ECONOMICS OF REGULATION AND ANTITRUST

Fourth Edition

W. Kip Viscusi
Joseph E. Harrington, Jr.
John M. Vernon

The MIT Press

Cambridge, Massachusetts
London, England
Contents

Preface to the Fourth Edition xvii

Introduction
The Rationale for Regulation and Antitrust Policies
Antitrust Regulation
The Changing Character of Antitrust Issues
Reasoning behind Antitrust Regulations
Economic Regulation
Development of Economic Regulation
Factors in Setting Rate Regulations
Health, Safety, and Environmental Regulation
Role of the Courts
Criteria for Assessment
Questions and Problems
Recommended Reading
Appendix
The Making of a Regulation
State versus Federal Regulation: The Federalism Debate
Advantages of Federalism
Advantages of National Regulations
Product Labeling Example
The Overlap of State and Federal Regulations
The Character of the Rulemaking Process
The Chronology of New Regulations
Nature of the Regulatory Oversight Process
The Nixon and Ford Administrations
The Carter Administration
The Reagan Administration
The Bush Administration
The Clinton Administration
The George W. Bush Administration
Regulatory Reform Legislation
Benefit-Cost Analysis
Discounting Deferred Effects
Present Value
Contents

The Criteria Applied in the Oversight Process

Regulatory Success Stories
Promotion of Cost-Effective Regulation
Distortion of Benefit and Cost Estimates
The Regulatory Role of Price and Quality
The Impact of the Oversight Process
The Cost of Regulation
Other Measures of the Size of Regulation
The Character of Regulatory Oversight Actions
What Do Regulators Maximize?
The Capture Theory
Other Theories of Influence Patterns
Comprehensive Models of Regulatory Objectives
Conclusion
Questions and Problems
Appendix: Trends in Regulatory Agency Budgets and Staff

ANTITRUST

Introduction to Antitrust
Industrial Organization
Structure
Conduct
Performance
Government
Antitrust
Federal Antitrust Laws
Enforcement and Remedies
Exemptions from Antitrust
Summary and Overview of Part I
Appendix: Antitrust Statutes
Sherman Act
Clayton Act
Federal Trade Commission Act
Contents

Efficiency and Technical Progress

Economic Efficiency
Partial Equilibrium Welfare Tools
Monopoly-versus-Competition Example
Oil Industry Application
Some Complications
X-Inefficiency
Monopoly-Induced Waste
Estimates of the Welfare Loss from Monopoly
Technical Progress
Importance of Technological Change
A Model of R & D Rivalry
Summary
Questions and Problems
Oligopoly, Collusion, and Antitrust
Game Theory
Example 1: Advertising Competition
Example 2: Compatibility of Standards
The Strategic Form of a Game
Nash Equilibrium
Oligopoly Theory
The Cournot Solution
Other Models of Oligopoly
Product Differentiation
Collusion
A Theory of Collusion
Challenges to Collusion
Collusion in Practice
Antitrust Law and Policy toward Price Fixing
Economic Analysis of Legal Categories
Per Se Rule Cases
Tacit Collusion
Enforcement Policy
Summary
Questions and Problems
vi Contents

Appendix
Game Theory: Formal Definitions
6 Market Structure and Strategic Competition
Market Structure
Concentration
Scale Economies
Entry Conditions
Dominant Firm Theory
Static Analysis
Dynamic Analysis: Limit Pricing
Strategic Competition
Limit Pricing
Investment in Cost-Reducing Capital
Raising Rivals' Costs
Preemption and Brand Proliferation
Summary
Questions and Problems
7 Mergers
Antitrust Laws and Merger Trends
Reasons for Mergers
Monopoly
Economies
Reducing Management Inefficiencies
Horizontal Mergers
Benefits and Costs
Effects of Airline Mergers
Cases
U.S. Department of Justice Merger Guidelines
Conglomerate Mergers
Potential Benefits
Anticompetitive Effects and Cases
Summary
Questions and Problems
vii Contents

8 Vertical Mergers and Vertical Restraints

Vertical Mergers
Benefits
Anticompetitive Effects
Commitment and the Restoration of Market Power
Raising Rivals' Costs
Antitrust Law and Policy
Historical Development
Time Warner and Turner
Vertical Restraints
Exclusive Dealing
Antitrust Law and Policy
Sing
Modem Theories of Leveraging
Manufacturer-Retailer Restraints
Summary
Questions and Problems
9 Monopolization and Price Discrimination
Establishing Monopolization Claims
Measuring Monopoly Power
Assessing Intent to Monopolize
Development of Antitrust Case Law
1890-1940: Standard Oil and United States Steel
1940-1970: Alcoa and United Shoe Machinery
1970 to Present: Kodak, IBM, Microsoft, and Others
Predatory Pricing
Theories of Predatory Pricing
Efficiency Rationales
Antitrust Policy
The Areeda-Turner Rule and Other Single-Parameter Rules
The Brooke Case and the Two-Tier Rule
Recent Developments
Refusal to Deal and the Essential Facilities Doctrine
Essential Facilities Doctrine
Intellectual Property Rights
Kodak and Monopoly Power in Aftermarkets
1 viii Contents

