Download Monopoly and Antitrust

ECONOMICS:
EXPLORE & APPLY
by Ayers and Collinge
Chapter 20
“Monopoly and Antitrust”
©2004 Prentice Hall Publishing
Ayers/Collinge, 1/e
1
Learning Objectives
1. Describe how barriers to entry create
market power.
2. Discuss the profit maximization process
for a monopolist.
3. Explain the inefficiencies of monopoly.
4. Name and briefly discuss major U.S.
antitrust laws and potentially
punishable practices.
©2004 Prentice Hall Publishing
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Learning Objectives
5. Identify government policies toward
monopoly.
6. Assess the merits of protecting the U.S. Postal
Service from competition.
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20.1
SOURCES OF MONOPOLY
When one firm supplies the entire market, the
market structure is called a monopoly.
A monopoly is characterized by a single firm
selling an output for which there are no close
substitutes.
Monopoly is caused by very high barriers to
entry, which exist when investors or
entrepreneurs find obstacles to joining a
profitable industry.
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Barriers to Entry
Monopoly by law (legal monopoly) – when one
firm is protected by law from competition, and
there are no close substitutes for the good.
Monopoly by possession – when one firm is the
only owner of a resource needed to produce a
good, and there are no close substitutes for the
resource or for the good.
Natural monopoly – when it is cheaper for one
firm to produce the entire industry’s output
than it would be for two or more firms to
produce the same output.
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Barriers to Entry
Barriers to entry bring about market power.
This market power reveals itself in the slope of
the firm’s demand curve.
The steeper the demand curve, the more
market power the firm has and the greater its
ability to determine price.
Monopoly represents the most market power,
in which case the firm’s demand is identical to
market demand.
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The Effect of Increasing
Market Power
$
Increasing
market power.
Demand facing
monopoly, the
extreme case of
a price taker.
Demand facing a
price taker
Demand
Quantity
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Natural Monopoly
• Natural monopoly occurs when one firm
can supply the entire market at a lower
price than two or more separate firms.
• This means that natural monopoly will
occur any time the minimum point on
long-run average cost near or to the right
of market demand.
• Natural monopoly occurs when there are
substantial economies of scale.
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Natural Monopoly
Long-run average cost
declines throughout the
relevant range of output.
Long-run average cost reaches
its minimum point near demand
$
$
The larger the
firm size, the lower
the average cost of
output
Long-run
average cost
Demand
Quantity
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Average cost with
multiple firms
Lower average
cost with one firms
Long-run
average cost
Demand
Quantity
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20.2
THE PROFIT-MAXIMIZING MONOPOLY
o Total revenue is maximized when the elasticity
of demand equals one.
o With a straight line demand curve this happens at
the midpoint.
o Even if production cost were zero, the
monopoly would not produce any more than
the revenue-maximizing output, since to do so
would lower its total revenue, and thus profit.
o The monopoly firm always chooses to produce
in the elastic range of demand.
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The Profit-Maximizing Monopoly
o The rule of profit maximization is the
same for a monopoly as for all other
firms:
o Produce at the point where marginal
revenue equals marginal cost.
o MR=MC rule
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The Profit-Maximizing Monopoly
When total revenue is
maximized, marginal
revenue is zero.
•
$
Unit Elastic
•
Demand
Total revenue
•
Monopoly output
is in the elastic
range of demand.
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Quantity
Marginal
revenue
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The Profit-Maximizing Monopoly
A downward sloping demand curve is
associated with a marginal revenue curve
that slopes down even more steeply.
The result is that the marginal revenue
from an additional unit of output would
equal the price of that unit minus the
price reduction on every other unit sold.
The monopolist has no unique supply
curve.
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Marginal Revenue less than Price
$
...minus less
revenue from
lower price on
other units sold.
Lower
price
Marginal revenue
equals added
revenue from one
more unit sold...
Demand
Quantity
Larger
quantity
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Marginal
revenue
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Demand and Revenue
Revenue
Marginal revenue
Total revenue (change in price/
Price Quantity (price x quantity) change in quantity)
$12
0
$0
undefined
$11
1
$11
$11
$10
2
$20
$9
$9
3
$27
$7
$8
4
$32
$5
30
25
20
15
Demand
10
5
Marginal revenue
0
0
The data above is plotted. Note that the data
confirm that marginal revenue has a steeper
slope than demand.
