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Antitrust
Chapter Objectives
After reading this chapter you should be able to Understand why economists worry about monopolies and why some monopolies are inevitable and even good for society. Be aware that laws regulate the existence and pricing behavior of monopolies. See how antitrust law has been applied to specific industries within the United States.
Chapter Outline
Whats Wrong with Monopoly? Natural Monopolies and Necessary Monopolies Monopolies and the Law Examples of Antitrust Action Summary
When a business treats us badly, most of us get a high degree of satisfaction by announcing that we will never be back. When the business is the phone, gas, electric, or water company, though, it is frustrating because in most cases we cannot get our phone, gas, electricity, or water somewhere else. We all buy goods or services from businesses that are monopolists. It is likely that you have only one source of cable television, local phone service, electricity, water, or natural gas. When a representative of a monopolistic company makes you mad, you know and the representative knows that you have no alternatives; you are stuck. You can scream and complain, but in the end you have to go back to the same company for service. For capitalism to function, these situations work best when there is both a carrot of high profits and a stick of bankruptcy to keep firms working in the consumers best interest. Without such incentives, a companys profit motive tends to work against consumers rather than in their best interests. It is for this reason that we have laws that inhibit firms from becoming monopolies through merger, and we have laws that prevent the monopolies that do exist from using their power to the detriment of consumers. That said, this chapter reviews what it is about monopoly that concerns economists and we also discuss situations where monopolies may be necessary evils. We then turn to laws that are
in place to protect consumers from the problems that monopolists cause. We attempt to figure out how many competitors are needed for competition to work, and we provide a few examples of firms that have been accused of using their monopoly power to the detriment of their customers.
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more of its good, the firm has to progressively lower the price it charges. When the firm lowers prices, the resulting graph shows that the marginal revenue curve is not flat, as it is under perfect competition, but is downward sloping. In particular, it has the same vertical intercept as the demand curve, and it cuts the horizontal axis at exactly half where the demand curve does. (Refer back to Chapter 4 and the discussion of marginal revenue to see why this is the case.) Assuming that its goal is to maximize profits, a monopolistic organization will sell its output at a price that is determined by the point on the graph at which marginal cost and marginal revenue are equal. In Figure 28.1 that output level is Qmonopoly. The price a monopolistic firm would charge for that output can be found by going up from Qmonopoly to the demand curve and over to the price axis to get Pmonopoly. To compare this monopoly outcome to what would exist in an industry made up of many firms in perfect competition, we need to recall that the supply curve for each individual perfect competitor is its marginal cost curve. To find the industry supply curve, we would horizontally add the individual supply curves together. When we do that we find that we have also created the marginal cost curve for an industry ruled by one firm. That is why, in Figure 28.1, the supply curve for the industry of perfect competitors is also labeled as the marginal cost curve for the monopolist. It is simply a different interpretation of the same information. It is not, however, the monopolists supply curve. There is no such thing because monopolists do not take the price
as given; they search for the price that makes them the most money. Given that, we can say that if an industry is characterized by many perfectly competitive firms rather than a monopolistic firm, then the pricequantity combination will be where supply equals demand: PPC, QPC. Under perfect competition we know that the consumer surplus, depicted as the area under the demand curve but above the price line, would be PPCAC and the producer surplus, depicted as the area under the price curve but above the supply or marginal cost curve, would be FPPCC for a combined social benefit of FAC. (See Chapter 3 if you need to review consumer and producer surplus.) In an industry that is ruled by just one firm rather than many, the consumer surplus is much smaller and the producer surplus somewhat larger. To be precise, the consumer surplus shrinks to PmonopolyAB and the producer surplus grows to FPmonopolyBE. The combined area is FABE. This is smaller than the combined area under perfect competition by the triangle EBC. Economists call this area deadweight loss because it represents the loss in economic benefits to society that results from carrying a deadweightthat is, a monopolist. The desire to eliminate deadweight loss is at the heart of why economists, usually reluctant to let government control markets, generally accept the need for government to intervene in monopoly cases.
Reduced Innovation
Another problem with monopoliesboth those subject to price control by government and those that are government-owned, like the post officeis the reduction in the motivation to innovate. When there are no competitors to keep a business on its toes, it can easily get lax. Monopolies like your local telephone company are much less likely to engage in cost-saving or serviceenhancing innovation when they are not threatened with competition. Even worse, since they use their costs to justify their prices to regulators, they have an incentive to pad costs that make their own jobs easier. This problem is not limited to privately held monopolies. The U.S. Postal Service is a government-held monopoly for letters. It did not consider overnight delivery important until Federal Express and United Parcel Service developed the business. Cost-saving or serviceenhancing technology is less likely to come from the U.S. mail than it is from the private package delivery companies.
