Ch. 12 Monopoly and Antitrust

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Ch. 12 Monopoly and Antitrust

• 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
  firms 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

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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

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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.

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Firm Decision-Making Price is the Fourth
Decision Variable

• Firms with market power must decide
• how much to produce
• how to produce it
• how much to demand in each input market
• what price to charge for their output.
• 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

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Price and Output Decisions in Pure Monopoly
Markets

• 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.

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For a Pure Monopolist

• 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 monopolists 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.

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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 Marginal Revenue Facing a Monopolist Marginal Revenue Facing a Monopolist Marginal Revenue Facing a Monopolist Marginal Revenue Facing a Monopolist Marginal Revenue Facing a Monopolist Marginal Revenue Facing a Monopolist Marginal Revenue Facing a Monopolist
(1)QUANTITY (1)QUANTITY (2)PRICE (2)PRICE (3)TOTAL REVENUE (3)TOTAL REVENUE (4)MARGINAL REVENUE (4)MARGINAL REVENUE
0 11 -
1 10
2 9
3 8
4 7
5 6
6 5
7 4
8 3
9 2
10 1
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Marginal Revenue CurveFacing a Monopolist

• 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
  monopolists marginal revenue is below price. (MR
  lt P)

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Marginal Revenue and Total Revenue

• A monopolists 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.

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Price and Output Choice for a Profit-Maximizing
Monopolist

• 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

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The Absence of a SupplyCurve 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.

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Price and Output Choices for a Monopolist
Suffering Losses in the Short-Run

• It is possible for a profit-maximizing 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.

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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.

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Perfect Competition andMonopoly Compared
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 gt Pc and Qm lt 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.

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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.

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The Social Costs of Monopoly
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 gt MC), which
  means that the firm is underproducing from
  societys point of view.
• Perfect Competition is efficient
• Price equals MC (Pc MC), and the efficient
  quantity is being produced (Qc)

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The Social Costs of Monopoly

• 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.

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Rent-Seeking Behavior
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.

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Price Discrimination
No Price Discrimination
Perfect Price Discrimination
A monopolist who cannot price discriminate would
maximize profit by charging 4. There is profit
and consumer surplus.
For a perfectly price discriminating monopolist,
the demand curve is the same as marginal
revenue. There is profit but no consumer surplus.
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Remedies for MonopolyAntitrust Policy

• 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 trusts 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.

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The Enforcement of Antitrust Law

• 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.

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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 dont 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 doesnt act
  like a monopolist.
• This is generally done by restricting the prices
  the monopolist can charge and preventing it to
  restrict output.

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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
MC
Pc
Qc
Qm
MR