Transcript - Univerzita Karlova v Praze

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Government can—and does—contribute to the
economic efficiency of markets by providing
infrastructure that permits markets to function

 There is a strong relation between infrastructure
quality and economic performance
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 physical infrastructure - bridges, airports,
waterways, and buildings
 institutional infrastructure - laws, courts,
and regulations, stepping in when markets
are not working properly
4

The backbone of a market economy’s institutional
infrastructure is the legal system

Important part of the institutional infrastructure is
regulation
5

Important part of the institutional infrastructure
that supports a market economy

In addition to protecting public safety and health,
regulation is also used to help markets function
more efficiently
Intervention in the market is often required to ensure
that the pursuit of profit does not conflict with social
welfare

Regulation differs from use of legal procedures in a
fundamental way

Under regulation, a government agency has power
to direct business to take specific actions

While legal procedures typically result in fines or
other penalties if businesses do something wrong,
regulators reach deep into the operations of business
to tell them what to do
 Ownership of the regulated firm remains private.
 Pricing and production decisions controlled
by a government regulatory agency
 Justification for government regulation - the use
of private property can be regulated to serve the
public interest
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
An efficient regulatory infrastructure must consider
and balance benefits - safer products, reduced crime
- against the costs of achieving legal and regulatory
goals

A legal and regulatory system ensuring complete
elimination of crime, unsafe products, and other
unwelcome activities would be less efficient than a
system that tolerated some amount of these activities
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By the 1960s government regulation of prices and
entry was commonplace in the
- transportation (railroads, trucking, airlines),
- communications (telephone services, radio,
television),
- “natural monopoly”/utility (electricity, natural gas)
industries
Increased significantly starting late 1960s and continuing
in the 1970s with the emergence of environmental and
consumer movements

Scale & scope of regulatory activity expanded

Governments imposed new controls on environmental
pollution, the safety of the workplace and consumer
products

Cycles of regulation:
◦ periods of heavy regulation
◦ followed by periods of deregulation

Economic and political influences
The last decades of the 20th century saw a wave of
attempts to remove, reduce, or simplify restrictions on
business and individuals

The goal was to encourage more efficient operation
of markets.

The stated rationale for deregulation, i.e. greater
reliance on market forces, was often that fewer and
simpler regulations will lead to a raised level of
competitiveness, therefore higher productivity, more
efficiency and lower prices overall.


Removal of many price and entry restrictions in
regulated industries (telecommunications, electrical
utilities, banking/financial services etc.)
 For example, deregulation of the air industry in
Europe in 1992 gave carriers from one EU country the
right to operate scheduled services between other EU
states.
In addition, there have been regulatory innovations,
usually suggested by economists, such as emissions
trading

 While
economic regulation declined, social
regulations (e.g., environmental, product and
workplace safety,, equal employment opportunity,
increased min. wage) remained
 Interest
groups and general public support remained
high for social regulation

What is the rationale for economic regulation ?

Whose interests are represented in regulation?
(Sometimes regulatory commissions protect the
interests of companies they are supposed to
regulate.)
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 Monopolies and natural monopolies,
anti-competitive behaviour (e.g. predatory pricing)
 Information inadequacies and asymmetry
 Unequal bargaining power
 Moral hazard
 Continuity and availability of service
 Scarcity and rationing
 Distributional justice and social policy

Consumer protection

Health care

Employer-Employee relationships

Energy use

Parliament

Government institutions (ministries)

Independent regulatory bodies (central banks,
specialized agencies)

European Commission

Courts

Self-regulatory (private) bodies

If regulation is implemented through independent
commissions and agencies, regulatory statutes and
practices can be appealed to the courts to test their
constitutionality and to ensure that agencies satisfy
due process in their decision making
- direct intervention (bans, requirements,
e.g. price regulation, rate of return regulation)
- indirect intervention (taxes, subsidies)

A firm has monopoly power when it can influence the
price that it charges for its product

Monopolies (imperfectly competitive markets) are
generally inefficient: price is too high, and output is
too low, to maximize net benefits in market
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
Government responds to the problem of
monopoly in one of three ways
◦ Making monopolized industries more
competitive.
◦ Regulating the behaviour of monopolies.
◦ Turning some private monopolies into
public enterprises.
 Legislation
designed to encourage competition and
discourage/ban the use of monopoly practices can
limit the inefficiencies resulting from market power
in general and monopoly in particular

To promote economic efficiency, anti-trust legislation
attempts to ensure entry and fair competition in
industries with barriers to entry and anti-competitive
practices
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(1)
-
-
Horizontal Restraint of Trade
a division of market, which reduces competition and
creates monopoly
a single company dominates a market and/or industry
(2) Vertical Restraint of Trade
-
a single firm controls supply chain
-
resale price control - manufacturer tries to control the
retail price
(3) Predatory Pricing
-
firms price below cost until other firms get driven out
of business and then they set prices as a monopolist
-
most relevant in industries with high barriers to entry
(e.g., airlines)

Anti-trust policies (as with all govt regulations)
change over time and are strongly influenced by
economics and politics

Broad language of anti-trust acts leaves considerable
room for interpretation for courts/judges
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what is the relevant market
market share of competitors
barriers to entry (capital costs, distribution chains,
software platforms)
is there international competition
cost structure of industry (is it subject to
increasing returns to scale?
incentives to innovate
the effect of tech change on relevant market
Breaking up a monopoly would not make sense when
the market would perform even worse with more
competition
Monopolies that arise from patents and copyrights,
provide an incentive for artistic creations and scientific
discovery
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Monopoly power that arises from network
externalities offers benefits that would be hard to
achieve under more competitive conditions