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Total revenue
1
2
3
4
Quantity
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Monopoly Output and Price
Marginal Cost
#2 The monopolist charges
as much as the market will
bear for that output.
Monopoly
price
#1 the monopolist sets
output to equate
marginal revenue and
marginal cost
Demand
Monopoly
output
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Marginal Revenue
Quantity
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Monopoly Output and Price
Marginal Cost
•
Monopoly
price
•
#2 The monopolist
price falls.
#1 When elasticity of
demand rises….
•
Demand
Monopoly
output
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Marginal Revenue
Quantity
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Profit, Breakeven, or Loss
 The profit-maximizing quantity graphically, for
a monopolist occurs at the point where
marginal revenue equals marginal cost.
 The profit maximizing price is set at the
corresponding point on the demand curve.
 The average profit per unit sold is multiplied
by the number of units sold.
 The average profit per unit is the difference
between price and average cost at the profitmaximizing quantity.
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Profit, Breakeven, or Loss
Marginal Cost
Average Cost
Price
Profit
per unit
Profit
Number
of unit
Demand
Profit maximizing
output
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Marginal Revenue
Quantity
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Monopoly Breakeven, or Loss
Maximum
profit is
zero profit
Average cost
exceeds price
Marginal cost
Average Price
cost
Loss
per
unit
Price
Demand
Marginal cost
Average cost
Number
of units
Demand
Quantity
Profit-maximizing
output
Quantity
Loss-minimizing
Marginal revenue
quantity
Marginal revenue
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Efficiency and Price
Discrimination
• Monopoly is allocatively inefficient because the
quantity that equates marginal cost and
marginal revenue falls short of the quantity
that equates marginal cost and demand.
– The profit-maximizing quantity is less than
the efficient quantity.
– The area of deadweight loss shows the
benefits that consumers would have received
from the additional output minus the cost
the firm would have incurred to produce it.
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Limit Pricing
•In order to avoid the threat of potential competition,
a monopolist might practice limit pricing.
•This is where the monopolist charges the highest
price customers will pay, subject to the limit that the
price not be so high that it attracts potential
competitors.
•The limit price will be lower than the short-run
profit-maximizing price.
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The Inefficiency of Monopoly
Efficiency forgone:
the deadweight loss
from monopoly.
Monopoly
Price
Marginal Cost
•
Average cost
Marginal
revenue
Monopoly
Output
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Efficient
Output
Demand = marginal benefit
Quantity
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Price Discrimination
Price discrimination is selling a good or service
at different prices to various buyers, when such
differences are not justified by cost differences.
Price discrimination is feasible when different
prices can be charged to different market
segments.
Matching prices exactly to the demand curve is
the extreme of perfect price discrimination
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Price Discrimination
The arrows are prices,
which differ from
customer to customer
$
$19
$18
$17
$16
$15
$14
$13
$12
Marginal cost
$11
•
$10
Demand
= Marginal benefit
= Marginal revenue
1 2 3 4 5 6 7 8 9 10
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Efficient and profitmaximizing output
Quantity
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Price Discrimination
o Another example of price discrimination is multipart pricing.
o Multi-part pricing depends on the amount
consumed.
o The monopolist sets sets the price high for the first
units consumed, since those are the hardest to do
without. The price for additional units could be
lower.
o Multi-part pricing causes marginal revenue to fall
somewhere between the extremes of the monopolist
with a single price, and one able to practice perfect
price discrimination.
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20.3
ANTITRUST POLICY
Antitrust law is a body of public policies
designed to limit the abuse of market power,
and is enforced by the justice department.
The antitrust laws neither make monopoly
illegal nor apply only to monopoly.
Antitrust laws are intended to curb abuses of
market power, of which monopolist have the
most.
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Examples of Antitrust Legislation
 Sherman Act (1890)
 Federal Trade Commission Act (1914)
 Clayton Act (1914)
 Robinson-Patman Act (1936)
 Celler-Kefauver Antimerger Act (1950)
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Antitrust Policy
GLOSSARY OF TERMS
Exclusive
dealing:
A firm prohibits its distributors from selling
competitors’ products.
