Antitrust Laws and Government Regulation of Monopolies - Online Tutor, Practice Problems & Exam Prep

Monopolies can be regulated through antitrust laws, such as the Sherman Act, which prohibits collusion and price fixing, and the Clayton Act, which restricts stock purchases in competitors. The government can also set price ceilings, determining socially optimal prices where price equals marginal cost, or fair return prices where price equals average total cost. While socially optimal pricing maximizes efficiency, it may lead to economic losses for firms. Fair return pricing ensures firms cover costs but may result in deadweight loss, highlighting the complexities of market regulation and the need for effective oversight.

Antitrust Laws

Alright, so we've seen how monopolies will restrict their output to increase profits. Well, sometimes this gets out of hand and the government will step in to regulate. Let's check out some of their options. So the first topic we want to go over here is the antitrust laws. When these started coming about in the late 1800, early 1900s, there were problems with trusts. Now it's monopolies, right? They just kind of changed forms, so they're still called antitrust laws, but they're dealing with monopolies. Okay? So, the whole point of these laws is to limit the market power of the monopolies, right? So that they can't just completely have control over our market, how much they want to produce to maximize their profits, right? So, in the US, we've had quite a few laws that have come out. These are some of the most substantial ones and we're not going to go into a lot of detail, let's just kind of on a high level just discuss what these laws do and you can see how they're kind of restricting the monopoly's power, cool?

So the first one was the Sherman Act of 1890, and this one prohibited collusion and price fixing, and this was between firms, right? So, there were different firms between which there was basically colluding. So collusion is when firms that are separate work together to set prices or output. So, you can imagine if you and me were the only producers of a product and we got together under the table we're like, “Hey, I know the going price is $5 for this product, but if you charge $10 and I charge $10 there's nothing anyone can do about it. Let’s set this higher price and we'll make more money,” right? So, that’s obviously not good for the economy, for these competitors to start working together, right? It reduces the competition, it’s not good. So, this act prohibited that collusion, cool?

The next one, the Clayton Act, well, it prohibited companies from buying stock in their competitors or serving on the competitors’ board of directors, right? You can see that sounds like a red flag right there, buying competitor stock, that just doesn't sound right, right? So that was prohibited in 1914, and at the same time in the same era, in 1914, they created the Federal Trade Commission. So, FTC is the Federal Trade Commission and they basically enforce these laws. There are these antitrust laws and the FTC has been charged to enforce them, cool?

The next one was the Robinson Patman Act of 1936 and this one prohibited price discrimination. So, we talked about price discrimination a little bit, right? Charging different prices to different customers. Well, it doesn't prohibit price discrimination altogether, right? We even saw some real-world examples of price discrimination. It had to be price discrimination that was reducing competition, right? So, anytime we're reducing competition that's increasing the market power of the firm, they're going to have more influence over the price, more influence over the output to the economy, right? So, anything that's reducing competition is generally seen as a bad thing. Just like we see with this last one, the Celler-Kefauver Act, right? I'm not sure if I'm saying that totally right, but I think that's what it is and this act, it prohibited mergers that would reduce competition, right? So, mergers, that's when 2 firms merge together, right? And not all mergers are prohibited. There still are guidelines for how a how to how a merger should be allowed or disallowed, but basically it created this idea that if the merger was reducing competition substantially, then that merger should not be allowed to happen.

Cool? Alright, so now let's go on and see a different way that the government can regulate other than just making laws. Cool, let’s check that out in the next video.

