Public Policy Toward Oligopolies

One of the 7«en Principles of Economics in Chapter 1 is that governments can sometimes improve market outcomes. This principle applies directly to oligopolistic markets. As we have seen, cooperation among oligopolists is undesirable front the standpoint of society as a whole, bccauso it leads to production that is too low and prices that are too high. To move the allocation of resources closer to the social optimum, policymakers should try to induce firms in an oligopoly to compete rather than cooperate. let'* consider how policymakers do this and then examine the controversy's that arise in this area of public policy.

Restraint of Trade and the Antitrust Laws

One way that policy discourages cooperation is through the common law. Normally, freedom of contract is an essential part of a market economy. Businesses and households use contracts to arrange mutually advantageous trader In doing this, they rely on the court system to enforce contracts. Yet, for many centuries, judges in England and the United States have deemed agreements among competitors to reduce quantities and raise prices to be contrary to the public good. They have therefore refused to enforce such agreements.

The Sherman Antitrust Act of 1890 codified and reinforced this policy:

Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, b declared to be illegal Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any person or persons to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a misdemeanor, and on conviction therefor, shall be punished by tine not exceeding fifty thousand dollars, or by imprisonment not exceeding one year, or by both said punishments, in the discretion of the court.

"The Sherman Act elevated agreements among oligopolists from an unenforceable contract to a criminal conspiracy.

The Clayton Act of 1914 further strengthened the antitmst laws. According to this law, if a person could prove that he was damaged by an illegal arrangement to restrain trade, that person could sue and recover three times the damages he sustain**.! The purpose of this unusual rule of triple damages is to encourage private lawsuits against conspiring oligopolists.

Today, both the US. Justice Department ami private parties have the authority to bring legal suits to cnfurcc the antitrust laws- As wc discussed in Chapter 15, these laws are used to prevent mergers that would lead to excessive market power in any single firm. In addition, these laws are used to prevent oligopolists from acting together in ways that would make their markets le» competitive.


Firms in oligopolies have a strong incentive to collude in order to reduce production, raise price, and increase profit. The great 18th-century economist Adam Smith was well aware of this potential market failure. In The WedJlh of Sat tow he wrote, "People of the same trade seldom meet together, but the conversation ends in a conspiracy against the public, or in some diversion to raise prices."

To see a modern example of Smith's observation, consider the following excerpt of a phone conversation between two airline executives in the early 1980s. The call was reported in the New York Times on February 24, W83. Robert Crandall was president of American Airlines, and Howard Putnam was president of Uraniff Airways.

Crandall: I think it's dumb as hell ... to sit here ami pound the out of each other and neither one of us making a & dime. Putnam: IX> you liave a suggestion for me? Crandall: Yes, I have a suggestion for you. Raise your fares 2(1 percent. I'll raise mine the next morning. Put nam : Robert, we... Crandall: You'll make more money, and I will, loo.

Putnam: We can't talk about pricing! Crandall: Oh Howard. We can talk about any thing we want to talk about.

Putnam was right: The Sherman Antitrust Act prohibits competing executives from even talking about fixing prices. When Putnam gave a tape of this conversation to the Justice Department, the Justice Department filed suit against Crandall.

Two years later, Crandall and the Justice Department reached a settlement in which Crandall agreed to various restrictions on his business activities, including his contacts with officials at other airlines. The Justice Department said that the terms erf settlement would "protect competition in the airline industry, by preventing American and Crandall from any further attempts to monopolize passenger airline service on any route through discussions with competitors about the prices of airline services." •

Controversies over Antitrust Policy

Over time, much controversy has centered on what kinds of behavior the antitrust laws should prohibit. Most commentators agree that price-fixing agreements among competing firms should be illegal. Yet the antitrust laws have been used to condemn some business practices whose effects are not obvious. Here we consider three examples.

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