© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair 12 Prepared by: Fernando Quijano and Yvonn Quijano Monopoly and

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair

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Prepared by: Fernando Prepared by: Fernando Quijano and Yvonn QuijanoQuijano and Yvonn Quijano

Monopoly and Antitrust PolicyMonopoly and Antitrust Policy


Imperfect CompetitionImperfect Competitionand Market Powerand Market Power

• An An imperfectly competitive industryimperfectly competitive industry is is an industry in which single firms have an industry in which single firms have some control over the price of their output.some control over the price of their output.

• Market powerMarket power is the imperfectly is the imperfectly competitive firm’s ability to raise price competitive firm’s ability to raise price without losing all demand for its product.without losing all demand for its product.


Defining Industry BoundariesDefining Industry Boundaries

• The ease with which consumers can The ease with which consumers can substitute for a product limits the extent to substitute for a product limits the extent to which a monopolist can exercise market which a monopolist can exercise market power.power.

• The more broadly a market is defined, the The more broadly a market is defined, the more difficult it becomes to find more difficult it becomes to find substitutes.substitutes.


Pure MonopolyPure Monopoly

• A A pure monopolypure monopoly is an industry with a is an industry with a single firm that produces a product for single firm that produces a product for which there are no close substitutes and in which there are no close substitutes and in which significant barriers to entry prevent which significant barriers to entry prevent other firms from entering the industry to other firms from entering the industry to compete for profits.compete for profits.


Barriers to EntryBarriers to Entry

• Things that prevent new firms from Things that prevent new firms from entering and competing in imperfectly entering and competing in imperfectly competitive industries include:competitive industries include:

• Government franchisesGovernment franchises, or firms that , or firms that become monopolies by virtue of a become monopolies by virtue of a government directive.government directive.




• PatentsPatents or barriers that grant the exclusive or barriers that grant the exclusive use of the patented product or process to use of the patented product or process to the inventor.the inventor.




• Economies of scale and other cost Economies of scale and other cost advantagesadvantages enjoyed by industries that enjoyed by industries that have large capital requirements. A large have large capital requirements. A large initial investment, or the need to embark in initial investment, or the need to embark in an expensive advertising campaign, deter an expensive advertising campaign, deter would-be entrants to the industry.would-be entrants to the industry.




• Ownership of a scarce factor of Ownership of a scarce factor of production:production: If production requires a If production requires a particular input, and one firm owns the particular input, and one firm owns the entire supply of that input, that firm will entire supply of that input, that firm will control the industry.control the industry.


Price: The Fourth Decision VariablePrice: The Fourth Decision Variable

• Firms with market power must decide:Firms with market power must decide:

1.1. how much to produce,how much to produce,

2.2. how to produce it,how to produce it,

3.3. how much to demand in each input market, how much to demand in each input market, andand

4.4. what price to charge for their output.what price to charge for their output.


Price and Output Decisions in Pure Price and Output Decisions in Pure Monopoly MarketsMonopoly Markets

• To analyze monopoly behavior we assume To analyze monopoly behavior we assume that:that:

• Entry to the market is blockedEntry to the market is blocked

• Firms act to maximize profitFirms act to maximize profit

• The pure monopolist buys in competitive input The pure monopolist buys in competitive input marketsmarkets

• The monopolistic firm cannot price discriminateThe monopolistic firm cannot price discriminate

• The monopoly faces a known demand curveThe monopoly faces a known demand curve



• With one firm in a monopoly market, there With one firm in a monopoly market, there is no distinction between the firm and the is no distinction between the firm and the industry. In a monopoly, the firm is the industry. In a monopoly, the firm is the industry.industry.

• The market demand curve is the demand The market demand curve is the demand curve facing the firm, and total quantity curve facing the firm, and total quantity supplied in the market is what the firm supplied in the market is what the firm decides to produce.decides to produce.



• The demand curve facing a perfectly competitive The demand curve facing a perfectly competitive firm is perfectly elastic; in a monopoly, the market firm is perfectly elastic; in a monopoly, the market demand curve is the demand curve facing the firm.demand curve is the demand curve facing the firm.


Marginal Revenue Facing a MonopolistMarginal Revenue Facing a Monopolist

Marginal Revenue Facing a MonopolistMarginal Revenue Facing a Monopolist

(1)(1)QUANTITYQUANTITY

(2)(2)PRICEPRICE

(3)(3)TOTAL REVENUETOTAL REVENUE

(4)(4)MARGINAL REVENUEMARGINAL REVENUE

00 $11$11 00

11 1010 $10$10 $10$10

22 99 1818 88

33 88 2424 66

44 77 2828 44

55 66 3030 22

66 55 3030 00

77 44 2828 22

88 33 2424 44

99 22 1818 66

1010 11 1010 88


Marginal Revenue CurveMarginal Revenue CurveFacing a MonopolistFacing a Monopolist

• For a monopolist, an For a monopolist, an increase in output involves increase in output involves not just producing more not just producing more and selling it, but also and selling it, but also reducing the price of its reducing the price of its output to sell it.output to sell it.

