ations a" sore istructional ial UNIT 14 ECON OMIC REGULA’ OF BUSINESS TIONS Structure 14.0 Introduction 14.1 Objectives 14.2 Antitrust The ory and Regulati M21 Antara euatons 1422 Activi i ena se oe Bue Require the Use of Antitrust Laws ners ‘ : i 1 Elements ofthe Paradigm raaueenac neo 2 Criticisms of the SCP Paradigm. ! eppecutratons Overview and Measurement Pi eae Industrial Concentration ‘42 Monopoly Vs Concentration of E 14.5 Regulation of Externalities “estan 146 Aj oe oe Check Your Progress Questions 14.8 Key Words 14.9 Self Assessment Questions and Exercises 14.10 Further Readings 14.0 INTRODUCTION The economic framework within which the firm functions plays a crucial role in its efforts to thrive, grow and beat its competitors. Since business is fundamentally an economic activity, the economic environment, both within the country as well as beyond its national frontiers will have a definite influence on its fortunes. It is inconceivable that there could be any institution, bodies or persons who are ‘insulated from the effects of the economic environs. Business has to: deal witha vastnumber of governmental bodies, rules, regulations, and guidelines relating to its statutory responsibilities, the capital market, sources of finance including stock market options, venture capital, offshore funds, disinvestment options, bank’ funding and so on. In this unit, we will study the concept: of economic regulations of business. 14.1 OBJECTIVE! ‘After going through this ‘unit, you will beable to: Discuss the antithrust theory and ree © Describe the st re-con Explain the concept of coEconomie Regulations 14.2 ANTITRUST THEORY AND REGULATIONS of Business. Antitrust laws are often mentioned as ‘competition laws”. These are laws established by the governments to protect the consumers from predacious practices of business, NOTES The laws ensure existence of impartial competition in economy which is based open-market. They have developed as the markets have evolved and are in keeping wtith the recent trends, They safeguard the markets and the consumers from prospective monopolies which will become a cause of commotions 10 the productivity and competitive flow. 1 Antitrust Theory ical viewpoint on competition maintained that particular agreements and practices of business may result in unreasoned restriction over people’s freedom in business attempting to carn a livelihood. Restrictions were adjudged as acceptable or unacceptable by courts as fresh incidents came 10 light with the changes in the business environment. Therefore, the courts established exact Slssifications of agreement, explicit articles, towards foul play oftheir code on fair economic practices, and courts did not scheme for a central notion ofmarket power. Initial theorists of the field like Adam Smith had precluded power of monopoly on such grounds. He was of the view that any form ofmonopoly practiced in the market has similar impact as that of secret in business or the producers. It does not matter how the producers monopolise the market, they could under supply or sell their products more than the actual price and increase their profits. Inhis book The Wealth of ‘Nations, Adam Smith observed problems related to cartel, buthe did not preach any legal methods to curtail them, he observed: “People of the same trade ‘seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. Itis impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary.’ At the: same time, Smith overruled the mere presence of any kind of corporations whether big, dominating or foul. pie Large corporations had become an the middle of the nineteenth century. D i approach in his book treatise On Liber regarded business as a. social activity 2 interest of others and entire goods and this leaves the b of Free Trade; this was no! emphasized earlier. A for the trade.8 sectional TheNeo-classical yj prrnodeler eer ea ere at cee After both these contradictory theories, the Seer Connected with the Chicago University advocated an a ‘ed towards establishing laws for competition. ; s ert Bork was not much in favour laws and he voiced his Opinions in his boi views of Harv; arene Force tofessor Philip Areeda who was keen forthe court to adopt ‘eful laws and policies overantitrust, of decisions taken by court on antitrust 0k The Antitrust Paradox. There are .2.2 Activiti i 14.2.2 Activities of Business which Require the use of Antitrust Laws Ree eta eat activities of business on which the Antitrust laws le: . Allocation of Market: Suppose company B functions in eastern part of the city and company C functions in western parts of the city so they would continue to function in their specified areas. This will givekind of monopoly to bothin theirrespective areas as cost of setting up