|The Regulation of Business
|Antitrust vs. Regulation
- Under ideal conditions, the market mechanism may also
provide optimal outcomes.
- Laissez Faire – the doctrine of “leave it alone,” of
nonintervention by government in the market mechanism.
- To achieve this ideal
These ideal conditions are rarely, if ever, attained
leading to market failure.
- all producers must be perfect competitors
- people must have full information about tastes, costs,
- all costs and benefits must be reflected in market
- pervasive economies of scale must be absent.
- Government intervention may be appropriate in industries
where market power prevails.
- There are two options for the focus of intervention:
Antitrust laws address both issues.
Government regulation focuses almost exclusively on
Social vs. Economic Regulation
- the structure of an industry.
- the behavior of an industry.
- Social regulation is concerned with such issues as
workplace safety, health, environmental protection, and highway safety.
- Economic regulation is more directly focused on prices,
production, and the conditions for industry entry or exit.
- The choice is not between imperfect markets and flawless
intervention but rather between imperfect markets and imperfect
- Government failure may be worse than market failure.
- One of the best arguments for monopolies is that they can
achieve economies of scale.
Declining ATC Curve
- there are doubts as to whether consumers will benefit
from the resulting cost savings.
- Natural Monopoly - an industry in which one firm can
achieve economies of scale over the entire range of market supply.
- The distinctive characteristic of a natural monopoly is
its downward-sloping average total cost (ATC) curve.
- The marginal cost (MC) curve lies below the ATC curve at
all rates of output.
- The economies of scale offered by a natural monopoly
that no other market structure can supply the good as cheaply.
natural monopoly is a desirable market structure.
- Although the structure of a natural monopoly may be
beneficial, its behavior may leave something to be desired.
- The unregulated pricing of a natural monopolist violates
the competitive principle of marginal cost pricing.
- Because P > MC, consumers are not getting accurate
about the opportunity cost of products sold in monopoly markets.
- The economic profits potentially earned by monopolist may
violate our visions of equity.
- Price Efficiency - The government could force the
monopolist to set its price equal to marginal cost.
- Subsidy - in a natural monopoly, MC is always less than
Hence, marginal cost pricing by a natural monopolist implies a loss on
unit of output produced. In order to provide efficient pricing, a
must be provided to the natural monopoly.
- Production Efficiency – In a natural monopoly, production
is achieved at capacity production, where ATC is at a minimum.
- The government can regulate the natural monopoly so that
it makes a “normal” profit
- If a firm is permitted a specific profit rate, it has no
incentive to limit costs.
- The government can regulate the natural monopoly’s output.
- Regulation in the quantity produced may induce a decline
- Goal conflicts are inescapable, and any regulatory rule
may induce undesired producer responses.
- Second-best Solutions - A realistic goal for regulation
that regulators will have to choose a strategy that balances competing
(e.g., Price efficiency, equity) to improve market outcomes, not to
|The Costs of Regulation
- Someone must sit down and assess these regulation
The costs of these lawyers, accountants, engineers, etc. represent a
cost to society.
- There is a cost for regulated firms to educate
change their production behavior and to file reports with the
Balancing Benefits and Costs
- Inefficient regulation (bad decisions, incomplete
information, and faulty implementation) has a cost associated with it.
- Regulatory intervention must balance the anticipated
improvements in market outcomes against the economic cost of regulation.
|Deregulation in Practice
- The push to deregulate is prompted by two concerns:
- The dynamic inefficiencies that regulation imposes.
inefficiencies accumulate over time making the regulated industry less
- Advancing technology destroys the basis for natural
- The railroad industry is an example of natural monopoly
with high fixed costs and negligible marginal costs.
- The Interstate Commerce Commission (ICC) was created in
to limit monopolistic exploitation of the railroad situation while
a “fair” profit to railroad owners.
- With the advent of buses, trucks, subways, airplanes and
as alternative modes of transportation, railroad regulation became
- The Railroad Revitalization and Regulatory Reform Act of
followed by the Staggers Rail Act of 1980, granted railroads much
freedom to adapt their prices and service to market demands.
- Railroad companies used that flexibility to increase
their share of total freight traffic.
- The railroads prospered under deregulation by
routes and services, cutting operating costs, and offering lower
Between 1986 and 1993, the average cost of moving freight by rail
by 69 percent.
- Not all rates fell, however. After a series of
and acquisitions the top four railroads moved nearly 90 percent of all
freight in 1998-99. Some firms held monopoly positions on
routs. Shippers in these ‘captive’ markets were paying rates
percent higher than in non-monopoly routes.
- In the 1930s, Congress broadened the powers of the ICC to
interstate trucking to protect the industry from the effects of the
- As a result, the industry flourished with its
profits. It became so profitable that people were willing to pay
for a trucking license.
- Entry regulations were relaxed in 1978 and major reforms
instituted by 1979. Between 1980 and 1992, the number of firms
from 18,000 to over 48,000. By 1981, the value of existing truck
had fallen to $13,000.
