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E i Economics 1000Essentials of EconomicsEssentials of Economics
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R I C H A R D N . L A N G L O I S
M O D U L E 6 :M O D U L E 6 :
C O M P E T I T I O N A N D M O N O P O L Y
The University of Connecticut
Competition as a process.
A popular meaning of ‘competition’
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A popular meaning of competition is playing to win.When economists use the termcompetition they mean a state of affairs.
A large number of buyers and A large number of buyers and sellers.Full information.Sellers produce a homogenous product.C tl bilit f Costless mobility of resources.
Competition as a process.3
But real-world competition is a pconstant adjustment process.process.
Illustration: shoppers iti t th h k twaiting at the checkout.
The pressures of competition.
Sellers.
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Face a downward sloping demand curve.
Price > opportunity cost, which invites competition from rivals.
Example.
Slice of pie costs 50 cents to produce.
Vendor sells the pie for $1.50.
The pressures of competition.
P D
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$1.50 Price
.50
Q
Cost
Q
The “margins” of competition.6
Price.
Quality.
Cost.
Innovation
Creative destruction.7
“[T]he problem that is [T]he problem that is usually being visualized is y ghow capitalism administers existing structures
Joseph A. Schumpeter (1883-
1950) author of
existing structures, whereas the relevant
bl i h i 1950), author of Capitalism,
Socialism, and Democracy (1942)
problem is how it creates and destroys them”y y
Creative destruction.8
“… competition from the new commodity, the new … competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance) — competition which commands a decisive ) pcost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives. Th k d f h ff
Joseph A. Schumpeter (1883-
1950) author of
This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door, and so much more important that it becomes a matter of comparative indifference 1950), author of
Capitalism, Socialism, and
Democracy (1942)
that it becomes a matter of comparative indifference whether competition in the ordinary sense functions more or less promptly; the powerful lever that in the long run expands output and brings down prices is in y long run expands output and brings down prices is in any case made of other stuff”
Creative destruction.9
Monopoly.p y
Two systems of belief about monopoly
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Two systems of belief about monopoly.
Spontaneous monopoly.“N t l t d ” f “Natural tendency” for monopolies to arise and persist.Need for active antitrust policy.
Interventionist monopoly.Competition tends to eliminate
p y
market power unless there are structural barriers.True monopoly is a creature of p ythe state.
Monopoly.
Sources of monopoly
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Sources of monopoly.
• “Natural” monopoly.• Because of economies of scale,
only one firm “fits” in a market.• Example: cable TV.p b• Example: network effects and
software.But franchise bidding• But: franchise bidding.
• But: which stages of production have the economies of scale?
Monopoly.
Sources of monopoly
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Sources of monopoly.
• Ownership of a scarce input.• DeBeers and diamond mines.
i h• A property right to exclude.
P t t d i t ll t l • Patents and intellectual property rights.
• The Postal Monopoly statute.
Taxi medallions.14
Average Annual Medallion Prices 1947, 1950, 1952, 1959, 1960 and annually since 1962. Source: Schaller Consulting.
13,257 medallions
Taxi medallions.15
$/medS
P22
P1 D′
D
13,257 # medallions
Taxi medallions.16
13,257 medallions
Si th t t f 2008 hil Since the start of 2008, while the stock market was going through its worst decline through its worst decline since the Great Depression, the price of a corporate p pmedallion has jumped 28%, to $766,000; the price of an i di id l h i % individual one has risen 33%, to $572,000.
Source: USA Today
Analysis of monopoly.
Fi ’ d d i h k d d
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Monopolist chooses Qm to make d l bi
$/Q• Firm’s demand curve is the market demand curve.
producer surplus as big as possible.
• Demand curve Pm
cost
determines monopoly price Pm.
D
cost
Q/tQm
Analysis of monopoly.
• Not true that a monopolist
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$/Q
• Why? Suppose monopolist lowers price
• Not true that a monopolist can set “any price it wants.”
Why? Suppose monopolist lowers price.
Loss in revenue from lowering price to existing (inframarginal)
P1
P2
Gain in revenue from
existing (inframarginal) customers.
attracting new customers.
No price
Q/tQ1 Q2
No price discrimination.
Revenue is P*Q
What’s wrong with monopoly?
A competitive industry would drive price
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A competitive industry would drive price down to cost, implying an output of Qc.$/Q
Producer surplus (profit) would be zero• Producer surplus (profit) would be zero.
• Shaded area is consumer surplusCS
costP
• Shaded area is consumer surplus.
D
costPc
Q/tQc
What’s wrong with monopoly?
Monopoly restricts output and raises price
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Monopoly restricts output and raises price relative to the competitive benchmark.$/Q
• Some consumers’ surplus becomes d ’ l ( fit)CS producer’s surplus (profit).
Pm• Is this what is wrong
with monopoly?
CS
costP
with monopoly?
Transfers of surplus can be regressive or
PS
D
costPc regressive or progressive.
Q/tQcQm
What’s wrong with monopoly?21
Monopoly restricts output and raises price $/Q
• As a result some potentially beneficial CS
Monopoly restricts output and raises price relative to the competitive benchmark.
As a result, some potentially beneficial gains from trade don’t take place.
Pm• Total surplus is diminished by the
CS
costP
p yextent of the deadweight-loss triangle.
Total (social) surplus
PSDWL
D
costPcota (soc a ) su p us
is CS + PS.
Q/tQcQm