation and Antitrust Policy in a Globalized Economy
◼ Overview
This chapter is concerned with the issues of economic and social regulation and antitrust policy.
Of special interest is the regulation of natural monopoly. Another important objective of this chapter is
to point out that antitrust is geared toward preventing the formation of monopolies or monopolistic
power. Economic regulation is a procedure by which specific firms that either have monopoly power
because of the technical nature of the production function or are granted monopoly power by government
are “controlled.” Presumably, both antitrust policy and regulation are attempts to defeat the more obvious
◼ Learning Objectives
After studying this chapter, students should be able to:
• 27.1 Distinguish between economic regulation and social regulation
• 27.2 Recognize the practical difficulties in regulating the prices charged by natural monopolies
◼ Outline
I. Forms of Industry Regulation: There are two basic types of government regulation: (1) economic
regulation and (2) social regulation. (See Figure 27-1.)
A. Economic Regulation: Initially, this was regulation to control prices that natural monopolies
were allowed to charge. Over time, federal and state governments have sought to regulate the
characteristics of products or processes in industries without monopolistic characteristics.
1. Regulation of Natural Monopolies: The regulation of natural monopolies has emphasized
408 Miller • Economics Today, Nineteenth Edition
B. Social Regulation: The aim of social regulation is to improve the quality of life through
II. Regulating Natural Monopolies
A. The Theory of Natural Monopoly Regulation: Whenever a single firm has the ability
to produce all of the industry’s output at a lower per-unit cost than any other firm, a natural
monopoly arises. The long-run average costs are falling over such a large range of
production rates (relative to demand) that only one firm can survive in such an industry.
(See Figure 27–1.)
1. The Unregulated Natural Monopoly: The natural monopolist will produce to the point
2. The Impracticality of Marginal Cost Pricing: The government determines the price that
3. Average Cost Pricing: Because regulators cannot force a natural monopolist to charge a
price equal to marginal cost and make it stay in business, regulation has often taken the
B. Natural Monopolies No More? For years, the electricity, natural gas, and telecommunications
industries were subject to economic regulation because they were viewed as natural
monopolies.
1. Electricity and Natural Gas: Separating Production from Delivery: Regulators decided
the function of producing electricity or natural gas could be separated from the delivery
2. Telecommunication Services Meet the Internet: The same principles have been
applied to telecommunications. The network over which telephone service is delivered is
III. Regulating Nonmonopolistic Industries: Protecting consumer interests has been the main
rationale for government regulatory functions.
A. Rationales for Consumer Protection in Nonmonopolistic Industries: At one time, the rule
of “caveat emptor,” or “let the buyer beware” was the rule in market transactions. Today,
federal regulations require sellers to meet certain minimum standards in their dealings with their
customers.
1. Reasons for Government-Orchestrated Consumer Protection: There are two major
reasons:
a. Market Failures
b. Asymmetric Information
2. Asymmetric Information and Product Quality: In extreme cases, asymmetric
information can lead to a situation where most of the products are of low quality. This
is called the lemons problem with used cars.
3. The Lemons Problem: The possibility that asymmetric information will lead to a general
4. Market Solutions to the Lemons Problem: Market solutions to the lemons problem are
sellers offering warranties, setting industry standards, and seeking external product
certification.
B. Implementing Consumer Protection Regulation: Governments implement legal remedies
1. Liability Laws and Government Licensing: Some liability laws specify penalties for
2. Direct Economic and Social Regulation: A government may determine that the lemons
IV. Incentives and Costs of Regulation: Because abiding by regulation is costly for firms, they
engage in activities that are intended to avoid the intent of regulations or to change established
regulations.
A. Creative Response and Feedback Effects: Results of Regulation: This is a firm’s behavioral
B. Explaining Regulators’ Behavior: The two best-known explanations of regulator behavior are
the capture hypothesis and the “share the gains, share the pains” theory.
