Chapter 15 - Economic Regulation and Antitrust Policy

When there are just a few businesses serving a market, they can occasionally coordinate their behavior, either overtly or implicitly, to operate as monopolists. Market power refers to a company's capacity to raise prices without losing all of its customers to competitors. Any company that faces a downward-sloping demand curve has some pricing control and hence some market power. A monopoly, or a collection of companies operating as a monopoly, is assumed to limit output in order to charge a greater price than competing firms.

Because the marginal benefit of the last unit sold exceeds its marginal cost when output is limited, the increasing output would enhance social welfare.

Monopolies have also been linked to other types of distortions. Some opponents say that since monopolies are protected from competition, they are less inventive than aggressive competitors. Worse, monopolies may use their size and economic clout to influence public policy in order to protect and enhance their monopolistic power.

Three kinds of government policies are designed to alter or control firm behavior: social regulation, economic regulation, and antitrust policy

• The term social regulation refers to government regulations aimed at improving health and safety.

• The term economic regulation refers to government regulation of natural monopoly, where, because of economies of scale, the average production cost is lowest when a single firm supplies the market.

• The term antitrust policy refers to government regulation aimed at preventing monopoly and fostering competition in markets where competition is desirable

A natural monopoly has a long-run average cost curve that slopes downward throughout the spectrum of market demand due to economies of scale. This indicates that when one business services the whole market, the lowest average cost is attained. A subway system, for example, is a natural monopoly. The average cost per trip would be greater if two competing systems tunnel parallel routes throughout a metropolis than if just one system provided this service.

By pushing the monopolist to decrease prices and boost output, the government can improve societal welfare. Government can either operate the monopoly directly, as it does with most urban transportation systems, or control a privately held monopoly, as it does with certain urban transit systems, local phone services, cable TV services, and power transmission. Public utilities are monopolies that are owned or regulated by the government. Though the concerns mentioned are identical if the government owns the monopoly, we will focus on government regulation here.

• The term capture theory of regulation refers to the producers’ political power and strong stake in the regulatory outcome leading them, in effect, to “capture” the regulating agency and prevail on it to serve producer interests

During this first wave, similar merger activity occurred in Canada, Great Britain, and elsewhere, creating dominant firms, some of which still exist. The U.S. merger wave cooled with the severe national recession of 1904 and with the first stirrings of antitrust laws with real bite.

Vertical mergers were more prevalent during the second merger wave, from 1916 and 1929 when antitrust regulations began to restrict horizontal mergers. A vertical merger is one in which two businesses join at separate phases of the manufacturing process, with one firm supplying inputs and the other demanding products. A copper refiner, for example, may join with a copper pipe fabricator. The stock market boom of the 1920s drove this second wave, which was abruptly ended by the stock market crash of 1929.

For two decades, the Great Depression and World War II slowed mergers, but after the war, the third merger wave began. As a result of the third merger wave, which lasted from 1948 to 1969, more than 200 of the 1,000 biggest companies in 1950 had vanished by the early 1960s. During that time, several major corporations were acquired by other, generally larger corporations.

During the third merger wave, which lasted from 1964 to 1969, conglomerate mergers, which brought together companies from several industries, accounted for four-fifths of all mergers. Litton Industries, for example, merged companies that produced calculators, appliances, electrical equipment, and machine tools. Merging companies wanted to broaden their product offerings.

In 1982, the fourth merger wave erupted, involving both horizontal and vertical mergers. During the fourth wave, some major conglomerate mergers from the third wave were dismantled as the main business sold off unrelated operations. In the 1980s, hostile takeovers accounted for around a third of all mergers, with one business buying control of another against the target firm's management's desires. During the 1990s and afterward, hostile takeovers accounted for fewer than a tenth of all mergers.

During the second part of the 1990s, merger activity picked up, with the dollar amount of each new deal breaking the previous record. The majority of mergers during this time were financed through the exchange of business shares, which was aided by a growing stock market (like the mergers of the 1920s). The collapse of the Soviet Union brought an end to the Cold War and strengthened global capitalism. Companies combined in order to get a competitive advantage in global marketplaces.

The fourth merger wave continues, as the global economic slump of 2008 and 2009 forced firms in some industries, especially banking and finance, to merge in order to survive. But not all mergers work out.