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Announcements: Tuesday Breakout sections: the DeBeers case Next week: the Dupont case

Remember to take Quiz 1 on Oncourse

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Announcements: Thursday mng.

Pd question—no change

Last part of Market failure, missed because of fire alarm

Remember to take Quiz 1 on Oncourse

Next week: the Dupont case

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Announcements: Thursday evng.

PD question---no change

Remember to take Quiz 1 on Oncourse

Next week: the Dupont case

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5: Market Power

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What you will learn today... Why your company and the

government care about market power

How the government controls market power

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Market Power

P

Q

P

QA business withmarket power

A business with no market power

Demand Demand5

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Two ways to increase profit

P

Q

Reduce costs

DemandP

Q

Increase the price

Demand

P0 P0

P1

Q1 Q0Q0

MC0 MC0

MC1

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Sources of Market Power

________________________ ________________________ ________________________ ________________________ ________________________

Unique products Economies of scale Network externalities Anti-competitive strategies Government entry barriers

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What’s Wrong with Market Power?

1. _______________________________

2. _______________________________

3. ________________________________

4._________________________________

1. Customers pay prices above marginal cost, and buy less—“deadweight loss”

2. Low-cost firms are kept out of the market—bad for them and consumers both

3. Higher costs “the lazy monopolist”

4. Rent-seeking

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Two Losses from Monopoly

Pcomp MC

DemandQuantity

Price

Qmonop Qcomp

Pmonop

Monopoly profit

Deadweight loss

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What Should the Government Do About Monopolies?

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Sometimes monopoly may be unavoidable because costs are lowest if a single firm supplies the whole market.

We call this a _____________________Examples:________________________________

________________________________________________________

natural monopoly

electricity, telephone service, cable TV, water to homes

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Natural Monopoly$/Q

Q

5

910

800 900

MC

AC

Demand

___________________

18

500

The monopoly price is ___,marginal cost is ___, and P=AC requires a price of ___.

185

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Deadweight loss

P=MC ________subsidiesGovt. ownership government failure_______________

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Rate of Return Regulation: P=AC

Find the value of the firm’s equity Decide a fair rate of return on equity Find the firm’s variable costs Estimate an output price that gives

the firm the fair rate of return on equity

The rate of return is not guaranteed--only the price is, for a few years.

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Which area is deadweight loss?

MC

Demand

A

B CD E

F

GH

IJ K

Q

P

Pmon

Qmon

(a) B+C

L

(c) C+H

(b) C

(d) C+D

(e) C+D+H+J

Write on a notecard: What does area A+B+C+G+H represent?

1. Did the sign-in sheet get around? 2. If you answered a question, bring up anotecard for me.

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Antitrust Law

Having a monopoly is legal: creating one without creating social value is not

Sherman Act (1890): No price-fixing, dividing up markets, cartels

Clayton Act (1914): Mergers, exclusive dealing, tying, bundling, low pricing are illegal if done to monopolize

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Price fixing is illegal per se

Sotheby’s and Christie’s auctioneers (2001)

New York city school lunch suppliers (2001)

Oil rig workers (2001) (a private suit)

Those who are hurt by it can sue for treble damages

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Firms apply for permission to merge

The Justice Department and Federal Trade Commission ask: Will this merger substantially lessen competition?

Often firms must divest portions of their business

Mergers

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Why Did the Government Go After Microsoft?

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Bill Gates in 1994, on anti-trust law:

"None of the people who run Microsoft's seven divisions are going to change what they do or think or forecast. Nothing. Nothing."

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A Justice Dept. Attorney:

"It was foolish and provocative. It was like saying, 'I'm going to break the law. Catch me if you can.' "

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The Justice Department’s Accusations: Bundling Internet Explorer with

Windows and making it hard to use Netscape

Requiring computer makers who bought Windows for any of their machines to pay a royalty per machine whether they use Windows on it or not

Offering AOL to bundle AOL with Windows if AOL dropped Netscape

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What Happened

Microsoft decided to fight, not settle the suit

Judge Jackson found Microsoft guilty

On appeal, the higher court said that Jackson’s remedy was inappropriate

Settlement proposal: MS will stop using exclusive contracts and will charge uniform prices