CHAPTER 13 Monopoly and Antitrust Policy
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Monopoly andAntitrust Policy
Fernando & Yvonn Quijano
Prepared by:
PART III MARKET IMPERFECTIONS ANDTHE ROLE OF GOVERNMENT
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CHAPTER OUTLINE
Monopoly andAntitrust Policy
Imperfect Competition and Market Power: Core Concepts
Defining Industry Boundaries
Barriers to Entry
Price: The Fourth Decision Variable
Price and Output Decisions in Pure MonopolyMarkets
Demand in Monopoly Markets
Perfect Competition and Monopoly Compared
Collusion and Monopoly Compared
The Social Costs of Monopoly
Inefficiency and Consumer Loss
Rent-Seeking Behavior
Price Discrimination
Examples of Price Discrimination
Remedies for Monopoly: Antitrust Policy
The Development of Antitrust Law: HistoricalBackground
Landmark Antitrust Legislation
The Enforcement of Antitrust Law
Initiating Antitrust Actions
Sanctions and Remedies
Criminal Actions
A Natural Monopoly
Do Natural Monopolies Still Exist?
Imperfect Markets: A Review and a Look Ahead
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Imperfect Competition and Market Power: Core Concepts
imperfectly competitive industry Anindustry in which individual firms havesome control over the price of theiroutput.
market power An imperfectlycompetitive firm’s ability to raise pricewithout losing all of the quantitydemanded for its product.
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Imperfect Competition and Market Power: Core Concepts
Forms of Imperfect Competition and Market Boundaries
pure monopoly An industry with a singlefirm that produces a product for whichthere are no close substitutes and in whichsignificant barriers to entry prevent otherfirms from entering the industry to competefor profits.
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Imperfect Competition and Market Power: Core Concepts
Forms of Imperfect Competition and Market Boundaries
FIGURE 13.1 The Boundary of a Market and Elasticity
We can define an industry as broadly or as narrowly as we like. The more broadly we definethe industry, the fewer substitutes there are; thus, the less elastic the demand for thatindustry’s product is likely to be. A monopoly is an industry with one firm that produces aproduct for which there are no close substitutes. The producer of brand X hamburger cannotproperly be called a monopolist because this producer has no control over market price andthere are many substitutes for brand X hamburger.
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Price and Output Decisions in Pure Monopoly Markets
Demand in Monopoly Markets
FIGURE 13.2 The Demand Curve Facing a Perfectly Competitive Firm Is Perfectly Elastic
Perfectly competitive firms are price-takers; they are small relative to the size of the marketand thus cannot influence market price. The implication is that the demand curve facing aperfectly competitive firm is perfectly elastic. If the firm raises its price, it sells nothing andthere is no reason for the firm to lower its price if it can sell all it wants at P* = $5.
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Price and Output Decisions in Pure Monopoly Markets
Demand in Monopoly Markets
FIGURE 13.3 Marginal Revenue Curve Facing a Monopolist
At every level of output except 1 unit, a monopolist’s marginal revenue (MR) is belowprice. This is so because (1) we assume that the monopolist must sell all its product at asingle price (no price discrimination) and (2) to raise output and sell it, the firm must lowerthe price it charges. Selling the additional output will raise revenue, but this increase isoffset somewhat by the lower price charged for all units sold. Therefore, the increase inrevenue from increasing output by 1 (the marginal revenue) is less than the price.
Marginal Revenue and Market Demand
TABLE 13.1 Marginal Revenue Facing a Monopolist
(1)Quantity
(2)Price
(3)TotalRevenue
(4)MarginalRevenue
0
$11
0
-
1
10
$10
$10
2
9
18
8
3
8
24
6
4
7
28
4
5
6
30
2
6
5
30
0
7
4
28
-2
8
3
24
-4
9
2
18
-6
10
1
10
-8
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Price and Output Decisions in Pure Monopoly Markets
Demand in Monopoly Markets
FIGURE 13.4 Marginal Revenueand Total Revenue
A monopoly’s marginal revenuecurve bisects the quantity axisbetween the origin and thepoint where the demand curvehits the quantity axis. Amonopoly’s MR curve showsthe change in total revenue thatresults as a firm moves alongthe segment of the demandcurve that lies exactly above it.
