Public Policy in Private Markets

Understanding Public Policy

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Why public policy?

Class overview

What prompts public policy?

Why Public Policy?

Rationales for government intervention: Dominant belief: US favors free enterprise Regulation: Why alter the operation of markets? What is done when there is unhappiness about

market outcomes? Extent of government intervention varies with cycles

(politics) Government regulation is often criticized (e.g. mortgage

crisis); how should things work? However, regulation remains in place and is

continuously growing and evolving

Why Public Policies in Private Markets?

In the US, we value perfectly competitive markets:

Effectively executes large # of decisions Most transactions can be handled by markets Government burden is reduced

But, in real world, markets are not perfectly competitive

Focus of public policy: how well do markets work compared with perfect competition?

Example: The NFL

Professional and College sports exempt from antitrust law (controversial)

Prior to ‘93: If drafted, player belonged to team Blocking linemen lowest paid players

After ‘93: Players become free agents (after a few years) and negotiate with other teams.

Blocking linemen are the second most highly paid players in the NFL (after QB’s)

Why? Free markets are, under certain conditions, able to bring about efficient prices.

Example: Cartel

Example: Vitamin Cartel (1990’s) Cartel involved vitamins, A, B, C and folic acid Firms involved: Roche, BASF, Aventis, Solvay,

Merck, Daiichi, Esai and Takeda Firms admitted to participating in worldwide

price fixing conspiracy over 10 years 1999: in US, Canada and Australia, Roche &

BASF pay $750 million in fines to settle suit. 2001: in EU 8 companies pay approx. 1.2 bill

Why Public Policies in Private Markets?

Private Sector Individual decision making (max π)

Example: should a firm adopt an exclusive dealing policy? Discussion

Government sector Group decision making, among (often disagreeing)

individuals (maximize: social welfare, equity?) Example: Should we allow a merger because it

brings about efficiency (good for everyone) or should we block it because it brings about higher prices (bad for consumers)?

Class Overview: Competition Policies

Antitrust laws: how firms compete with each other (rules of

the game) What is legal? What is illegal? What are the economics behind government

intervention? Focus: market power and its use in detriment

of buyers and consumers

Example: Vitamin Cartel

Legal issues Why was this illegal? How did they conspire? How did they get caught?

Economic issues How are damages calculated?

Example: AT&T – T-Mobile merger

Example: ATT + T-Mobile

Customers nationwide: Verizon: 102 million ATT: 97 Spring: 49 T-Mobile: 33

Will this merger be challenged?

Example: ATT + T-Mobile Arguments for merger:

Synergies, better call quality, better service Easier roll out of new 4G network (most powerful in

terms of data transmission) – priority for Obama administration

Example: ATT + T-Mobile

Arguments against merger: More concentrated industry: main concern is less

competitive pressure

Higher prices? Less variety? Decreased customer service? High barriers to entry

ATT + T-Mobile

What is main issue antitrust authorities should look at:

A. Risk of less competitive pressure (i.e. higher prices, less innovation, etc.)

B. Benefits of enhanced efficiency (i.e. greater coverage, less infrastructure overlap)

C. Higher barriers to entry (potential entrants are less likely to emerge)

D. Increased bargaining power against suppliers (lower prices for consumers)

ATT + T-Mobile Should this merger be challenged?

A. Yes

B. No

Will it be challenged?

A. Yes

B. No

Class Overview (time permitting)

Information Policies How much information is needed? What

format should this information have? E.g. Nutrition labeling: recent proposals to

have traffic lights on nutrition labels

Product Quality Safety: crash ratings for cars, pesticide

levels, etc. What are the processing standards? Do we

need this? (cost-benefit analysis)

Class Overview: Types of regulation

2. Information Policies: Regulation on how products are presented

to consumers E.g.: advertisement, labeling, unit pricing

How much information is needed? What format should this information have?

E.g. Nutrition labeling: new proposal to have traffic lights on nutrition labels

What prompts Public Policy?

1. Market imperfections (markets work but not so well)

2. Market Failure (markets do not work)

3. Ethical Criteria (we want markets to consider certain aspects)

What prompts Public Policy?

1. Market imperfectionsA. Monopoly/oligopoly

One or several structural requirements are violated: #small number of sellers, differentiated products, blocked or difficult entry

Examples of high concentration (possibly large market power)

RTE cereal industry: CR4=90% Soft drinks: CR2=70% Microsoft: >90% of PC’s are Windows compatible

1. Market Imperfections

Why regulate monopolies/oligopolies? Market can be influenced by few firms’

decisions on pricing (e.g. collusion) Allocative inefficiency: P>MC, output is

depressed and prices increase X-inefficiency: Less competition may

reduce incentives to minimize costs

1.A Monopoly, Oligopoly

Note of caution: Sources of market power

Natural/Legal: e.g. large economies of scale (electricity), network effects (iPod, Windows), or simply a “successful business model”

Artificial/Illegal (abuse): collusion, predatory pricing, limit pricing, price discrimination. Response: Antitrust laws, trade regulation

1.B Information Inadequacies

1. Market imperfectionsB. Information inadequacies

Perfect information of PC model is violated People and/or firms lack complete information Best decisions are not made (e.g. persuasive

advertising) Responses:

Information regulation (product labeling) Product regulation (standards)

2. Market Failures

A. Externalities: positive and negative

Externalities

Which of the following is a positive externality:

A. Consuming a California apple gives you 40 calories

B. Consuming a California apple increases your ability to fight colds (vitamin C intake)

C. Consuming a California apple increases carbon footprint (compared to a locally produced one)

D. Consuming a California apple is better than consuming a candy bar

2. Market Failures

A. Externalities: positive and negative1. Positive: price/market does not reflect all

societal benefits of the product. Examples?

2. Market Failures

A. Externalities1. Positive: price/market does not reflect all

benefits of the product. Examples?• Fiber in food (reduced heart disease)• Hybrid cars (lower air pollution)

2. Market Failures

A. Externalities1. Positive: price/market does not reflect all

benefits of the product. Examples?

2. Negative: price/market does not reflect all costs of the product. Examples?

• Fiber in food (reduced heart disease,)• Hybrid cars (lower air pollution)

2. Market Failures

A. Externalities1. Positive: price/market does not reflect all

benefits of the product. Examples?

2. Negative: price/market does not reflect all costs of the product. Examples?

• Fiber in food (reduced heart disease,)• Hybrid cars (lower air pollution)

• Alcohol consumption: increased traffic accidents, health risks

• SUV’s: increased pollution, larger damages to other cars in crashes

2. Market Failures

B. Public Goods?

2. Market Failures

B. Public Goods Examples: national defense, clean air,

public parks, highways Ideally: joint efforts to provide good (e.g.

neighbors get together to build a park) Problem: free riding on others’ efforts

(contributions) In short: you can get it even if you don’t

pay, and you might not get it even if you pay

3. Ethical criteria

Do markets yield fair and equitable treatment of people?

Response: tax code, equal opportunity, non-discrimination laws, etc.