Microeconomics principles and policy 13th edition baumol solutions manual

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Chapter 13/Limiting Market Power: Regulation and Antitrust

CHAPTER 13 LIMITING MARKET POWER: REGULATION AND ANTITRUST DISCUSSION QUESTIONS 1. Why is an electric company in a city often considered to be a natural monopoly?

What would happen if two competing electric companies were established? How about telephone companies? How can changes in technology affect your answer?

Electric companies and telephone companies usually have declining average costs as more customers are added and more use is made of their services. A large part of the costs are fixed, in the form of the distribution network. It would be wasteful to add a second or third distribution network that covers the same routes as the first. Costs to consumers would have to rise. So a monopoly can serve the public interest, provided that the firm does not use its market power to exploit its customers. Changes in technology can significantly alter the cost structure of an industry and potentially eliminate a natural monopoly. An example is the impact of small satellite TV dishes on cable TV networks.

2. Suppose that a 20 percent cut in the price of coast-to-coast telephone calls brings in so much new business that it permits a long-distance telephone company to cut its charges for service from Chicago to St. Louis, but only by 2 percent. In your opinion, is this practice equitable? Is it a good idea or a bad one?

If a cut in the price of coast-to-coast telephone calls brings in so much business that it allows the long-distance carrier to reduce the price of Chicago to St. Louis calls, then both the long-distance carrier and the consumers benefit. Other long-distance competitors may be hurt, but then they have an added incentive to improve efficiency and provide better service to the public. Most observers would endorse such a rate reduction.

3. In some regulated industries, regulatory agencies prevented prices from falling, and as a result many firms opened for business in those industries. In your opinion, is this kind of regulation competitive or anticompetitive? Is it a good idea or a bad one?

When a regulatory agency imposes a price floor, it may encourage more firms to enter the industry, but it does not really encourage competition. The point of having many firms compete against each other is to force them to be efficient and to keep costs and prices low. In the case of the regulated price floor, the regulatory agency creates the appearance of competition, but at the expense of providing its benefits to the consumer.

4. Regulators are highly concerned about the prevention of “predatory pricing.” The U.S. Court of Appeals has noted, however, that “the term probably does not have a well-defined meaning, but it certainly bears a sinister connotation.” How might one distinguish “predatory” from “nonpredatory” pricing? What would you do about it?

A court should not find a price predatory and illegal simply because it is lower than other competitors can meet, if the low price can be sustained by the company. In such a case, consumers benefit in the long run. In contrast, if the firm with the lower price is © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Chapter 13/Limiting Market Power: Regulation and Antitrust

5.

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incurring a sustained economic loss, that would be a better indication that the firm is engaging in predatory pricing.

Do you think that it is fair or unfair for rural users of telephone service to be crosssubsidized by other telephone users?

Students will have their own criteria for fairness. But it is helpful to approach this question by thinking of what the alternative is to having urban telephone users subsidize rural telephone users. One alternative is that rural rates would be higher than urban rates—this could be seen as fairer (because rural average costs are higher than urban) or less fair (because people are being charged different prices for the same service). One consequence of higher rural rates might be that some rural households would choose to go without telephone service, and students may feel this is an undue burden. Another alternative, however, is that rural rates could be kept at the urban level by means of a government subsidy—this would impose the burden of the subsidy upon all taxpayers, in proportion to their capacity to pay income taxes, rather than upon urban phone users, and students may feel that this is more fair.

To provide incentives for increased efficiency, several regulatory agencies have eliminated ceilings on the profits of regulated firms but instead put caps on their prices. Suppose that a regulated firm manages to cut its prices in half, but in the process it doubles its profits. Should rational consumers consider this to be a good or a bad development? Why? Rational consumers should consider any fall in price to be a good development, because it increases their utility. They are in no way harmed by the increase in the company’s profitability. In fact, it may well have been the incentive of the increased profits that led the firm to figure out how to reduce costs and prices.

A shopkeeper sells his store and signs a contract that restrains him from opening another store in competition with the new owner. The courts have decided that this contract is a reasonable restraint of trade. Can you think of any other types of restraint of trade that seem reasonable? Can you think of any that seem unreasonable?

An agreement between a library and construction firms under which the firms agree to limit their hours of work in the neighborhood would seem to be a reasonable restraint on trade. So would a voluntary agreement among owners of fishing boats to limit the size of their catch in order to preserve the long-run yield of the fishery. But many commercial agreements are deemed by the law to be unreasonable, for example a cartel arrangement in which a small group of large firms agrees to limit their output in order to raise the market price.