anew companyis Very high hence nonew company will provide competition. ¢ Bid Rigging: In this scenario three corporations join hands and form a cartel. In this they equally permit all members to have an equal share. and. do not try to encroach over others share, thus they do not compete against each other. There is no competition in the market. Bid rigging further have three sub-types: () Bid Suppression: Participants abstain to bid against each other by withdrawing from the bid so that the decided bidder can win i) Complementary Bidding: This typeis also called courtesy bidding, this takes place in situations where the applicants purposely submit much higher bids and allow the decided bidder to quote less and accommodate all the demands of: the buyer. The ro rigging and are developed to provide a s about the market environments (ii) Bid Rotation: As the the biddings in ro Price Fixing: Comp Z products are complethan the price of the product. Both the companies sell their products atthe | *«2"emlc Reguiauons same price so that they can avoid the conflict because of price. Selling the product at the same price helps in maintaining the margin and results in the customers paying more for the product which they could have got at a None lower price. * Monopolies: The formulation of antitrust laws occurred in order to avoid monopolies. Among the most prominent legal cases of antitrust was of Microsoft Corporation, it was charged with undertaking actions which encouraged its monopoly in market and were against the competitive norms “ofthe market. The corporation was compelling its users to install their web browsers for the operating system of Windows. Controllers have to make sure that monopolies are prevented from cultivating an environment which is obviously competitive and market share should be eamed with the help of business expertise and new inventions. Earning market share by illegal means is considered wrong. Following are some of the arrangements which lead to monopolising market share in an illegal manner and are subjective to action by law: » Exclusive Supply Agreements: This happens in case a supplier is stopped from retailing to any other buyer other than the ones mentioned in the contract. These type of agreements kills all the competition from the market and helps in establishing monopoly. ‘* Securing the Sale of Two Products: In cases where a producer has a strong monopoly over a product in the market and desires to acquire monopoly over second product, the producer in order to acquire monopoly, on the second product ties the sale of strong product with the new one and ‘compels the buyers to purchase the new product as well even ifit is not needed by them. This compelling is against the antitrust laws. * Predacious Pricing: Though this practice of establishing monopoly isnot easy to bring out in the open and, the firm may keep prices low for a long time and maintain the market share so that it can overcome the losses in the longrun. + Rebuff Deals: Companies who haye monopoly over the market are able to decide the firms with whom they wish to have dealings. In instances where they use their. cul 1 liable for violating the antit ‘i * Mergers and Acqyotions ores ional (i) Verticay Mergers; 1) he two companies at different nee Which are undertaken when a ace ir operations, S of the production of same product i) Conglomer. companies cess aiese are mergers where between : in different inducers ; extension and market extension eee for synergy, product Competition Laws in India : India was among the f; rst dey . form of the Mo; Polies and acbing Countries to have a competition law in the development. Thy tshed in the history of India’s economic “Ane india required new rules, Hence, the nocd nen new competition la i pares oa pvordinty the Competition Act was passed in 2002 and on March 1, 2009 a © Competition Commission of India (CCI) was established > Lote eonemous body comprising ofa Chairperson and six members. An appellate bods ci i i! i May 2009 with final et -Ompetition Appellate Tribunal was also set up in ‘Ying to the Supreme Court of India. Subsequently, phe rane westepealed, MRTP Commission established under that act was 7 Shed and its pending cases were transferred to the CCI. Sections 5 & 6 relating to Merger & Acquisition were notified in June, 2011. The Competition Act, 2002, as amended bythe Competition (Amendment) Act, 2007, follows the philosophy of modem competition ews, The Act prohibits anti-competitive agreements, abuse of dominant position by enterprises and. regulates combinations (acquisition, acquiring of control and M&A), which causes or likely to cause an appreciable adverse effect on competition within India, The sectors that have been covered are as diverse