Microsoft Case
Network Externalities
Antitrust Case
Tying and Monopolization of the Browser Market
Maintenance of Monopoly in the Operating Systems Market
Remedies and Harm
Price Discrimination and the Robinson-Patman Act
Systematic Discrimination
Unsystematic Discrimination
Cases
Summary
Questions and Problems

I1 ECONOMIC REGULATION

10 Introduction to Economic Regulation

What Is Economic Regulation?
Instruments of Regulation
Control of Price
Control of Quantity
Control of Entry and Exit
Control of Other Variables
Brief History of Economic Regulation
Formative Stages
Trends in Regulation
The Regulatory Process
Overview of the Regulatory Process
Regulatory Legislation
Independent Regulatory Commissions
Regulatory Procedures
The Theory of Regulation
Normative Analysis as a Positive Theory
Capture Theory
Economic Theory of Regulation
Testing Theories of Regulation
Summary and Overview of Part I1
ix Contents

Appendix
A Theory of Interest Group Competition
Questions and Problems
11 Theory of Natural Monopoly
The Natural Monopoly Problem
Permanent and Temporary Natural Monopoly
Subadditivity and Multiproduct Monopoly
Alternative Policy Solutions
Ideal Pricing
Franchise Bidding
Actual Solutions
Summary
Appendix
The Troublesome Case of a Natural Monopoly
Questions and Problems
12 Natural Monopoly Regulation and Electric Power
Traditional Rate-of-Return Regulation
The Rate Case
Averch-Johnson Effect
Incentive Regulation
Performance Standards
Earnings Sharings
Price Caps
Yardstick Regulation
Rate Structure
FDC Pricing
Undue Discrimination
Peak-Load Pricing
Costs of Power Production
Peak-Load Pricing Model
Regulation and Restructuring of Electric Power
Historical, Technological, and Regulatory Background
Overview of Recent Legislation
Restructuring in California
Summary
Questions and Problems
X Contents

13 Franchise Bidding and Cable Television

Theory of Franchise Bidding
Competition at the Bidding Stage
Contractual Arrangements for the Postbidding Stage
Assessment of Franchise Bidding
Cable Television
HistoricaVRegulatory Background
Cable Television as a Natural Monopoly
Franchising Process
Assessment of Franchise Bidding
Rate Regulation
Is There a Role for Government Intervention?
Summary
Questions and Problems
14 Public Enterprise
General Background
Positive Theory of Public Enterprise
Managerial Model of a Firm
Managerial Model of a Private Enterprise
Managerial Model of a Public Enterprise
Comparison of Public and Private Enterprise
Municipal Electric Utilities
Pricing Behavior
Allocative Efficiency Comparison
Productive Efficiency Comparison
Assessment of Private versus Public Utilities
Airlines
Privatization
Summary
Questions and Problems
15 Dynamic Issues in Natural Monopoly Regulation: Telecommunications
Transformation of a Natural Monopoly
Basis for Natural Monopoly Regulation
Sources of Natural Monopoly Transformation
Regulatory Response
Intercity Telecommunications Market
Contents

TelecommunicationsAct of 1996
Separation of Regulated Monopolies and Competitive Markets
Benefits and Costs of Separation
Breakup of AT&T
Summary
Questions and Problems
The Regulation of Potentially Competitive Markets: Theory and Estimation
Methods
Theory of Price and EntrylExit Regulation
Direct Effects of Price and EntrylExit Regulation: The Competitive Model
Direct Effects of Price and EntryIExit Regulation: The Imperfectly Competitive
Model
Indirect Effects of Price and Entry Regulation
Some Indirect Effects of Price and Exit Regulation
Regulation and Innovation
Methods for Estimating the Effects of Regulation
Overview of Estimation Methods
Intertemporal Approach
Application: New York Stock Exchange
Intermarket Approach
Application: Advertising of Eyeglasses
Application: 44 Liquormart Decision
Counterfactual Approach
Application: State Usury Laws
Measuring the Return to Price and Entry Restrictions: Taxicab Regulation
Summary
Questions and Problems
Economic Regulation of Transportation: Surface Freight and Airlines
Transportation Industry
Surface Freight Transportation
Regulatory History
Description of Regulatory Practices
Effects of Regulation
xii Contents

Airlines
Regulatory History
Description of Regulatory Practices
Effects of Regulation
Competition and Antitrust Policy after Deregulation
Lessons from Regulation and Deregulation
Summary
Questions and Problems
18 Economic Regulation of Energy: Crude Oil and Natural Gas
The Theory of Price Ceilings
Price and Quantity Regulation of the Crude Oil Industry
Regulatory History
Oil Prorationing
Regulatory Practices
Rationale for Prorationing
Solutions to the Common Pool Problem
Effects of Prorationing
Mandatory Oil Import Program
Regulatory Practices
Effects of Regulation
Crude Oil Price Controls
Regulatory Practices
Effects of Price Regulation
Price Regulation of the Natural Gas Industry
Regulatory History
Regulatory Practices
Effects of Price Regulation
Transition from Regulation to Markets in the Transmission of Natural Gas
Summary
Questions and Problems

