Antitrust and Regulation

This is Unit Ten of Principles of Microeconomics: what governments do about market power, from the antitrust statutes to the regulation of a natural monopoly. Unit nine ended with a cartel that game theory says will usually break, and with the note that the law makes such agreements unenforceable. This unit is that law, and the regulation that stands in for competition where cost makes one firm cheapest. Its tools are the ones you already hold: the concentration measures, the market-definition question, and the three pricing points on one demand curve. By the end you will be able to name the statutes and the kinds of merger. To measure a merger and apply the dated thresholds. To classify a practice short of merger. To state the options for a natural monopoly and compute its three prices. And to describe deregulation and capture, and carry one merger from table to decision.

Five entries on the law and mergers: the statutes, the kinds of merger, measuring one, the thresholds, and where the disputes live.

The statutes.

MIC 0901 Antitrust Law: The Statutes

Antitrust law began with the Sherman Act of eighteen ninety, against monopolization and restraint of trade. The Clayton Act of nineteen fourteen barred mergers that substantially lessen competition, price discrimination and tied sales, and the Federal Trade Commission followed that year; one oil trust became thirty-four firms in nineteen eleven. Monopoly itself is not illegal, and a better product earns a lawful share.

The mergers the law watches.

MIC 0902 Mergers and Acquisitions

A merger joins two firms; an acquisition is one buying another. Horizontal mergers join rivals, vertical ones join stages of a supply chain, conglomerate ones join unrelated businesses, and large mergers are notified in advance. Regulators allow most, block a few, and some on condition a plant is sold. A merger can raise efficiency and market power at once, and regulators weigh both.

Measuring one.

MIC 0903 Measuring a Merger

From a share table, compute the four-firm ratio and the Herfindahl-Hirschman Index before the merger, then combine the merging shares and recompute both. The increase in the index equals twice the product of the two merging shares. Report the post-merger level and the increase, and note that a merger among small firms can leave the ratio unchanged while still raising the index. Shares of twenty-five, twenty, fifteen, twelve, ten, eight, six and four give a ratio of seventy-two and an index of one thousand six hundred ten. The third and fourth firms merge into one at twenty-seven: the ratio becomes eighty-two, the increase is two times fifteen times twelve, three hundred sixty, and the index is one thousand nine hundred seventy. Had the two smallest merged, the increase would be forty-eight, the index one thousand six hundred fifty-eight, and the ratio unchanged. The shortcut works only for the two merging firms, and an increase of forty-eight is small though the merged firm doubled, because the index weights large shares.

What the agencies do with the numbers.

MIC 0904 The Agencies' Thresholds, Dated

The December twenty twenty-three Merger Guidelines call an index above one thousand eight hundred highly concentrated and presume a merger raising it there by over one hundred points lessens competition. The third-and-fourth merger trips both; the smallest-firm merger neither. A merged share above thirty percent with that increase is presumed too. The thresholds change with the guidelines, so learn the structure.

The assumption behind both measures.

MIC 0905 Market Definition and Actual Competition

Both measures assume the market is correctly defined, and that is where disputes live. Technology and globalization widen markets, and agencies also weigh evidence of actual competition, such as prices where rivals overlap; a grocery chain's merger has been judged on store-level prices rather than a share. The same merger can trip a threshold on one market definition and clear it on another.

Two entries on conduct short of merger: collusion and restrictive practices, and naming one from a description.

Conduct short of merger.

MIC 0906 Collusion and Restrictive Practices

Collusion, whether fixing prices, limiting output, rigging bids or dividing territories, is illegal. Restrictive practices reduce competition without an explicit agreement and are judged case by case: exclusive dealing, tying, bundling, predatory pricing; selling one product only with another is tying. Bundling at a discount with separate purchase available is usually lawful, and predatory pricing is tested by price below average variable cost.

Naming a practice.

MIC 0907 Classifying a Practice

Given a described practice, name it and say when it is likely lawful. Dealing only through one's own outlets is exclusive dealing, lawful when it sharpens dealer competition and suspect when one retailer locks up many makers. Conditioning one product on buying another is tying, suspect when it forces unwanted purchases. A package at a better price with separate purchase available is bundling, usually lawful. Pricing below average variable cost to drive out an entrant is predatory pricing, illegal but hard to prove. Four cases: a car maker selling only to its franchised dealers is exclusive dealing, lawful, since the dealers compete. A software firm selling its operating system only with its own browser is tying, contested. A cable company selling television, internet and phone together at a discount and separately at full price is bundling, lawful. An airline cutting fares on one route below the cost of flying it until the newcomer leaves is predatory pricing, illegal if the below-cost pricing and the intent can be shown. The same practice can be lawful in one setting and not another, and a price cut that hurts a rival is not predatory unless it is below the cutter's own variable cost.

Three entries on regulating the natural monopoly: the four options, the three pricing points, and how the regulator sets the price in practice.