as infrastructure, finance, entertainment, IT, telecom, civil aviation, energy, insurance, travel, automobile manufacturing, real estate and pharmaceuticals etc. 14.3. THE STRUCTURE — CONDUCT — PERFORMANCE PARADIGM neo-classical theory of firm fi bak been the focal point ifall the industrial organons wi ost ‘ructional t their behaviour makes it gj ooo itdifficutttopredi is consistent. Seyera} to predict and a, paradigm and these par eect OME Up while aren market structure which market but moreimpro ums A not just be "mpting an explanation of t ination of the manifold classifications tly they are faced “ause of changing behaviours in the fi : sa result of inad the SCP technique for ry iltion ofmarkets. Fosentinn gnu’ data and the demarcated boundary gr Sins the market and anager LsHeinapplving Of the . e an industry i: i aaah. © particular industry, ry is that there is no Fig. 14.1 The SCP Paradigm 14.3.2 Criticisms of the scp Paradigm The paradigm provided basis toa i i ii eee number of theories of economics, yet it is not ‘The paradigm of SCP is drawn from microeconomic theory which is used to observe the pragmatic behaviour of firms, Conversely, economic theory is not able to provide the accurate relationships prevailing among the three elements. For instance, oligopoly theory is considered to be highly uncertain and it fails to generate any precise conclusions. There are many indicators for measuring the structure yet the paradigm emphasis only on concentration. The concem of the SCP is focused on the equilibrium of shortrun and does not take into account the future evolutions and changes in structure, on both accounts the conduct and performance will also undergo changes. Another criticism directed towards SCP. is also about its loose derivation of the theoretical foundations, and as aresultitis often referred along with the neoclassical theory. Check Your Progress 1. Whatis complementary bidding? 2. When was the Competition Actp 3. What is conduct in the SCP partctional + Absolute Measures of Concentration e Bh pe sees eee tis classification isthatthe numberof firms is absolute in measurements for this: Tvice OF capital in the industry. There are two ) The Con i ‘ o romiulacrieneiion Ratio (CR): This ratio measures the share of illustration the de eeu at of three or five largest firms. In the istaken intone DS! ofthe manufacturing taken, Th share of ten firms it; assume there are for in in of five largest firms is as given below: rty firms in total. Total manufacturing a I manufactures 10,000 Parts Firm 2 manufactures 12,000 Parts Firm 3 manufactures 9,000 Parts Firm 4 manufactures 15,000 Parts Firm S manufactures 14,000 Parts Total Production ofthe five biggest firms 60,000 Parts Total Production in Industry—1,10,000 Concentration Ratio of the Five firms (60,000/1,10, 000) x 100= 54.54% ‘Thus the five firms have an industrial concentration of 54.54% (i) The Herfindahl Index: This is another absolute measure for industrial concentration, it is also referred to as Herfindahl-Hirschman Index, HHT, or even as HHl-score. It gives the measure of magnitude of firms in comparison to others in the industry and also indicates the quantity of competition between the firms. It takes its name from its creators Orris C. Herfindahl and Albert O. Hirschman, both are renowned economists and the index is often used cases of in competition law. In this all firms existing in the industry are taken into account. H-index is explained below: Assume, n=Number of firms in the industry. x= Absolute amount of firm manufacturing. T= Total manufacturing of the industry. ‘As stated above the H index takes into account all firms of the industry while calculating. The index value is zero to one. In case the indi ‘more firms of similar size then the index value is taken as zen hand, in case industry has one firm been explained in the follow firms totally and each respectively. Thisfirm in total manufacturing is [x1/T] 2 that makes the share of each firm as 0.372, 0.262, 0.222 and 0.152 as a result, the value of H index is 0.275. Since this is very close to zero, hence it is clear that concentration levels are Jow in the industry. The index helps in showing the extent of concentration forall periods. © Relative Measures of Concentrat “The inequality of firms is focused in this measure. This implies that markets which are constituted with firms of uneven proportions have uneven productions as well. be measured by using the Lorenz ‘The approximate industrial concentration may’ : eLorer Curve, The Lorenz curve provides the representation of wealth distribution with the help ofa graph. In 1905, Max O. Lorenz developed this curve to represent the disparity in the distribution of wealth. In mathematics it is referred as Gini- coefficient. Gini Concentration Ratio is the statistical measure | centered on Lorenz Curve. ‘The value of Gini coefficient is 0 tol in a Gini coefficient of inequality. In situations where all the firms are of same size then the line representing equality and Lorenz, Curve will be similar: The value of Gini co-efficient will be zero in such a situation. Increased inequality will result in increasing the value of the Gini coefficient. 