I11 HEALTH, SAFETY, AND ENVIRONMENTAL REGULATION

19 Introduction: The Emergence of Health, Safety, and Environmental Regulation

Risk in Perspective
Measuring Mortality Risks
 ...
xlll Contents

The Infeasibility of a No-Risk Society

Homeland Security
Wealth and Risk
Irrationality and Biases in Risk Perception
Policy Evaluation
Regulatory Standards
Benefit-Cost Analysis
The Role of Heterogeneity
Uncertainty and Conservatism
The Role of Risk Ambiguity
The Role of Political Factors
Economic Models of Environmental Policies
Voting Patterns
Summary and Overview of Part 111
Questions and Problems
Recommended Reading
20 Valuing Life and Other Nonmonetary Benefits
Policy Evaluation Principles
Willingness-to-Pay versus Other Approaches
Variations in the Value of Statistical Life
The Labor Market Model
Empirical Estimates of the Value of Life
Value of Risks to Life for Regulatory Policies
Survey Approaches to Valuing Policy Effects
Valuation of Air Quality
Exploratory Nature of the Survey Approach
Sensitivity Analysis and Cost-Effectiveness
Risk-Risk Analysis
Establishing Prices for Health, Safety, and Environmental Regulation
Questions and Problems
21 Environmental Regulation
The Coase Theorem for Externalities
The Coase Theorem as a Bargaining Game
A Pollution Example
Long-Run Efficiency Concerns
Transaction Costs and Other Problems
xiv Contents

Smoking Externalities
Special Features of Environmental Contexts
Siting Nuclear Wastes
Selecting the Optimal Policy: Standards versus Fines
Setting the Pollution Tax
The Role of Heterogeneity
The Role of Uncertainty
Pollution Taxes
Cost Heterogeneity for Water Pollution Control
Current Market Trading Policies
The Future of Market Approaches
Global Warming and Irreversible Environmental Effects
Assessing the Merits of Global Warming Policies
How Should We React to Uncertainty?
Multiperson Decisions and Group Externalities
The Prisoner's Dilemma
The N-Person Prisoner's Dilemma
Applications of the Prisoner's Dilemma
The Enforcement and Performance of Environmental Regulation
Enforcement Options and Consequences
Hazardous Wastes
Contingent Valuation for the E n o n Valdez Oil Spill
The Senior Discount for the Value of Life
Evaluating Performance
Summary
Questions and Problems
22 Product Safety
Emergence of Product Safety Regulations
Current Safety Decisions
Changing Emphasis of Product Regulation
Premanufacturing Screening: The Case of Pharmaceuticals
Weighing the Significance of Side Effects
Drug Approval Strategies
The Behavioral Response to Product Safety Regulation
Consumer's Potential for Muting Safety Device Benefits
The Costs of Product Safety Regulation: The Automobile Industry Case
xv Contents

Trends in Motor Vehicle and Home Accident Deaths

Accident Rate Influences
The Decline of Accident Rates
The Rise of Product Liability
The Negligence Standard
The Strict Liability Standard
The Ford Pinto Case
Escalation of Damages
Risk Information and Hazard Warnings
Self-Certification of Safe Products
Government Determination of Safety
Alternatives to Direct Command and Control Regulation
Regulation through Litigation
Breast Implant Litigation and Regulation
The Future of Product Safety Policy
Questions and Problems
Regulation of Workplace Health and Safety
The Potential for Inefficiencies
How Markets Can Promote Safety
Compensating Wage Differential Theory
Risk Information
On-the-Job Experience and Worker Quit Rates
Inadequacies in the Market
Externalities
OSHA's Regulatory Approach
Setting OSHA Standard Levels
The Nature of OSHA Standards
The Reform of OSHA Standards
Regulatory Reform Initiatives
Changes in OSHA Standards
OSHA's Enforcement Strategy
Inspection Policies
Trivial Violations
OSHA Penalties
Enforcement Targeting
xvi Contents

The Impact of OSHA Enforcement on Worker Safety

OSHA Regulations in Different Situations
OSHA and Other Factors Affecting Injuries
The Role of Workers' Compensation
Agenda for Policy Reform Efforts
Questions and Problems
24 Patents and Pharmaceuticals
Economics of Invention and Patents
Background on Patents
Incentives to Invent: Monopoly versus Competition
Welfare Analysis of Patents
Pharmaceuticals and the Role of Patents
Industry Structure
The 1984 Drug Price Competition and Patent Restoration Act
Other Policies That Affect R&D Incentives
Summary
Questions and Problems

Author Index
Subject Index