2.1: The Role of Government

The Role of the Government

Government plays a role in the marketplace. Sometimes the government creates laws to protect labor, consumers, or industries. In other cases, the government is concerned with encouraging competition and regulating big business for the public welfare. When this happens, the government is modifying the marketplace. Economists would then define our economic system as a “modified free enterprise economy” because it consists of three different market structures, various types of business organizations, and a varying degree of government laws and regulations.

Universal Generalizations

• Public disclosure is used to promote competition.
• Today, the United States government takes part in economic affairs to promote and encourage competition.
• The modern American free enterprise market is a mixture of various markets, business organizations, and government regulations.

Guiding Questions

1. Should the United States government still enforce anti-monopoly legislation?
2. How does the federal government attempt to preserve competition among businesses?
3. How can public disclosure be used to prevent market failures?

Regulating Anticompetitive Behavior

In the closing decades of the 1800s, many industries in the U.S. economy were dominated by a single firm that had most of the sales for the entire country. Supporters of these large firms argued that they could take advantage of economies of scale and careful planning to provide consumers with products at low prices. However, critics pointed out that when competition was reduced, these firms were free to charge more and make permanently higher profits, and that without the goading of competition, it was not clear that they were as efficient or innovative as they could be.

 Anti-Monopoly Legislation Description Sherman Anti-trust Act 1890 First significant law against monopolies; sought to do away with monopolies and restraints that hinder competition Clayton Anti-Trust Act 1914 Law gives government greater power against monopolies; outlawed price discrimination Federal Trade Commission (FTC) 1914 Administers antitrust laws forbidding unfair competition, price fixing, and other deceptive practices; used in conjunction with the Clayton Act Robin-Patman Act 1936 Strengthened the Clayton Act, companies cannot offer special discounts to some consumers while denying them to others

Antitrust Laws

In many cases, these large firms were organized in the legal form of a “trust” in which a group of formerly independent firms were consolidated together by mergers and purchases, and a group of “trustees” then ran the companies as if they were a single firm. Thus, when the U.S. government passed the Sherman Antitrust Act in 1890 to limit the power of these trusts, it was called an antitrust law. In an early demonstration of the law’s power, in 1911, the U.S. Supreme Court upheld the government’s right to break up Standard Oil, which had controlled about 90% of the country’s oil refining. Standard Oil was broken into 34 independent firms, including Exxon, Mobil, Amoco, and Chevron. In 1914, the Clayton Antitrust Act outlawed mergers and acquisitions (where the outcome would be to “substantially lessen competition” in an industry), price discrimination (where different customers are charged different prices for the same product), and tied sales (where purchase of one product commits the buyer to purchase some other product). Also in 1914, the Federal Trade Commission (FTC) was created to define more specifically what competition was unfair. In 1950, the Celler-Kefauver Act extended the Clayton Act by restricting vertical and conglomerate mergers. In the twenty-first century, the FTC and the U.S. Department of Justice continue to enforce antitrust laws.

 Federal Regulatory Agency Description Food and Drug Administration (FDA) 1906 Enforces laws to ensure purity, effectiveness, and truthful labeling of food, drugs cosmetics; inspections production and shipment of these products Federal Trade Commission (FTC) 1914 Administers antitrust laws forbidding unfair competition, price fixing, and other deceptive practices Federal Communications Commission (FCC) 1934 Licenses and regulates radio and television stations and regulates interstate telephone, telegraph rates and services Securities and Exchange Commission (SEC) 1934 Regulates and supervises the sale of securities and the brokers, dealers, and bankers who sell them National Labor Relations Board (NLRB) 1935 Administers federal labor-management relations laws; settles labor disputes; prevents unfair labor practices Federal Aviation Administration (FAA) 1958 Oversees the airline industry Equal Employment Opportunity Commission (EEOC) 1964 Investigates and rules on charges of discrimination by employers and labor unions Environmental Protection Agency (EPA) 1970 Protects the environment Occupational Safety and Health Administration (OSHA) 1970 Investigates accidents at the workplace; enforces regulations to protect employees at work Consumer Product Safety Commission (CPSC) 1972 Develops standards of safety for consumer goods Nuclear Regulatory Commission (NRC) 1974 Regulates civilian use of nuclear materials and facilities Federal Energy Regulatory Commission (FERC) 1977 Supervises transmission of the various forms of energy