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efficient. A carefully regulated monopoly in this case may save money for the consumer. The quality of regulation is definitely the key, because the company will want to charge Pmonopoly and produce only Qmonopoly. The monopolist wants to exploit the power it has, and it is part of the governments job to provide the regulation that prevents that from happening. Government regulators will allow monopolies normal profit, the profit consistent with what a similar investment would get them in another industry. This is depicted in Figure 28.2 as the point at which the average total cost curve ATC crosses the demand curve D. It should be clear that the difference between what an unregulated natural monopoly would charge, Pmonopoly, and what a regulator would let it charge, Pregulated, is substantial. For this reason, it is argued that we are better off with one utility company that is prevented from exploiting its position, and we know that most local telephone, electrical power, and natural gas is provided through regulated monopolies in the United States. This need not be the end of the story. Technology and a revised legal structure are changing the competitive nature of many of these utilities. Satellite dishes are doing as much to keep cable TV rates down as regulation ever did. Cable companies are now selling phone and Internet access that was once provided only by a monopoly telephone company. An additional challenge to local phone companies is coming from the wireless phone industry. Many young people no longer have a home phone; they simply use cellular phones. Though the poorly thought-out California electricity deregulation experiment was a disaster, some communities are deregulating the electric power industry successfully. These forms of deregulation have the existing provider charge a wire access fee. This fee is similar to the fee that your local telephone company charges you to use its lines with a different long-distance provider. In this way there are competing electricity producers that sell to customers. It may be that in the near future these once inevitable natural monopolies will face competition.
Pmonopoly
Pregulated
Copyrights and patents are examples of other legalized monopolies that we have decided are needed for the economy to work well. The only way singers, authors, or moviemakers make money on their creative work is through their exclusive right to sell it. If you electronically
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copy a CD, a book, or a movie, you know the cost is usually much lower than if you buy it in the store at full retail price. Monopoly power is given to record companies, publishers, and movie producers so they can make enough money to inspire their efforts. Consider the late 1990s and early 2000s history of file-sharing networks like the original Napster and Kazaa. For many of you this was your first introduction to the Internet and downloaded music. You learned that you could get all the latest music without paying for it. Many in the music industry believed that you were in violation of the copyright laws. They were correct and a federal court shut the original Napster down.2 The economic issue at the time was how this type of service affected the motivation to produce new music. Whats interesting now is that downloaded music has become another interesting antitrust example with Apples dominance in that market area as it has successfully used its iPod and iTunes brands to reinforce each other. Patents are given to inventors of new things for the same reason that copyrights are given to writers and performers. Patents expire after a number of years, depending on the type of invention. While the patent is in force, however, the inventor is the only one who has the right to sell his or her invention. Whether the invention is a new drug, or the proverbial better mouse trap, it belongs to the inventor. In the modern era, scientists usually work for a big company that retains the right to buy their ideas for $1 each. Although this may seem unfair, scientists are often part of a team that jointly creates ideas. In addition, since inventing is a risky business with inventions only rarely striking it big in the marketplace, the companies guarantee the scientist an income. For that, they get to keep the high returns. In any event, the exclusive right to sell something creates the incentive to be creative or innovative, as the case may be. The author of the book you are reading right now would like to think he would have written this book for the good of his own students understanding, but the truth is he is working for money, too. Lest you think I am the only one, ask yourself whether you too are not motivated to work by money. Writers, singers, moviemakers, or inventors need the protection accorded monopolies to make money at their endeavors. The rationale for other monopolies is that they provide a social good. The U.S. Postal Service performs the social service of providing equal mail service at an equal price to
everyone anywhere in the United States. Though its detractors suggest that a privatized system would be more efficient and cost less, its defenders believe that the social good is sufficient to justify any monopoly inefficiencies.
FN 3
While a number of important laws amending and clarifying the Sherman Act have been enacted since 1890, for simplicity and brevity we will consider this one body of antitrust law.
