The JSBF Report
Market Economics and the Role of Anti-Trust Laws
- By Aakash Thomas
In a world of dwindling resources, economics as a discipline examines the link between consumption and production of commodities and services. The social science's inclination to ascertain why rational agents' behaviour changes as and when resources are exchanged has proven intriguing to many and has helped solve some of the most complex questions regarding prices, goods, and, most importantly, people themselves. The notion of market power, innovation, and anti-trust regulations is one such issue that has become a focal point of economic debate throughout the years.
By emphasising on how markets and corporations work in an economy, how their conduct affects society, and how government action influences their behaviour, this research paper strives to foster a broader understanding of the inherent contradictions found within market economics and the role anti-trust laws play in economic markets. The process of building a narrative along these lines would involve critically analysing works of several well renowned
economists who have authored extensive and intricate research on related economic domains such as creative destruction, capitalism, and monopolisation. Some of the issues that will be discussed in depth in this paper in order to provide alternative perspectives include: How can a few firms achieve market power and is this efficient? Is it important to innovate, and does it diminish market power? What are the anti-trust laws and what do they attempt to achieve? Do we need anti-trust laws? Is creative destruction vital for future progress, and what is its influence on the general population?
While discussing the aforementioned subjects, this paper seeks to provide the reader with a sense of clarity on their judgement about these vast domains and contradictions while centralising around the paradox of market economics and anti-trust laws.
II. ANALYSIS A: MARKET POWER AND HOW FIRMS ACHIEVE IT
In an economy, firms are the main suppliers of goods and services, whereas markets are the medium through which transactions take place. However, the prices at which the goods are sold differ from product to product. Firms providing unique or differentiated products typically have pricing and quantity control, allowing them to maximise profits, sometimes at the expense of customers.
This is because differentiated products usually don't have any close substitutes. This results in relatively low elasticity of demand for the product, which implies that regardless of how the price varies, the quantity demanded remains unchanged. Such a firm is said to have market power. Firms with market power have a lot of bargaining power with their consumers. As a result, they may charge a high price (price above marginal cost) without the fear of losing customers to competitors. Such a firm is known to be reaping monopoly rents, which refer to profits generated beyond the production costs.
Another way of gaining market power and establishing a monopoly is when average costs are decreasing. In such cases, the average cost curve is above the marginal cost curve while it is sloping downwards. This results in the average cost of production being greater than the marginal cost of production. In order for the firm to make a profit, the price at which the product is sold has to be equal or above the average cost, and thus, above the marginal cost (Core- econ, 2017).
In a fiercely competitive market, the ability of firms to charge higher prices for inelastic goods functions as a stimulant for market failure and inefficiency. Regardless, businesses continue to do so.
ANALYSIS B: EFFICIENCY OF MONOPOLIES
Firms maximise profit at the point where the slope of the isoprofit curve (curve showing combinations of different variables like price and quantity that generate the same amount of profit) is equal to the slope of the demand curve. At this point, MRS = MRT. Thus, the price at which the good is sold will be the price at which the firm maximises profit. Profit is also maximised at the point where the Marginal Revenue curve intersects the Marginal Cost curve
(MR=MC). This is because any production after this point creates a higher marginal cost than marginal revenue (MC>MR) for the firm.
The area of the triangle shaded in the light colour above is the consumer surplus (the difference between what consumers are willing to pay and what they actually pay) and below is the producer surplus (the difference between the price of a good and the lowest price producers are willing to accept).
When the price of the good is equal to the marginal cost (Point F), the market allocation is pareto efficient as producing an additional unit would cost more and there are no consumers with the willingness to pay (maximum amount a consumer is willing to pay for a commodity) to purchase the good at the same price.
However, monopolies set the price above the marginal cost (Point E), knowing that, due to the unavailability of close substitutes and competition, consumers will purchase the good. In doing so, the consumer surplus reduces and the producer surplus increases in comparison to when the monopoly sets a price equal to the marginal cost. As a result, there is a loss of potential surplus [deadweight loss (DWL)] as the firm is choosing a pareto inefficient market allocation.