14.4.1 Monopoly Vs Concentration of Economic Power ‘A firm’s control over production and distribution ofa product is referred to as monopoly, Monopolistic environment may be created in large as well as small scale industries. On the other hand, concentration of economic power refers to centrally controlling essential economic activities such as availability of capital, ‘employment and manufacturing in amajor industry or agriculture etc. The concentration of economic power in India is achieved by promoting monopoly, In fact, it is the means to acquire power and then promote monopolistic activities so that the power can be maintained. The aim ofall modem economies is to diffuse concentration of economic power as it hampers social justice. 14.5 REGULATION OF EXTERNALITIES \e8s, once capital has been sourced, the investors need to determine how cent capital will be needed to produce a, oi output. This is revealed through the capital output ratio. Capital output 0 period of time. In orderto cak produced by a country, Bi investment decisions may existand can problems or side. Economie Regulations of Business NOTES 2653 poets ores vional Externalities are one required in econom; between the private return and the costs of the commnnt agoodexample ofanexie nnd, of the reasons that caffairs of fovern ment j , thestate. Also, thig ener ettion is particularly te. Also, this j commodity (to the oye BY there is a difference moc Ic owners of fi to asocietyas wie nts ictors of production) ole. Environmental pollution is extemality, Additi *y ‘ ionall and Develo pany may be fundi Ment D. ing effects on the society as factors such as taxation pols eter 7 Anextermali eo i ity exis impose a cost, or uote when the act ly, external tions or decisions of one: The presence rani pecranieraarets SCS ernaliticg isa significant phenomenon in modern life. congestion; automobile secre et lands sight, and sound pollution; traffic passive smoking are only lents; abandoned housing; nuclear accidents; and that affect the enviro few of them, Because there are so many externalities ment, the study of externalities is a major concern of environmental economics, Externalities S ar she dees en ‘ie see and benefits of economic activity that do not enter culations of costs or revenues. Thus, in the absence of some sort ofnon-market correcti TECH 2 i is i ceanen or reat teenl ion (usually government action), they lead to inefficient i Extemal costs and benefits are at the core of the common resource problem. A new producer creates higher costs for all previous entrants, or all producers impose external costs on the general population. In either case, in the absence of regulation, taxes, or property rights for environmental quality, external costs are not borne by the producers who cause them. It is obvious then that the prices of their products do not reflect the social costs of production. Thus, more of these resource-depleting or -polluting goods and services are produced and consumed. than would be the case if prices reflected external costs. Hence, societies pollute more than their people would choose if! ‘markets reflected all social costs. Ina market with competitive producers, the supply curve represents. private marginal costs. But, ifthis isa polluting industry, the external costs would make the social marginal cost, SMC, higher. If these costs were reflected in the market, the price would jump higher and ‘demand, and therefore, output would be reduced. ’As less of the offending product would be grown or manufactured, there would be Jess environmental degradation. shane TRructional l Remedies for Externalities The market provides As No remedy for the mj ternalities, fe misallocati oxtomabiies. Therefore, non-market means havoc ot Of Tesources o one is government action, Ave to be found. The most sont OY com ° Government regulation: re ey Peas that force some firms to ‘intemalize” Ree oe examples are anti-pollution laws that , medying negative pollution externalities, © Taxation: Governm, in: ent also can impose a tax upon fi i ea ‘ pon firms creatin, avin 'ax collections then are used to reimburse those aie Sed ree pene costs. The problems in such an arrangement include aaa casuring the social cost involved; how to see to it that those 'Y do pay the external costs are the ones who get