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Lesson 3 Regulation of Monopoly.

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In perfect competition, once a long run equilibrium has been established, the ... Thus perfect competition is seen as a situation of maximal efficiency. ... – PowerPoint PPT presentation

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Title: Lesson 3 Regulation of Monopoly.


1
Lesson 3 - Regulation of Monopoly.
  • The Economics of Monopoly and competition.
    Anti-monopoly law in theory and practice. The
    current anti-trust environment

2
What does it mean?
  • The term monopoly is commonly understood to mean
    a single seller of a valuable item (good or
    service).
  • This can be very misleading. Being a single
    seller is neither a sufficient nor a necessary
    condition for the possession of monopoly power.
  • The discussion is confused by the tendency to use
    the categories that have been developed in
    neoclassical economics to define monopoly and to
    fashion legislation and regulation to deal with
    it.
  • In order to understand both the question of
    monopoly and the anti-monopoly (anti-trust)
    regulatory environment, therefore, we need to
    understand the categories that have been
    development in neoclassical economics and how
    this has become embodied in the law and in the
    regulatory environment.
  • Once we understand this we can analyze its
    limitations and move beyond it.

3
A Little Neoclassical Economics
  • What is competition how would you know it if
    you saw it?
  • If monopoly is one seller, then perhaps
    competition is many sellers each one is a price
    taker (as compared to a price maker or price
    searcher).
  • A buyers monopoly exists if there is one buyer
    (monopsony), then perhaps competition is many
    buyers each one is a price taker..
  • In order to compete equally buyers and sellers
    must
  • Buy and sell the same identical product - no
    product differentiation - all firms are identical
    - new firms can enter in pursuit of profit.
  • Be aware of everything they need to know about
    the product and what is happening in the market
  • Be competing in a market in which technology is
    not changing and in which property rights are
    well enforced.
  • Be competing in a market in which there are no
    hidden or external costs (absence of market
    failure).

4
The Neoclassical Spectrum
(Perfect) Monopoly One seller - one seller Static
no changes in technology or the nature of the
product
Perfect Competition A large number of sellers and
buyers Static no changes in technology or the
nature of the product
5
Production costs
AC, MC

AC
MC
MC cuts AC at its minimum
Q
0
6
Production costs 3a
When MC is below AC When AC is falling AC is
falling MC is below AC When MC is above
AC When AC is rising AC is rising. MC is
above AC When MC is equal to AC When AC is
constant AC is constant MC is equal to AC If
AC is U shaped, then MCAC at its minimum.
7
The Case of Perfect Competition - 1
P
AC
MC
D AR MR
Pc1
Profits
ACc1
Q
Qc1
0
8
The Case of Perfect Competition - 2
P
AC
MC
D AR MR
E
Pc2
Optimum point P MC MR AR AC
Q
Qc2
0
9
The Case of Perfect Competition 3 The Industry
and the firm
P
S1
AC
S2
MC
P1
E industry
E
P2
Optimum point
D
q2
q1
Q
Q1
Q2
10
The Case of Perfect Competition - 4
  • In summary
  • This is a market for a standardized good or
    service, each competitor selling exactly the same
    item (no product differentiation) there is
    freedom of entry.
  • This market is one in which buyers and sellers
    are very well informed about all costs and
    prices, and n which the technology of production
    and the characteristics of the good or service is
    not changing
  • There are well defined and enforced property
    rights there are no hidden social costs
  • Neoclassicals refer to this as perfect
    competition.
  • In perfect competition, once a long run
    equilibrium has been established, the price will
    equal the marginal cost and both will be equal to
    the average cost at the lowest possible average
    cost.
  • Thus perfect competition is seen as a situation
    of maximal efficiency. A competitive output is
    being produced at the lowest possible cost.
  • This is frequently seen as a competitive ideal
    for economic policy in the sense that where it
    does not apply policy should take steps to
    promote it or simulate it (for example, by
    forcing the regulated company to produce at a
    price that is equal to marginal cost).

11
Costs and Revenues price taker (perfect
competition)
TC
TR PQ
TR
TC
Maximum Profit
Q
0
Q
12
Costs and Revenues price searcher (monopoly)
TC
TC
TR PQ
TR
Maximum Profit
0
Q
Q
13
MR, Elasticity and the TR curve
ED 1 MR 0
Total Revenue
?
TR
ED 1 MR 0
ED ED ?QD/?P
0
Quantity Demanded/Sold
14
Demand, AR and MR
P
ED? 8
ED 1
.
Midpoint ED 1
D P AR
ED MR
Q
0
MR0
ED 0
15
Consumer Surplus
P
Consumer surplus and the difference between price
and value the diamond-water paradox.
P1
P2
P3
P
D
Q
O
Q1
Q3
Q2
Q
16
Producer Surplus
P
S
P
P3
P2
P1
Q
O
Q1
Q3
Q2
Q
17
Consumer and Producer Surplus
S
Consumer surplus
P
Producer surplus
D
Q
18
Monopoly in Neoclassical Economics
P
Loss of consumer and producer surplus
AC
MC
Pm
Monopoly Profit
ACm
TC
D AR
MR
Q
0
Qm
19
Costs and Revenues price searcher (monopoly)
with constant costs

