Question

2. How did the Clayton Act of 1914 differ from the Sherman Antitrust Act of 1890? 3. Even when allowed to collude, firms in an oligopoly may choose to cheat on their agreements with the rest of the cartel. Why? 4. What effect does the number of firms in an oligopoly have on the characteristics of the market?

Answer 1

2.

In the late 1800’s and early 1900’s, the U.S. government struggled with anti-competitive practices between businesses. Part of the concern was related to artificial pricing practices that harmed consumers. In response to these monopolies, cartels, and trusts, Congress passed two major pieces of legislation: The Sherman Antitrust Act and the Clayton Act.

The Sherman Antitrust Act

Passed in 1890, the Sherman Antitrust Act was the first major legislation passed to address oppressive business practices associated with cartels and oppressive monopolies. The Sherman Antitrust Act is a federal law prohibiting any contract, trust, or conspiracy in restraint of interstate or foreign trade.

Even though the title of the act refers to trusts, the Sherman Antitrust Act actually has a much broader scope. It provides that no person shall monopolize, attempt to monopolize or conspire with another to monopolize interstate or foreign trade or commerce, regardless of type of business entity.

Penalties for violating the act can range from civil to criminal penalties; an individual violating these laws may be jailed for up to three years and fined up to $350,000 per violation. Corporations may be fined up to $10 million per violation. Like most laws, the Sherman Antitrust Act has been expanded by court rulings and other legislative amendments since its passage. One such amendment came in the form of the Clayton Act.

The Clayton Act

The purpose of the Clayton Act was to give more enforcement teeth to the Sherman Antitrust Act. Passed in 1914, the Clayton Act regulates general practices that may be detrimental to fair competition. Some of these general practices regulated by the Clayton Act are: price discrimination, exclusive dealing contracts, tying agreements, or requirement contracts; mergers and acquisitions; and interlocking directorates.

The Clayton Act is enforced by the Federal Trade Commission (FTC) and the Department of Justice (DOJ). Many of the provisions of the Clayton Act set out how the FTC or DOJ can respond to violations. Other parts of the Clayton Act are designed to proactively prevent anti-trust issues. For example, before two companies can merge, they must notify the FTC and obtain approval prior to the merger. The Clayton Act also created exemptions from enforcement for certain organizations, the most significant being labor unions.

3. By the use of Game theory we can show that cheating is dominant strategy for firms in cartel.

In a simple model of a duopoly, two firms produce the same good, for which each
firm charges either a low price or a high price. Each firm wants to achieve the
highest possible profit. If both firms choose High then each earns a profit of $1000.
If one firm chooses High and the other chooses Low then the firm choosing High
obtains no customers and makes a loss of $200, whereas the firm choosing Low
earns a profit of $1200 (its unit profit is low, but its volume is high). If both firms
choose Low then each earns a profit of $600. Each firm cares only about its profit,
so we can represent its preferences by the profit it obtains, yielding the game

High Low High 1000, 1000 1200, -200 Low - 200, 1200 600,600

firm 1 prefers (Low, High) to (High, High) to (Low, Low) to (High, Low), and firm2
prefers (High, Low) to (High, High) to (Low, Low) to (Low, High).

4.

As number of firms in an oligopoly market increases it tends towards Monopolistic Competition. Price level and profit of each firm decreases and advertising cost increases.