1. The Capture Hypothesis: A theory of regulatory behavior that predicts that the regulators
will eventually be captured by the special interests of the industry that is being regulated.
2. “Share the Gains, Share the Pains”: A theory of regulatory behavior in which the
C. The Benefits and Costs of Regulation: Although there are many potential benefits of
regulation, it is difficult to measure the actual benefits of regulation.
1. The Direct Costs of Regulation to Taxpayers: Currently, the federal government spends
nearly $55 billion per year to fund the staff and activities of federal regulatory agencies.
2. The Total Social Cost of Regulation: The estimated total social cost of complying with
V. Antitrust Policy: The logic behind antitrust legislation is that if the courts can prevent collusion
among sellers of a product, monopoly prices will not result, and there will be no restriction of
output. There will be no economic profits in the long run.
A. Antitrust Policy in the United States: Congress has enacted four key antitrust laws.
(See Table 27-2.)
1. The Sherman Antitrust Act of 1890: This act was the first attempt by the federal
government to control the growth of monopoly in the United States. The most important
2. Other Important Antitrust Legislation: The Sherman Act was so vague that in 1914 a
new law was passed called the Clayton Act. It legally prohibited a number of very specific
3. Exemptions from Antitrust Laws
• Labor unions
• Public utilities—electric, gas, and telephone companies
B. International Discord in Antitrust Policy: Differing antitrust laws in the United States and
the European Union (EU).are a major issue. Under the antitrust laws of the EU, any business
Chapter 27 Regulation and Antitrust Policy in a Globalized Economy 411
C. Antitrust Enforcement: Most antitrust enforcement today is based on the Sherman Act. The
Supreme Court has defined the offense of monopolization as “(1) possession of monopoly
1. The Relevant Market: To assess whether a monopolistic capability exists, antitrust
authorities first seek to define a market. The relevant market consists of (1) a relevant
2. HHI Limits for Merger Evaluations: Either a combined HHI change greater than 100
3. Merger Enforcement Actions: If the antitrust enforcement authority views that a
D. Product Packaging and Antitrust Enforcement: In U.S. antitrust enforcement, it is important
to determine whether a firm has engaged in “willful acquisition or maintenance” of market
power. Two actions, versioning and bundling, are presented.
1. Product Versioning: Versioning is selling an item in slightly altered forms to different
groups of consumers at different prices.
2. Product Bundling: The joint sale of two or more products as a set. If it is only offered as a
set and not individually, then U.S. antitrust authorities view it as a form of price
discrimination known as tie-in sales. Tie-in sales require consumers who wish to buy one
of a company’s products to purchase another item the firm sells as well.
◼ Points to Emphasize
Are Natural Monopolies Inefficient?
Natural monopolies are said to be economically inefficient because in long-run equilibrium P MC.
Economic profits are possible, and equilibrium output is unlikely to occur at minimum ATC. If
412 Miller • Economics Today, Nineteenth Edition
Economic Regulation and Natural Monopoly
Some opponents of price regulation point out that the real issue is not whether prices should be controlled
but whether prices can be controlled. If price is set too low so that regulated firms cannot make a profit
(or at least a competitive or reasonable one), lower quality will result, which is really a price increase.
Antitrust Laws
Antitrust laws were passed to control, or limit, business behavior and to keep or make market structure
reasonably competitive. The laws and their application are better understood in the context of their purpose.
