Download Chapter 12: Monopoly and Antitrust Policy

Ch. 12 Monopoly and Antitrust
12.1
In this chapter we study markets that are controlled by a single firm.
Some basics:
• An imperfectly competitive industry: single firms have some
control over the price of their output.
• Market power is the imperfectly competitive firm’s ability to raise
price without losing all demand for its product.
We define an industry/market with:
 The ease with which consumers can substitute one product for
another. Ease of substitution limits the extent to which a
monopolist can exercise market power.
 The more broadly a market is defined, the more difficult it
becomes to find substitutes
Pure Monopoly
A pure monopoly is an industry with a single firm
• that produces a product for which there are no close
substitutes
• significant barriers to entry prevent other firms from
entering the industry to compete for profits.
Examples:
12.2
What are Barriers to Entry?
Things that prevent new firms from entering and competing
in imperfectly competitive industries include:
•
Government franchises, or firms that become monopolies by virtue of
a government directive.
•
Patents or barriers that grant the exclusive use of the patented product
or process to the inventor.
•
Economies of scale and other cost advantages enjoyed by industries
that have large capital requirements. A large initial investment, or the
need to embark in an expensive advertising campaign, deter would-be
entrants to the industry.
•
Ownership of a scarce factor of production: If production requires a
particular input, and one firm owns the entire supply of that input, that
firm will control the industry.
12.3
Firm Decision-Making: Price is the Fourth
Decision Variable
Firms with market power must decide:
1. how much to produce
2. how to produce it
3. how much to demand in each input market
4. what price to charge for their output.
12.4
Price and Output Decisions in Pure Monopoly
Markets
To analyze monopoly behavior we assume that:
• Entry to the market is blocked
• Firms act to maximize profit
• The pure monopolist buys in competitive input markets
• The monopoly faces a known demand curve
• The monopolistic firm cannot price discriminate
12.5
Price and Output Decisions in Pure Monopoly
Markets
With one firm in a monopoly market, there is no
distinction between the firm and the industry. In a
monopoly, the firm is the industry
 The firm faces the entire market demand curve, and
total quantity supplied in the market is what the firm
decides to produce.
12.6
12.7
Remember the Perfect Competition Case:
The p.c. firm faces a perfectly elastic demand curve, the
height of which is determined in the market. The p.c.
firm can sell all it wants to at the market price.
Widget Firm
Widget Market
S
d=P=MR
$70
$70
D
Q
q
For a Pure Monopolist:
12.8
The monopolist faces a downward-sloping market demand curve;
it is NOT perfectly elastic.
 The monopolist cannot sell all that it wants to at a given price.
It can only sell what the consumers will buy at each possible
price, as reflected by the market demand curve.
The monopolist’s objective is the same as that of the perfectly
competitive firm: to choose the output level (Q*) that
maximizes profits.
 It will be where MR = MC.
Note: a choice of Q* implies a choice of Price (P*) because the
monopolist must locate at a point on the demand curve.
Marginal Revenue Facing a Monopolist
For the monopolist, marginal revenue is not equivalent to price because the
monopolist cannot sell all that it wants to at a particular price. To sell one
more unit, the monopolist must lower price
Marginal Revenue Facing a Monopolist
(1)
QUANTITY
(2)
PRICE
0
$11
1
10
2
9
3
8
4
7
5
6
6
5
7
4
8
3
9
2
(3)
TOTAL REVENUE
(4)
MARGINAL REVENUE
-
12.9
Marginal Revenue Curve
Facing a Monopolist
12.10
• For a monopolist to sell one more
unit, it must lower the price on all
units sold 
At every level of output except one
unit, a monopolist’s marginal
revenue is below price. (MR < P)
Marginal Revenue and Total Revenue
12.11
• A monopolist’s marginal revenue
curve shows the change in total
revenue that results as a firm moves
along the segment of the demand
curve that lies exactly above it.
• For a linear demand curve, the MR
curve will be twice as steep.
Price and Output Choice for a Profit-Maximizing
Monopolist
12.12
• A profit-maximizing
monopolist will raise output as
long as marginal revenue
exceeds marginal cost (like any
other firm). As the monopolist
produces and sells more, MC ↑
and MR ↓.
• The profit-maximizing level of
output is the one at which
MR = MC
The Absence of a Supply
Curve in Monopoly
A monopoly firm has no supply curve that is
independent of the demand curve for its product.
• A monopolist sets both price and quantity, and the
amount of output supplied depends on both its
marginal cost curve and the demand curve that it
faces.
12.13
Price and Output Choices for a Monopolist Suffering
Losses in the Short-Run
12.14
• It is possible for a profitmaximizing monopolist
to suffer short-run losses.
