In other cases, the government becomes concerned about the general well-being of society and chooses to
regulate markets. This type of social regulation, used to protect workers, consumers, and the environment, has
captured an increasing portion of federal dollars and concern. Agencies such as the Environmental Protection
Agency, the Occupational Safety and Health Administration, and the Consumer Protection Agency have a broad
scope in determining policy that often has a far-reaching effect across all markets.
There are both costs and benefits to government regulation of industry, and the debate becomes heated at
times. Two theories purport to explain the existence of regulation: First, the public interest theory claims that
regulation arises because of the failure of private markets to generate socially optimal outcomes. The existence of
natural monopolies, externalities in production, and imperfect information are all cases of market failure. To some,
this necessitates the entrance of government.
Second, the special interest theory of regulation holds that regulation is designed to benefit certain segments of
the economy at the expense of others. That is, industries desire regulation, which in some cases holds prices high,
eliminates the possibility of entry, and relieves pressure to produce efficiently. This theory states that the regulators
and the regulated begin to work together to promote the best interests of the industry, not social well-being and
consumer interests.
Consider the role of the regulator in a natural monopoly. Several different pricing strategies are available to
the regulators. However, regulators are not operating with perfect information concerning the actual costs that the
firm incurs. Thus decision making is difficult. (Please read the chapter for
the details)
An alternative to regulated monopoly is introduced: public ownership. However, history has shown that this
is not a good alternative, and that however unsure we are about the success of regulated monopoly, the prospect of
public ownership is enough to keep regulators in business.
As we have seen in the past few chapters, any amount of monopoly power
has benefits and costs to consumers. Although product variety and greater
information are provided to buyers, higher prices and lower output levels
can erode purchasing power. Hence the government has stepped into the marketplace;
its job is to assess market concentration and to take steps to eliminate
"excessive" concentration where these steps are necessary.
The tough question is "When is concentration "excessive?" That is,
when are the benefits created by the existence of big business overwhelmed
by the costs? And how can these benefits and costs be quantified? Two measures
commonly used to assess the extent of concentration in a market are the
concentration ratio and the Herfindahl Index. A problem with both of these
indexes is that it is difficult to define the relevant market. Thus it
is also important to measure the overall concentration in the U.S. economy.
This can be done by determining value added for the largest companies or
by summing concentration ratios across the major industrial sectors.
Antitrust legislation is used when the government decides to step into
markets in order to change the level of concentration. Major pieces of
legislation include the Sherman Antitrust Act, the Clayton Act, the Federal
Trade Commission Act, the Robinson-Patman Act, and the Cellar-Kefauver
Act. Although the general impact of these laws has been to limit concentration,
their interpretation has changed over the years. In some cases they have
been very strictly enforced and in other cases very loosely enforced. Due
to the differences in opinion about the costs and benefits of big business,
future court rulings, the degree of FTC and Justice Department enforcement,
and changes over time, future policy decisions remain a mystery.
Outline I. The Market Concentration Ratio A. The market concentration ratio refers to the market share of the four largest firms B. Difficulties arise when economists attempt to define the relevant market C. Shortcomings of the concentration ratio 1. It overlooks competition from imports, other industries, and prospective producers 2. It focuses on national output, even though many markets are local or regional 3. It ignores the distribution of sales among the top four producers II. The Herfindahl Index A. The Herfindahl Index sums the market shares of all firms in the industry, but only after the market shares have been squared B. Unlike the concentration ratio, the Herfindahl Index effectively captures the market power of firms that dwarf their competitors C. Since 1982, the Justice Department has been using the Herfindahl Index to settle antitrust cases III. Antitrust A. Government actions aimed at influencing the structure and conduct of business are referred to as antitrust policy B. Consider industrial developments leading to the need for such policy