Thus, we can see that monopolies set a price that frequently leads to market failure because a large amount of gain from trade remains untapped.
ANALYSIS C: THE FLAW OF MARKET ECONOMICS AND WHY WE NEED ANTI-TRUST LAWS
The inefficient tendency of monopolies to repeatedly generate market failure enticed the government to enact certain regulations. The statutes created were designed to ensure a fair playing field for enterprises to operate in while preventing the amassing of bargaining power in the hands of a single corporation. As a result, consumer discrimination would be greatly reduced, and market flow would be seamless. There were two areas of particular concern: companies involved in "unfair methods of competition" and mergers and acquisitions that created giant corporations with significant market power.
The underlying conception of anti-trust laws is that every market should be robustly competitive. It is assumed that competition drives sellers to provide high-quality goods and services to consumers and precludes any sort of scenario where the seller takes advantage of the buyer, as consumers have the option of interacting with another seller. Economic marketplaces that are fiercely competitive are thus capable of ensuring continuous development in goods and consumer satisfaction.
However, unbridled competition often results in the domination of the marketplace by a few powerful firms. This lowers the present competition to nothing more than a shamble. The creation of such monopolies exploits customers while impeding quality. Antitrust laws were created to provide relief in these circumstances as they are based on the premise that vigorous competition keeps all producers in check, including monopolies and enormous corporations. This is the everlasting paradox of market economics, and it is this conflict that anti-trust regulations strive to correct. However, these laws often impede the progress of numerous firms (Markham, 2021).
ANALYSIS D: ANTI-TRUST POLICIES AND THEIR SPECIFICS
The true purpose for which anti-trust laws were enacted was to promote and protect competitive processes in market economies. They are not intended to penalise those who have grown to the stature of a dominant corporation or monopoly, despite the fact that they frequently result in the demise of a few firms. Thus, the anti-trust laws have never been anti- market or anti-business.
The passage of the Sherman Act in 1890 marked the beginning of the rise of anti-trust legislation and initiated a trajectory of uncertain but important events. This act " outlawed every contract, combination or conspiracy in restraint of trade" and "monopolization, attempted monopolization, or conspiracy or combination to monopolize" and treated violations as crimes (Kovacic & Shapiro, 2000).
Initially, economists were divided on whether competition genuinely threatened enterprises with large, fixed costs and low marginal costs, or if government intervention was required to allow fixed costs to be recovered. However, the courts swiftly realised that identifying the behaviour that constituted unlawful monopolisation was critical.
The case of Standard Oil Co. v. United States represents a watershed moment in antitrust history as it was seen as the first beacon of success. In 1879, Standard Oil Company established a new type of trust to allow the expanding firm to buy shares in other enterprises. While Standard Oil was the most dominant corporation at the time, mergers and acquisitions were on the rise in many industries, resulting in the accumulation of market dominance in the
hands of a few. The court ruled in favour of the United States, stating that Standard Oil benefitted not just from the establishment of improved business practices and trusts but also through unfair means that did not go unsupervised (Jimison, Floyd, Hall, Robinson, & Thorne, 2016).
As a result, the corporation was divided into smaller denominations, each of which competed with its previous self, proving to be an efficient technique of price reduction. However, Congress's never-ending dread led to the development of the Clayton Act.
The Clayton Act prohibits certain details that the Sherman Act fails to address. These mainly include mergers and interlocking directorates. This effectively overcomes the issue of one individual influencing business choices for other organisations. With the passage of the Clayton Act, the anti-trust system entered a period of relative stability.
This was followed by the emergence of the associationalist view of business and government interactions. The rationale behind this was that numerous economists believed that business- government collaboration provided the best way to organise the economy. Advocates of such a partnership motivated the formation of a new act, the National Industrial Recovery Act (NIRA).