- Technology outpaced regulation and greatly reduced the
cost for new firms to provide long-distance service.
- Long Distance
- In 1982, the courts put an end to AT&T’s
- Since then, over 800 firms have entered the industry,
and long-distance telephone rates have dropped sharply.
- Between 1983 and 1990, long-distance telephone rates
fell more than 40 percent.
- The quality of service has also been improved with
cable, advanced switching systems, cell phones, and myriad new
- Long-distance telephone use in the United States has
- As long distance services increased, the monopoly
nature of local rates became painfully apparent.
- Local rates kept increasing after 1983 while
long-distance rates were tumbling.
- New technologies permitted “wireless” companies to
offer local service if they could gain access to the monopoly networks.
- Congress passed the Telecommunications Act of 1996
the Baby Bells to grant rivals access to their transmission networks.
- Potential rivals accuse the Baby Bells of foot dragging
charging excessive access fees, imposing overly complex access codes,
unnecessary capital equipment, and raising other entry barriers.
- Four years after the mandate the “open access” the Baby
Bells still held near monopoly positions in local telephone service.
- The Civil Aeronautics Board (CAB) was created in 1938 to
regulate airline routes and fares.
No Price Competition
- The primary objective was to ensure a viable system of
transportation for both large and small communities. The focus of
CAB was on profit regulation.
- A secondary objective was to ensure air service to
less-traveled communities. Short hauls entail higher average
and, therefore, higher fares. Cross-subsidization was used in the
of the industry to keep local rates low.
- By fixing airfares, the CAB eliminated price
competition between established carriers.
- The CAB eliminated price competition between
- The absence of new entrants and price competition kept
interstate airfares high.
- Using intrastate airlines, which are not regulated by
ICC, studies showed that regulated interstate fares were as much as 60
higher than those on comparable intrastate routes.
- Despite the high regulated fares, established carriers
unable to reap much profit. Unable to compete on the basis of
the established carriers had to engage in nonprice competition through
differentiation (advertising, more frequent flights, first-run moves,
- The profit regulation came to be regarded as a failure
the airlines were not making substantial profits and consumers were not
offered very many price-service combinations.
- The Airline Deregulation Act of 1978 changed the
structure and behavior of the airline industry.
- This act eliminated the regulatory barrier to entry.
- Between 1978 and 1985, the number of airline companies
increased from 37 to 174.
- The share of domestic markets with four or more
carriers grew from 13 percent in May 1978 to 73 percent in May 1981.
- Price competition reduce average fares as much as 40
percent below regulated levels.
- There were some unforeseen positive externalities
with the airline industry deregulation. In addition to the 40%
drop in airline fares, the increased use of air travel led to fewer
accidents and fatalities as well as better air traffic control.
- To exploit their hub dominance, major carriers must
keep rivals out.
- One of the most effective entry barriers is their
ownership of landing “slots”.
- In 1998 United Airlines controlled 82 percent of the
slots at Chicago’s O’Hare, up from 66 percent in 1986.
- Delta controls 83 percent of the slots at New York’s
- Smaller airlines complain that they can’t get access to
these slots, even when they are not being used.
- Critics argue that despite the increasing industry
there is more competition in most airline markets. They argue the
industry is a contestable market.
- The cable TV industry has gone through both deregulation
- Initially a regulated industry, Congress was convinced by
that broadcast TV and related technologies offered sufficient
to ensure consumers fair prices and quality service. The Cable
Policy Act of 1984 deregulated the industry.
- After a period of rapid price growth, the industry was
re-regulated in 1992.
- Cable operators claim that with the emergence of new and
technologies (e.g. satellite subscription services), regulation is not
They claim that the lost revenue will keep them from desired upgrades.
- Congress responded to these industry complaints by
the cable industry again. The Telecommunications Turns Act of
mandated that rate regulation be phased out and ended completely by
- Cable prices soared again. In 1997-98, cable rates
rose four times faster than inflation.
- As the deadline for rate regulation approached, Congress
contemplating re-regulating the industry. Critics asserted that
technologies were still not viable competitors to the cable monopolies.
- The electric utility industry is the latest target for
- New high-voltage transmission lines can carry power
thousands of miles with negligible power loss.
- There is no longer a need to rely on a regional utility
- At the wholesale level, utility companies have been
electricity across state lines since 1992. Now they are under
to allow retail competition as well.
- As in the telephone industry, the local utilities are
being forced to grant rival power companies access to their wires.
- Norway deregulated its electric industry in 1991 and
prices soon declined by 20 percent.
- In 1998, California opened its transmission networks to
and 200 companies, from as far away as Atlanta, registered to supply
- In many industries, deregulation has resulted in more
competition, lower prices, and improved service.
- Even as technology grows, there will likely always be a
for regulation to some degree to keep existing firms from erecting
to entry to these new industries.
- The transmission networks for local telephone service and
delivery are still natural monopolies. Although the government
force owners to permit greater access, an unregulated network owner
still extract monopoly profits through excessive prices.