Chapters 11 & 13
Among its many terms, the Airline Deregulation Act:
gradually eliminated the CAB's authority to set fares; required the CAB to expedite processing of various requests; liberalized standards for the establishment of new airlines; allowed airlines to take over service on routes underutilized by competitors or on which the competitor received a local service subsidy; authorized international carriers to offer domestic service; placed the evidentiary burden on the CAB for blocking a route as inconsistent with "public convenience"; prohibited the CAB from introducing new regulation of charter trips; terminated certain subsidies for carrying mail effective January 1, 1986 and Essential Air Service subsidies effective 10 years from enactment (however, as of 2009, the EAS is still in existence, serving 146 communities in the U.S.); terminated existing mutual aid agreements between air carriers; authorized the CAB to grant antitrust immunity to carriers; directed the Federal Aviation Administration (FAA) to develop safety standards for commuter airlines; authorized intrastate carriers to enter into through service and joint fare agreements with interstate air carriers; required air carriers, in hiring employees, to give preference to terminated or furloughed employees of another carrier for 10 years after enactment; gradually transferred remaining regulatory authority to the U.S. Department of Transportation (DOT), and dissolved the CAB itself. Safety inspections and air traffic control remained in the hands of the FAA, and the act also required the Secretary of Transportation to report to Congress concerning air safety and any implications deregulation would have in that matter.
The stated goals of the Airline Deregulation Act included
the maintenance of safety as the highest priority in air commerce; placing maximum reliance on competition in providing air transportation services; the encouragement of air service at major urban areas through secondary or satellite airports; the avoidance of unreasonable industry concentration which would tend to allow one or more air carriers to unreasonably increase prices, reduce services, or exclude competition; and the encouragement of entry into air transportation markets by new air carriers, the encouragement of entry into additional markets by existing air carriers, and the continued strengthening of small air carriers.
Explain why the labor supply curve slopes upward in a perfectly competitive market even though the labor supply for individuals is backward bending.
1. As W increases, workers from other industries enter the market in question, so L increases. When W increases, we assume it increases in one market only. For example, if the wage paid to janitors increases, convenience store clerks will apply to become janitors. 2. As W increases, nonworkers enter the market in question. Some workers who were not previously working in any market, will start to apply for jobs if the wage rises high enough. Examples might be stay at home spouses and students. In both cases, an increase in W leads to an increase in L. This is required for the supply curve to slope upward for the market. These two forces will outweigh any "backward bending" effect. So wages are determined by the supply and demand for the job or occupation.
Railroad deregulation
1. Between 1986 and 1993 freight costs fell 69%. (Schiller) 2. Due to mergers, the top 4 firms moved 90% of the freight during 1998 and 1999. Rates in monopoly routes were 20-30% higher than non-monopoly rates. (Schiller)
Airline Deregulation
1. From 1938-1977, the Civil Aeronautics Board never awarded a major route to any new airline. (Microeconomics for Today by Irvin Tucker) 2. Revenue per passenger mile of airline travel declined 16 percent from 1978 to 1990, adjusted for inflation. (Irvin Tucker) 3. Passenger miles doubled from 227 billion (1978) to 458 billion (1990) to 620 billion (1998). (Irvin Tucker) 4. Number of airlines increased from 37 in 1978 to 214 in 1980. By 1998 it was back down to 97. (Irvin Tucker) 5. A single firm controls at least 55% of traffic at 10 of the largest 15 airports. (O'Sullivan and Sheffrin) Ticket prices are 45-85% higher on monopolized routes than on routes where at least two airlines compete. (The Economy Today by Bradley R. Schiller) 6. On average fairs have decreased by 33% since deregulation, adjusted for inflation. (O'Sullivan and Sheffrin) 7. According to Richard McKenzie, airline deregulation resulted in 600,000 fewer auto accidents a year and reduced traffic fatalities by nearly 1,700 per year. (Schiller) 8. United, Delta and American increased their market share from 35% in 1985 to 60% in 2001. 9. Fatalities per 100,000 departures have decreased by almost 75% since 1978.