Regulators’ Behavior
It should be clear that regulation is inherently political because it represents attempts by government to
alter the effects of the operation of markets to achieve some desirable goal. In the process of regulation, the
Relevant Market
Modern antitrust enforcement centers on the concept of the relevant market. The necessary condition that
must be met in antitrust cases is that two or more sellers have restricted competition in a relevant market in
◼ For Those Who Wish to Stress Theory
Efficiency of Regulatory Pricing
Regulation that forces a natural monopolist to set price at marginal cost results in the firm incurring
economic losses. If a subsidy is paid to the monopolist to keep it in business in the long run, then the cost
Chapter 27 Regulation and Antitrust Policy in a Globalized Economy 413
Social Regulation
In industries where third parties can be injured by an industry’s product or operation, a strong case can be
made for regulation. Here, no matter how well informed a person is, he or she can still be injured. The
◼ Further Questions for Class Discussion
1. A good example of the feedback effect has to do with automotive safety regulation. Since the
1960s, the federal government has required the automobile manufacturers to make cars
increasingly safer. The desired result was fewer injuries and deaths for drivers and their passengers
involved in accidents. According to economist Sam Peltzman, however, due to the feedback effect,
drivers have begun driving more recklessly. Automobiles with more safety features have been
2. Considerable controversy can be generated in the classroom when the issue is one of a regulation
designed to prevent the loss of life. Should a regulation be rejected if costs of the regulation are
greater than its benefits, if it means that a number of persons will die who would otherwise have
lived? That is, is society better off in an economic sense if the regulation is rejected? Society is
3. Most of the arguments for social regulation assume consumers either are uninformed or cannot
make rational decisions because of asymmetric information. For example, regulation and licensing
of physicians is based on the idea that it is impossible for an average consumer to be able to
evaluate the quality of a given physician. Is this really true? In the case of physicians, is there an
alternative to licensing and regulation? If the problem is not so much one of complexity as it is of
4. Postal laws make it illegal for any competing service to charge less than three times the U.S.
Postal Service (USPS) rate for first class mail for any type of delivery service. Wherever
competition has been allowed, the USPS has fared badly. Yet, the federal government
5. There are about 250 egg-producing companies in the United States, many of which belong to the
United Egg Producers (UEP), the industry’s trade association. A small number of members of this
group are large vertically integrated companies that produce the bulk of the nation’s eggs.
Recently, they got together to restrict supply and to raise the price of eggs. They were successful
in increasing price. Agricultural cooperatives are exempt from the antitrust laws, and UEP is a
cooperative. The federal law was passed to allow farmers organized into cooperatives to control
the price. Which theory of regulatory behavior appears to describe what is allowed in the market
6. How does the fact that higher prices could result from either higher market demand or collusive
efforts to monopolize a market complicate efforts to determine whether a Sherman Act violation
◼ Answers to Questions for Critical Analysis
Lighting Up the Holidays Now Requires Satisfying Eleven Pages of Federal Rules
(p. 602)
Who pays for the many hours of work that numerous officials of agencies such as the Consumer
Product Safety Commission devote to establishing new regulations?
Mandated Energy Efficiencies Threaten Power Companies-And Electricity Buyers
(pp. 605–606)
What would happen to electric companies’ profits if regulators were to require them to set the price
of electricity equal to the marginal cost of providing each unit of power?
Chapter 27 Regulation and Antitrust Policy in a Globalized Economy 415
Does Bounded Rationality Strengthen or Weaken the Argument for Regulation?
(p. 611)
Why do you suppose that a growing number of behavioral economists are calling for adoption of
more pragmatic approaches to formulating regulations? Explain Briefly.
A U.S. Firm Asks French Antitrust Authorities to Halt a Pricing Conspiracy
(pp. 612–613)
Why do you suppose that nearly all of the world’s antitrust authorities agree that collusive
conspiracies to restrain trade and fix prices are illegal?
European Antitrust Authorities Charge Hollywood with Restraining Film Trade
(p. 614)
How might the fact that this antitrust case involves three groups-movie studios, distributors, and
broadcasters-complicate assessing whether consumers ultimately gain or lose from current
arrangements?
◼ You Are There
A Feedback Effect of Truck Safety Regulations: Unsafe Truck Parking (p. 617)
1. Why do you suppose that the U.S. Transportation Department has been considering new
regulations mandating that states construct parking facilities for trucks?
2. Why do you think that many firms with lengthy truck routes now try to recruit married
couples to drive their trucks?
