Regulation of Markets Exam 1

What is regulation?

• Any attempt by a gov to control the behavior of individuals, companies, or other governments. Regulations restrict choice sets.

• Taxes/subsidies try to establish incentives via the pricing mechanism

Why do we regulate?

• To correct market failures, promote efficiency (maximize benefits relative to cost)

  • Regulations ask if we value benefits to consumers more than producers

• Politics

• Change the distribution of welfare (regulations aimed at helping certain groups)

Pros of Federal Regulation

• Economies of scale for firms: cheaper for firms, uniform/consistency so firms don’t have different processes of approval per state

• Prevent race to the bottom

  • ex) 2 states, no safety standards, one keeps reducing regulations so they get more firm business

• Problems may cross state/local lines (externalities)

• Expertise: fed budget is a lot larger than a state/local budget

• Interest group capture: at a local level, interest groups can influence more & capture regulators

Pros of state/local regulation

• Heterogeneity of costs/benefits

• Diversity/preferences (easier to tailor preferences to smaller areas)

• Allows people to vote with their feet (people can move around and vote in accordance with their beliefs around regulations)

Cost-Benefit

• Benefit-cost ratio should be greater than 1 or equal to 1

• Want to maximize the difference total cost and total benefits

Capture Theory & What Regulators Maximize

In theory: National interest subject to legislative mandates

Capture Theory: Regulatory agency is captured by economic interests that it serves

What are 3 key antitrust laws?

Sherman Act, Clayton Act, FTC Act

Sherman Act (1890)

• Motivation: widespread growth in “trusts” in 1800s

• Section 1: Prohibits contracts, combinations, conspiracies in restraint of trade

• Section 2: Prohibits monopolization, attempts/conspiracies to monopolize

• Summary: No acting like a monopoly

Clayton Act (1914)

• Dealing with price discrimination, mergers, vertical restraints (different supply chain contracts), interlocking directorates (same people in board of directors for both firms)

• Creates system for approving mergers

  • All mergers illegal if they substantially lessen competition or create a monopoly

  • If 2 firms want to merge, they need to submit a request

• Summary: A framework for mergers and acquisitions

Federal Trade Commission Act (1914)

• Unfair methods of competition are unlawful

• Created Federal Trade Commission (FTC)

• Summary: unfair methods of competition & creates FTC

What agencies enforce Antitrust?

• Department of Justice (DOJ)

  • Brings criminal and civil enforcement actions

• Federal Trade Commission (FTC)

  • both investigatory & adjudicative functions, brings civil enforcement actions

What are some antitrust enforcement tools?

• Block mergers

• Fines

• Criminal penalties

• Structural remedies (divestiture)

Explain the Principal/Agent Problem

Principal Owner/Shareholders → Agent Manager

• Manager now looks after their own incentives as opposed to yours (the principal owner)

• Principal hires agent, agent makes $ and sends back to manager/company, but now the agent has access to the company (leverage)

Explain Perfect Competition

• Firms make zero profit, free entry/exit, all information is readily available to consumers, there are no externalities, homogenous products, many buyers/sellers, firms have same technology

• Supply = MC, Demand = MB

• Maximizes total surplus

• A competitive equilibrium is pareto optimal

Price Controls & Effects & Calculations to Know

• Price ceilings (binding vs. non-binding)

• Shortages

Welfare Effects of Price Controls

• Consumer Surplus (top triangle)

• Producer Surplus (bottom triangle)

• Deadweight loss

• Efficiency vs. equity

Calculations

• Solve for equilibrium price & quantity (MC=MD), compute welfare

What is a monopoly?