In addition to supply and demand, which factors influence wages
1. Human Capital-The knowledge and skills acquired by workers, principally through education and training. Doctors and lawyers, for example, have skills that are valued but they had to go to school to learn them. When going to school to learn such skills economists say that people are investing in their human capital. 2. The Screening Hypothesis-When employers hire people based on educational attainment that does not necessarily teach skills. For example, many companies require applicants to have a college degree to enter a management training program. Sometimes the actual major does not matter. It can be history or English or accounting. Firms want workers with certain traits, like intelligence and dedication. The chances that you have those traits are higher if you have a college degree than if you don't. So employers attempt to "screen out" applicants who are less likely to have the desired traits or characteristics. 3. Compensating wage differential-The wage premium for jobs with undesirable characteristics. Firefighters get paid more than others will comparable training since the job is dangerous. Workers on arctic oilrigs get paid more because they have to work in the unpleasantly cold temperatures. 4. Discrimination-Treating unequals the same and treating equals differently.
Capture Hypothesis happens for 2 reasons
1. The government has to hire people who understand the industry and they end up hiring people who used to work for the industry that is supposed to be regulated. 2. Most citizens will not care what they agence does because they are too busy with their own lives. But the companies will lobby and try to influence the agency because it is worth their time.
Why new firms are not likely to enter an industry which is a natural monopoly
1. There is only one seller with no close substitutes. 2. The monopoly has large control over price. The firm is a price maker. 3. There are significant barriers to entry.
Trust
A combination of companies acting in concert in order to increase control of an industry.
Federal Trade Commission Act of 1914
A companion to the Clayton Act. It prohibits "unfair methods of competition in commerce." It also created the Federal Trade Commission (FTC) to enforce antitrust laws. A later amendment gave the FTC power to halt false or deceptive business practices (like making false advertising claims).
Vertical merger
A merger between a company supplying an input and a company buying it. Ford buying U.S. Steel is an example, since steel is an input in making cars.
Horizontal merger
A merger between companies in the same market. Ford and GM merging would be an example
Conglomerate merger
A merger between companies in unrelated markets. An example would be if GM merged with Nabisco.
Predatory pricing
A practice whereby one or more firms temporarily reduce price in order to drive weaker firms from the industry and then raise price once these competitors have been eliminated.
Capture Hypothesis
A theory of regulatory behavior that predicts that regulators will eventually be captured by special interests of the industry being regulated. Then the agency will serve the needs of the industry instead of society
Average cost price regulation
Average cost pricing is the policy where the provider is required to set price equal to average cost and supply the quantity demanded. i. With economies of scale, average cost curve is higher than marginal cost curve. ii. Lower level of provision than marginal cost pricing. Economically inefficient level: marginal benefit equals price equals average cost.
Clayton Act of 1914
Banned some forms of price discrimination, those not based on cost. It outlawed tying contracts. Companies could not buy stock in other companies if doing so reduced competition. It also banned interlocking directorates between competing companies.
How was the power crisis in California resolved?
California had an installed generating capacity of 45GW, but at the time of the blackouts demand was 28GW. A demand supply gap was created by energy companies, mainlyEnron, to create an artificial shortage. Energy traders took power plants offline for maintenance in days of peak demand to increase the price.[6][7] Traders were thus able to sell power at premium prices, sometimes up to a factor of 20 times its normal value. Because the state government had a cap on retail electricity charges, this market manipulation squeezed the industry's revenue margins, causing the bankruptcy of Pacific Gas and Electric Company (PG&E) and near bankruptcy of Southern California Edison in early 2001.[8] The financial crisis was possible because of partial deregulation legislation instituted in 1996 by Governor Pete Wilson. Enron took advantage of this deregulation and was involved in economic withholding and inflated price bidding in California's spot markets.[9] The crisis cost $40 to $45 billion.[10]
Celler-Kefauver Act of 1950
Companies were banned from buying the assets of rival firms. This closed a loophole in the Clayton Act. Before this, firms could simply not buy rivals' stock but buy their factories and shut them down or use them to produce their own product. That could reduce competition.