When a monopoly arises as a natural monopoly, using
anti-trust law to break it up or even to prevent its
formation is a poor remedy


A natural monopoly exists when, due to economies
of scale, one firm can produce for the entire market
at a lower cost per unit than can two or more firms
If government steps aside, such a market
will naturally evolve toward monopoly
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
If breaking up a natural monopoly is not advisable,
what can government do to bring us closer to
economic efficiency?
One option is public ownership and operation,
the other is price regulation
40

Under regulation, a government agency takes
some of the firm’s decisions
In the case of a natural monopoly, regulators
are interested in achieving economic efficiency,
which they do by telling the firm what price
it can charge
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
At first glance, one might think that natural
monopoly regulators have an easy job
There is the matter of information:
regulators often depend on information obtained from
monopolies
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Regulators determine a price that gives owners a
“fair rate of return” for funds they’ve put into the
monopoly
This price should give monopoly what economists
call normal profit, i.e. profit just high enough to cover
all of the owners’ opportunity costs, including the
foregone interest of their own funds
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
Price regulation is not a perfect solution:
When a firm is not striving to maximize profit (in this case,
because the government guarantees a specific rate of return), it
does not economize on costs. Regulated firms thus have little
incentive to hold down costs.
 Tendency of regulated natural monopolies to overinvest in
capital
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 Regulatory
boards are often made up of individuals
from the industry being regulated.
 Industries
that could very well compete desire to be
declared natural monopolies.
 If
the competition laws are to raise social welfare,
the government must determine which mergers are
desirable and which are not
The two views of competition are judgment
by performance and judgment by structure
: 47

Judgment by performance – we should judge the
competitiveness of markets by the performance
(behavior) of firms in the market
 A firm’s size within an industry is
insufficient evidence for the court to rule
against it in an antitrust suit. Issue is
behavior not size.
 Evidence must show that the firm actually
used its size to violate antitrust laws.
: 49

Judgment by structure – we should judge the
competitiveness of markets by the structure of the
industry.
A firm’s size within an industry is
considered sufficient evidence for the court
to rule against it in an antitrust suit.
Does not differentiate between good and bad
monopolies.
: 51

A trust or cartel is a combination of firms in
which the firms have not actually merged, but
act as a single entity.

A trust sets common prices and governs the output of
individual member firms.
A trust can, and often does act
like a monopolist

In 1911, the U.S. Supreme Court determined that both
Standard Oil and American Tobacco were structural
monopolies in that each controlled over 90 percent of
their markets.

In spite of this, they were not judged to have violated
the antitrust legislation because of their structure, but
because of their “unfair business practices.”

This judgment on performance, not structure, is often
called the abuse theory since a firm is legally
considered a monopoly only if it commits monopolistic
abuses.
 Structure
is a predictor of future performance.

A monopolist may be charging low prices now.

Once the competition melts away, the offending
firm raises its prices.

Judgment by performance requires that each action
of a firm must be analyzed on a case-by-case basis.

This is enormously expensive and time-consuming.

The structural approach is not without faults.

Choosing the relevant market when evaluating
competition is difficult

In the du Pont case (1956), the relevant
market for cellophane was the flexible-wrap
industry not the cellophane market of which
du Pont owned 100 percent.

Therefore, du Pont was not considered a
monopolist.

Technology was changing so fast that by the
time case reached the court, the issues were no
longer relevant.

In order to achieve economies of scale as well as
other advantges, firms have been simultaneously
breaking up and merging.

The law allows firms to break up any way they
like.

Mergers, on the other hand, must fall within
the law's antitrust guidelines.

Acquisitions and takeovers both result in the
combining of firms

The term merger is a general term meaning the
act of combining two firms

There are three types of mergers: horizontal,
vertical, and conglomerate

A horizontal merger is the merging of two companies
in the same industry

Most antitrust policy has centered on horizontal
mergers

A vertical merger is a firm merging with the supplier
of one of its inputs

If the merged firms are able to limit access of other
buyers or sellers to the market, the merger would be in
violation of the antitrust law

A conglomerate merger is the merging of two
companies in unrelated industries

There are several reasons why unrelated firms would
wish to merge
To achieve economies of scope
 To get a good buy
 To diversify
 To ward off a takeover bid
 To strengthen their political-economic influence


Globalization leads to mergers because firms can gain
instant foreign distribution, knowledge of local
markets, and lower the costs by redirecting production
to low-cost areas.

Deregulation has caused mergers to occur among
banks, electricity, and telecommunications companies.

Technological change has created takeover targets.
 If a firm wants a new technology it can buy the firm
that owns it.

Regulators sometimes will not let mergers to go
through without a deacquisition program.

Deacquisitions occur when a firm sells parts of another
company it has bought or parts of itself.

Some countries oppose antitrust laws because of
economies of scale and strong ties between government
and business.
 Competition
laws have costs and benefits.
Sometimes companies merge not to reduce
competition but to lower costs through joint
production
The benefits of greater efficiencies through
mergers are called synergies

Almost all economists agree that antitrust enforcement
has not reduced the size of firms below the minimally
efficient level, the level at which a firm can take full
advantage of economies of scale

In recent years, antitrust law has worked mainly
through its deterrent effect

Many potential mergers are never even proposed
because firms know the merger would not be allowed.

Price discrimination is the business practice of
selling the same good at different prices to
different customers, even though the costs for
producing for the two customers are the same.

Price discrimination is not possible when a good is
sold in a competitive market since there are many
firms all selling at the market price. In order to
price discriminate, the firm must have some
market power

Perfect Price Discrimination refers to the
situation when the monopolist knows exactly the
willingness to pay of each customer and can
charge each customer a different price.