Positive and Negative externalities

Public goods

rent seeking

Government in the Marketplace (Topic #63)

Definition and Explanation:
Governments play a key role in the marketplaces through their rules, regulations and policies. According to the text, Managerial Economics & Business Strategy by Michael R. Bay, one of the main reasons governments have a presence in the market is due to the marketplace not operating efficiently or in the best interest of society. Thus, the government enforces rules/policies when it thinks the market will not act in the best interest of society. There are several examples of government’s presence in the marketplace.

Price floor/Price Ceilings
The government can set policies that affect the equilibrium price in the market. The government might enforce a price floor when it believes the equilibrium price is too low. The price floor is set above the equilibrium price causing a surplus of goods supplied. For example, the government may set a price floor in the agriculture market to help farmers. The government normally buys the excess goods. When the equilibrium price is too high, the government can enforce a price ceiling, placing a maximum price on goods that is lower than the equilibrium price. For example, the government can set rent prices for apartment housing.

Anti-Trust/Price Regulation
The government also sets policies specifically targeted toward monopolies, anti-trust and price regulation. These policies are enforced by the Anti-Trust Division of the Department of Justice and the Federal Trade Commission.
Anti-trust polices are used to help prevent monopolization in a market. The policies help reduce deadweight loss caused by the monopolist’s market power and prevent price fixing agreements and collusive practices. The most notable anti-trust policy was the Sherman Anti-Trust Act enacted in 1890. According to Bay, Section 1 & 2 of the Act makes it illegal to collude with domestic or foreign firms. It also considers people who monopolize guilty of a felony. (p511) The Sherman Anti-Trust Act can be found at http://uscode.law.cornell.edu/uscode/html/uscode15/usc_sup_01_15_10_1.html
Other important Anti-trust laws enacted are the Clayton Act of 1914 and the Robinson Act of 1936.
In some instances a monopoly may be beneficial to society, for example when economies of scale exist. The government uses price regulations to keep the monopoly in line and deadweight loss at a minimum. The monopoly is allowed to exist but must follow the government’s pricing rules.

Merger Guidelines
The government can use Horizontal Merger Guidelines to prevent mergers that result in highly concentrated markets. The guidance uses the Herfindahl-Hirschman Index or HHI to determine the post-merger concentration of a market. The value of the HHI determines the concentration of a market as described below. Moderately concentrated and highly concentrated post merger markets where the merger increased the HHI by more than 100 or 50 respectively, raise anti-trust concerns. (Bay p513)

HHI= HHI = 10,000 X SUM wi^2
HHI < 1000 considered Unconcentrated
HHI 1000-1800 considered moderately concentrated
HHI > 1800 considered highly concentrated

International Policies
Government policies can also be targeted towards the domestic firms’ interaction with international markets. Quotas and Tariffs are two examples of government international policies. According to Bay, a quota is “a restriction that limits the quantity of imported good that can legally enter the country” (p532). This decreases the amount of goods entering the domestic market from foreign countries. A tariff places a fee on imported good. The goal of quotas and tariffs is to limit foreign competition in the domestic market (Bay 534).

Real World Examples:

Government Policies-Protect Consumers
Liberals often claim that government regulation of the marketplace is necessary to protect the interests of consumers. In contrast, economists argue that government rarely offers solutions to market problems, but rather makes matters worse. A report by the Pacific Law Foundation (PLF) further underscores the notion of government as a creator rather than a solver of societal problems. The report describes a host of outrageous examples of bureaucratic meddling in the marketplace, most of which yielded little or not societal benefit. For example:
· In Tampa, FL, it is illegal to charge people less than $40 per hour for a limo ride, even for serving disabled clients.
· The state of Oklahoma requires those wishing to sell coffins to obtain an undertaker's license, even though they will not officiate at funerals.
· In Massachusetts, it is against the law to have barbers work in the same room as cosmetologists--in other words, one can get a hair cut or have it styled, but one cannot get one under the same roof.