• At every level of output At every level of output except one unit, a except one unit, a monopolist’s marginal monopolist’s marginal revenue is below price.revenue is below price.


Marginal Revenue and Total RevenueMarginal Revenue and Total Revenue

• A monopolist’s marginal A monopolist’s marginal revenue curve shows the revenue curve shows the change in total revenue change in total revenue that results as a firm that results as a firm moves along the segment moves along the segment of the demand curve that of the demand curve that lies exactly above it.lies exactly above it.


Price and Output Choice for a Profit-Price and Output Choice for a Profit-Maximizing MonopolistMaximizing Monopolist

• A profit-maximizing A profit-maximizing monopolist will raise monopolist will raise output as long as output as long as marginal revenue marginal revenue exceeds marginal cost exceeds marginal cost (like any other firm).(like any other firm).

• The profit-maximizing The profit-maximizing level of output is the level of output is the one at which one at which MRMR = = MCMC..


The Absence of a SupplyThe Absence of a SupplyCurve in MonopolyCurve in Monopoly

• A monopoly firm has no supply curve that A monopoly firm has no supply curve that is independent of the demand curve for its is independent of the demand curve for its product.product.

• A monopolist sets both price and quantity, and A monopolist sets both price and quantity, and the amount of output supplied depends on both the amount of output supplied depends on both its marginal cost curve and the demand curve its marginal cost curve and the demand curve that it faces.that it faces.


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

• It is possible for a It is possible for a profit-maximizing profit-maximizing monopolist to monopolist to suffer short-run suffer short-run losses.losses.

• If the firm cannot If the firm cannot generate enough generate enough revenue to cover revenue to cover total costs, it will total costs, it will go out of business go out of business in the long-run.in the long-run.


Perfect Competition andPerfect Competition andMonopoly ComparedMonopoly Compared

• In a perfectly competitive industry in the long-run, In a perfectly competitive industry in the long-run, price will be equal to long-run average cost. The price will be equal to long-run average cost. The market supply is the sum of all the short-run market supply is the sum of all the short-run marginal cost curves of the firms in the industry.marginal cost curves of the firms in the industry.


Perfect Competition andPerfect Competition andMonopoly ComparedMonopoly Compared

• Relative to a competitively organized industry, a Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, monopolist restricts output, charges higher prices, and earns positive profits.and earns positive profits.


Collusion and Monopoly ComparedCollusion and Monopoly Compared

• CollusionCollusion is the act of working with other is the act of working with other producers in an effort to limit competition producers in an effort to limit competition and increase joint profits.and increase joint profits.

• When firms collude, the outcome would be When firms collude, the outcome would be exactly the same as the outcome of a exactly the same as the outcome of a monopoly in the industry.monopoly in the industry.


The Social Costs of MonopolyThe Social Costs of Monopoly

• Monopoly leads to Monopoly leads to an inefficient mix of an inefficient mix of output.output.

• Price is above Price is above marginal cost, which marginal cost, which means that the firm means that the firm is underproducing is underproducing from society’s point from society’s point of view.of view.


The Social Costs of MonopolyThe Social Costs of Monopoly

• The triangle The triangle ABCABC measures the net measures the net social gain of moving social gain of moving from 2,000 units to from 2,000 units to 4,000 units (or 4,000 units (or welfare loss from welfare loss from monopoly).monopoly).


Rent-Seeking BehaviorRent-Seeking Behavior

• Rent-seeking behaviorRent-seeking behavior refers to actions taken by refers to actions taken by households or firms to households or firms to preserve positive profits.preserve positive profits.

• A rational owner would be A rational owner would be willing to pay any amount willing to pay any amount less than the entire less than the entire rectangle rectangle PPmmACPACPcc to to

prevent those positive prevent those positive profits from being profits from being eliminated as a result of eliminated as a result of entry.entry.


Government FailureGovernment Failure

• The idea of rent-seeking behavior The idea of rent-seeking behavior introduces the notion of introduces the notion of government government failurefailure, in which the government becomes , in which the government becomes the tool of the rent-seeker, and the the tool of the rent-seeker, and the allocation of resources is made even less allocation of resources is made even less efficient than before.efficient than before.


