ECONOMICS OF REGULATION AND ANTITRUST Fifth Edition

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ECONOMICS OF REGULATION AND ANTITRUSTFifth EditionW. Kip ViscusiJoseph E. Harrington, Jr.David E. M. SappingtonThe MIT PressCambridge, MassachusettsLondon, England

ContentsPreface to the Fifth Editionxxi1IntroductionThe Rationale for Regulation and Antitrust PoliciesAntitrust RegulationThe Changing Character of Antitrust IssuesReasoning behind Antitrust RegulationsEconomic RegulationDevelopment of Economic RegulationFactors in Setting Rate RegulationsHealth, Safety, and Environmental RegulationRole of the CourtsCriteria for AssessmentQuestions and ProblemsRecommended ReadingAppendix134456668991111122The Making of a RegulationState versus Federal Regulation: The Federalism DebateAdvantages of FederalismAdvantages of National RegulationsProduct Labeling ExampleOverlap of State and Federal RegulationsThe Character of the Rulemaking ProcessChronology of New RegulationsNature of the Regulatory Oversight ProcessThe Nixon and Ford AdministrationsThe Carter AdministrationThe Reagan AdministrationThe Bush AdministrationThe Clinton AdministrationThe George W. Bush AdministrationThe Obama AdministrationThe Trump AdministrationRegulatory Reform LegislationBenefit-Cost AnalysisDiscounting Deferred EffectsPresent Value151617181920212125262729303030303132343737

ContentsThe Criteria Applied in the Oversight ProcessRegulatory Success StoriesPromotion of Cost-Effective RegulationDistortion of Benefit and Cost EstimatesRegulatory Role of Price and QualityImpact of the Oversight ProcessTrends in Major RegulationsThe Costs and Benefits of Major RegulationsAlternative Measures of the Scale of RegulationThe Character of Regulatory Oversight ActionsJudicial Review of Regulatory Impact AnalysesWhat Do Regulators Maximize?Capture TheoryOther Theories of Influence PatternsComprehensive Models of Regulatory ObjectivesConclusionQuestions and ProblemsAppendixTrends in Regulatory Agency Budgets and UST653Introduction to AntitrustCompetition and WeifareWeifare ToolsMonopoly versus Competition ExampleIs the Compensation Principle Compelling?Some ComplicationsX-InefficiencyMonopoly-Induced WasteEstimates of the Weifare Loss from MonopolyInnovation: Monopoly versus CompetitionIndustrial OrganizationDehning the Market and Market 737578798083888991939494

vii4ContentsAntitrustPurpose and Design of Antitrust LawsU.S. Federal Antitrust Law and EnforcementGlobal Competition Law and EnforcementSummary of the Chapter and Overview of Part IQuestions and ProblemsAppendix: Excerpts from Antitrust StatutesUnited StatesEuropean UnionChina9696100106108109111111112114Oligopoly, Collusion, and AntitrustGame TheoryExample 1: Advertising CompetitionExample 2: Compatibility of StandardsThe Strategie Form of a GameNash EquilibriumOligopoly TheoryThe Cournot ModelOther Models of OligopolyProduct DifferentiationCollusionA Theory of CollusionChallenges to CollusionCase Studies of CollusionRailroads and Price Wars Due to Imperfect MonitoringNasdaq Market Makers and Price TransparencyToy Stores and Hub-and-Spoke CollusionAntitrust Law and Enforcement with Respect to Price FixingFundamental Features of the LawThe Concept of an AgreementParallelism PlusLegal ProceduresEnforcement PolicySummaryQuestions and ProblemsAppendixGame Theory: Formal 146146148151153154156158159161167168171171

viiiContents5Market Structure and Dynamic CompetitionMarket StructureConcentrationEntry ConditionsSources of ConcentrationDynamic CompetitionLimit PricingInvestment in Cost-Reducing CapitalRaising Rivals' CostsPreemption and Brand ProliferationSummaryQuestions and ontal MergersAntitrust Laws and Merger TrendsThe Effects of Horizontal MergersWhy Firms MergeWeifare AnalysisMerger Law and EnforcementMerger Evaluation: Activity and ProceduresDevelopment of Merger Law and PolicyPractices for Evaluating a MergerInternational IssuesSummaryQuestions and cal Mergers and Vertical RestraintsVertical MergersBenehtsAnticompetitive EffectsFixed ProportionsVariable ProportionsAntitrust Law and PolicyCasesVertical RestraintsExclusive DealingTyingManufacturer-Retailer Restraints259260260265266268277280284285296312

