A practice is illegal if it restricts competition in some significant way without any overriding business justification. Thus, while a monopoly is not illegal per se, a rule of reason analysis may find that the methods used to achieve and maintain it had no other business objective other than monopolizing a market, and this is illegal.
However, any practice considered illegal under the Clayton Act is illegal only if it substantially reduces competition or tends to create monopoly power. The Clayton Act prohibits price discrimination , interlocking directorates, tying arrangements, and, if they restrain trade, mergers and acquisitions. The Clayton Act also allows private parties to sue for treble damages. The Federal Trade Commission Act was also passed in , creating the Federal Trade Commission FTC with the power to conduct investigations and to prohibit unfair practices in interstate commerce.
Section 5 of the FTC Act covers all anticompetitive practices not covered under the other federal antitrust laws, generally prohibiting unfair, deceptive, or anticompetitive practices affecting commerce. Only the FTC is authorized to implement the Act's provisions. The main remedies of violating antitrust laws are divestiture, where the company is forced to give up 1 or more of its acquisitions or functions, injunctive relief, and dissolution.
A private party can sue for treble damages and attorney's fees under Section 4 of the Clayton Act, if the party was injured as a result of any federal antitrust law violations except under Section 5 of the FTC Act. Other countries have also enacted antitrust laws, including the European Union and Japan and several countries in Southeast Asia. Antitrust laws apply to foreign firms operating domestically, where the domestic operations have a significant effect on competition.
The main types of practices considered anticompetitive under antitrust laws include the following:. There are some products that can be provided at a lower cost by a natural monopoly than what could be provided by competing firms. The primary characteristic of a natural monopoly is that its average total cost declines continually over any quantity demanded by the market. If the industry has a large fixed cost, then a single firm can provide the product at a much lower cost than several or many firms, because the average total cost of each firm will be much higher than it will be for the natural monopoly.
Hence, a natural monopoly can provide a product for a lower price if there is no competition. Some examples of a natural monopoly include the distribution of natural gas, electricity, and landline phone service.
What price should be set for the natural monopoly? However, since the average total cost of a natural monopoly continually declines, the marginal cost will always be less than the average total cost ATC , since the average total cost is the average of all costs including the large fixed costs while the marginal cost is only the extra cost of producing an additional unit.
Therefore, a natural monopoly will continually lose money if the price that they can charge is limited to its marginal cost. In a situation with a downward-sloping average cost curve, two smaller firms will always have higher average costs of production than one larger firm for any quantity of total output. In addition, the antitrust authorities must worry that splitting the natural monopoly into pieces may be only the start of their problems.
If one of the two firms grows larger than the other, it will have lower average costs and may be able to drive its competitor out of the market. Alternatively, two firms in a market may discover subtle ways of coordinating their behavior and keeping prices high.
Either way, the result will not be the greater competition that was desired. A third alternative is that regulators may decide to set prices and quantities produced for this industry.
The regulators will try to choose a point along the market demand curve that benefits both consumers and the broader social interest. Point C illustrates one tempting choice: the regulator requires that the firm produce the quantity of output where marginal cost crosses the demand curve at an output of 8, and charge the price of 3. This rule is appealing because it requires price to be set equal to marginal cost, which is what would occur in a perfectly competitive market, and it would assure consumers a higher quantity and lower price than at the monopoly choice A.
In fact, efficient allocation of resources would occur at point C, since the value to the consumers of the last unit bought and sold in this market is equal to the marginal cost of producing it. Attempting to bring about point C through force of regulation, however, runs into a severe difficulty. At point C, with an output of 8, a price of 3. Unless the regulators or the government offer the firm an ongoing public subsidy and there are numerous political problems with that option , the firm will lose money and go out of business.
Perhaps the most plausible option for the regulator is point F; that is, to set the price where AC crosses the demand curve at an output of 6 and a price of 6. This plan makes some sense at an intuitive level: let the natural monopoly charge enough to cover its average costs and earn a normal rate of profit, so that it can continue operating, but prevent the firm from raising prices and earning abnormally high monopoly profits, as it would at the monopoly choice A.
Of course, determining this level of output and price with the political pressures, time constraints, and limited information of the real world is much harder than identifying the point on a graph. For more on the problems that can arise from a centrally determined price, see the discussion of price floors and price ceilings in Demand and Supply. Indeed, regulators of public utilities for many decades followed the general approach of attempting to choose a point like F in Figure 1.
They calculated the average cost of production for the water or electricity companies, added in an amount for the normal rate of profit the firm should expect to earn, and set the price for consumers accordingly.