The report concludes that such laws serve only to protect companies from fair competition by making market entry by rivals more costly. Ultimately, government provision of preferential treatment to its political favorites comes at the expense of consumers through higher prices and lower quality products.

Government Policies-Protect People
There are also examples where government in the marketplace is meant to protect people. Below are examples:
-The Clean Air Act covers 189 toxic air pollutants and covers any industry that releases over 10 tons per year of any of the listed pollutants or 25 tons per year of any combination of those pollutants. A firm in the industry covered by the Clean Air Act is required to obtain a permit to be able to pollute.
· A government regulation designed to alleviate market failures due to asymmetric information is the law against insider trading in the stock market. The purpose of the law is to ensure that asymmetric information does not destroy the market by inducing outsiders to stay out of it.
· Advertising regulation, which encourages truth in advertising, usually is enforced by civil suits. Under Section 43 of the Lanham Act, false and misleading advertising is prohibited. Technically, the FTC can bring suit against any false advertising using the Lanham Act, although most cases are filed in civil court by those harmed by deceptive advertising rather than by the FTC.
· Under the Horizontal Merger Guidelines, a merger that leads to moderate or high levels of concentration may be challenged (potentially blocked).


1. What makes it illegal for manager of U.S. firms to collude with other domestic or foreign firms?
A) Clayton Act
B) Robinson Patman Act
C) Sherman Act
D) Horizontal merger guidelines
The answer is C. The Sherman Act makes it illegal for managers of U.S. firms to collude with other domestic or foreign firms. Even OPEC is not bound by U.S. law; the manager of a U.S. oil company cannot legally participate in the OPEC oil cartel. The interpretation of the antitrust policy is largely shaped by the courts, which rule on ambiguities in the law and previous cases.

2. When the post-merger HHI exceeds it is presumed that mergers producing an increase in the HHI of more than 100 points are likely to create or enhance market power or facilitate its exercise.
A) 1,000
B) 1,800
C) 1,500
D) 750
The answer is B. HHI stands for Herfindahl-Hirschman index and it is the sum of the squared shares on the market for every firm in a particular market times 10,000. If the HHI is greater than 1,800; it is presumed that mergers producing an increase in the HHI of more than 100 points are likely to create or enhance market power or facilitate its exercise.

3. In the marketplace, the government believes the equilibrium price is not high enough, thus the government regulates a price above the equilibrium price in the market. Which of the following best describes the government’s presence in the marketplace?

A) Government has implemented antitrust policy.
B) Government has implemented a price ceiling.
C) Government has implemented a price floor.
D) Government can not regulate the market price.

The answer is C. A price floor is set above the equilibrium price. A price ceiling is set below the equilibrium price. Antitrust policy deals with preventing monopolies from forming in the market.

4. Which of the following statements is false regarding governments in the marketplace?
A) A price floor is when the government sets a price higher than the equilibrium price.
B) Anti-Trust policies are targeted toward preventing oligopolies in the market.
C) Price regulation is one way to control monopolies in the market.
D) A price ceiling is when the government sets a price lower than the equilibrium price.

The answer is B. Anti-Trust policies are targeted toward preventing monopolies in the market. Price floor is higher than the equilibrium price while a price ceiling is a price below the equilibrium price. Government use price regulation as a way to control monopolies.

5. Which of the following policies is targeted towards international markets?
A) Price Floor
B) Price Regulation
C) Tariff
D) Price Ceiling

The answer is C. A tariff places a fee on imported goods. A, B, & D are governmental policies targeted towards domestic firms.

6) What governmental agency is responsible for enforcing anti-trust regulation?
A) Congress
B) Department of Treasury
D) Federal Trade Commission

The answer is D. Along with the Anti-Trust Division of the Department of Justice; the Federal Trade is responsible for enforcing anti-trust regulation.

Managerial Economics & Business Strategy, Bay, Michael R., 5th Ed, McGraw Hill 2006, Chapter 14 (509-537)