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Price and Output Decisions in Pure Monopoly Markets
The Monopolist’s Profit-Maximizing Price and Output
FIGURE 13.5 Price andOutput Choice for a Profit-Maximizing Monopolist
A profit-maximizingmonopolist will raiseoutput as long as marginalrevenue exceeds marginalcost. Maximum profit is atan output of 4,000 unitsper period and a price of$4. Above 4,000 units ofoutput, marginal cost isgreater than marginalrevenue; increasing outputbeyond 4,000 units wouldreduce profit. At 4,000units, TR = PmAQm0, TC =CBQm0, and profit =PmABC.
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Price and Output Decisions in Pure Monopoly Markets
The Absence of a Supply Curve in Monopoly
A monopoly firm has no supply curve that is independent of thedemand curve for its product.
A monopolist sets both price and quantity, and the amount ofoutput that it supplies depends on both its marginal cost curveand the demand curve that it faces.
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Price and Output Decisions in Pure Monopoly Markets
Perfect Competition And Monopoly Compared
FIGURE 13.6 A Perfectly Competitive Industry in Long-Run Equilibrium
In a perfectly competitive industry in the long run, price will be equal to long-run averagecost. The market supply curve is the sum of all the short-run marginal cost curves of thefirms in the industry. Here we assume that firms are using a technology that exhibitsconstant returns to scale: LRAC is flat. Big firms enjoy no cost advantage.
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Price and Output Decisions in Pure Monopoly Markets
FIGURE 13.7 Comparison of Monopoly and Perfectly Competitive Outcomes for a Firm withConstant Returns to Scale
In the newly organized monopoly, the marginal cost curve is the same as the supply curvethat represented the behavior of all the independent firms when the industry was organizedcompetitively. Quantity produced by the monopoly will be less than the perfectly competitivelevel of output, and the monopoly price will be higher than the price under perfect competition.Under monopoly, P = Pm = $4 and Q = Qm = 2,500. Under perfect competition, P = Pc = $3and Q = Qc = 4,000.
Perfect Competition And Monopoly Compared
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Price and Output Decisions in Pure Monopoly Markets
Monopoly in the Long Run: Barriers to Entry
barriers to entry Factors that preventnew firms from entering andcompeting in imperfectly competitiveindustries.
natural monopoly An industry thatrealizes such large economies of scalein producing its product that single-firmproduction of that good or service ismost efficient.
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Price and Output Decisions in Pure Monopoly Markets
Monopoly in the Long Run: Barriers to Entry
FIGURE 13.8 A NaturalMonopoly
A natural monopoly is afirm in which the mostefficient scale is verylarge. Here, average totalcost declines until a singlefirm is producing nearlythe entire amountdemanded in the market.With one firm producing500,000 units, averagetotal cost is $1 per unit.With five firms eachproducing 100,000 units,average total cost is $5per unit.
Economies of Scale
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Price and Output Decisions in Pure Monopoly Markets
Monopoly in the Long Run: Barriers to Entry
patent A barrier to entry that grantsexclusive use of the patented productor process to the inventor.
Patents
Government Rules
Ownership of a Scarce Factor of Production
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Price and Output Decisions in Pure Monopoly Markets
Monopoly in the Long Run: Barriers to Entry
Managing the Cable Monopoly
In the last 20 years, the cable system has grownto a multi-billion dollar industry covering most ofthe country. What you might not realize aboutthe cable system is that it consists of a networkof local monopolies. cities negotiate with thevarious cable companies to give one of them theright to be the monopoly supplier of cable servicein return for a fee that is typically on the order of5 percent of the cable revenues.
Network Effects
network externalities The valueof a product to a consumerincreases with the number of thatproduct being sold or used in themarket.
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The Social Costs of Monopoly
Inefficiency And Consumer Loss
FIGURE 13.9 WelfareLoss from Monopoly
A demand curve shows theamounts that people arewilling to pay at eachpotential level of output.Thus, the demand curve canbe used to approximate thebenefits to the consumer ofraising output above 2,000units.
MC reflects the marginal costof the resources needed.
The triangle ABC roughlymeasures the net social gainof moving from 2,000 units to4,000 units (or the loss thatresults when monopolydecreases output from 4,000units to 2,000 units).