ixContentsSummaryQuestions and Problems3203218Monopolization and Price DiscriminationEstablishing Monopolization ClaimsMeasuring Monopoly PowerAssessing Intent to MonopolizeDevelopment of Antitrust Case Law1890-1940: Standard Oil and United States Steel1945-1970: Alcoa and United Shoe Machinery1970 to Present: Kodak, IBM, Microsoft, and OthersPredatory PricingTheories of Predatory PricingEfüciency RationalesAntitrust PolicyRefusal to Deal and the Essential Facilities DoctrineEssential Facilities DoctrineIntellectual Property RightsKodak and Monopoly Power in AftermarketsPrice Discrimination and the Robinson-Patman ActTheory of Price DiscriminationCasesSummaryQuestions and 3543583653653703723739Antitrust in the New EconomyEconomic Fundamentals of the New EconomyAntitrust Issues in the New EconomyNetwork EffectsMarkets with Network EffectsMicrosoftBig DataTwo-Sided PlatformsPrices at a Two-Sided PlatformChallenges in Antitrust AnalysisIndustries with Rapid and Disruptive InnovationSegal-Whinston ModelSummaryQuestions and Problems375375379383383392399404407415419421427429

XContentsIIECONOMIC REGULATION43310Introduction to Economic RegulationWhat Is Economic Regulation?Reasons for RegulationInstruments of RegulationBrief History of Economic RegulationFormative StagesTrends in RegulationThe Regulatory ProcessOverview of the Regulatory ProcessRegulatory LegislationIndependent Regulatory CommissionsRegulatory ProceduresTheory of RegulationNormative Analysis as a Positive TheoryCapture TheoryEconomic Theory of RegulationTaxation by RegulationSummary and Overview of Part IIAppendixA Theory of Interest Group CompetitionQuestions and 45745846747347447447711Alternatives to Regulation in the Market: Public Enterpriseand Franchise Bidding, with an Application to Cable TelevisionPublic EnterpriseBasic Elements of Franchise BiddingInformation Advantages of Franchise BiddingPotential Drawbacks to Franchise BiddingContractual Arrangements for the Post-bidding StageAssessment of Franchise BiddingEarly Regulation of Cable TelevisionCable Television as a Natural MonopolyTechnological BackgroundEconomies of Density and Scale479479482485486488491492494494495

xiContentsFranchising ProcessAssessment of Franchise BiddingRate RegulationThe Limits of Government RegulationCompetition among Suppliers of Video ServicesSummaryQuestions and Problems49849950250750750850912Optimal PricingSubadditivity and Multiproduct MonopolyOptimal Pricing PoliciesOptimal Pricing of a Single ServiceLinear PricingNonlinear PricingOptimal Pricing of Multiple ServicesRamsey PricingNon-Ramsey Pricing of Telephone ServicesOptimal Pricing in Two-Sided MarketsRate StructureFDC PricingAvoiding Inefficient EntryTime of Use PricingCosts of Power ProductionTOU Pricing ModelSummaryQuestions and 53153253753713Incentive RegulationTraditional Rate of Retum RegulationRate HearingsAverch-Johnson EffectPrudence Reviews and Cost DisallowancesRegulatory LagIncentive RegulationPrice Cap RegulationEamings SharingPerformance Based Regulation in the Electricity Sector539539540541544545546546550553

XllContentsRegulatory OptionsYardstick RegulationSummaryQuestions and Problems55555655755814Dynamic Issues in Natural Monopoly Regulation: TelecommunicationsBasis for Natural Monopoly RegulationSources of Natural Monopoly TransformationDemand SideCost SideRegulatory ResponseAsymmetrie Regulation and Cream-SkimmingInterstate Telecommunications MarketRegulatory BackgroundTransformation of a Natural MonopolyRegulatory Policy in the Microwave EraRegulated Monopoly to Regulated CompetitionRegulated Competition to Unregulated CompetitionTelecommunications Act of 1996Net NeutralityInternet StructureThe Meaning of Net NeutralityRationale for Net NeutralitySummaryQuestions and 58158258458558858815Regulation of Potentially Competitive Markets:Theory and Estimation MethodsTheory of Price and Entry/Exit RegulationDirect Effects of Price and Entry/Exit Regulation: The Competitive ModelDirect Effects of Price and Entry/Exit Regulation: The ImperfectlyCompetitive ModelIndirect Effects of Price and Entry RegulationIndirect Effects of Price and Exit RegulationRegulation and InnovationMethods for Estimating the Effects of RegulationOverview of Estimation MethodsIntertemporal Approach591591591595598601602604605605