compensated. ¢ Subsidy: In the case of firms that ‘produce them, thus ‘providing the firms with revenue fully reflecting the social benefit that they produce. Taxes on Negative Externality In many areas, state and central governm: r lent Negative extemalities, require firms to Pay the Positive externalities, government can subsidize Because pollution imposes costs on the general public, the social marginal cost of the pollution (SMC) exceeds the private marginal cost (PMC) of making the good by the good’s external marginal cost (EMC). The private marginal cost is the marginal cost to the producers of the good. The social cost is the cost to everyone, including the public and the producer. In this case, we have the following equation: SMC = PMC + EMC; and SMC > PMC when’ EMC > 0 Assuming there are no positive externalities, the de the social marginal benefit (SMB) and the private marginal benefit (PMB) making the good (SMB = PMB). In the absence ofa tax, the free Sea oe ee ae i = PMB. But becal for at a price where PMC = PMB. eM socially optimal level of ‘production is ose SMC=MB. oe ‘Anoptimal tax would equal the good's external mars=! : fax =E This makes the SMC curve in effect the industry's PM = a /e. the demand curve reflects both from‘We assume there are no negative externalities in this figure. So, the supply curve reflects both the private and social marginal cost of making the good (PMC = SMC). Inthe absence of a tax, the free market will produce the good, and sell them. ata price where PMC = PMB. But because SMB > PMB, the socially optimal level of production is where where SMB = MC. “The socially optimal subsidy is equal t the good’ extemal marginal benefit (subsidy=EMB). Pollution as an Externality In this section, we will restrict: ‘our study to learn: about pollution as an externality. The government regulation of pollution illustrates some ofthe principles we have been talking about. Pollution: is anegative extemality. Because of transaction conts, itis t00 difficult for people to, by themselves, bargain with firms for the optimal level of ‘pollution. ‘Two solutions have emerged: 1. Taxing polluters: One solution has been proposed to tax polluters. Emission charges are common in Europe. Water polluters have to pay ‘a waste disposal tax there is also an emission charge on gasoline. The social cost includes the private cost plus the cost of pollution emitted by cars. An emission tax equal to the difference between the social and private marginal cost will result in the optimal level of driving. 2. Limiting the amount of pollution: The second solution is limiting the amount of pollution. In place ofa tax, the government can regulate and limit the amount of pollution allowed. However, ifthe same limit is imposed on all individuals, we are not taking into consideration that the needs of driving vary from individual to individual. Regarding the preceding example of driving, some people havea greater demand for driving than others. Similarly, some people drive cleaner cars than others. The Optimal Level of Pollution ‘What level of pollution should a regulatory agency allow? Pollution is costly. Itis a subject of controversy as to how costly itis. pretend that v knowing and have precise figures on pollutior is rid of pollution. Let us also s decide what is the correct | Total cost = Total The socially opti We can use marginal Economic Regulations ofBusiness NOTES‘ctional ahigher risk of getting sick. The marginal benefit of increasin, ; Pi eae in pollution abatement costs. O should be incronce ea MB>MC. At the optimal Q, MB = MC. Because the cheapest ways to reduce. pollution willbe use first, the subsequent units of pollution will ostmore ese, up. Similatly, the marginal cost of pollution will increase, This means the Mieke: the level of pollution; the costlier a given addition is in terms of the damage thet itdoes. Check Your Progress - 4. Name the factors which affect the extent of industrial concentration. 5. What is HHI? 6. Mention some of the other names for externalities, 7. What represents Private marginal costs in a market with competitive producers? 14.6 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS 1. Complementary bidding is also called courtesy bidding, this takes place in situations where the applicants purposely submit much higher bids and allow the decided bidder to quote less and accommodate all the demands of the buyer. These are most prone to rigging and are developed to provide a false picture for the buyer about the market environment, The Competition Act was passed in 2002 and amended in 2007. Conduct in the SCP paradigm refers to the behaviour of the consumers and retailers, their behaviour with each other as well as between themselves have an impact, The behaviour of the firms is based on their strategy which is decided after researching aspects like investment, development, levels of advertisement and collusions, yor ‘Two factors affect the extent of industrial concentration, one factor is quantity of firms active in a particular: market, and the other factor is percentage of the share of the market demand fulfilled by the firm. Herfindah!