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15 UNDERSTANDING MONOPOLY
Monopoly MR and Demand
The Monopolist’s Profit
Contrasting Competition and Monopoly Competitive Markets Monopoly Many firms One firm Produces efficient level of output (since P = MC) Produces less than the efficient level of output (since P > MC) Cannot earn long run economic profits May earn long run economic profits Has no market power (is a price taker) Has significant market power (is a price maker)
The Problems with Monopoly • Monopolies can make societies worse off – Restricting output and charging higher prices compared to competitive markets – Operate inefficiently (deadweight loss). This is referred to as market failure. – Less choices for consumers – Unhealthy competition called “rent seeking”
Deadweight Loss of Monopoly
Monopoly versus Competition • Output (quantity) – QMonopoly < QCompetition • Price – PCompetition < PMonopoly • Deadweight loss – Monopoly DWL > 0 – Competition DWL = 0
Monopoly Problems • Few choices – Restricts consumer ability to put downward pressure on prices. No substitutes. – Cable companies and bundling. Monopolies can force you to buy more. – And not necessarily the channels you want
What’s So Bad About Monopolies? • Compared to Perfect Competition – Higher Price for Fewer Goods • Economic Considerations – P > MC • Consumer’s value (MV) of Q* > Cost (MC) of resources used – Thus -> Deadweight Loss (Economic Inefficiency) • Allocatively Inefficient – Q* not produced at lowest cost (ATC > min(ATC)) • Productively Inefficient – Little Incentive to Adopt New Technology • No competition -> no incentive to adopt new tech & reduce cost
How Did It Happen? • Monopoly – Firm that is the sole seller of a product without close substitutes • Barriers to entry – prevent firms from entering this market when there are + economic profits • Legal and Cost Barriers – NBA, Medical, Patents (pharmaceutical) • Monopoly resources – Oil, Diamonds, Professional Sports • Government regulation – Comcast • High Cost Barriers to Enter the Market – Aerospace
Big Pharma • Big Pharma Is America’s New Mafia – Pharmaceutical companies have more power than ever, and the American people are paying the price—too often with our lives. • http: //time. com/3700497/john-oliverlast-week-tonight-big-pharma/
Professional Sports • At the federal level, antitrust legislation serves as one culprit in the city-switching games played by teams. • Pro sports leagues have been classified by government officials as monopolies, and are therefore subject to antitrust regulation. • The exception to this has been Major League Baseball, which operates under an antitrust exemption, and indeed, baseball teams remain far less mobile than, for example, NFL teams.
Aerospace • Boeing and Airbus – Market Share
Solutions to Monopoly • “Divestiture” (Sherman Act (1890) – Breaking one big company into a smaller number of “competing” companies • AT&T (1982), Standard Oil (1911) • Telecomm Act (1996) – Allows competitors to access/rent current Telecomm companies network at “forward-looking” costs (best, most efficient technology) • Ignored that: (1) local phone company’s costs based on historical costs to be recovered over 20 years • (2) Residential rates subsidized (below costs)for universal service – higher costs business rates
Solutions to Monopoly • Preventing anti-competitive mergers – Sherman Act (1890) – FCC, FTC and SEC – AT&T and T-Mobile • Reduce competition
AT&T – A Short History • Alexander Graham Bell patented the telephone in 1876, – formed Bell Telephone which licensed local telephone exchanges in major US cities. AT&T was formed in 1885 • In 1913 AT&T became a regulated monopoly. – had to connect competing local companies – And let the Federal Communication Commission (FCC) approve their prices and policies. • All customers rented phones from AT&T, and no other equipment could be attached to the network for fear of "breaking" it.
AT&T – A Short History • On January 1, 1984, a court forced AT&T to give up its 22 local Bell companies (Divestiture) • This established seven Regional Bell Operating Companies (RBOC). – Since that time, mergers have reduced the number of RBOCs to four: Verizon (originally Bell Atlantic and Nynex), Qwest (Qwest Communications International took over US West), Bell. South and SBC (originally Southwestern Bell and Pacific Telesys).
