Supply and Demand

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Problems and Applications

1.   Do the antitrust statutes in the United States actually outlaw monopoly? How does the existence of
     antitrust statutes affect the incentive firms have to exercise monopoly power? Explain why
     indiscriminate antitrust suits can actually cause more harm than good.

     Answer: The antitrust laws don't outlaw monopoly. Instead, they outlaw unfair business practices
     designed to fix prices or prevent new firms from entering the market. The threat of an antitrust suit,
     which is expensive to defend against, reduces the incentive firms have to exercise monopoly power.
     The transaction costs of antitrust suits divert resources from other uses, and this cost can outweigh the
     benefits of initiating a suit. The benefits would be lower prices to consumers that result from the suit.

2.   Suppose an organization of real estate agents orders all real estate firms to charge a 6 percent
     commission on sales. Firms that refuse aren't permitted to use services of the organization that make it
     easier to sell homes. In addition, such firms are considered to be engaging in "unethical behavior" and
     aren't allowed to belong to the organization. How would the U.S. Department of Justice view this

     Answer: The arrangement is (and has been) likely to be viewed as collusion to fix prices and would be

3.   On the route between Detroit and Providence, an airline deliberately sets fares below the level that
     permits it to cover its costs. This pricing policy drives its only rival out of business. The airline then
     jacks up its fares. Is the airline guilty of an antitrust violation?

     Answer: The airline is likely to be viewed as engaging in predatory pricing, which is viewed as an
     unfair business practice.

4.   Defenders of IBM in an antitrust case argued that the government's claim of the firm's high market
     share was a result of improper definition of the product group in which IBM products competed. How
     would you define the market for computer products?

     Answer: You would have to examine the cross-elasticity of demand for computers and other close
     substitutes, and decide whether mainframe computers are good substitutes for personal computers. A
     number of arbitrary judgments would be necessary to define the market.

5.   A cigarette company merges with a company that produces breakfast cereals. Is this type of merger
     likely to increase monopoly power in either of the markets served by the two companies?

     Answer: This is a conglomerate merger that's unlikely to increase market concentration and monopoly

6.   How can a merger of two steel firms lead to lower prices?

     Answer: The merger of two steel firms can lead to lower prices if it results in economies of scale and
     other cost savings that reduce average costs of production.

7.   What guidelines are used by the U.S. Department of Justice in approving mergers?

     Answer: The Department of Justice looks at market shares of firms and how market shares of the
     largest firms selling in the market will be affected by the merger. It also looks at the degree of
     contestability (ease of entry) of the market and how average costs of production in the industry might
     be affected by the merger.
8.   Why have regulatory commissions traded off low prices for stable prices?

     Answer: Fears of fluctuating prices and supplies with changes in profitability led the regulatory
     commissions to favor stable supply and prices over low prices.

9.   Why do critics of industrial policy argue that it's a form of protectionism against foreign competition?

     Answer: Industrial policy often results in governments, under political pressure, subsidizing industries
     that don't really enjoy a comparative advantage in international markets. If inefficient industries are
     subsidized through industrial policy, then it amounts to little more than protectionism.

10. Explain why U.S. industry was harmed by the European government subsidies that were used to
    develop the airbus.

     Answer: Boeing and other U.S. aircraft producers have, for years, enjoyed a comparative advantage in
     production of commercial airliners. The European subsidies to airbus lowered their costs of production
     and allowed them to compete with Boeing by charging lower prices for their airliners than would have
     been possible without the government subsidies. The subsidies, therefore, harmed U.S. producers by
     lowering their sales and revenue from aircraft production.

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