TR
TC
Maximum Profit
Q
0
Q
20
TC and MC when cost increases are constant
TC
TC aQ
Q
0
MC
MC ?TC/ ?Q AC TC/ Q
MC a AC
Q
0
21
Monopoly in Neoclassical Economics
P
A
Loss of consumer surplus Deadweight loss
PM
Monopoly Profit
B
AC MC
ACPC C
TC
D AR
MR
Q
0
QC
QM
22
Neoclassical theory of monopoly summary
  • Neoclassical theory identifies the monopolist as
    a single seller. The single seller will maximize
    profits (like everyone else) by producing a
    quantity for which the marginal revenue equals
    the marginal cost and this, obviously, implies a
    lower quantity and a higher price than that which
    would prevail under hypothetical perfect
    competition.
  • This approach leads one to infer the degree of
    monopoly by
  • the number of firms (sellers) there are in an
    industry, by market share the fewer the greater
    the degree of alleged monopoly power
  • or by the extent to which the seller can control
    the price - the elasticity of demand (but
    remember a seller will always raise the price as
    long as the elasticity is less than one (unity
    1), so even observing elasticity in this
    framework may be misleading).
  • Solutions
  • Continuing oversight consent decrees
  • Breakups
  • Price controls
  • Some combination of the above

23
Evaluating the Neoclassical Approach to Monopoly
  • This view of monopoly is, like the view of
    perfect competition, completely static it makes
    no mention of the passage of time and its
    effects. In reality, at any point of time one or
    a few sellers may dominate the market only to be
    replaced over time by a more efficient
    competitor. Even one or a very small number of
    sellers can face vigorous competition over time,
    or the threat of competition, which may greatly
    reduce their control over price.
  • Perfect competition may be an inappropriate
    standard. It is not really a competitive
    situation.
  • It is a situation in which all competition has
    ceased. No profits are earned, no innovation is
    taking place and there is no ignorance or
    bargaining in the market.
  • It has very little relevance to the benefits that
    consumers may expect to gain from real world
    competition.

24
An alternative view of monopoly
  • Thinking about monopoly in the real world forces
    us to consider the process of competition over
    time. All of the conditions of the model of
    perfect competition are violated in important
    ways that make the perfect competition standard
    inappropriate.
  • In the real world competition proceeds by
    companies experimenting with
  • new products
  • new methods of production
  • new resources
  • new organizational methods
  • In the real world competition proceeds competing
    with one another vigorously for the consumers
    business by lowering prices and/or improving
    quality.
  • There is no way to predict who will win the
    competitive struggle and todays winner may be
    eclipsed tomorrow.

25
A different view of monopoly leads to a different
view of anti-trust policy
  • This alternative dynamic view sees monopoly as
    the power that a seller has over the price he/she
    can charge by virtue of special protection
    against competition over time barriers to
    entry.
  • It is all about the ability to compete and
    freedom of entry by actual or potential
    competitors.

26
What constitutes a real or credible barrier to
entry?
  • We may ask, that would protect a seller? A number
    have been discussed in the literature and
    include
  • Product differentiation
  • Advertising
  • Capital
  • Economies of scale
  • Predatory behavior
  • Pricing
  • Other bundling
  • Vertical agreements and anti-trust (is the law
    necessary).
  • Tying
  • Resale price maintenance
  • In the final analysis only one remains one
  • governmental protection.

27
Identifying monopoly
  • From this perspective, monopoly power has nothing
    to do with the number of sellers or the size of
    the elasticity of demand.
  • The only relevant consideration is whether the
    seller in question has the power to prevent
    competitors from entering the industry
  • And the relevant consideration for policy is
    whether the policy-makers can be assured of
    making things better for consumers.

28
Price Discrimination
  • What is it?
  • The ability to charge different prices to the
    same consumer or different consumer.
  • Perfect discrimination would look like this

P
P1
P2
P3
Q
Q1
Q2
Q3
29
Conditions for price discrimination
  • There are only two both are necessary take
    the case of only two markets second degree
    price discrimination
  • The ability to separate the markets
  • Different elasticities of demand in the two
    markets
  • MR1 MR2 MC
  • P1 P2 if E1
  • Vertical agreements and anti-trust (is the law
    necessary).
  • Sound business practice dictates buying at the
    lowest cost/price
  • Tying
  • Resale price maintenance

30
Different elasticities different prices
P1
P2
MC
D2
D1
MR2
MR1
Q1
Q2
31
Natural Monopoly
  • What is it?
  • It is a matter of decreasing cost - economies of
    scale
  • Examples are public utilities - water, gas,
    electricity, cable
  • Do we need to regulate them?
  • What kind of regulation is best?
  • MC pricing
  • Return on capital
  • Simple monopoly franchising - the renewal problem


AC
Q
32
Network Monopolies
  • Network effects what are they?
  • Do they lead to monopoly through lock-in and
    lock-out?
  • In the final analysis it is a matter of
    presumption burden of proof, but the history
    suggests that the market works.
  • VHS/Beta
  • QWERTY

33
The legal environment
  • There are three major federal antitrust laws
  • the Sherman Antitrust Act - 1890
  • the Clayton Act
  • the Federal Trade Commission Act.
  • (see http//www.usdoj.gov/atr/public/div_stats/914
    2.htm )
  • The FTC, the Justice Department (anti-trust
    division), the states.
  • Per se violations and rule of reason
    violations.
  • Price fixing the question of cartels
  • Cartels maintenance requires
  • The allocation of quotas
  • The prevention of cheating
  • The prevention of alternative (non-cartel) supply
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