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Antitrust and Regulation

• Key Concepts• Summary

©2005 South-Western College Publishing

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What will I learn in this chapter?

You will explore and form opinions on the Microsoft case, the Standard Oil case, and other major antitrust cases

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What is a trust?A combination or cartel consisting of firms that place their assets in the custody of a board of trustees

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What ispredatory pricing?

The practice of one or more firms temporarily reducing prices in order to eliminate competition and then raising prices

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When was the age of the robber barons?

In the later part of the 1800’s

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What was done to limit the power of trusts?

Congress passed laws aimed at preventing firms from engaging in anticompetitive activities

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What is theSherman Act?

The federal antitrust law enacted in 1890 that prohibits monopolization and conspiracies to restrain trade

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What is the Clayton Act?

A 1914 amendment that strengthens the Sherman Act by making it illegal for firms to engage in certain anticompetitive business practices

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What business practices were

declared illegal under the Clayton Act?

• Price discrimination• Exclusive dealing• Tying contracts• Stock acquisition of

competing companies• Interlocking directorates

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Was the Clayton Act an improvement over

the Sherman Act?Although more specific than the Sherman Act, the Clayton Act is also vague

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What is the Federal Trade Commission Act? The federal act that in 1914 established the Federal Trade Commission (FTC) to investigate unfair competition

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What is theRobinson-Patman Act?

A 1936 amendment to the Clayton Act that strengthens the Clayton Act against price discrimination

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What is the basic purpose of the

Robinson-Patman Act?To prevent large sellers from offering different prices to different buyers where the effect is to harm even a single small firm

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What is theCeller-Kefauver Act?

A 1950 amendment to the Clayton Act that prohibits one firm from merging with a competitor by purchasing its physical assets if the effect is to substantially lessen competition

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What are some key antitrust cases?

• Standard Oil Case 1911• Alcoa Case 1945• IBM Case 1982• AT&T Case 1982• MIT Case 1992• Microsoft Case 1995

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What was the outcome of the

standard oil case?The rule of reason

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What is therule of reason?

The antitrust doctrine that the existence of monopoly alone is not illegal unless the monopoly engages in illegal business practices

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What was the outcome of the Alcoa case?

The per se rule

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What is the per se rule?

The antitrust doctrine that the existence of monopoly alone is illegal, regardless of whether or not the monopoly engages in illegal business practices

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What was the result of the IBM case?A switch back to the rule of reason

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What was the result of the AT&T case?

Technology made this government-regulated natural monopoly obsolete, and AT&T was found guilty of anticompetitive pricing

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What was the result of the MIT case?

Eight Ivy League schools agreed to stop colluding to fix prices, and MIT was found guilty of price fixing

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What was the result of the Microsoft case?

Microsoft was not allowed to purchase Intuit Inc., a competitor in the personal finance software industry

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What was the Microsoft case of 2001?

This case charged Microsoft with predatory pricing by tying its monopoly in Windows to its Internet Explorer browser

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How can firms avoid charges of

price fixing?They can merge into one company

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When did a lot of mergers begin taking place?

In the 1980’s

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What are the different types of mergers?

• Horizontal • Vertical• Conglomerate

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What is ahorizontal merger?

A merger of firms that competes in the same market

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What is avertical merger?A merger of a firm with its suppliers

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What is aconglomerate merger?A merger between firms in unregulated markets

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What can be said about conglomerate mergers?

They are generally allowed because they do not significantly decrease competition

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What can be said about antitrust laws in other countries?They are weak in comparison to U.S. antitrust laws

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What is the history of government regulation?

From the later part of the 1800’s to the 1970’s, there was an increase in regulation; in the 1970’s there was a movement away from regulation

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What is the basic argument in favor of

government regulation?Market failure

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In what ways does the market fail?

• Natural monopoly• Externalities• Imperfect information

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What is anatural monopoly?