The U.S. antitrust laws reach beyond blocking mergers that would reduce competition to include a wide array of anticompetitive practices. For example, it is illegal for competitors to form a cartel to collude to make pricing and output decisions as if they were a monopoly firm. The Federal Trade Commission and the U.S. Department of Justice prohibit firms from agreeing to fix prices or output, rigging bids, or sharing or dividing markets by allocating customers, suppliers, territories, or lines of commerce.

The Role of Government in Paying for Public Goods

The key insight in paying for public goods is to find a way of assuring that everyone will make a contribution and to prevent free riders. For example, if people come together through the political process and agree to pay taxes and make group decisions about the quantity of public goods, they can defeat the free rider problem by requiring, through the law, that everyone contributes.

However, government spending and taxes are not the only way to provide public goods. In some cases, markets can produce public goods. For example, think about radio. It is nonexcludable, since once the radio signal is being broadcast, it would be very difficult to stop someone from receiving it. It is nonrivalrous, since one person listening to the signal does not prevent others from listening as well. Because of these features, it is practically impossible to charge listeners directly for listening to conventional radio broadcasts.

Radio has found a way to collect revenue by selling advertising, which is an indirect way of “charging” listeners by taking up some of their time. Ultimately, consumers who purchase the goods advertised are also paying for the radio service, since the cost of advertising is built into the product cost. In a more recent development, satellite radio companies, such as SirusXM, charge a regular subscription fee for streaming music without commercials. In this case, however, the product is excludable—only those who pay for the subscription will receive the broadcast.

Some public goods will also have a mixture of public provision at no charge along with fees for some purposes. For example, a public city park may be free to use, but the government charges a fee for parking your car, for reserving certain picnic grounds, and for food sold at a refreshment stand.

In other cases, social pressures and personal appeals can be used, rather than the force of law, to reduce the number of free riders and to collect resources for the public good. For example, neighbors sometimes form an association to carry out beautification projects or to patrol their area after dark to discourage crime. In low-income countries, where social pressure strongly encourages all farmers to participate, farmers in a region may come together to work on a large irrigation project that will benefit all. Many fundraising efforts, including raising money for local charities and for the endowments of colleges and universities, also can be viewed as an attempt to use social pressure to discourage free riding and to generate the outcome that will produce a public benefit.

Common Resources and the “Tragedy of the Commons”

There are some goods that do not fall neatly into the categories of private good or public good. While it is easy to classify a pizza as a private good and a city park as a public good, what about an item that is nonexcludable and rivalrous, such as the queen conch?

In the Caribbean, the queen conch is a large marine mollusk found in shallow waters of seagrass. These waters are so shallow, and so clear, that a single diver may harvest many conch in a single day. Not only is conch meat a local delicacy and an important part of the local diet, but also, the large ornate shells are used in art and can be crafted into musical instruments. Because almost anyone with a small boat, snorkel, and mask, can participate in the conch harvest, it is essentially nonexcludable. At the same time, fishing for conch is rivalrous; once a diver catches one conch it cannot be caught by another diver.

Goods that are nonexcludable and rivalrous are called common resources. Because the waters of the Caribbean are open to all conch fishermen, and because any conch that you catch is conch that I cannot catch, common resources like the conch tend to be overharvested.