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The Social Costs of Monopoly
Rent-Seeking Behavior
rent-seeking behavior Actions taken byhouseholds or firms to preserve positiveprofits.
government failure Occurs when thegovernment becomes the tool of the rentseeker and the allocation of resources ismade even less efficient by the interventionof government.
public choice theory An economic theorythat the public officials who set economicpolicies and regulate the players act intheir own self-interest, just as firms do.
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Price Discrimination
price discrimination Chargingdifferent prices to different buyers.
perfect price discriminationOccurs when a firm charges themaximum amount that buyers arewilling to pay for each unit.
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Price Discrimination
FIGURE 13.10 Price Discrimination
In Figure 13.10(a), consumer A is willing to pay$5.75. If the price-discriminating firm can charge$5.75 to A, profit is $3.75. A monopolist whocannot price discriminate would maximize profitby charging $4. At a price of $4.00, the firmmakes $2.00 in profit and consumer A enjoys aconsumer surplus of $1.75.
In Figure 13.10(b), for a perfectly price-discriminating monopolist, the demandcurve is the same as marginal revenue.The firm will produce as long as MR > MC,up to Qc. At Qc, profit is the entire shadedarea and consumer surplus is zero.
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Remedies for Monopoly: Antitrust Policy
Major Antitrust Legislation
The Sherman Act of 1890 The substance of the ShermanAct is contained in two short sections:
Section 1. Every contract, combination in the form of trust orotherwise, or conspiracy, in restraint of trade or commerceamong the several States, or with foreign nations, is herebydeclared to be illegal....
Section 2. Every person who shall monopolize, or attempt tomonopolize, or combine or conspire with any other person orpersons, to monopolize any part of the trade or commerce
among the several States, or with foreign nations, shall bedeemed guilty of a misdemeanor, and, on conviction thereof,shall be punished by fine not exceeding five thousanddollars, or by imprisonment not exceeding one year, or byboth said punishments, in the discretion of the court.
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Remedies for Monopoly: Antitrust Policy
rule of reason The criterion introduced bythe Supreme Court in 1911 to determinewhether a particular action was illegal(“unreasonable”) or legal (“reasonable”)within the terms of the Sherman Act.
Major Antitrust Legislation
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Remedies for Monopoly: Antitrust Policy
Major Antitrust Legislation
Clayton Act Passed by Congress in 1914 tostrengthen the Sherman Act and clarify the rule ofreason, the act outlawed specific monopolisticbehaviors such as tying contracts, pricediscrimination, and unlimited mergers.
Federal Trade Commission (FTC) A federalregulatory group created by Congress in 1914 toinvestigate the structure and behavior of firmsengaging in interstate commerce, to determine whatconstitutes unlawful “unfair” behavior, and to issuecease-and-desist orders to those found in violationof antitrust law.
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Remedies for Monopoly: Antitrust Policy
The GovernmentTakes on WholeFoods
FTC opposing Wild Oats,Whole Foods mergerThe Denver Post
“Whole Foods and Wild Oats are eachother’s closest competitors in premiumnatural and organic supermarkets,and are engaged in intense head-to-head competition in markets acrossthe country,” Jeffrey Schmidt, directorof the FTC’s Bureau of Competition,said in a press release. “If WholeFoods is allowed to devour Wild Oats, it will mean higher prices,reduced quality, and fewer choices for consumers. That is a dealconsumers should not be allowed to swallow.”
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Imperfect Markets: A Review and a Look Ahead
A firm has market power when it exercises some control over theprice of its output or the prices of the inputs that it uses. Theextreme case of a firm with market power is the pure monopolist.In a pure monopoly, a single firm produces a product for whichthere are no close substitutes in an industry in which all newcompetitors are barred from entry.
Our focus in this chapter on pure monopoly (which occurs rarely)has served a number of purposes. First, the monopoly modeldescribes a number of industries quite well. Second, themonopoly case illustrates the observation that imperfectcompetition leads to an inefficient allocation of resources. Finally,the analysis of pure monopoly offers insights into the morecommonly encountered market models of monopolisticcompetition and oligopoly, which we discussed briefly in thischapter and will discuss in detail in the next two chapters.
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REVIEW TERMS AND CONCEPTS
natural monopoly
network externalities
patent
perfect price discrimination
price discrimination
public choice theory
pure monopoly
rent-seeking behavior
rule of reason
barrier to entry
Clayton Act
Federal Trade Commission (FTC)
government failure
imperfectly competitive industry
market power