How Do We “Fix” Monopolies • Lower Barriers to Entry – Goal is to increase competition by allowing more firms to enter the market and compete against each other • AT&T Divestiture (1980) – DOJ and FCC sought to introduce competition into the local phone markets (dominated by 7 RBOCs, “bab y bells”) – Required AT&T/RBOCs to lease local wirelines, switching networks, transmission satellites and local household connections at “forward” looking economic costs (which were below historical costs)
How Do We “Fix” Monopolies •
AT&T Before and After the Break-up •
After the Break Up
Colbert on the AT&T Break-Up http: //www. ebaumsworld. com/video/watch/9 55486/
Natural Monopoly – Avg Cost Decrease with Increasing Size/Scale of the Firm – Divestiture Raises Avg Cost Average Total Cost ATC in short run with small factory ATC in short run with medium factory ATC in short run with large factory ATC in long run 6 $12, 000 10, 000 Economies of scale 0 Constant returns to scale 1, 000 1, 200 Diseconomies of scale Quantity of Cars per Day Because fixed costs are variable in the long run, the average-total-cost curve in the short run differs from the average-total-cost curve in the long run. 23
Why Monopolies Arise • The production process – A single firm can produce output at a lower cost than can a larger number of producers • Natural monopoly – Arises because a single firm can supply a good or service to an entire market • At a smaller cost than could two or more firms 24 – Economies of scale over the relevant
Solutions to Monopoly • For Natural Monopolies – Price regulation • Often, we don’t want to break up firms due to large economies of scale • Don’t need to have redundant water pipes, power lines – In this case, a monopoly may be desirable, but we may still need to regulate the firm to prevent market power abuse
1 Economies of scale as a cause of monopoly Costs Average total cost 0 Quantity of output When a firm’s average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a result, a single firm can produce any given amount at the smallest cost 26
Regulatory Solution for Natural Monopoly
Marginal Cost Pricing • At P = MC – The monopolist experiences a loss – MC < ATC, so P < ATC (results in losses) • Solutions? – Government subsidies given to the firm – Set P = ATC at the P = MC output level – Government ownership of the firm – French approach • Set P=MC => subsidize ∆ (ATC-MC) from taxes
Government Failure • Government intervention – Can eliminate the profit motive and the necessity to innovate and improve efficiency • Free market – Firms under MC pricing have no incentive to lower costs. • Price Caps: – Set maximum price to recover costs (P+ATC) – Adjust price over time for efficiency » P(next year) = P(today) – Average Industry Productivity – Often better than government intervention and changing incentives for a firm
Conclusion • While competitive markets generally bring about welfare-enhancing outcomes for society, monopolies often do the opposite – Government seeks to limit monopoly outcomes and promote competitive markets • Perfectly competitive markets and monopoly are market structures at opposite extremes – Most economic activity takes place between these two alternatives
Natural Barriers to Entry • Economies of scale – “Bigger is better” (more cost-efficient) – This is due to the ATC being downwardsloping over a large range of output – Lower costs lower prices – Car production, electricity production, mail delivery • Natural monopoly – A monopoly exists because a single large firm has lower costs than any potential competitor – In addition, breaking up the firm into multiple competitors may increase costs as well
Summary • Monopolies – Market structure characterized by a single seller who produces a well-defined product with few good substitutes – Operate in a market with high barriers to entry, the chief source of market power. – May earn long run profits • Perfectly competitive firms are price takers. Monopolists are price makers.
Summary • Like perfectly competitive firms, a monopoly tries to maximize its profits. – Same profit maximizing rule of MR = MC is used. • From an efficiency standpoint, the monopolist charges too much and produces too little. • Since the output of the monopolist is smaller than would exist in a competitive market, the outcome also results in deadweight loss.
Summary • Government grants of monopoly power encourage rent seeking • There are four potential solutions to the problem of monopoly – First, the government may break up firms to restore a competitive market – Second, government can promote open markets by reducing trade barriers – Third, the government can regulate a monopolist’s ability to charge excessive prices – Finally, there are circumstances in which it is better to leave the monopolist alone
Practice What You Know Which of the following firms will most likely be a natural monopoly? A. B. C. D. A grocery store A cable TV company A gas station A barbershop
Practice What You Know Which of the following most accurately describes a patent? A. B. C. D. An incentive to innovate A profit-sharing mechanism A redistribution of wealth An original invention
Practice What You Know What is true for a profit-maximizing monopoly? A. B. C. D. P = MR = MC P = MR > MC P > MR = MC P > MR > MC
Practice What You Know What is the reason for monopoly deadweight loss (relative to perfect competition)? A. The monopolist faces a downward sloping demand curve B. People boycott monopolies more often C. The monopolist sells less output at a higher price D. The monopolist has no competitors
Practice What You Know A monopolist will have negative profits and exit the industry in the long run if: A. B. C. D. A new competitor enters the industry Demand becomes more elastic Price < ATC A monopolist never has negative profits