xiiiContentsIntermarket ApproachCounterfactual ApproachMeasuring the Effects of Price and Entry Restrictions: Taxicab RegulationRegulatory HistoryEntry RestrictionsValue of a MedaillonThe Rise of Ride SharingSummaryQuestions and Problems60761061461461561661762262316Economic Regulation of Transportation: Surface Freight and AirlinesTransportation IndustrySurface Freight TransportationRegulatory HistoryWhy Was Regulation Imposed?Regulatory PracticesEffects of RegulationLessens front RegulationAirlinesRegulatory HistoryDescription of Regulatory PracticesEffects of RegulationCompetition and Antitrust Policy after DeregulationMeasuring Concentration in the Airline IndustryAnticompetitive Nonprice PracticesAnticompetitive Pricing PracticesLessons front Regulation and DeregulationSummaryQuestions and 65765966566666717Economic Regulation in the Energy SectorRegulation in the Electricity SectorHistorical, Technological, and Regulatory BackgroundRestructuring in CaliforniaCalifornia Energy Crisis, 2000-2001Effects of Restructuring in the Electricity SectorDistributed GenerationFuture Regulation in the Electricity Sector669669669671673678680683

xiv18ContentsEconomic Regulation in the Oil SectorIndustry BackgroundEffects of Price CeilingsRationale for Restricting Domestic Oil ProductionRestricting Oil ImportsGrude Oil Price ControlsSummaryQuestions and Problems683683684687692694697698Regulation in the Financial SectorRole of the Financial SectorRationale for Regulation in the Financial SectorBank RunsBank Runs in PracticeGovernment Intervention and RegulationDeposit InsuranceRestrictions on Banks' InvestmentsReserve RequirementsLimiting Competition among BanksOngoing Monitoring of Bank ActivitiesHistorie Legislation in the Financial SectorFederal Reserve Act of 1913Banking Acts of 1933 (Glass-Steagall) and 1935Gramm-Leach-Bliley Act of 1999Depository Institutions Deregulation and Monetary Control Act of 1980Securities and Exchange Act of 1934Sarbanes-Oxley Act of 2002Causes of the Great RecessionRising Housing PricesThe Bubble BurstsCrisis in the Financial SectorRegulatory Reform: The Dodd-Frank Act of 2010Limiting Systemic Risk to Avoid Future Financial ShocksBanking ReformEnding Bailouts of Firms That Are "Too Big to Fail"Reducing Risks Posed by 06707707707708709709711713714715715715716

XVContentsNew Requirements and Oversight of Securities Rating AgenciesIncreased Transparency and Accountability in Securities MarketsSummaryQuestions and Problems716716717717IIIHEALTH, SAFETY, AND ENVIRONMENTAL REGULATION71919Introduction to Health, Safety, and Environmental RegulationThe Emergence of Health, Safety, and Environmental RegulationRisk in PerspectiveMeasuring Mortality RisksInfeasibility of a No-Risk SocietyHomeland SecurityWealth and RiskPolicy EvaluationRegulatory StandardsBenefit-Cost AnalysisRole of HeterogeneityRole of Political FactorsSummary and Overview of Part IIIQuestions and ProblemsRecommended 4220Valuing Life and Other Nonmonetary BenefitsPolicy Evaluation PrinciplesWillingness-to-Pay versus Other ApproachesVariations in the Value of a Statistical LifeLabor Market ModelEmpirical Estimates of the Value of a Statistical LifeValue of Risks to Life for Regulatory PoliciesSurvey Approaches to Valuing Policy EffectsValuation of Air QualitySupplementary Nature of the Survey ApproachSensit!vity Analysis and Cost EffectivenessRisk-Risk AnalysisSummaryQuestions and Problems743744746749751756757763765765765767769769