Public Choice TheoryPublic Choice Theory

• The idea of government failure is at the The idea of government failure is at the center of center of public choice theorypublic choice theory, which , which holds that public officials who set holds that public officials who set economic policies and regulate the players economic policies and regulate the players act in their own self-interest, just as firms act in their own self-interest, just as firms do.do.


Remedies for Monopoly:Remedies for Monopoly:Antitrust PolicyAntitrust Policy

• A A trusttrust is an arrangement in which is an arrangement in which shareholders of independent firms agree shareholders of independent firms agree to give up their stock in exchange for trust to give up their stock in exchange for trust certificates that entitle them to a share of certificates that entitle them to a share of the trust’s common profits. A group of the trust’s common profits. A group of trustees then operates the trust as a trustees then operates the trust as a monopoly, controlling output and setting monopoly, controlling output and setting price.price.


Landmark Antitrust LegislationLandmark Antitrust Legislation

• Congress began to formulate antitrust Congress began to formulate antitrust legislation in 1887, when it created the legislation in 1887, when it created the Interstate Commerce Commission (ICC)Interstate Commerce Commission (ICC) to oversee and correct abuses in the to oversee and correct abuses in the railroad industry.railroad industry.

• In 1890, Congress passed the In 1890, Congress passed the Sherman Sherman ActAct, which declared every contract or , which declared every contract or conspiracy to restrain trade among states conspiracy to restrain trade among states or nations illegal; and any attempt at or nations illegal; and any attempt at monopoly, successful or not, a monopoly, successful or not, a misdemeanor.misdemeanor.



• The The rule of reasonrule of reason is a criterion is a criterion introduced by the Supreme Court in 1911 introduced by the Supreme Court in 1911 to determine whether a particular action to determine whether a particular action was illegal (“unreasonable”) or legal was illegal (“unreasonable”) or legal (“reasonable”) within the terms of the (“reasonable”) within the terms of the Sherman Act.Sherman Act.



• The The Clayton ActClayton Act, passed by Congress in , passed by Congress in 1914, strengthened the Sherman Act and 1914, strengthened the Sherman Act and clarified the rule of reason. The act clarified the rule of reason. The act outlawed specific monopolistic behaviors outlawed specific monopolistic behaviors such as tying contracts, price such as tying contracts, price discrimination, and unlimited mergers.discrimination, and unlimited mergers.



• The The Federal Trade Commission (FTC),Federal Trade Commission (FTC), created by Congress in 1914, was created by Congress in 1914, was established to investigate the structure and established to investigate the structure and behavior of firms engaging in interstate behavior of firms engaging in interstate commerce, to determine what constitutes commerce, to determine what constitutes unlawful “unfair” behavior , and to issue unlawful “unfair” behavior , and to issue cease-and-desist orders to those found in cease-and-desist orders to those found in violation of antitrust law.violation of antitrust law.


The Enforcement of Antitrust LawThe Enforcement of Antitrust Law

• The The Wheeler-Lea Act (1938)Wheeler-Lea Act (1938) extended the extended the language of the Federal Trade Commission Act to language of the Federal Trade Commission Act to include “deceptive” as well as “unfair” methods of include “deceptive” as well as “unfair” methods of competition.competition.

• The The Antirust Division (of the Department of Antirust Division (of the Department of Justice)Justice) is one of two federal agencies is one of two federal agencies empowered to act against those in violation of empowered to act against those in violation of antitrust laws. It initiates action against those who antitrust laws. It initiates action against those who violate antitrust laws and decides which cases to violate antitrust laws and decides which cases to prosecute and against whom to bring criminal prosecute and against whom to bring criminal charges.charges.


The Enforcement of Antitrust LawThe Enforcement of Antitrust Law

• The courts are empowered to impose a The courts are empowered to impose a number of remedies if they find that number of remedies if they find that antitrust law has been violated.antitrust law has been violated.

• Consent decreesConsent decrees are formal agreements are formal agreements on remedies between all the parties to an on remedies between all the parties to an antitrust case that must be approved by antitrust case that must be approved by the courts. Consent decrees can be the courts. Consent decrees can be signed before, during, or after a trial.signed before, during, or after a trial.


Natural MonopolyNatural Monopoly

• A A natural monopolynatural monopoly is an is an industry that realizes such industry that realizes such large economies of scale in large economies of scale in producing its product that producing its product that single-firm production of that single-firm production of that good or service is most good or service is most efficient.efficient.


Natural MonopolyNatural Monopoly

• With one firm With one firm producing 500,000 producing 500,000 units, average cost units, average cost is $1 per unit. With is $1 per unit. With five firms each five firms each producing 100,000 producing 100,000 units, average cost units, average cost is $5 per unit.is $5 per unit.

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© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair 12 Prepared by: Fernando Quijano and Yvonn Quijano Monopoly and