The monopoly the law permits.

MIC 0908 Regulating a Natural Monopoly: Four Options

A natural monopoly's average cost falls across the whole market, so one firm serves it cheapest. The options: leave it alone, and it restricts output; split it, and average cost rises, since two half-size water systems duplicate the pipes; require marginal-cost pricing, efficient but loss-making; or average-cost pricing. Marginal-cost pricing needs a subsidy, since price is below a falling average cost.

The numbers.

MIC 0909 Regulating a Natural Monopoly: The Numbers

From a demand schedule, a fixed cost and a constant marginal cost, compute revenue, marginal revenue and average cost at each quantity. The unregulated point is where marginal revenue meets marginal cost, price from demand, with its profit. The marginal-cost point is where price equals marginal cost, with its loss, which equals the fixed cost when marginal cost is constant. The average-cost point is where price equals average cost: zero profit. A water utility faces demand from two thousand households at ten dollars down to ten thousand at two; fixed cost is twenty-one thousand and marginal cost two dollars a household. Marginal revenue for the third through sixth thousand runs seven, five, three and one, so the unregulated utility serves five thousand at seven dollars, where average cost is six twenty, for a profit of four thousand. Marginal-cost pricing means two dollars and ten thousand households, a loss of twenty-one thousand. Average-cost pricing lands at seven thousand households and five dollars, where average cost is exactly five. Read the regulated price from demand at the chosen quantity, and the average-cost point is the course's fair-return price, a normal profit, which is what zero economic profit means.

How the regulator sets the price in practice.

MIC 0910 Cost-Plus Against Price-Cap Regulation

Cost-plus regulation sets price at average cost plus a normal profit, so the firm has little reason to cut costs. A price cap fixes a price for years, and a firm that cuts cost keeps the gain; a cap that declines yearly rewards the utility that finds savings. A cap set too low, or hit by a cost shock, can break the firm.

Two entries to close: regulation's other edge, and the unit's capstone, one merger carried from the share table to the decision.

Regulation's other edge.

MIC 0911 Deregulation and Regulatory Capture

From the nineteen seventies airlines, railroads, trucking and gas were deregulated; no entrant had joined major air routes for forty years before nineteen seventy-eight. Regulation can also be captured: regulated firms shape the rules, supply the data and hire the regulators, so it serves incumbents. Deregulation brings entry, exit and layoffs along with lower prices, and the regulation bullet has both edges.

One merger from table to decision.

MIC 0912 One Merger, Start to Finish

Begin with the market as the merging firms describe it. Compute the ratio and the index before the merger, combine the two shares and recompute; the increase is twice the product of the merging shares. Compare with the thresholds: a post-merger index above one thousand eight hundred with an increase above one hundred is presumed to lessen competition, as is a merged share above thirty percent with that increase. Then question the market, because if the product competes nationally or online every share shrinks and the same merger may clear; this is argued first, since it decides the rest. Then look at actual competition where the two firms overlap, and weigh the efficiency claim, since scale that lowers cost can benefit consumers if enough is passed on. The decision is allow, block, or allow on conditions, usually divestiture where the overlap is worst. The regional cement market: shares of twenty-five, twenty, fifteen, twelve, ten, eight, six and four, and the third and fourth propose to merge. Before, a ratio of seventy-two and an index of one thousand six hundred ten; after, eighty-two and one thousand nine hundred seventy, an increase of three hundred sixty, so the presumption is tripped. The firms reply that cement ships across three states, where their shares are eight and six, an increase of ninety-six. Price data show prices ten percent lower where the two firms' plants overlap. The agency rejects the wider market, credits the overlap evidence, and allows the merger on condition that the overlapping plants, seven points of share, are sold to a new entrant: the merged firm holds twenty, the index is one thousand six hundred ninety, and the increase is eighty. Three cautions. The thresholds create a presumption, not a verdict. The efficiency defense cuts both ways, since scale that lowers cost is real and so is the power that comes with it. And the thresholds are the agencies' as of December twenty twenty-three; an exam may state older ones, so compute the level and the increase and apply the thresholds given.

Look at what you can now do. You can name the Sherman and Clayton Acts and the Federal Trade Commission, say that monopoly itself is not illegal, and sort a merger as horizontal, vertical or conglomerate. You can measure a merger with the ratio and the index, take the increase as twice the product of the merging shares, and apply the December twenty twenty-three thresholds while remembering that they change. You can separate collusion, which is illegal, from restrictive practices judged case by case, and name exclusive dealing, tying, bundling and predatory pricing from a description. You can state the four options for a natural monopoly, compute the unregulated, marginal-cost and average-cost points on one demand curve, and say why a price cap rewards cost cutting where cost-plus does not. And you can describe deregulation and capture as the two edges of the same tool, and carry one merger from the share table through market definition and overlap evidence to a conditional decision. Unit eleven turns to a failure the law of competition cannot fix.