The problem of overharvesting common resources is not a new one, but ecologist Garret Hardin put the tag “Tragedy of the Commons” to the problem in a 1968 article in the magazine Science. Economists view this as a problem of property rights. Since nobody owns the ocean, or the conch that crawl on the sand beneath it, no one individual has an incentive to protect that resource and responsibly harvest it. To address the issue of overharvesting conch and other marine fisheries, economists typically advocate simple devices like fishing licenses, harvest limits, and shorter fishing seasons. When the population of a species drops to critically low numbers, governments have even banned the harvest until biologists determine that the population has returned to sustainable levels. In fact, such is the case with the conch, the harvesting of which has been effectively banned in the United States since 1986.

Visit this website for more on the queen conch industry:

www.fishwatch.gov/seafood_profiles/species/conch/species_pages/queen_conch.htm

Positive Externalities in Public Health Programs

One of the most remarkable changes in the standard of living in the last several centuries is that people are living longer. Thousands of years ago, human life expectancy is believed to have been in the range of 20 to 30 years. By 1900, average life expectancy in the United States was 47 years. By the start of the twenty-first century, U.S. life expectancy was 77 years. Most of the gains in life expectancy in the history of the human race happened in the twentieth century.

The rise in life expectancy seems to stem from three primary factors. First, systems for providing clean water and disposing of human waste helped to prevent the transmission of many diseases. Second, changes in public behavior have advanced health. Early in the twentieth century, for example, people learned the importance of boiling bottles before using them for food storage and baby’s milk, washing their hands, and protecting food from flies. More recent behavioral changes include reducing the number of people who smoke tobacco and precautions to limit sexually transmitted diseases. Third, medicine has played a large role. Immunizations for diphtheria, cholera, pertussis, tuberculosis, tetanus, and yellow fever were developed between 1890 and 1930. Penicillin, discovered in 1941, led to a series of other antibiotic drugs for bringing infectious diseases under control. In recent decades, drugs that reduce the risks of high blood pressure have had a dramatic effect in extending lives.

These advances in public health have all been closely linked to positive externalities and public goods. Public health officials taught hygienic practices to mothers in the early 1900s and encouraged less smoking in the late 1900s. Many public sanitation systems and storm sewers were funded by government because they have the key traits of public goods. In the twentieth century, many medical discoveries came out of government or university-funded research. Patents and intellectual property rights provided an additional incentive for private inventors. The reason for requiring immunizations, phrased in economic terms, is that it prevents spillovers of illness to others—as well as helping the person immunized.

Funding Innovation

If the private sector does not have sufficient incentive to carry out research and development, one possibility is for the government to fund such work directly. Government spending can provide direct financial support for research and development (R&D) done at colleges and universities, nonprofit research entities, and sometimes by private firms, as well as at government-run laboratories. While government spending on research and development produces technology that is broadly available for firms to use, it costs taxpayers money and can sometimes be directed more for political than for scientific or economic reasons.

The first column of Table shows the sources of total U.S. spending on research and development; the second column shows the total dollars of R&D funding by each source. The third column shows that, relative to the total amount of funding, 26% comes from the federal government, about 67% of R&D is done by industry, and less than 3% is done by universities and colleges.

 Sources of R&D Funding Amount ($billions) Percent of the Total Federal government$103.7 26.08% Industry $267.8 67.35% Universities and colleges$10.6 2.67% Nonprofits $12 3.02% Nonfederal government$3.5 0.88%

In the 1960s the federal government paid for about two-thirds of the nation’s R&D. Over time, the U.S. economy has come to rely much more heavily on industry-funded R&D. The federal government has tried to focus its direct R&D spending on areas where private firms are not as active. One difficulty with direct government support of R&D is that it inevitably involves political decisions about which projects are worthy. The scientific question of whether research is worthwhile can easily become entangled with considerations like the location of the congressional district in which the research funding is being spent.

Visit the NASA website http://www.nasa.gov/ and the USDA website http://www.usda.gov/wps/portal/usda/usdahome?navid=conservation to read about government research that would not take place without government support.

Self Check Questions

1. What is a trust?
2. Identify at least 4 pieces of anti-monopoly legislation.