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Market Power: Antitrust Policy and Economic Regulation
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n the textbook model of perfect competition, firms earn a normal market rate of return in the long run. Of course, some firms may have superior technologies and management, which enable them to earn an above-normal rate of return for an indeterminate length of time. But when a firm attempts to capture consumer surplus by engaging in illegal conduct to monopolize a market or by abusing its market power, government policy, as codified in the antitrust laws, can improve consumer welfare by stopping these actions and discouraging other firms from engaging in such behavior. A market’s technological characteristics may give rise to natural monopoly, an unusual situation where social costs are minimized when one (wellbehaved) firm serves the market. Competition under these conditions could therefore result in industrywide bankruptcy or a monopoly survivor. Because an unregulated monopolist is likely to extract consumer surplus at the expense of total welfare, government policy in the form of economic regulation can improve economic welfare by setting more efficient prices for the monopoly provider and preventing other firms from entering the market, albeit with adverse incentives for innovation. Optimal prices could be set either at marginal cost with a subsidy or tax that enables the regulated monopolist to earn a normal return or at Ramsey prices that satisfy a break-even constraint. (Under Ramsey pricing, the percentage markup of 13