NIRA was possibly the most unorthodox law ever enacted, as it suspended antitrust restrictions and encouraged industry coalitions. Under the NIRA, companies were required to write industrywide codes of fair competition that effectively fixed wages and prices, established production quotas, and placed restrictions on the entry of other companies into the alliances. These codes were a form of industry self-regulation and represented an attempt to regulate and plan the entire economy to promote stable growth and prevent another depression. Firms were compelled to draft rules of fair competition, which essentially regulated pricing and wages, imposed output quotas, and restricted the admission of other companies into the alliances. These codes were a version of industry self-regulation, and they constituted an attempt to govern and organise the whole economy in order to encourage balanced development. However, the NIRA was also seen as a controversial piece of legislation, such that its opponents considered it the "most gigantic scheme for the promotion of cartelism" they had ever seen (Commission, 2017).
Following the NIRA act was the Robinson-Patman Act of 1936, which focused primarily on the reduction of price discrimination by ensuring the same price was levied on all customers. The legislation was enacted to counteract unfair trading practices that allowed chain stores to obtain items at lower prices than other retailers.
Finally, the Federal Trade Commission Act bans all "unfair methods of competition" and "deceptive practices". Under this, all violations of the Sherman Act also violate the FTC (Commission, 2017).
The anti-trust laws addressed numerous aspects of unfair market practices that resulted in the exploitation of consumers and smaller businesses by larger corporations. Arrangements such as forcing the purchase of a second product after an initial purchase, limiting retailers to a certain geographic area (vertical non-price restraints), competitors forming alliances to manipulate prices (horizontal price fixing), bid rigging, distribution of markets through customers/product lines (horizontal market allocation), and group boycotts where
manufacturers who sell to discounters are not transacted with, are usually deemed unlawful (Kovacic & Shapiro, 2000).
However, given the constraints, executing them effectively was difficult since proof of engaging in unlawful practices such as conscious parallelism and price leadership was sometimes hard to procure. As a result, courts pondered how to handle such situations, and with the help of economists at the time, they concluded that a firm's ability to innovate would ultimately determine how well it does in the long run, but uncertainty spread as the market contradiction continued to assert its dominance.
ANALYSIS E: CREATIVE DESTRUCTION
To comprehend what creative destruction is and what it entails, it's essential to realise that any economic innovation operates as a catalyst, setting off a cascade of desired and unforeseen economic consequences. Over time, creative destruction has evolved to be the focal point of economic argument. Its proclivity to have both favourable and negative implications for the economy has divided economists and society into two factions. One wing perceives creative destruction as a root of fear and apprehension. The other concentrates on how the perks outweigh the risks and how economies can flourish.
Creative destruction refers to the "incessant product and process innovation mechanism by which new production units replace outdated ones”. (Caballero, 2021) This economic process tends to occur when a newer technological model replaces an older, inefficient model. As stated by Wells, "Nothing marks more clearly the rate of material progress than the rapidity with which that which is old and has been considered wealth is destroyed by the results of new inventions and discoveries (Perelman, 1995)."
Innovations in our era, like Netflix and Amazon Prime, are perfect examples of products of creative destruction. Netflix and Amazon Prime were able to garner a large customer base by offering inexpensive streaming services of blockbusters and popular series. However, numerous professions in the sector, such as movie rental businesses, were lost as a result of this. While some may argue that these advancements are causing individuals to lose their livelihoods, it is crucial to remember that they, too, were a part of this cycle. The market is constantly evolving and adapting to ensure people have access to products that have higher functionality and accessibility at a lower cost.
The sections of society that are employed in newly generated positions, employment that would not have existed if not for innovation, and the customers who have access to the new product, are the two that profit the most from the creative destruction process. However, if the economy's prosperity was completely dependent on job growth, the labour market would ultimately become less productive as stated by economist Frederic Bastiat,"thousands of window-making jobs could be created if rascals went around throwing rocks at storefronts and breaking windows. Although society would demand a higher number of window-making jobs, nothing useful would actually be produced or gained from this ineffective practice (Oster, 2015)."
