Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 32 Monopoly

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© 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 32

Monopoly A firm that is the only seller of a good or service that does not have a close substitute.

Is Any Firm Ever Really a Monopoly?

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1 Government blocks the entry of more than one firm into a market.

2 One firm has control of a key resource necessary to produce a good.

3 There are important network externalities in supplying the good or service.

4 Economies of scale are so large that one firm has a natural monopoly.

Where Do Monopolies Come From?

To have a monopoly, barriers to entering the market must be so high that no other firms can enter.

Barriers to entry may be high enough to keep out competing firms for four main reasons:

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Entry Blocked by Government Action

Patents and Copyrights

Patent The exclusive right to a product for a period of 20 years from the date the product is invented.

Copyright A government-granted exclusive right to produce and sell a creation.

Public Franchises

Public franchise A designation by the government that a firm is the only legal provider of a good or service.

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Natural Monopoly

Natural monopoly A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms.

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Average Total Cost Curve for a Natural Monopoly


Natural Monopoly

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Control of a Key Resource

Most resources, including raw materials such as oil or iron ore, are widely available from a variety of suppliers, but before World War II, the Aluminum Company of America (Alcoa) and the International Nickel Company of Canada were two monopolies based on control of a key resource.

Network externalities A situation in which the usefulness of a product increases with the number of consumers who use it.

Network Externalities

From a firm’s point of view, network externalities can set off a virtuous cycle:

If a firm can attract enough customers initially, it can attract additional customers because the value of its product has been increased by more people using it, which attracts even more customers, and so on.

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The End of the Christmas Plant MonopolyMaking

the

Connection

For many years, the Paul Ecke Ranch in Encinitas, California had a monopoly on poinsettias, whose striking red and green colors that blossom in the winter make them ideal for Christmas decorating.

After discovering a new technique for growing the wildflower that was kept secret for decades, the Ecke family was able to maintain a monopoly on its commercial production without acquiring a patent,

until a university researcher discovered the technique and published it in an academic journal.

As a result, many new firms quickly entered the industry and the price of poinsettias plummeted.

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Are Diamond Profits Forever?

The De Beers Diamond MonopolyMaking

the

Connection

The most famous monopoly based on control of a raw material is the De Beers diamond mining and marketing company of South Africa,

which became one of the most profitable and longest-lived monopolies in history by carefully controlling the supply of diamonds to keep prices high.

As competition in the diamond business gradually increased over the years, De Beers abandoned its strategy of attempting to control the worldwide supply of diamonds, concentrating instead on differentiating its diamonds by marking each one with a microscopic brand—a “Forevermark.”

Other firms have followed suit by branding their diamonds.

Whether consumers will pay attention to brands on diamonds remains to be seen,

although through 2011, the branding strategy had helped De Beers to maintain a 35 to 40 percent share of the diamond market.

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• The good thing. It sells more units of the product.

• The bad thing. It receives less revenue from each unit than it would have received at the higher price.

How Does a Monopoly Choose Price and Output?

Marginal Revenue Once Again

When a firm cuts the price of a product, one good thing happens, and one bad thing happens:

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Marginal Revenue Once Again

Calculating a Monopoly’s Revenue

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Profit Maximization for a Monopolist: MR = MC

Profit-Maximizing Price and Output for a Monopoly

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What Happens If a Perfectly Competitive Industry Becomes a Monopoly?

Does Monopoly Reduce Economic Efficiency?

Comparing Monopoly and Perfect Competition

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The Inefficiency of Monopoly


Measuring the Efficiency Losses from Monopoly

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1 Monopoly causes a reduction in consumer surplus.

2 Monopoly causes an increase in producer surplus.

3 Monopoly causes a deadweight loss, which represents a reduction in economic efficiency.


Measuring the Efficiency Losses from Monopoly

We can summarize the effects of monopoly as follows:

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Market power The ability of a firm to charge a price greater than marginal cost.

Market Power and Technological Change

The introduction of new products requires firms to spend funds on research and development.

Because firms with market power are more likely to earn economic profits than are perfectly competitive firms, they are also more likely to carry out research and development and introduce new products.


How Large Are the Efficiency Losses Due to Monopoly?

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Government Policy toward Monopoly

Antitrust Laws and Antitrust Enforcement

Collusion An agreement among firms to charge the same price or otherwise not to compete.

Antitrust laws Laws aimed at eliminating collusion and promoting competition among firms.

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Antitrust Laws and Antitrust Enforcement

Important U.S. Antitrust Laws

LAW DATE PURPOSE

Sherman Act 1890 Prohibited “restraint of trade,” including price fixing and collusion. Also outlawed monopolization.

Clayton Act 1914 Prohibited firms from buying stock in competitors and from having directors serve on the boards of competing firms.

Federal Trade Commission Act

1914 Established the Federal Trade Commission (FTC) to help administer antitrust laws.

Robinson-Patman Act 1936 Prohibited charging buyers different prices if the result would reduce competition.

Cellar-Kefauver Act 1950 Toughened restrictions on mergers by prohibiting any mergers that would reduce competition.

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Horizontal merger A merger between firms in the same industry.

Vertical merger A merger between firms at different stages of production of a good.


Mergers: The Trade-off between Market Power and Efficiency

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A Merger That Makes Consumers Better Off


Mergers: The Trade-off between Market Power and Efficiency

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1 Market definition

2 Measure of concentration

3 Merger standards

Market Definition

A market consists of all firms making products that consumers view as close substitutes.


The Department of Justice and Federal Trade Commission Merger Guidelines

The guidelines have three main parts:

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• 1 firm, with 100% market share (a monopoly): HHI = 1002 = 10,000

Measure of Concentration

• 2 firms, each with a 50% market share: HHI = 502 + 502 = 5,000

• 4 firms, with market shares of 30%, 30%, 20%, and 20%: HHI = 302 + 302 + 202 + 202 = 2,600

• 10 firms, each with market shares of 10%: HHI = 10 (102) = 1,000



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• Post-merger HHI below 1,000. These markets are not concentrated, so mergers in them are not challenged.

Merger Standards

• Post-merger HHI between 1,000 and 1,800. These markets are moderately concentrated. Mergers that raise the HHI by less than 100 probably will not be challenged. Mergers that raise the HHI by more than 100 may be challenged.

• Post-merger HHI above 1,800. These markets are highly concentrated. Mergers that increase the HHI by less than 50 points will not be challenged. Mergers that increase the HHI by 50 to 100 points may be challenged. Mergers that increase the HHI by more than 100 points will be challenged.



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Should AT&T Have Been Allowed to Merge with T-Mobile?

Makingthe

Connection

The two main ways that a merger between two large firms can increase the combined firm’s profits are by (1) increasing market power so as to increase prices, which the federal government may see as violating the antitrust laws, and (2) lowering costs through increased efficiency, which firms typically emphasize.

AT&T argued that the combined company, which would become the largest wireless firm in the United States, could operate at lower cost than could the companies operating separately.

AT&T was proposing a horizontal merger that would sharply increase both concentration in the wireless industry and HHI points, but because the Antitrust Division didn’t believe that cost savings would offset the increased market power the newly merged firm would acquire, it filed a lawsuit to stop the merger.

AT&T’s attempt to merge with T-Mobile was shaping up as a classic antitrust case of reduced price competition more than offsetting increased efficiency.

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Regulating a Natural Monopoly


Regulating Natural Monopolies

Documents

Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 1 of 32 Monopoly