Monopoly and Antitrust PolicyMonopoly and Antitrust Policy

Imperfect CompetitionImperfect Competitionand Market Powerand Market Power

• Imperfectly competitive industryImperfectly competitive industry (some (some firms with power to control over price)firms with power to control over price)

• 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.

Pure MonopolyPure Monopoly

• Pure monopolyPure monopoly

single firmsingle firm with with no close substitutesno close substitutes and and significant entry barrierssignificant entry barriers

Sources of MonopolySources of Monopoly• PatentsPatents

• Franchises and Licensing SchemeFranchises and Licensing Scheme

• Government enforced Barriers Government enforced Barriers

• Economies of scale and other cost Economies of scale and other cost advantagesadvantages

• Ownership of a scarce factor of Ownership of a scarce factor of productionproduction

• Any Illegal ways to sustain market powerAny Illegal ways to sustain market power

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

• PProfit-maximizing firmrofit-maximizing firm

• VVery powerful entry barriersery powerful entry barriers

• Competitive input marketsCompetitive input markets

• The monopolistic firm The monopolistic firm cannotcannot price discriminateprice discriminate

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

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 monopolist sets both price and quantity, and A monopolist sets both price and quantity, and the amount of the amount of output supplied depends on both 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.

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.

Ch. 12. Regulation and Antitrust PolicyCh. 12. Regulation and Antitrust 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.

Landmark Antitrust LegislationLandmark Antitrust Legislation

• 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.

Landmark Antitrust LegislationLandmark Antitrust Legislation

• 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.

Landmark Antitrust LegislationLandmark Antitrust Legislation

• 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.