Monopoly:Socially Optimal Price and Fair-Return Price

Alright, so the government could also get directly involved in the market and set price ceilings on what a monopoly can charge. Okay? So the government can also regulate a monopoly through the use of price ceilings. Cool? Remember that price ceilings is the amount that could be charged, so they're setting a limit on the price. What is the highest price that could be charged? Well, they have 2 options when they're trying to figure out a correct price ceiling. The first one is a socially optimal price as we see on the left graph, and this is where price equals marginal cost, right? Remember, socially optimal means we're trying to achieve the efficient amount of production. If the price equals marginal cost, that means that all of the benefits, right? Remember that the price represents the marginal benefit to consumers, to the last unit sold, that price is the marginal benefit to that last user, right? And the marginal cost, well that's the cost to the firm. So socially optimal is where the marginal benefit equals the marginal cost, so price equals marginal cost. We can see this on the graph, this is the price marked SO for socially optimal. The price of a socially optimal price is right there where the demand and marginal cost meet. If we follow this line, we see that at this price, the demand curve and the marginal cost curve are touching, and that means we're going to produce all of the units that there is a benefit to produce. We're going to make the efficient quantity of units, the same amount that would be produced in perfect competition, reaching that efficient equilibrium quantity. But, notice what could happen, there is a potential outcome: look at the average total cost at that point. If we're producing at this quantity, the socially optimal quantity, look at the profit to the firm. If this is the price here and this is the average total cost, well, the firms actually got a loss. There's going to be a loss of all of this amount, right? Everything here is all loss to the firm. This is a potential downfall of the socially optimal price because we've got these average total costs and that average total cost curve could be above our price. It's not always the case but that is a side effect of socially optimal prices. But, as we see underneath, our benefit is that we get this maximum efficiency. We're getting all of the trades we want to make and we're maximizing total surplus. But, like we said, there's that negative where there could actually be losses to the monopoly and if there are long-term losses, if they can't cover average total costs then they can't run the business. They would have to exit the business in the long run because they can't cover their total cost. This is the socially optimal price. We'll get to this last bit, the incentive to minimize costs, after we discuss the fair return price. Okay, so the fair return price, this is the other option, is where price equals average total cost. Remember where price equals average total cost, that's productive efficiency. We're producing at the lowest possible cost. Notice when we are talking about the socially optimal, we're considering allocative efficiency, and over here, we are talking about productive efficiency. We're trying to minimize cost. Notice at the fair return price, they are able to cover their total cost. But when price equals average total cost, there's no profit. Notice at this price level here, the price marked FR for fair return, and note that it's touching the average total cost at that price as well, so when the price and average total cost are the same, we've got no profit. There's no economic profit for the firm, but we're not reaching the fully efficient point would have been way out here, as we saw in the other example. This point, where the marginal cost curve touches the demand curve. Since we didn't achieve the efficient quantity, we instead have the fair return quantity here, and this gives us a deadweight loss. This area here illustrates those trades that were not made and represents our deadweight loss. So what do we see? We have lowered the deadweight loss because if we didn't regulate at all, we would have been producing way down here, where marginal revenue and marginal cost cross, and we would have had a huge deadweight loss. There's no profit for the monopoly anymore. They don't have the incentive to minimize cost anymore because they are being forced to charge what their costs are, they might try and inflate their costs as much as possible. They might try to include lots of entertainment expenses, taking clients out to baseball games, fancy dinners, anything that they could turn into a cost of the firm. They're not going to try their hardest to minimize costs anymore because they can set their price at this average total cost. This adds other layers of regulation. It gets pretty difficult, but for this class and this purpose, it's more just about knowing about these points and the repercussions of these types of things. Cool? Alright, this is the other option that governments have, they can put antitrust laws to just regulate and prohibit actions of monopolies or they can step into the market itself and put price ceilings at these socially optimal or fair return prices. Cool? Alright, let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What are the main antitrust laws in the United States?

The main antitrust laws in the United States include the Sherman Act of 1890, the Clayton Act of 1914, and the Federal Trade Commission (FTC) Act of 1914. The Sherman Act prohibits collusion and price fixing among firms, aiming to maintain competition. The Clayton Act restricts companies from buying stock in competitors or serving on their boards, preventing anti-competitive practices. The FTC Act established the Federal Trade Commission, which enforces these antitrust laws. Additionally, the Robinson-Patman Act of 1936 prohibits price discrimination that reduces competition, and the Celler-Kefauver Act of 1950 restricts mergers that significantly reduce market competition.

How does the government regulate monopolies through price ceilings?

The government can regulate monopolies by setting price ceilings, which limit the maximum price a monopoly can charge. There are two main types of price ceilings: socially optimal prices and fair return prices. A socially optimal price is set where the price equals the marginal cost (P = MC), ensuring maximum efficiency and benefiting consumers. However, this may lead to economic losses for the firm if the price is below the average total cost. A fair return price is set where the price equals the average total cost (P = ATC), allowing the firm to cover its costs without making a profit. This approach reduces deadweight loss but may not achieve full efficiency.

What is the difference between socially optimal pricing and fair return pricing?

Socially optimal pricing occurs when the price is set equal to the marginal cost (P = MC), aiming to achieve allocative efficiency by producing the quantity where the marginal benefit to consumers equals the marginal cost of production. This maximizes total surplus but may result in economic losses for the firm if the price is below the average total cost. Fair return pricing, on the other hand, sets the price equal to the average total cost (P = ATC), ensuring the firm covers its costs without making a profit. While this approach achieves productive efficiency, it may result in deadweight loss due to not reaching the socially optimal quantity.

What are the potential downsides of socially optimal pricing for monopolies?

While socially optimal pricing (P = MC) maximizes efficiency and total surplus, it has potential downsides for monopolies. One major issue is that it may lead to economic losses for the firm if the price is set below the average total cost (ATC). This can result in the firm being unable to cover its costs, leading to long-term financial instability and potential exit from the market. Additionally, without the incentive to minimize costs, firms may inflate their expenses, further complicating regulation and oversight. These challenges highlight the complexities of implementing socially optimal pricing in practice.

How does the Federal Trade Commission (FTC) enforce antitrust laws?

The Federal Trade Commission (FTC) enforces antitrust laws by investigating and taking action against anti-competitive practices. Established by the FTC Act of 1914, the agency monitors business activities to ensure compliance with laws like the Sherman Act and the Clayton Act. The FTC can initiate investigations, conduct hearings, and issue cease-and-desist orders to prevent unfair methods of competition. It also reviews mergers and acquisitions to ensure they do not substantially reduce competition. By enforcing these laws, the FTC aims to maintain a competitive market environment, protect consumers, and promote economic efficiency.