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Other parts of the law work toward preventing companies from becoming monopolistic by merging. It is very much against the law for two separate companies, in an industry of only a few, to share information or to collude on setting prices. This is called price fixing, and local gasoline stations are accused of it all the time. Just as someone realized that companies could fix prices if they merged, Congress gave power to the Federal Trade Commission (FTC) to allow or to deny proposed mergers. When two airlines merge and it is a merger that would lead to a monopoly at an important airport, the FTC steps in. It can simply say no to the merger, or it can require that the airline sell its gate access to another airline.
means that Southwest can get at least one additional flight, if not two more flights, out of a plane and crew each day. This means it can outcompete everyone else on the price of tickets. Suppose you are in charge of pricing tickets for another airline and you have a monopoly in a particular city. You know that Southwest chooses its next target city on the basis of its ability to charge much less than the price that is currently being charged. What will you do? You keep your price low in hopes that Southwest will ignore you. contestable markets To its firm believers, this hypothesis contestable markets hypothesis One firm is all that is means that the answer to the quesnecessary for competitive prices to exist as long as tion of how many firms it takes to that firm is threatened by have competitive prices is one, as hit-and-run entry. long as it is one that is scared.
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money by buying the pipelines at low prices and by selling his products to filling stations at high prices. Our debt to Rockefeller is that much of the law making trusts illegal simply makes illegal what he did so well. The breakup of Standard Oil made several companies out of one. Each competed with the others for pipeline services and to sign up gas stations. Among others, we know these companies today as Exxon, Amoco, and Standard Oil. The lessons that Rockefeller taught the world were learned very well and most developed countries now have laws that make it illegal to use monopoly pressure to limit competition.
for the mainframes, from another little-known company called Intel. When others found that they too could put parts together to make a computer and use Microsofts DOS to run it, all chances of an IBM monopoly were gone.
Microsoft
In the mid-1980s, Apple Computer introduced a new personal computer, called a Macintosh. It used pictures, called icons, on a monitor screen and a pointing device, called a mouse, instead of using typed-in commands to tell the computer what to do. Microsoft followed shortly thereafter with its own changes that relied on a mouse. It called its new operating system Windows. While the first two versions of Windows were terrible and could have lost Microsoft its advantage in operating systems, Windows 3.1 took over the industry in short order. Since that time,Windows (in its 3.1, 95, 98, 2000, XP, or NT form) has dominated the operating system market. The only serious threat that Windows faced during this time was IBMs introduction of OS/2 and its follow-on Warp. Both offered multitasking, an attribute that Windows 3.1 did not possess. Multitasking allows a computer to divide its resources so that it can work on more than one task at a time. Because that is what mainframes do, IBM got it working first, Apple struggled to get it to work, and Microsofts Windows 95, which included multitasking, was more than a year from being released. If the Justice Department and many of Microsofts critics are to be believed, this made Microsoft very nervous. Critics charged that it was at this point that Microsoft began using its preeminence in the industry to pressure software companies to write exclusively for the soonto-be released Windows 95. The Justice Department also charged that Microsoft pressured the vendors of such hardware as modems, sound cards, disk drives, and network cards not to provide software for OS/2. If Microsoft did those things, it was in flagrant violation of the law. In another questionable practice, Microsoft offered manufacturers a low price on its versions of Windows but with a catch. The manufacturers would pay Microsoft a fixed fee per machine it sold, whether the customer wanted Windows or not. That way people who bought PCs had to pay for Windows even if they wanted a different operating system. Since most people did not have a good reason to pick another operating system, no other operating system succeeded in getting past this initial stage. Again if Microsoft did this to eliminate competition, it was in violation of the law. In any event, the threat that OS/2 posed to Windows evaporated.
IBM
International Business Machines, better known as IBM, came into the world as a producer of typewriters and adding machines. Your grandparents may remember working in an office where the secretarys IBM Selectric was the most sophisticated machine in the place, because it could erase a typo. By the 1960s, however, IBM was well into the business of computers. Back then a state-of-the-art mainframe computer with the computational capacity of a current Palm Pilot would fill several rooms. Moreover, if you needed that kind of computing you had one choice, IBM. As the monopolist in mainframe computers, IBM could use this power to get a leg up on the companies that produced mainframe software as well as other hardware. In 1969 the Justice Department sued, arguing that IBM was using its monopoly in one area, the central processing units for mainframes, to develop a monopoly in other mainframe areas. This lawsuit dragged on in court for years. By 1977 an upstart company, Apple, developed the first personal computer, and somewhat later IBM decided to join in this market and began to make computers for the home and office. These computers were novel and they possessed far more power than the computers that flew to the moon. By the early1980s it became apparent that the mainframe market was dying as the PCs popularity grew. In 1982 the case was dropped because even if IBM had a monopoly in mainframe processors, which it no longer had, it was no longer an important area. One of the reasons that IBM had lost any chance of generating a monopoly in PCs was that it had licensed the operating system of that original PC, called DOS (disk operating system), to a little-known company in Washington State called Microsoft. Further, it was buying its microprocessors, so named because they were physically much smaller than the processors developed
