This is “Busting Up Monopolies”, chapter 14 from the book Theory and Applications of Microeconomics (v. 1.0).
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You have probably never considered working for the Department of Justice, yet here is a job opportunity open to everyone.
If you have information about a possible antitrust violation or potential anticompetitive activity, use the following questions as a guideline to describe your complaint:
You may never have heard about antitrust laws. You may have only a vague idea of what antitrust is. Yet these laws have a direct impact on your day-to-day life because they can have a significant impact on the prices you pay for goods and services. As the Department of Justice explains,
Most states have antitrust laws, and so does the federal government. Essentially, these laws prohibit business practices that unreasonably deprive consumers of the benefits of competition, resulting in higher prices for inferior products and services…
When competitors agree to fix prices, rig bids, or allocate customers, consumers lose the benefits of competition. The prices that result when competitors agree in these ways are artificially high; such prices do not accurately reflect cost and therefore distort the allocation of society’s resources. The result is a loss not only to U.S. consumers and taxpayers, but also the U.S. economy.US Department of Justice, “Antitrust Enforcement and the Consumer,” accessed March 14, 2011, http://www.justice.gov/atr/public/div_stats/211491.
Antitrust laws in the United States are principally codified in three acts of Congress—the Sherman Antitrust Act, the Clayton Act, and the Federal Trade Commission Act—and the Federal Trade Commission and the Department of Justice enforce each act. In other countries, similar government agencies perform these same tasks.
How might you become involved in pursuing antitrust violations? Without knowing the provisions of these laws, it is hard to see how you could ever detect and report violations. Fortunately, the Department of Justice provides some further guidance: look for situations where the price of a good is in excess of the marginal cost of producing that good. Remember that marginal cost is the cost of producing one additional unit of output. In a competitive market, firms set prices equal to marginal cost, but when they have market power, firms set prices in excess of marginal cost.Chapter 6 "Where Do Prices Come From?" contains more information. The Department of Justice’s suggestion reflects this conclusion: price in excess of marginal cost is a likely indicator of market power.
In practice, it is more complicated. For example, the cost of producing one more compact disc (CD) is the cost of the material it is made from, the cost of burning the CD, and the cost of the jewel case in which it is packed. These costs are very small: no more than a few cents. Yet, if you have bought a CD recently, you probably paid between $10 and $20 for it. Should you be reporting your local CD retailer to the Department of Justice?
In fact, the government sometimes actively protects and creates market power, despite the fact that it has entire divisions devoted to encouraging competition. It creates market power through patent and copyright laws, which prevent people from copying inventions and created works (like music or books). In the case of CDs, the government grants copyright protection because the creation of the very first copy of a CD is very costly. When a CD is produced, there are enormous music creation costs incurred by the musicians and the company recording and producing the music. These costs are much more sizable than the actual cost of producing the CD you purchased. From this perspective, the high prices are needed to make it worthwhile for the artist to incur the creation costs.
You can perhaps sense the tension. The costs of producing the very first CD are high, but the cost of producing the thousands (or millions if the artist is successful) of copies of the first CD are relatively small. Should the price reflect the marginal cost of that last CD or should it be higher to cover the creation costs as well? This argument was vividly illustrated in 2001 when music file sharing first became popular. A firm called Napster (http://music.napster.com) supplied a technology that facilitated the sharing of music through the Internet. Napster essentially reduced the marginal cost and the price of a song all the way down to zero. Napster’s technology was in direct competition with the record companies, and a legal battle ensued. The final ruling forced Napster to block its file sharing and effectively ended its ability to share music. Other peer-to-peer networks have replaced it, however, and a lot of music is still available for free on the Internet.
In this chapter, we investigate these varied aspects of competition policy. This might seem like an arcane topic, but it has a huge impact on the prices you pay for goods and services. It is competition policy that keeps the price of CDs high and the price of airline tickets low. In this chapter, we evaluate the impact of competition policy on the economy and answer the following questions.
To make sense of competition policy, we need to first understand what firms would do if there were no antitrust laws constraining them. We therefore begin by looking at economic outcomes in the absence of government protection. We first contrast a market in which there is a single seller with a market that is serviced by many sellers—that is, a competitive market. From this comparison, we can understand the basis of antitrust laws.
Next, we look at why the government sometimes actively promotes market power through patents and copyright. Specifically, we show how such laws can encourage innovation and creation of intellectual property. Finally, we look at situations where there are only a few competing firms. We explain how the outcome is different depending on whether firms choose to set prices or to set the quantity that they produce, and we again look at the role of government policy.