Slide 1Knowledge RecapPublic Policy toward OligopoliesPublic Policy toward OligopoliesTypes of cartel activityTypes of cartel activityTypes of cartel activityCartel Activity and the Per Se RuleCartel Activity and the Per Se RuleCartel Activity and the Per Se RuleEffects of Regulation of OligopoliesEffects of Regulation of OligopoliesEffects of Regulation of OligopoliesPublic Policy toward OligopoliesECON 203: Principles of MicroeconomicsClass 20: Public Policy toward Oligopolies1Knowledge Recap•In an oligopoly, there are few firms selling very similar or identical products•An oligopoly can lead to collusion: an agreement among firms over quantities and/or prices–The group of firms acting together is called a cartel.–Cartels may be hard to maintain due to individual incentives to deviate from the agreement (cheat).•Oligopoly market equilibrium.–Effective collusion leads to monopolistic outcomes.–Strategic behavior leads to QC > QO > QM and PC < PO < PM•Welfare effects:–Strategic behavior leads to a social outcome that is better than a monopoly (or cartel) but worse than competition.2Public Policy toward Oligopolies•Antitrust Laws.–Section 1 of the Sherman Act:“Every contract, combination in the form of trust or otherwise, or conspiracy in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal.”•Three common types of cartel behavior considered as violations of antitrust law:–Price fixing–Bid rigging–Customer allocation among competitors•These are examples of “horizontal agreements”.–A horizontal agreement is an agreement between competitors to restrain their rivalry.–Horizontal agreements are subject to the per se rule.3Public Policy toward Oligopolies•Price fixing: –Any agreement to tamper with prices or price levels, or terms and conditions of sale.–Examples:•Agreement to raise prices to a specific amount on a given date.•Agreement to establish or adhere to uniform price discounts.•Agreement to eliminate discounts.•Agreement to adopt a specific price formula.•Agreement not to advertise prices.–Just because all prices in a market are equal is not evidence of price fixing. •Price fixing requires evidence of a conspiracy (e.g. emails, phone calls, etc.)4Types of cartel activity•Example: canned tuna prices.–Amended complaint filed in May of 20175Types of cartel activity•Example: canned tuna prices.–Amended complaint filed in May of 20176Types of cartel activity•Example: canned tuna prices.–Amended complaint filed in May of 20177Cartel Activity and the Per Se Rule•Cartel activity that constitutes a horizontal agreement is considered a per se antitrust violation. –All that needs to be proven, is that the agreement took place; no proof of its negative effect on competition is required.–Implicit assumption: all horizontal agreements are anticompetitive.–Economists sometimes disagree about whether or not this assumption is correct.8Cartel Activity and the Per Se Rule•Example: Trans-Missouri case (1897).–18 railroads formed an association to set railroad rates.–Railroads argued their agreement was competitive because, without it, “ruinous competition would ultimately lead to monopoly…”–Analysis of Trans-Missouri case:•Industry with high fixed costs.•If competition drives prices to zero (when MC=0), railroads may not enter, leading to a natural monopoly.•Monopoly outcomes could be improved by setting prices at a level where more firms could enter the market.9Cartel Activity and the Per Se Rule•Problem with Trans-Missouri type arguments: –Such cases are rare and do not consider enforcement costs“… economic policy must be contrived with a view to the typical rather than the exceptional, just as all other policies are contrived.” George Stigler, 1952 (cited in Whinston, 2003). 10Effects of Regulation of Oligopolies •Effects of antitrust enforcement (Sproul, 1993)–Expected price behavior resulting from cartel formation and subsequent government prosecution11Effects of Regulation of Oligopolies •Effects of antitrust enforcement (Sproul, 1993)–Actual price behavior, based on a study of 25 cartels between 1970 and 198412Effects of Regulation of Oligopolies •Effects of antitrust enforcement (Sproul, 1993)–Possible explanations for difference:•The cartel did not successfully restrict competition (i.e. all firms were cheating).•Firms were driven out as a result of prosecution (explains increase in prices at the end, but not lack of increase at beginning).•Cost reducing cartel–Actual explanation may be some combination of above reasons, as well as other reasons such as sample selection. –The “true effect” of regulation on price fixing remains a topic of debate among economists.13Public Policy toward Oligopolies•Conclusion:–Horizontal agreements that represent cartel behavior such as agreements on quantities or prices are per se illegal under U.S. antitrust law.–As with everything, the treatment of such agreements by the U.S. antitrust authorities remains a subject of debate:•Effectiveness of regulation.•Case-by-case anticompetitive