Many people are unable to recognise the emphasis on the larger benefit that perpetual innovation brings because they believe the market somewhat represents a zero-sum game. It is unfathomable to think about destroying an entire job sector for the sake of creativity and invention. This "negligence of morality" prevents one's perspective from perceiving the
market as a positive-sum game, where the tremendous potential for expansion becomes apparent (Oster, 2015).
As the contradiction between markets, firms, and antitrust regulations has become increasingly apparent, economists throughout the world have become dubious of both dominating and competitive enterprises' innate capability to not deviate from a trajectory of rapid and continuous innovation. The pressure anti-trust laws impose on firms to stimulate vigorous competition more often than not results in large expenses and inefficient production for firms through intricacies like attorneys, bad press, effort, and time. This is particularly detrimental for enterprises that enjoy economies of scale. However, the Schumpeterian theory, that the process of creative destruction is a significant phenomenon and is at the heart of economic growth in market economies, is supported by a large body of recent empirical evidence. On reviewing numerous comprehensive publications and analyses on linear demand functions and marginal cost, it is evident that both forms of market structure are perpetually incentivised to innovate (Caballero, 2021).
Competitive businesses are more likely to embrace newer technology from the standpoint of market power, profitability, and motivation since a proportionate increase in profitability would imitate exponential growth for the firm and attract all market demand, giving the firm an obvious marketing edge. Monopolies, on the other hand, are more likely to innovate in terms of finance, budgeting, and large-scale pricing. As a result, monopolies are more inclined to seek deeper, more radical breakthroughs rather than incremental improvements in manufacturing that provide insignificant cost economies. The monopoly, thus, benefits from the innovation since the lower price acts as an entry-limit pricing device, keeping competitors out of the market (Todorova, 2021).
We see that the despondent and pessimistic lens through which individuals perceive the marketplace renders it irrational to conclude that a certain economic theory should be completely disregarded because it demands a single demographic to adapt to the market when their previous effort is replaced by a more productive solution.
The objective of this research paper is to deconstruct the paradox that occurs in market economies and how antitrust legislation has evolved over time to address this. This has been accomplished by first offering insights into how selective organizations are able to distinguish themselves while participating in vigorously competitive markets. Furthermore, we see that these firms repeatedly generate market failure and charge higher prices, necessitating some form of legislation (anti-trust laws) to prevent widespread consumer discrimination and market inefficiency.
This paper also attempts to clarify the true purpose of anti-trust laws, which is to foster and safeguard competitive processes in market economies. The presupposed notion that competition maintains principles like integrity and honesty in markets while motivating sellers to strive to greater heights, while maximising customer growth and satisfaction is the very soul of anti-trust regulations. Furthermore, this study debunks and discredits a commonly held misconception about the economic processes of creative destruction and innovation by demonstrating that enterprises are always incentivised to innovate.
The process by which markets operate will never cease to amaze. The mechanism to reward those who enter the market through unseen and innovative angles and punish those who are simply not as hardworking or rise through the ranks by unfair means is simply stunning. People have started to come to terms with the contradiction that competition, which is known to produce high-quality products and spread prosperity throughout society, is also the root of monopolisation and trading abuse, and that perhaps it is the behaviour of institutions, not the laws, that should be condemned.
Several sceptics may claim that the laws are ambiguous, costly, and stifle the very thing they were intended to enable. However, if we looked at the market through an alternative lens where anti-trust laws failed to exist, we would witness a colossal rise of stultifying monopolies and groups of firms with massive amounts of bargaining power, which would inevitably result in the wide-scale discrimination of consumers and competition. Antitrust laws are required merely because they address the market economics contradiction and are preferable to the alternative of inaction.
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