MICROECONOMICS: Theory &Applications
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
10th Edition, Copyright 2009
PowerPoint prepared by Della L. Sue, Marist College
Chapter 15: Using Noncompetitive Market Models
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Learning Objectives
Determine the relative magnitude of thedeadweight loss of monopoly.
Ascertain the extent to which, if any,monopolies suppress innovations.
Explore whether government interventioncan promote efficiency in the case of naturalmonopoly.
Explore the concepts of iterated dominanceand commitment in the context of gametheory models.
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The Size of the Deadweight Loss ofMonopoly [Figure 15.1]
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Why Are the Estimates of theDeadweight Loss Not Large?
Estimates of the deadweight loss ofmonopoly in relation to GNP are not large.
Reasons:
Deadweight loss is compared to the size of thewhole economy (GNP), not to the size of themonopoly
There are few, if any, pure monopolies in theU.S.
We cannot measure the restriction in output inany industry, only actual output.
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Other Possible DeadweightLosses of Monopoly
2 undesirable consequences of monopoly:
Restriction of output
Redistribution of income in favor of the owner ofthe monopoly
Other effects:
In the absence of competition with other firms,the monopolist is under less pressure to minimize(production) cost.
A monopoly may incur other costs (in addition toproduction costs) to ensure continuation of itsmonopoly power.
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Do Monopolies Suppress Inventions?
Worthwhile invention:one that allows a firmto produce a higher-quality product at anunchanged cost or toproduce the same-quality product at alower cost.
A worthwhile inventioncan be profitable for amonopolist.
Figure 15.2
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Natural Monopoly
Natural monopoly – thecase in which theaverage cost of a singleenterprise declines overthe entire range ofmarket demand
Economies of scaleextend to very highoutput levels.
Figure 15.3
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How can policymakers do whennatural monopoly conditions exist?
4 options:
Leave the market alone
Permit a monopoly to operate but to regulateits activities
Allow the government to own and operate thefacility
Allow the government to accept competitivebids from potential firms for the right tooperate the facility
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Regulation of Natural Monopoly:Theory
Public utilities – public agencies charged withregulating natural monopolies
2 pricing approaches:
Average-cost pricing: AC=demand curve
Marginal-cost pricing: MC=demand curve
Average-cost pricing is more practical
Output is greater and price is lower than if themonopoly were unregulated
Monopoly’s owners receive no profit
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Regulation of Natural Monopoly[Figure 15.4]
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Regulation of Natural Monopoly:Practice
Rely on the rate of return on invested capital(accounting profit) earned by a monopolybecause complete knowledge of cost anddemand conditions is unattainable
Problems:
The monopolist’s incentive to minimize cost isdiminished.
Regulated rates reduces the incentive to engagein research and development activities designedto develop new services or new products.
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Regulating Natural Monopolythrough Public Ownership
Example: United States Postal Service(USPS)
Objective: P=AC, not profit maximization
Profit is constrained to equal zero
Incentive to innovate and/or toencourage cost-minimization isattenuated
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More on Game Theory: IteratedDominance
Iterated dominance –the concept ofeliminating anystrategy that is inferiorto or dominated byanother strategy
Table 15.1
(continued)
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More on Game Theory: IteratedDominance (continued)
Eliminatingdominated strategies
Table 15.2
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Iterating Toward an Airline MarketEquilibrium (Starting Position) [Table 15.3]
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Iterating Toward an Airline MarketEquilibrium (Step 1) [Table 15.4]
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Iterating Toward an Airline MarketEquilibrium (Step 2) [Table 15.5]
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More on Game Theory: Commitment
Commitment – thestrategy of adoptinga particular course ofaction, constrainingone’s choice ofstrategies, in order toincrease yourequilibrium payoff
Table 15.6
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