◼ Issues and Applications
How Firms Engage in Conspiracies to Restrain Trade (pp. 618–619)
1. Why do you suppose that assigning market shares, regions, or customers and exchanging
sales information are the most common means of coordinating collusion?
2. Suppose that a firm’s self-interested owners or managers have no moral or ethical qualms
and do not anticipate being caught if they agree to participate in a collusive conspiracy.
Why might they still decide not to do so if only a moderate revenue gain would result?
(Hint: How would engaging in the collusion techniques listed in Figure 27-4 affect a
conspiring firm’s total costs?)
◼ Research Project
1. Learn about how the U.S. Justice Department enforces the Sherman Act’s prohibition of collusive
◼ Answers to Problems
27-1. Local cable television companies are sometimes granted monopoly rights to service a
particular territory of a metropolitan area. The companies typically pay special taxes and
licensing fees to local municipalities. Why might a municipality give monopoly rights to a
cable company?
27-2. A local cable company, the sole provider of cable television service, is regulated by the
municipal government. The owner of the company claims that she is normally opposed to
regulation by government, but asserts that regulation is necessary because local residents
would not want a large number of different cables crisscrossing the city. Why do you think
the owner is defending regulation by the city?
27-3. The table below depicts the cost and demand structure a natural monopoly faces.
Quantity
Price ($)
Long-Run Total Cost ($)
0
100
0
1
95
92
2
90
177
3
85
255
4
80
331
5
75
406
6
70
480
Chapter 27 Regulation and Antitrust Policy in a Globalized Economy 417
a. Calculate total revenues, marginal revenue, and marginal cost at each output level. If
this firm is allowed to operate as a monopolist, what will be the quantity produced and
the price charged by the firm? What will be the amount of monopoly profit? [Hint:
Recall that marginal revenue equals the change in total revenues (P × Q) from each
additional unit and that marginal cost equals the change in total costs from each
additional unit.]
b. If regulators require the firm to practice marginal cost pricing, what quantity will it
produce, and what price will it charge? What is the firm’s profit under this regulatory
framework? [Hint: Recall that average total cost equals total cost divided by quantity
and that profits equal (P – ATC) × Q.]
c. If regulators require the firm to practice average cost pricing, what quantity will it
produce, and what price will it charge? What is the firm’s profit under this regulatory
framework?
a. As the table indicates, long-run average cost and long-run marginal cost decline with greater
Quantity
Price
($ per unit)
Long-Run
Total Cost ($)
LRAC
($ per unit)
LRMC
($ per unit)
0
100
$0
—
—
1
95
92
$92.00
$92
3
5
6
27-4. As noted in the chapter, separating the production of electricity from its delivery has led to
considerable deregulation of producers.
a. Briefly explain which of these two aspects of the sale of electricity remains susceptible to
natural monopoly problems.
b. Suppose that the potential natural monopoly problem you identified in part (a) actually
arises. Why is marginal cost pricing not a feasible solution? What makes average cost
pricing a feasible solution?
c. Discuss two approaches that a regulator could use to try to implement an average-cost-
pricing solution to the problem identified in part (a).
a. Separation of the production of electricity from delivery of this good has allowed electricity
418 Miller • Economics Today, Nineteenth Edition
b. Electricity delivery entails a long-run average cost curve that slopes downward throughout
its range. Thus, the long-run marginal cost curve also slopes downward and lies below the
27-5. Are lemons problems likely to be more common in some industries and less common in
others? Based on your answer to this question, should government regulatory activities
designed to reduce the scope of lemons problems take the form of economic regulation or
social regulation? Take a stand, and support your reasoning.
Lemons problems are likely to be more common in industries in which evaluating the
27-6. Research into genetically modified crops has led to significant productivity gains for
countries such as the United States that employ these techniques. Countries such as the
European Union’s member nations, however, have imposed controls on the import of these
products, citing concern for public health. Is the European Union’s regulation of genetically
modified crops social regulation or economic regulation?