Exclusive
territories:
A firm assigns a geographic area to a
distributor and prohibits other distributors
from operating in that territory.
A firm prices a product below the marginal
cost of producing it to drive rivals out of
business.
Predatory
pricing:
Price
A firm charges different customers different
discrimination: prices for the same product.
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Antitrust Policy
GLOSSARY OF TERMS
Refusals to
deal:
A firm prohibits rivals from purchasing/using
scarce resources (called essential facilities) that
are needed to stay in business.
Resale price
maintenance:
A manufacturer sets a minimum retail price
for its product.
Tie-in sales:
A firm conditions the purchase of one product
upon the purchase of another.
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Alternatives to Regulation
 If a monopoly is a natural monopoly the
government will typically either own it or
regulate it with rate-of-return regulation that
restrict the monopolist from charging more
than average cost.
 Rate-of-return pricing is also known as average
cost pricing.
 To avoid the inefficiencies of regulation,
economist recommend alternatives like
franchise monopoly, which is a right to be the
exclusive provider of a service.
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Alternatives to Regulation
o The government has allowed
deregulation in some industries.
o Deregulation is the scaling back of
government regulation of industry.
o The reduction of government ownership
of industries is referred to as
privatization.
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20.4 EXPLORE & APPLY
The U.S. Postal Service A Monopoly in the
Public Interest
The U.S. Post Office is the oldest monopoly in
the U.S.
It is intended to be self supporting.
In 2001, it had 776,000 employees, and earned $65.9
billion in revenues.
It expenses however were $67.6 billion, and as a
result lost $1.68 billion dollars.
To try to make up for the losses it hired FedEx
to handle its overnight deliveries, and increased
the basic rate for mailing a letter to 37 cents.
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The U.S. Postal Service A
Monopoly in the Public Interest
Other cost cutting measure include:
Possibly eliminating Saturday deliveries.
Installing new automated equipment.
Privatization
Additional challenges include:
The growing popularity of email.
The cost of protecting employees and
customers from the threat of anthrax.
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Terms Along the Way
o
o
o
o
monopoly
barriers to entry
monopoly by law
monopoly by
possession
o natural monopoly
o price maker
o limit pricing
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o price discrimination
o perfect price
discrimination
o Multi-part pricing
o antitrust law
o rate of return
regulation
o average price pricing
Ayers/Collinge, 1/e
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Terms Along the Way (continued)
o franchising
monopoly
o deregulation
o privatization
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Test Yourself
1.
a.
b.
c.
Barriers to entry
increase the number of firms in an industry.
decrease the number of firms in an industry.
have no effect on the number of firms in an
industry.
d. have unpredictable effects on the number of
firms in an industry.
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Test Yourself
2.
a.
b.
c.
d.
Market power is indicated by a(n)
horizontal demand curve.
shortage of barriers to entry.
ability to pick your selling price.
j shape to the marginal cost curve.
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Test Yourself
3. Which statement is true about monopoly?
a. A monopoly is a price taker.
b. A monopoly will have many good substitutes
for its output.
c. The monopoly demand curve is also the
market demand curve.
d. An unregulated monopoly is always
profitable.
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Test Yourself
4. A natural monopoly occurs when
a. government grants a patent to a firm.
b. government prohibits the entry of new
competitor firms.
c. one firm can produce at lower average
cost than any combination of two or
more firms.
d. the product that is monopolized
pertains to natural resources.
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Test Yourself
5. A marginal revenue curve for a
monopoly will
a. be shaped like the letter J.
b. lie below the demand curve.
c. lie above the demand curve.
d. be identical to the demand curve.
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Test Yourself
6. The best example of a natural monopoly
is
a. a local electric utility.
b. the U.S. Postal Service.
c. an airline.
d. a public school.
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Test Yourself
7. If a monopolist is able to practice
perfect price discrimination, the result
will be
a.
b.
c.
d.
inefficient, but consumers will be better off.
inefficient, and consumers will be worse off.
efficient, and consumers will be better off.
efficient, but consumers will be worse off.
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The End!
Next Chapter 21
“Oligopoly and
Monopolistic
Competition"
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