• If the firm cannot
generate enough revenue
to cover total costs, it
will go out of business in
the long-run.
Remember Perfect Competition
Perfectly Competitive industry in the long-run, price
will be equal to long-run average cost. The market
supply is the sum of all the short-run marginal cost
curves of the firms in the industry.
12.15
Perfect Competition and
Monopoly Compared
12.16
Pm is the price a
monopolist would set.
Qm is the quantity a
monopolist would
produce.
Pc is the price a
perfectly competitive
market would set. Qc
is the quantity a
perfectly competitive
market would produce.
Pm > Pc and Qm < Qc
• Relative to a competitively organized industry, a monopolist
restricts output, charges higher prices, and earns positive profits.
• There is no long-run equilibrium in which profits are competed
away through the entry of new firms.
Collusion and Monopoly Compared
Collusion is the act of firms working with other firms in
an effort to limit competition and increase joint profits.
Examples:
When firms collude, the outcome would be exactly the
same as the outcome of a monopoly in the industry.
12.17
The Social Costs of Monopoly
12.18
Suppose a firm has no fixed costs and marginal cost is constant.
These assumptions simplify the cost diagram as shown below.
Monopoly leads to an
inefficient mix of output
 Price is above marginal cost
(Pm > MC), which means that
the firm is underproducing
from society’s point of view.
Perfect Competition is efficient
 Price equals MC (Pc = MC),
and the efficient quantity is
being produced (Qc)
The Social Costs of Monopoly
12.19
The triangle ABC measures the
welfare loss (a.k.a. deadweight
loss or social cost) from the
market being monopolized.
This welfare loss or social cost
is measured as a loss in
consumer surplus from the
market being monopolized.
Rent-Seeking Behavior
12.20
Sometimes the cost is even greater than the triangle:
Rent-seeking behavior refers to
actions taken by households or
firms to preserve positive
economic profits.
A rational owner would be willing
to pay any amount less than the
entire rectangle PmACPc to
prevent those positive profits from
being eliminated as a result of
entry.
Government Failure
The idea of rent-seeking behavior introduces the notion
of government failure, in which the government
becomes the tool of the rent-seeker, and the allocation
of resources is made even less efficient than before.
The idea of government failure is at the center of
public choice theory, which holds that public officials
who set economic policies and regulate the players act
in their own self-interest, just as firms do.
Examples:
12.21
Price Discrimination
No Price Discrimination
A monopolist who cannot price
discriminate would maximize profit
by charging $4.
There is profit and consumer surplus.
12.22
Perfect Price Discrimination
For a perfectly price discriminating
monopolist, the demand curve is the
same as marginal revenue.
There is profit but no consumer
surplus.
Remedies for Monopoly:
Antitrust Policy
12.23
• A trust is an arrangement in which shareholders of independent firms agree
to give up their stock in exchange for trust certificates that entitle them to a
share of the trust’s common profits. A group of trustees then operates the
trust as a monopoly, controlling output and setting price.
• In 1890, Congress passed the Sherman Act, which declared every contract
or conspiracy to restrain trade among states or nations illegal; and any
attempt at monopoly, successful or not, a misdemeanor.
• The Clayton Act, passed by Congress in 1914, strengthened the Sherman
Act and clarified the rule of reason. The act outlawed specific monopolistic
behaviors such as tying contracts, price discrimination, and unlimited
mergers.
The Enforcement of Antitrust Law
12.24
• The Antirust Division (of the Department of Justice) is one of two federal
agencies empowered to act against those in violation of antitrust laws. It
initiates action against those who violate antitrust laws and decides which
cases to prosecute and against whom to bring criminal charges.
• The Federal Trade Commission (FTC), created by Congress in 1914, was
established to investigate the structure and behavior of firms engaging in
interstate commerce, to determine what constitutes unlawful “unfair”
behavior , and to issue cease-and-desist orders to those found in violation of
antitrust law.
Natural Monopoly
A natural monopoly is an industry that realizes such
large economies of scale in producing its product
that single-firm production of that good or service is
most efficient
 In this situation, we don’t want to use Antitrust laws
to prevent monopoly. Instead, one firm is allowed to
supply the market, but the government regulates its
behavior so that it doesn’t act like a monopolist.
 This is generally done by restricting the prices the
monopolist can charge and preventing it to restrict
output.
12.25
12.26
Natural Monopoly
Assume constant marginal cost and high fixed costs  ATC is falling over
the relevant Demand range. Only one firm is needed to supply the market.
Pm
Demand
ATC
Pc
MC
Qc
Qm
MR