27-7. Do you think that the regulation described in Problem 27-6 is more likely an example of the
capture hypothesis or the share-the-gains, share- the-pains theory? Why?
27-8. Prices of tickets for seats on commercial passenger planes are typically in the hundreds of
dollars, whereas trips often can be made by automobile at lower cost. Accident rates per
person per trip in the airline industry are considerably lower than auto accident rates per
person per trip. Based on these facts, discuss how regulatory costs and benefits may help to
explain why government regulations require children to be placed in safety seats in
automobiles but not on commercial passenger planes.
Chapter 27 Regulation and Antitrust Policy in a Globalized Economy 419
27-9. A few years ago, the U.S. government created a “Do Not Call Registry” and forbade
marketing firms from calling people who placed their names on this list. Today, an
increasing number of companies are sending mail solicitations to individuals inviting them
to send back an enclosed postcard for more information about the firms’ products. What
these solicitations fail to mention is that they are worded in such a way that someone who
returns the postcard gives up protection from telephone solicitations, even if they are on
the government’s “Do Not Call Registry.” In what type of behavior are these companies
engaging? Explain your answer. (Hint: Are these firms meeting the letter of the law but
violating its spirit?)
27-10. Suppose that a business has developed a very high-quality product and operates more
efficiently in producing that product than any other potential competitor. As a consequence,
at present it is the only seller of this product, for which there are few close substitutes. Is
this firm in violation of U.S. antitrust laws? Explain.
27-11. Consider the following fictitious sales data (in thousands of dollars) for both e-books and
physical books. Firms have numbers instead of names, and Firm 1 generates only e-book
sales. Suppose that antitrust authorities’ initial evaluation of whether a single firm may
possess “monopoly power” is whether its share of sales in the relevant market exceeds
70 percent.
E-Book Sales
Physical Book Sales
Combined Book Sales
Firm
Sales
Firm
Sales
Firm
Sales
1
$ 750
2
$4,200
2
$ 4,250
2
50
3
2,000
3
2,050
3
50
4
1,950
4
2,000
4
50
5
450
1
750
5
50
6
400
5
500
6
50
6
450
Total
$1,000
$9,000
$10,000
a. Suppose that the antitrust authorities determine that selling physical books and
e-bookselling are individually separate relevant markets. Does an initial evaluation suggest
that any single firm has monopoly power, as defined by the antitrust authorities?
b. Suppose that in fact there is really only a single book industry, in which firms compete
in selling both physical books and e-books. According to the antitrust authorities’ initial
test of the potential for monopoly power, is there actually cause for concern?
420 Miller • Economics Today, Nineteenth Edition
a. In the e-book market, percentage sales shares are as follows: 75.0 percent for Firm 1, and
27-12. Consider the data from Problem 27-11. Suppose that antitrust authorities have determined
that there are separate relevant markets for e-books and physical books. In addition, these
authorities perceive that a monopoly situation exists that can be challenged on legal grounds
if the value of the Herfindahl-Hirschman Index exceeds 5,000. On the basis of this criterion,
do the antitrust authorities conclude that there are grounds for a legal challenge in either
market? Explain.
27-13. Consider the data from Problem 27-11. Suppose that antitrust authorities have determined
that the relevant market includes both e-books and physical books. These authorities
perceive that a monopoly situation exists that can be challenged on legal grounds if the
value of the Herfindahl-Hirschman Index exceeds 5,000. On the basis of this criterion, do
the antitrust authorities conclude that there are grounds for a legal challenge? Explain.
27-14. A package delivery company provides both overnight and second-day delivery services. It
charges almost twice as much to deliver an overnight package to any world location as it
does to deliver the same package to the same location in two days. Often, second-day
packages arrive at company warehouses in destination cities by the next day, but drivers
intentionally do not deliver these packages until the following day. What is this business
practice called? Briefly summarize alternative perspectives concerning whether this activity
should or should not be viewed as a form of price discrimination.