This method was known as cost-plus regulation. Cost-plus regulation raises difficulties of its own. If producers are reimbursed for their costs, plus a bit more, then at a minimum, producers have less reason to be concerned with high costs—because they can just pass them along in higher prices.
Worse, firms under cost-plus regulation even have an incentive to generate high costs by building huge factories or employing lots of staff, because what they can charge is linked to the costs they incur. Thus, in the s and s, some regulators of public utilities began to use price cap regulation , where the regulator sets a price that the firm can charge over the next few years. A common pattern was to require a price that declined slightly over time.
If the firm can find ways of reducing its costs more quickly than the price caps, it can make a high level of profits. However, if the firm cannot keep up with the price caps or suffers bad luck in the market, it may suffer losses.
Price cap regulation requires delicacy. It will not work if the price regulators set the price cap unrealistically low. It may not work if the market changes dramatically so that the firm is doomed to incurring losses no matter what it does—say, if energy prices rise dramatically on world markets, then the company selling natural gas or heating oil to homes may not be able to meet price caps that seemed reasonable a year or two ago.
But if the regulators compare the prices with producers of the same good in other areas, they can, in effect, pressure a natural monopoly in one area to compete with the prices being charged in other areas. This typically happens when fixed costs are large relative to variable costs. As a result, one firm is able to supply the total quantity demanded in the market at lower cost than two or more firms—so splitting up the natural monopoly would raise the average cost of production and force customers to pay more.
Public utilities, the companies that have traditionally provided water and electrical service across much of the United States, are leading examples of natural monopoly. It would make little sense to argue that a local water company should be divided into several competing companies, each with its own separate set of pipes and water supplies.
Installing four or five identical sets of pipes under a city, one for each water company, so that each household could choose its own water provider, would be terribly costly.
The same argument applies to the idea of having many competing companies for delivering electricity to homes, each with its own set of wires. Before the advent of wireless phones, the argument also applied to the idea of many different phone companies, each with its own set of phone wires running through the neighborhood.
What then is the appropriate competition policy for a natural monopoly? Figure illustrates the case of natural monopoly, with a market demand curve that cuts through the downward-sloping portion of the average cost curve. Points A, B, C, and F illustrate four of the main choices for regulation. Figure outlines the regulatory choices for dealing with a natural monopoly. The first possibility is to leave the natural monopoly alone.
In this case, the monopoly will follow its normal approach to maximizing profits. The firm then looks to point A on the demand curve to find that it can charge a price of 9. Since the price is above the average cost curve, the natural monopoly would earn economic profits. A second outcome arises if antitrust authorities decide to divide the company, so that the new firms can compete. As a simple example, imagine that the company is cut in half.
Thus, instead of one large firm producing a quantity of 4, two half-size firms each produce a quantity of 2. Because of the declining average cost curve AC , the average cost of production for each of the half-size companies each producing 2, as point B shows, would be 9. Thus, the economy would become less productively efficient, since the good is produced at a higher average cost.
In a situation with a downward-sloping average cost curve, two smaller firms will always have higher average costs of production than one larger firm for any quantity of total output. In addition, the antitrust authorities must worry that splitting the natural monopoly into pieces may be only the start of their problems. If one of the two firms grows larger than the other, it will have lower average costs and may be able to drive its competitor out of the market.
Alternatively, two firms in a market may discover subtle ways of coordinating their behavior and keeping prices high. Either way, the result will not be the greater competition that was desired. A third alternative is that regulators may decide to set prices and quantities produced for this industry. The regulators will try to choose a point along the market demand curve that benefits both consumers and the broader social interest. Point C illustrates one tempting choice: the regulator requires that the firm produce the quantity of output where marginal cost crosses the demand curve at an output of 8, and charge the price of 3.
This rule is appealing because it requires price to be set equal to marginal cost, which is what would occur in a perfectly competitive market, and it would assure consumers a higher quantity and lower price than at the monopoly choice A.
In fact, efficient allocation of resources would occur at point C, since the value to the consumers of the last unit bought and sold in this market is equal to the marginal cost of producing it. Attempting to bring about point C through force of regulation, however, runs into a severe difficulty. At point C, with an output of 8, a price of 3. Unless the regulators or the government offer the firm an ongoing public subsidy and there are numerous political problems with that option , the firm will lose money and go out of business.
Perhaps the most plausible option for the regulator is point F; that is, to set the price where AC crosses the demand curve at an output of 6 and a price of 6.
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