Professor C.L. Ballard
Fall Semester, 2011

ECONOMICS 201 KEY CONCEPTS FROM THE FINAL PART OF THE COURSE

I. Regulation and Antitrust

A. An industry is a natural monopoly if a single firm can produce all of the relevant output at a lower average total cost than could any combination of two or more firms. This will occur where average total cost is declining throughout the relevant range. It was once thought that electric-power utilities are natural monopolies, although there is evidence that this may not be the case. In fact, there are probably few natural monopolies, if any.

B. If a natural monopoly does exist, marginal-cost pricing is problematic, since the firm would suffer economic losses if it were to charge a price that is equal to marginal cost. However, monopoly profit maximization is also unattractive. As a result of these problems, governments have sometimes responded by regulating the monopolies. Often, there is an attempt to guarantee a “normal” rate of return. This would mean that the firm would be required to charge a price that is equal to average total cost. The problem with this is that it may reduce the incentives to control costs. If a regulated industry is in fact not a natural monopoly, the best strategy is probably to allow new firms to enter the industry, so that competition can take hold.

C. Much of the regulation in the United States has not dealt with natural monopolies, but rather with industries that could be very competitive. Here, the regulation has come about as a result of the political power of the industries themselves. In many cases, regulation has stifled competition and led to higher prices. Starting in the late 1970s, deregulation succeeded in getting lower prices in trucking, airlines, and other industries.

D. The antitrust laws began with the Sherman Act in 1890, and were expanded by the Clayton Act in 1914. The antitrust laws prohibit monopoly, price fixing, certain types of price discrimination, tied sales, predatory pricing, and interlocking directorates. The most spectacular uses of these laws have been the breakups of large companies, such as Standard Oil and American Tobacco in 1911, ALCOA in 1945, and AT&T in 1984.

E. Other important antitrust cases include the electrical-equipment conspiracy, in which General Electric, Westinghouse, and other firms were found guilty of having fixed prices in the late 1950s. More recently, Archer, Daniels, Midland was fined for price fixing in the market for lysine in 1998.

F. The antitrust laws can also be used to prohibit mergers, in cases where the mergers will reduce competition substantially. A conglomerate merger is one between two firms in unrelated industries. Conglomerate mergers do not pose much of a problem for competition, and they are usually not the subject of antitrust actions. A vertical merger is one between a firm and one of its input suppliers. Vertical mergers may present more problems than conglomerate mergers, but vertical mergers still are not a major concern for antitrust officials. The main concern of the antitrust authorities is with horizontal mergers, which are mergers between firms in the same industry. Even with horizontal mergers, it is not always true that the mergers are a problem from the perspective of competition. If the merger is between two small firms in a very competitive industry, the resulting combined firm is unlikely to wield much market power. On the other hand, if two large firms merge, it is possible that the degree of competitiveness of the industry will be reduced substantially. In spite of this, the antitrust authorities have allowed many very large horizontal mergers.

II. Labor Markets

A. The benefit that a firm gets from hiring an extra unit of labor is the marginal revenue product (MRP). The MRP is equal to the marginal product multiplied by the marginal revenue: MRP = (MR)(MP). Marginal product is decreasing. Marginal revenue is