This is an example of versioning. From one perspective, this could be regarded as a method of
27-15. A firm that sells both Internet-security software and computer antivirus software will
sell the antivirus software as a stand-alone product. It will only sell the Internet-security
software to consumers in a combined package that also includes the antivirus software.
What is this business practice called? Briefly explain why an antitrust authority might
view this practice as a form of price discrimination.
27-16. Recently, a food retailer called Whole Foods sought to purchase Wild Oats, a competitor
in the market for organic foods. When the Federal Trade Commission (FTC) sought to
block this merger on antitrust grounds, FTC officials argued that such a merger would
dramatically increase concentration in the market for “premium organic foods.” Whole
Foods’ counterargument was that it considered itself to be part of the broadly defined
supermarket industry that includes retailers such as Albertson’s, Kroger, and Safeway.
What key issue of antitrust regulation was involved in this dispute? Explain.
27-17. A bank in Austin, Texas, has allowed its state banking license, under which it had been
regulated by the Federal Deposit Insurance Corporation, a U.S. bank regulator, to expire.
It has switched to a federal banking license, under which it is now regulated by the Office
of the Comptroller of the Currency, another bank regulator. Do these regulators subject
the bank to social or economic regulation?
27-18. Take a look at both panels of Figure 27-1. Suppose that we are willing to accept both federal
regulatory spending per year and the annual number of Federal Register pages as measures
of the extent of government regulation of businesses. Based on these measures, does any
period unambiguously appear to stand out as one in which the extent of regulation declined?
27-19. Suppose that in panel (a) of Figure 27-2, the vertical distances to points F and A are $10 per
unit and $2 per unit, and Qm is 1,000 units. To measure the degree of monopoly power,
economists often examine the differential between price and marginal cost as a percentage
of the price. What would be the value of this measure of monopoly power for the natural
monopolist depicted in panel (a) of the figure?
422 Miller • Economics Today, Nineteenth Edition
27-20. Consider panel (b) of Figure 27-2. The quantity Q1 is 2,000 units, the price P1 is $2 per unit,
the average cost AC1 is $4 per unit, and the vertical distance to point C is $6 per unit. What
is the dollar amount of the losses earned by this natural monopolist when its price is equal
to its marginal cost of producing Q1 units?
27-21. The manager of a Pittsburgh shop wishes to sell on eBay a used telescope that is in good
condition. The manager knows that prospective buyers perceive a 50-50 chance that the
telescope is in good condition. If it is, buyers are willing to pay $1,000, but if it is in poor
condition, they will pay only $200. What is the average amount a buyer will be willing to
pay? Is there a lemons problem? Explain.
27-22. Manufacturing firms based in Columbus, Ohio, and Erie, Pennsylvania, have proposed a
merger. If they were to merge, the resulting value of the Herfindahl-Hirschman Index in
the nationwide market for the product they produce would rise from 1,400 to 1,800. Under
current U.S. antitrust guidelines, would this proposed merger raise concerns for the U.S.
Justice Department or Federal Trade Commission?
◼ Selected References
Baratz, M. S., “Cost and the Prices in the Post Office,” D. C. Watson, ed., Price Theory in Action: A Book
of Readings, Boston: Houghton-Mifflin, 1965, pp. 319–323.
Bork, Robert H., The Antitrust Paradox, New York: Basic Books, 1978.
Brozen, Yale, “Competition, Efficiency, and Antitrust,” Selected Papers No. 32, of the Graduate School
of Business, University of Chicago.
Clarkson, Kenneth W. and Roger LeRoy Miller, Industrial Organization: Theory, Evidence, and Public
Policy, New York: McGraw-Hill, 1982.
Chapter 27 Regulation and Antitrust Policy in a Globalized Economy 423
Greer, Douglas F., Industrial Organization and Public Policy, 2nd ed., New York: Macmillan, 1984.
Katzman, Robert A., “The Attenuation of Antitrust,” The Brookings Review, Summer 1984, pp. 23–27.