Justice Department Guidelines
Competitive Market: HHI < 1000 Mergers in these industries will not be challenged or blocked by the government since there is a high level of competition. Moderately Concentrated: 1000 < HHI < 1800 -mergers may be challenged if they increase HHI by 100 or more points Concentrated: 1800 < HHI -mergers may be challenged if they increase HHI by 50 or more points The guidelines help show how the concentration ratio and the HHI might view two industries differently.
Antitrust policy
Government laws and procedures designed to shape market structure and influence the behavior of firms. Prevent and break up monopolist practices and firms.
Graphically illustrate the price and quantity a natural monopoly would sell and produce at.
If there is a product that has a downward- sloping average cost curve (as opposed to the U-shaped curves we have been working with), then it is likely that a natural monopoly will form.
Robinson-Patman Act of 1936
Large retail buyers could not get price concessions. When a manufacturer increases their quantity, they may experience economies of scale. So their ATC falls. Such firms might charge a lower price to large retailers to get the lower ATC. But if this hurts smaller firms (who may not get the concession) and competition, it is illegal.
Marginal Product of a given input can be expressed as
MP = ΔY/ΔX = (the change of Y)/(the change of X).
Least cost rule
MPL/w = MPK/r
Long distance
Rates fell 40% from 1983-1990 (Schiller) Rates fell from $.52 a minute in 1985 to $.15 in 1996
Did airline de-regulation achieve its objectives?
The Airline Deregulation Act (Pub.L. 95-504) is a United States federal law signed into law on October 24, 1978. The main purpose of the act was to remove government control over fares, routes and market entry (of new airlines) from commercial aviation. The Civil Aeronautics Board's powers of regulation were to be phased out, eventually allowing passengers to be exposed to market forces in the airline industry. The Act, however, did not remove or diminish the FAA's regulatory powers over all aspects of airline safety.
Alcoa, 1945
The New York Court of Appeals ruled that because the firm had 90% of the market, they were guilty of being monopolistic. The rule of reason was overturned. Alcoa was not shown to have done anything anti-competitive like using predatory pricing.
U. S. Steel, 1920
The Supreme Court ruled that although the firm had 52% of the market, this share was declining and it had done nothing specifically illegal to gain its large share. The rule of reason was again used.
Standard Oil, 1911
The Supreme Court ruled that the company had gained its 90% market share through unusual business practices like, as some believe, predatory pricing. This was the first case to use the rule of reason. The company was broken up into smaller firms.
Cable TV
The Telecommunications Act of 1996 mandated that rate regulation be phased out and ended completely by March 1999. (Schiller) But the price of cable TV rose more during un-regulated periods than in regulate periods.
Marginal Revenue Product (MRP)
The change in revenue that results from the addition of one extra unit when all other factors are kept equal.
Superiority hypothesis
The claim that large oligopolistic producers captured sizable market shares due to their superior efficiency or lower cost curves. The idea here is not to punish firms if they got their big market share by doing a better or more efficient job of making their product.
Berkey Photo versus Eastman Kodak, 1979
The court said that Kodak's monopoly was defensible because it resulted from innovation, not improper behavior. This moved the court back closer to the rule of reason. The court felt that gaining large or monopoly profit was an incentive for innovation.
Rule of reason
The doctrine that all monopolies are not illegal, only monopolies that have engaged in unreasonable behavior (like intentionally driving out the competition).
Brown Shoe, 1962
The firm owned Kinney Shoes, a retail outlet. Brown was ordered to divest itself of Kinney due to vertical integration. Kinney had only 2% of the retail market. But it was feared that Kinney might not sell shoes produced by other companies, thus hurting competition.
General Electric, Westinghouse, & others, 1961
The firms were found guilty of price-fixing. The firms had colluded to keep prices high for the power equipment they sold to the Tennessee Valley Authority, a government agency. Some executives were jailed and fined.
Sherman Act of 1890
Trusts or conspiracies to restrict interstate trade and attempts to monopolize interstate trade were made illegal. The act was vague. It did not specify how large a firm's market share had to be in order to be considered a monopoly. Was it illegal to simply be a monopoly? What practices are legal and which are illegal? So that led to the next law.