-Hirschman Index, HHI, or even as HHI-score is an absolute measure of concentration which gives the measure ofmagnitude of firms in comparison to others in the industry and also indicates the quantity of competition between the firms. itl14.7 SUMMARY '* The economic framework within which the firm functions plays a crucial role in its efforts to thrive, grow and beat its competitors, Since business is fundamentally an economic activity, the economic environment, both within the country as well as beyond its national frontiers will havea definite influence onits fortunes. * Business has to deal with a vast number of governmental bodies, rules, regulations, and guidelines relating to its statutory responsibilities, the capital market, sources of finance including stock market options, venture capital, offshore funds, disinvestment options, bank funding and so on. «Antitrust laws are often mentioned as “competition laws’. These are laws established by the governments to protect the consumers from predacious practices of business. The laws ensure existence of impartial competition in ‘economy which is based open-market, They have developed as the markets have evolved and are in keeping with the recent trends. « There are numerous debatable activities of business on which the Antitrust laws are used: allocation of market, bid rigging, price fixing, monopolies, etc. ‘© India was among the first developing countries to have a competition law in the form of the Monopolies and Restrictive Trade Practices (MRTP) Act, 1969. The MRTP Act was designed to check concentration of economic power, prohibit restrictive or unfair trade practices and control of monopolies. © The year 1991 proved to be a watershed in the history of India’s economic development. The new India required new rules. Hence, the need for a new competition law. Accordingly, the ‘Competition Act was passed in 2002 and amended in 2007. © The Competition Act, 2002, as amended by the Competition (Amendment) ‘Act, 2007, follows the philosophy of modern competition laws. The Act prohibits anti-competitive agreements, abuse of dominant position by enterprises and regulates combinations (acquisition, acquiring of control and M&A), which causes or likely to cause an appreciable adverse effect on competition within India. © Structure-Conduct-Performance (S affiliation among the marke of that market and the Economie Regulations ‘Business NOTES, amomic Regulations 4 r ‘ es i ture igs ok Economic concentration has several denotations in the industrial struc' and is often applied to various ‘indexes of concentration’ in order to Understand thecistnetve features ofthe structure in industries. Ac ari porns ‘o the economic theory, concentration is a vital factor as it det IES behaviour of the market and also affects its outcome. A firm’s control over production and distribution of a product is referred to 4s monopoly. Monopolistic environment may be created in large as well as small scale industries. On the other hand, concentration of economic power refers to centrally controlling essential economic activities such as availability of capital, employment and manufacturing in a majorindustry or agriculture ete Extemalities are costs and benefits of economic activity that do not enter into the firm’s own calculations of costs or revenues. Thus, in the absence ofsome sort of non-market correction (usually government action), they lead to inefficientallocation of resources. Remedies for Externalities include: ‘government regulations, taxation and subsidies. 14.8 KEY WORDS * Antitrust laws: Also known as ‘competition laws’, these are laws established by the governments to protect the consumers from predacious practices of business. * Structure-Conduct-Performance (SCP) framework: It suggests a connecting affiliation among the market’s structure (S), the conduct (C) of various firms of that market and their performance (P) in the economy. * Externality: An economic effect that results from an economic choice but is not reflected in market price 14.9 SELF ASSESSMENT QUESTIONS AND EXERCISES Short Answer Questions . Give a brief introduction to the development: of Antitrust theory. . Write a short note on competition laws in India, . What are the criticisms against the SCP paradigm? . What is the difference between monop. icone power? P ar eo SelfInstructional MMaterial