XVI21ContentsEnvironmental RegulationThe Coase Theorem for ExternalitiesThe Coase Theorem as a Bargaining GamePollution ExampleLong-Run Efficiency ConcernsTransaction Costs and Other ProblemsSmoking ExternalitiesSpecial Features of Environmental ContextsSiting Nuclear WastesSelecting the Optimal Policy: Standards versus EinesSetting the Pollution TaxRole of HeterogeneityStandard Setting under UncertaintyPollution TaxesPrices versus QuantitiesMarket Trading PoliciesNettingOffsetsBubblesBankingThe Expanding Role of Market ApproachesCap and Trade in Action: The S02 Allowance Trading SystemGlobal Warming and Irreversible Environmental EffectsPolicy Options for Addressing Global WarmingSocial Cost of CarbonAssessing the Merits of Global Warming PoliciesHow Should We React to Uncertainty?Multiperson Decisions and Group ExternalitiesThe Prisoner's DilemmaThe N-Person Prisoner's DilemmaApplications of the Prisoner's DilemmaEnforcement and Performance of Environmental RegulationEnforcement Options and ConsequencesHazardous WastesContingent Valuation for the Exxon Valdez Oil 7807809812

xvii22ContentsSenior Discount for the Value of a Statistical LifeEvaluating PerformanceSummaryQuestions and Problems815817817819Product SafetyEmergence of Product Safety RegulationsCurrent Safety DecisionsConsumer ComplaintsFactors Affecting Producer and Consumer ActionsProduct Performance and Consumer ActionsChanging Emphasis of Product RegulationPremanufacturing Screening: The Case of PharmaceuticalsWeighing the Significance of Side EffectsDrag Approval StrategiesAccelerated Drug Approval ProcessBehavioral Response to Product Safety RegulationConsumer's Potential for Muting Safety Device BenefitsThe Pulling EffectEffect of Consumer's Perception of Safety Device EfücacyCosts of Product Safety Regulation: The Automobile Industiy CaseTrends in Motor Vehicle and Home Accident DeathsAccident Rate InfluencesThe Decline of Accident RatesThe Rise of Product LiabilityNegligence StandardStrict Liability StandardTracing Accident Costs and CausesThe Ford Pinto CaseEscalation of DamagesRisk Information and Hazard WarningsSelf-Certification of Safe ProductsGovernment Determination of SafetyAlternatives to Direct Command and Control RegulationRegulation through LitigationBreast Implant Litigation and 858

xviiiContentsSummaryQuestions and Problems23Regulation of Workplace Health and SafetyPotential for InefficienciesHow Markets Can Promote SafetyCompensating Wage Differential TheoryRisk InformationOn-the-Job Experience and Worker Quit RatesInadequacies in the MarketInformational Problems and IrrationalitiesSegmented Markets and the Failure of Compensating DifferentialsExtemalitiesOSHA's Regulatory ApproachSetting OSHA Standard LevelsThe Nature of OSHA StandardsReform of OSHA StandardsRegulatory Reform InitiativesChanges in OSHA StandardsChemical LabelingEconomic Role of Hazard WamingsEffective Hazard WamingsInnovations in OSHA RegulationOSHA's Enforcement StrategyInspection PoliciesTrivial ViolationsOSHA PenaltiesEnforcement TargetingImpact of OSHA Enforcement on Worker SafetyOSHA Regulations in Different SituationsOSHA and Other Factors Affecting InjuriesDetermining OSHA's Impact on SafetyMixed Opinions Regarding OSHA's ImpactRole of Workers' CompensationSummaryQuestions and 6898900902904

xixContents24Behavioral Economics and Regulatory PolicyProspect Theory: Loss Aversion and Reference Dependence EffectsProspect Theory: Irrationality and Biases in Risk PerceptionRole of Risk AmbiguityExamples of Uncertainty and ConservatismIntertemporal IrrationalitiesEnergy Regulations and the Energy Efficiency GapMaking DecisionsBehavioral NudgesThe Behavioral Transfer TestSummaryQuestions and 37

The Rationale for Regulation and Antitrust Policies 3 Antitrust Regulation 4 The Changing Character of Antitrust Issues 4 Reasoning behind Antitrust Regulations 5 Economic Regulation 6 Development of Economic Regulation 6 Factors in Setting Rate Regulations 6 Health, Safety, and Environmental Regulation 8 Role of the Courts 9

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