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16.4 Review and Practice

Summary

This chapter has shown that government intervention in markets takes the form of antitrust action to prevent the abuse of market power and regulations aimed at achieving socially desired objectives that are not or cannot be provided by an unregulated market system.

We saw that antitrust policy has evolved from a view that big business was bad business to an attempt to assess how the behavior of firms and the structure of markets affect social welfare and the public interest. The rule of reason rather than per se illegality guides most antitrust policy today, but because there is considerable debate concerning the appropriate role of government antitrust policy and regulation, application of the rule of reason in specific cases is uneven. Prosecution and enforcement of the nation’s antitrust laws has varied over time.

The rising role of a global economy in the last half of the twentieth century reduced the degree of market power held by domestic firms. Policymakers have reconsidered antitrust policy and what types of joint ventures and cooperation among competing firms should be allowed. U.S. antitrust policy has not been abandoned, but since the early 1980s it has been applied with greater consideration of its implications for the competitiveness of U.S. businesses against Asian, European, and other firms. Whether or not antitrust laws among nations will be made more compatible with each other is an issue for the future.

We saw that there are many different schools of thought concerning regulation. One group believes that regulation serves the public interest. Another believes that much current regulation protects regulated firms from competitive market forces and that the regulators are captured by the firms they are supposed to regulate. Yet another group points out that the regulators may do little more than serve their own interests, which include increasing the bureaucratic reach of their agencies.

Finally, the chapter looked at the complex issues surrounding consumer protection regulations. Consumer protection legislation has costs, borne by consumers and taxpayers. Economists are not in agreement concerning which, if any, consumer protection regulations are warranted. They do agree, however, that market incentives ought to be used when appropriate and that the most cost-effective policies should be pursued.

Concept Problems

  1. Apex Manufacturing charges Zenith Manufacturing with predatory pricing (that is, selling below cost). What do you think the antitrust authorities will want to consider before they determine whether to prosecute Zenith for unfair practices in restraint of trade?
  2. Some states require firms to close on Sunday. What types of firms support these laws? Why? What types of firms do not support these laws? Why?
  3. Individual taxis in New York, Chicago, and many other cities must have permits, but there are only a fixed number of permits. The permits are typically sold in the marketplace. Who benefits from such a regulation?
  4. What do you predict is the impact on workers’ wages of safety regulations in the workplace if the labor market is competitive?
  5. Many states require barbers and beauticians to be licensed. Using the public interest theory of regulation as a base, what, if any, arguments could you make to support such a regulation? Do you think consumers gain from such regulations? Why not just allow anyone to open up a barber shop or beauty salon?
  6. Suppose a landowner is required to refrain from developing his or her land in order to preserve the habitat of an endangered species. The restriction reduces the value of the land by 50%, to $1 million. Under present law, the landowner does not have to be compensated. Several proposals considered by Congress would require that this landowner be compensated. How does this affect the cost of the regulation?
  7. A study by the Federal Trade Commission compared the prices of legal services in cities that allowed advertising by lawyers to prices of those same services in cities that did not. It found that the prices of simple wills with trust provisions were 11% higher in cities that did not allow advertising than they were in cities that did.See Carolyn Cox and Susan Foster, “The Costs and Benefits of Occupational Regulation,” Federal Trade Commission, October 1990, p. 31. This, presumably, suggests the cost of such regulation. What might be the benefits? Do you think that such advertising should be restricted?
  8. Economist W. Kip Viscusi, whose work was cited in the Case in Point, and Gerald Cavallo studied the effects of federal regulations requiring cigarette lighter safety mechanisms.W. Kip Viscusi, “The Lulling Effect: The Impact of Protective Bottlecaps on Aspirin and Analgesic Poisonings,” American Economic Review 74(2) (1984): 324–27. Explain how this technological improvement might improve safety and how it might reduce safety.
  9. Explain how licensing requirements for providers of particular services result in higher prices for such services. Are such requirements justified? Why or why not?
  10. What is so bad about price-fixing? Why does the government prohibit it?
  11. In a 1956 antitrust case against DuPont, the Justice Department argued that the firm held a near monopoly in the cellophane market. DuPont argued that the definition of the market should be changed to include all wrapping paper. Why is this issue of market definition important? (DuPont’s position prevailed.)
  12. The Case in Point on the efficacy of antitrust enforcement painted a rather negative view of antitrust enforcement. Do you agree with this assessment? Why or why not?
  13. The Case in Point on Boeing and the European Union discussed a situation in which a foreign government, the European Union, attempted to exert authority over a relationship between two U.S. firms. How is this possible?

Numerical Problems

In 1986, Pepsi announced its intention to buy 7-Up, and Coca-Cola proposed buying Dr Pepper. The table below shows the market shares held by the soft-drink firms in 1986. Assume that the remaining 15% of the market is composed of 15 firms, each with a market share of 1%.

Company Market share (percent)
Coca-Cola 39
PepsiCo 28
Dr Pepper 7
7-Up 6
  1. Calculate the Herfindahl–Hirschman Index (HHI) for the industry as it was structured in 1986.
  2. Calculate the postmerger HHI if only PepsiCo had bought 7-Up.
  3. Calculate the postmerger HHI if only Coca-Cola had bought Dr Pepper.
  4. How would you expect the Justice Department to respond to each merger considered separately? To both?

(By the way, the proposed mergers were challenged, and neither was completed.)