Which of the following industries do you expect to have high concentration ratios: automobile production, aircraft manufacture, computer and electronics production, pharmaceuticals, production of expensive jewelry? Compare your answers with the data in Table 2.

As of 2007, aircraft manufacture had the highest concentration ratio (81.3), followed by automobile production (67.6), then pharmaceuticals (34.5), then production of expensive jewelry (28.5), and finally by computer and electronics production (17.3).

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Chapter 13/Limiting Market Power: Regulation and Antitrust

9. Why do you think the specific industries you selected in Discussion Question 8 are highly concentrated?

Automobiles and aircraft are two industries that are highly mechanized and in which huge fixed costs lead to substantial economies of scale. In these cases, therefore, large companies have an advantage over small companies, and the industries tend to be quite highly concentrated. The production of computers and electronics do not require significant economies of scale and therefore these industries are relatively unconcentrated. The pharmaceutical industry is characterized by very high research and development costs as well as high sales costs. However, once created, many pharmaceutical products can be produced at a low marginal cost. The result is the drug industry is somewhat concentrated.

10. Do you think it is in the public interest to launch an antitrust suit that costs $1 billion? What leads you to your conclusion?

Costly antitrust suits may be justified if the activities they are attacking cause major harm to the public. But since antitrust suits do tend to be very expensive, the Department of Justice is well advised not to embark upon suits that are ill founded or frivolous.

11. In Japan and a number of European countries, the antitrust laws were once much less severe than those in the United States. Do you think that this difference helped or harmed American industry in its efforts to compete with foreign producers?

Why? American companies argue that they are harmed in their competition with foreign companies by the strict U.S. antitrust laws. They are sometimes correct, when American laws seem to prevent cooperation between firms in research and development, market research, and other areas. On the other hand, the intent of antitrust laws is to promote competition and to keep prices low, and to the extent that they are effective they should therefore help American companies to compete against foreigners.

12. Can you think of some legal rules that may discourage the use of antitrust laws to prevent competition while at the same time not interfering with legitimate antitrust actions?

Antitrust laws can discourage competition if they are used against a company that has grown larger simply because it has performed better than other firms in the industry, by developing better products, selling at a lower price, improving its marketing, etc. If the management of a firm fears prosecution under these circumstances, it may decide against innovation. The most obvious way to discourage the use of antitrust laws in such a way is to insist that the criterion of prosecution be illegal conduct, not simply market structure.

Another possibility is to require the plaintiff to pay the legal costs of the defendant if the plaintiff does not prevail.

13. During the oil crisis in the 1970s, long lines at gas stations disappeared soon after price controls were removed and gas prices were permitted to rise. Should this event be interpreted as evidence that the oil companies have monopoly power? Why or why not?

Nothing in the question indicates that oil companies have monopoly power. The supply and demand curves might be as shown in Figure 1 below. A price ceiling of PC might cause a shortage, that is to say an excess of quantity demanded, Q D, over quantity supplied, QS, and consequently long lines at gas stations. When the ceiling is removed, the price would naturally rise to its market equilibrium level, P1; this would increase the © 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Chapter 13/Limiting Market Power: Regulation and Antitrust

quantity supplied, reduce the quantity demanded and eliminate the shortage and the lines.

There is no evidence that the companies have monopoly power to raise prices.

FIGURE 1

14. Some economists believe that firms rarely attempt predatory pricing because it would be a very risky act even if it were legal. Why may this be so?

Predatory pricing exists when a firm temporarily reduces its price below the profitmaximizing level, in order to force other, weaker firms to reduce their prices, in the expectation that those firms will go out of business, thus allowing the initial firm to have greater power, set a higher price, gain market share and increase profits. The risk is that the predatory firm itself may incur losses and even go out of business, because it has chosen such low prices.

15. Firm X cuts its prices, and competing Firm Y soon goes out of business. How would you judge whether this price cut was an act of legitimate and vigorous competition or an anticompetitive act?

This is very similar to question 4 about predatory pricing. To distinguish between an anticompetitive act and a legitimate competitive act one should identify potential barriers to entry, determine if the market is contestable, estimate the relevant demand elasticities, estimate the firm’s average and marginal cost curves, and identify the number of potential and actual competitors. If Firm X is able to profitably sustain the new low price and if new, more efficient firms enter the market this action was a result of legitimate competition that resulted in the elimination of the inefficient Firm Y. If Firm X incurs a loss as a result of the initially low price, raise its price after the exit of Firm Y and is able to prevent new firms from entering the market, this price cut was an anti-competitive act.

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.