An industry in which long-run average cost is minimized when only one firm serves the market

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What ismarginal cost pricing?A system of pricing in which the price charged equals the marginal cost of the last unit produced

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$20$15$10

$5

1 2 3 4

$25$30$40$50

5 6 7 8 9DMR

Regulated Monopoly

A

LRMC

B

C

P

Q

efficient price

LRAC

Fair return price

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What is anormal profit?

The accounting profit required to induce a firm’s

owners to employ their resources in the firm

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Do production costs include normal profit?Yes, because normal profit is considered a necessary

expense of a business

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What kind of profit is made at the

fair return price?Normal Profit

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What happens when pollution is present?

Pollution causes polluting firms to overproduce, while causing firms that pay the cost of cleaning up the pollution to underproduce

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What can be done when the externality of pollution is present?The government can regulate the industry to minimize the pollution

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What happens with imperfect information?Deficient information on unsafe products can cause consumers to overconsume a product

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$10

$5

25 50

$15

$20

75 100

Impact of Imperfect InformationP

Q

D1

E1 S

D2

E2

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Consumers informed of defect

Increase in Demand

Decrease in quantity supplied

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Key Concepts

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• What is a trust?• What is predatory pricing?• What is the Sherman Act?• What is the Clayton Act?• What is the Federal Trade Commission Act?• What is the Robinson-Patman Act?• What is the Celler-Kefauver Act?• What is the rule of reason?• What is the per se rule?

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• What are the different types of mergers?• What is a horizontal merger?• What is a vertical merger?• What is a conglomerate merger?• What can be said about antitrust laws in other

countries?• What is a natural monopoly?• What happens when pollution is present?• What happens with imperfect information?

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Summary

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A trust is a cartel that places the assets of competing companies in the custody of a board of trustees. During the last decades of the 19th century, trusts engaged in anticompetitive strategies to eliminate competition and raise prices, such as predatory pricing.

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The Sherman Act of 1890 and the Clayton Act of 1914 are the two most important antitrust laws. The Sherman Act marked the first attempt of the U.S. government to outlaw monopolizing behavior. Because this act was vague, the Clayton Act was passed to define anticompetitive behavior more precisely.

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The Clayton Act prohibited (1) price discrimination, (2) exclusive dealing, (3) tying contracts, (4) stock acquisition, and (5) interlocking directorates.

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The Robinson-Patman Act of 1936 strengthened the Clayton Act by prohibiting certain forms of price discrimination. This law is called the “Chain Store Act” because it was aimed at large retail chain stores that were obtaining volume discounts.

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The Celler-Kefauver Act of 1950 strengthened the Clayton Act declaring illegal the acquisition of the assets of one firm by another firm if the effect is to lessen competition.

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The rule of reason and the per se rule are the two main philosophies the courts have used in interpreting antirust law. Under the rule of reason, monopolist were not subject to prosecution unless they acted in an anticompetitive manner.

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The Supreme Court decision in the Alcoa case of 1945 replaced the rule of reason with the per se rule, which states that the mere existence of monopoly is illegal. Today, the trend is in favor of dominant firms because of international competition.

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A horizontal merger is a merger of two competing firms. A vertical merger is a merger of two firms where one produces an input used by the other firm. A conglomerate merger is a merger of two firms producing unrelated products.

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Deregulation is a movement that began in the1980’s to eliminate regulations primarily in the transportation and telecommunications industries. Today, the current trend is toward further deregulation resulting from federal budget cuts.

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Marginal cost pricing is a competitive pricing strategy for a regulated natural monopoly. Using this approach, regulators set the monopolist’s price equal to its marginal cost. Another method is for regulators to establish a fair-return price equal to long-run average cost and the monopolist earns zero economic profit.

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Regulation of a natural monopoly is justified on the basis of market failure. Two other cases based on market failure include externalities and imperfect information.

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$20$15$10

$5

1 2 3 4

$25$30$40$50

5 6 7 8 9DMR

Regulated Monopoly

LRMC

A

B

C

P

Q

efficient price

LRAC

Fair return price

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END