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The Role of Government in Avoiding Market Failure

Key Terms

Trust- an illegal combination of corporations whose intent is to diminish competition.

Cease and desist order- a ruling from the FTC that requires a company to stop an unfair business practice that decreases the amount of competition in a certain market.

Price discrimination- the illicit practice of charging customers different prices for the same product.

Public disclosure- a federal requirement that forces a business to disclose information about its products or its operations to the general public.

Market failures, as discussed earlier, occur when one or all of the conditions below exist:

  • When adequate competition does not exist.
  • Buyers and sellers are not well informed.
  • Resources are not free to move from one industry to another.
  • Prices do not reasonably reflect the costs of production.

The government has an obligation to protect its citizens against market failures and thus takes steps to ensure that the conditions outlined above do not exist. The government guards against monopolistic business practices such as the formation of trusts.

Trust- an illegal combination of corporations whose intent is to diminish competition.

Most students are familiar with the effect that Trusts had on the American business landscape and the American consumer at the turn of the nineteenth century. Their monopolization of various industries led to increased price, lower quality and the abuse of workers. Many laws were passed to deal with the formation of trusts. Antitrust laws are legislation under which the United States government acted to break up any trust. The first of these laws was the Sherman Antitrust Act, founded upon the principle in the Constitution that Congress could regulate interstate commerce. The Sherman Act declared illegal every contract, combination, or conspiracy in restraint of interstate and foreign trade. In 1914 it was supplemented by the Clayton Antitrust Act, which prohibited exclusive sales, contracts, inter corporate stock holdings, and price discrimination in the cases where it may lead to a decrease in competition. That same year, the Federal Trade Commission Act was passed. This act established the Federal Trade Commission (FTC) and gave it the power to issue cease and desist orders. The Robinson-Patman Act of 1936 was designed to enhance the Clayton Act, particularly the clause that dealt with price discrimination. Under this act, companies were prohibited from offering special discount prices to certain customers.

Federal Antitrust Laws, 1887 - 1950


Date Enacted


Interstate Commerce Commission Act



First federal law regulating the abuse of monopoly power. Passed after "Granger" laws enacted by rural states were declared unconstitutional.

Banned certain unfair business practices in the railroad industry.

Sherman Antitrust Act


Made it illegal to create, or attempt to create, a monopoly. By declaring any combinations that were a "conspiracy in restraint of trade" illegal. This law was used by the courts and corporate lawyers to grant injunctions against union organization.

Clayton Antitrust Act


Sought to prevent the creation of monopolies by defining specific illegal practices such as trusts and interlocking directorates. Strengthened the Sherman Act. Specifically made unions legal.

Federal Trade Commission Act


Created the Federal Trade Commission (FTC). The FTC has the responsibility to carry out the provisions of the Clayton Antitrust Act and to enforce federal law in regard regulation of business.

Robinson - Patman Act


Protects small retailers from unfair competition by chain stores and other large scale competitors.

Celler - Kefauver Act


Outlawed mergers or acquisitions that would lessen competition or create a monopoly.

The government has the responsibility of maintaining the proper functioning of the economy. As such it maintains a legal system that:

  • Enforces contracts.
  • Protects property.
  • Guarantees the rights of individuals and corporations.

Another functions of the government is to maintain the stability and the well being of our economy. In doing so, it has to keep a sufficient level of competition in the markets by regulating some monopolists' prices, as well as directing the quality of public services. The goal for the government is to establish the same prices that might exist if there were competition. Local and state governments regulate many of the natural monopolies such as telephone service, and gas and electrical utilities. Usually it is a public commission or other government agency that approves of prices for their services. If the company wants a change in the charged rates, then it must argue its case before the commission. Privately owned agencies, such as the Federal Reserve system, have certain regulatory powers including the power to regulate the money supply (i.e. cutting interest rates), some bank operations, and even bank mergers.

One of the benefits of living in a democracy where a truly capitalistic society is prevented by the intervention of the government, is the weapon of public disclosure. Our government, in its effort protect the consumer and promote open competition, has throughout the years required companies to reveal to the consumer the contents of its products, and its methods of operation and corporate organizations. An example would be how the Food and Drug Administration (FDA) requires content labels on canned goods and other food products. The FTC, for example, has outlawed price discrimination and price gouging. In another move to curb businesses and protect investors, the Securities and Exchange Commission mandates that any corporation that sells stock to the public lists its stock on a stock exchange must send periodic reports to the SEC. The firms are also required to supply investors with annual reports on the money, securities, and property the investors own, as well as information on sales and profits.

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