Von's Grocery, 1965
Two supermarkets in Los Angeles wanted to merge. The new firm would have had only 7.5% of the market, but the court blocked the merger.
Herfindahl-Hirschman Index (HHI)
a measure of market concentration obtained by squaring the market share of each firm in the industry and then summing these numbers. "The sum of the squares of the market shares." IT USES ALL FIRMS, NOT JUST THE 4 BIGGEST.
Marginal factor cost (MFC)
a rate expressed in currency units per units of input, such as labor.
Marginal cost price regulation
a. Marginal cost pricing is the policy where the provider is required to set price equal to marginal cost and supply the quantity demanded. i. Production at economic efficient level: marginal benefit equals marginal cost. ii. Government subsidy may be required.
What caused the power crisis in California?
also known as the Western U.S. Energy Crisis of 2000 and 2001 was a situation in which California had a shortage of electricity caused by market manipulations and illegal shutdowns of pipelines by Texas energy consortiums. The state suffered from multiple large-scale blackouts, one of the state's largest energy companies collapsed, and the economic fall-out greatly harmed Governor Gray Davis's standing.
Government regulation
i. Conduct. ii. Information. iii. Structure.
Two philosophies for management of a natural monopoly.
i. Government ownership/provision. A government-owned enterprise tends to be relatively inefficient. (1). More prone to be beholden to employees, high wages and over staffing, resulting in higher costs. (2). Dependence on the government for investment funds. ii. Privatization: Privatization is the transfer of ownership from the government to the private sector. A private exclusive franchise awarded to a commercial enterprise, subject to government regulation. A government enterprise may be privatized and remain a monopoly, so that there is no competition on the seller side.
Divergence of marginal benefit and marginal cost.
i. Market power. ii. Asymmetric information. iii. Externalities and public goods.
Natural monopoly is a market where
i. The average cost is minimized with a single supplier, e.g., distribution of electricity and water. ii. A market is a natural monopoly when economies of scale or scope are large relative to market demand.
Natural Monopoly
monopoly considered beneficial: an industry believed by some to be of most benefit to consumers if it is dominated by one firm, which can exploit economies of scale by being as large as possible. Telecommunications, e.g. was once believed to be a natural monopoly.
Antitrust
opposing business monopoly: intended to oppose trusts and cartels, e.g. by preventing them from using monopolistic business practices to make unfair profits "antitrust legislation"
Marginal Revenue Product is calculated by
taking the marginal product of labor and multiplying it by the marginal revenue of a firm.
Regulation
the act of controlling or directing according to rule
Marginal Product of Labor
the change in output from hiring one additional unit of labor. Also known as MPL or MPN
Marginal revenue product of labor (MRPL)
the increase in total revenue when the firm adds one more worker. MRPL = DTR/DL (normally DL = 1) or MRPL = PX* MPL
Deregulation
the lifting of restrictions on business, industry, and professional activities for which government rules had been established and that bureaucracies had been created to administer.
Market Concentration Ratio
the percentage of industry sales attributable to the four largest firms in an industry. If the four biggest firms each have 15% of the total sales in an industry, that industry's concentration ratio is 60%
Per Se Rule
under the Sherman Act treats a business practice as automatically unlawful without any judicial inquiry into the motives or justification for the business. The per se rule is confined to restraints "that would always or almost always tend to restrict competition and decrease output."
Interlocking directorates
when a person serves on the board of directors of two or more companies in the same market or industry. So one person cannot be on the board of directors of both Ford and GM. They might influence both companies to raise price at the same time. This would be anti-competitive.
Tying contracts
when the sale of one good is conditional on the sale or purchase of a second good. If a company sells you product A, they say you must also buy product B from them. The idea is if they have a monopoly in one good, they will only sell it to you if you buy another good where that they sell in a competitive market. It is not clear if this strategy increases a firm's profits.
Derived demand
where demand for one good or service occurs as a result of demand for another.