Because monopolies reduce consumer welfare and

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Because monopolies reduce consumer welfare and efficiency, most governments regulate their behavior. Collusion refers to an agreement among firms to charge the same price or to otherwise not compete. Antitrust laws are laws aimed at eliminating collusion and promoting competition among firms. The passage of the first antitrust law was spurred by the formation of various “trusts” in the 1870s and 1880s. Trusts are combinations of firms in several industries that operate independently but are controlled by a common board of trustees. The Sherman Act of 1890 was the first important law regulating monopolies in the United States. This Act prohibited price fixing, collusion, and monopolization. The Clayton Act of 1914 made a merger illegal if its effect was to lessen competition or if the merger tended to create a monopoly. The federal government regulates business mergers because mergers can result in firms gaining market power. Horizontal mergers are mergers between firms in the same industry. Vertical mergers are mergers between firms at different stages of production of a good. It is important to define the appropriate market when evaluating a proposed merger. The newly merged firm may be more efficient than the merging firms were individually. Merging firms must substantiate efficiency claims that would result from their proposed merger. The Department of Justice and the Federal Trade Commission developed merger guidelines in 1982. The merger guidelines have three main parts: 1. Market definition. A market consists of all firms making products that consumers view as close substitutes.
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CHAPTER 14 | Monopoly and Antitrust Policy 396 2. Measure of concentration. A market is concentrated if a relatively small number of firms have a large share of total sales in the market. The guidelines use the Herfindahl-Hirschman Index (HHI) to measure concentration, which adds the squares of the market shares of each firm in an industry. 3. Merger standards. The HHI calculation for a market is used to evaluate proposed mergers. If the post-merger HHI is below 1,000, the merger will not be challenged because the market is not concentrated. If the post-merger HHI is between 1,000 and 1,800, this indicates the market is moderately concentrated. Depending on how much the HHI will be increased, the merger may be challenged. If the post-merger HHI is above 1,800, the market is highly concentrated. Mergers in this market may be challenged based on how much the merger will increase the HHI. Local or state regulatory commissions usually set prices for natural monopolies. To achieve economic efficiency, regulators should require that the monopoly charge a price equal to marginal cost. Often, though, a natural monopoly’s marginal cost will be less than its average total cost. In this case, most regulators will allow the monopoly to charge a price equal to its average total cost so that the owners of the monopoly can earn a normal return on their investment.
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