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Later Microsoft was to run into other problems. The Internet grew to a degree that Microsoft had seriously underestimated, and Netscape grabbed well over threequarters of the market for Internet browsers. On top of that, Sun Microsystems created Java, a programming language that is compatible with Windows, Apple, or any other computer. This threatened not only the Windows stranglehold, but the domination of the Windows Office Suite as well. In reaction to these events, Microsoft created Internet Explorer as its alternative to Netscape Navigator and, in Windows 98, integrated it into the operating system. Even more troubling to the Justice Department was its contention that Microsoft was insisting that PC makers not put any product on their PCs that competed with a Microsoft product. Specifically, it was alleged that Microsoft would not sell Windows to PC makers if they also bundled their PC with Netscape or Corels WordPerfect Suite. Last, it was believed by many in the industry that there were secret parts of Windows 98 that made computers using non-Microsoft products crash. If this was true, users of these non-Microsoft products would conveniently blame the makers of those products and want the more reliable Microsoft software. What the Justice Department charged in the trial of 1998 and 1999 was that Microsoft had used and was using the tactics of Rockefeller to drive out other competitors. On April 3, 2000, the judge for the case, Thomas Penfield Jackson, ruled first that the evidence showed that Microsoft wanted to monopolize a variety of areas of software, that it used its monopoly in Windows to further a monopoly in Office Suite, to build one for the Internet Explorer, and to prevent competition from, among others, Suns Java. He further ruled that Microsoft had harmed consumers in the process. In his June 7, 2000, ruling ordering a breakup of the company into an operating system business and an applications business, he also showed that he believed that Microsoft had indeed used secret parts of
Windows to cause other software to crash. By ordering that it shall not take any action it knows will interfere with or degrade the performance of any non-Microsoft software and by ordering that it disclose the interfaces, the software that allows applications to talk to the operating system, he was clearly implying that at some point in time Microsoft had done both. On appeal to a U.S. Court of Appeals, the important finding of facts with regard to the illegal activities of Microsoft was upheld but the breakup remedy was not. Prior to September 11, 2001, the Department of Justice was intently focused on settling the case and had taken the breakup off the table. In November of that year, with other matters to attend to, the Department of Justice ended the fight with Microsoft on terms quite friendly to the software giant. While some of the states that had sued alongside the federal government stuck to their guns, by 2003, when California settled for $1.1 billion in vouchers to the states citizens and AOL Time-Warner (the parent of Netscape) settled for $750 million, the battle was pretty much over.
Summary
You now understand why economists worry about monopolies, and why some monopolies have been seen as inevitable and even good for society. You know that laws were enacted to regulate the existence and pricing behavior of monopolies. Last, you saw how that body of law was applied to Standard Oil, IBM, and Microsoft.
Key Terms
barrier to entry, 000 contestable markets hypothesis, 000 trust, 000
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Quiz Yourself
1. Antitrust law is designed to limit the impact of a. Monopoly. b. Oligopoly. c. Monopolistic competition. d. Perfect competition. 2. One of the concerns about monopolies is that they a. Reduce the motivation to innovated. b. Reduce the motivation to make a profit. c. Hire people at an excessive level. d. Waste resources in pursuit of the next invention. 3. Monopoly creates prices that are ________________ which would exist under perfect comptetion. a. Lower than that. b. Equal to that. c. Greater than that. d. More volatile than that. 4. Using the monopoly power in one area to compel customers to buy goods in another area a. Is a violation of the Sherman Anti-Trust Act. b. Is legal, but bad business practice. c. Is illegal but would be bad business practice anyway. d. Is legal and a recommended strategy. 5. Standard Oils trust involved monopolizing a. Gas stations only. b. Oil exploration only. c. Refining. d. All aspects of the petroleum industry. 6. The suit against Microsoft accused it of a. Using its own innovation to thwart competition. b. Using its Windows monopoly to foster other monopolies. c. Incorporating more innovations into the Office Suite. d. Charging more than Windows was worth. Think about This Those that opposed the Department of Justice suit against Microsoft argue that the company was responsible for great innovation. They argue that the next Microsoft would be reluctant to be as successful. Does this criticism make sense to you? Would a multibillion-dollar corporation be limited in innovation for any reason? Talk about This If Apple used the high market share in iPods to generate a monopoly in music downloads via iTunes would that be a concern to you? For More Insight See Journal of Economic Perspectives 1, no. 2 (Fall 1987). See articles by Steven C. Salop, Lawrence J. White, Franklin M. Fisher, and Richard Schmalensee, pp. 354. Online Newshour, The Microsoft Antitrust Case, http://www.pbs. org/newshour/bb/cyberspace/july-dec99/ microsoft_index.html.