Monopoly and Antitrust Policy

Imperfect Competition and Market Power Imperfectly competitive industry (some firms with power to control over price) Market power is the imperfectly competitive firm’s ability to raise price without losing all demand for its product.

Pure Monopoly Pure monopoly single firm with no close substitutes and significant entry barriers

Sources of Monopoly Patents Franchises and Licensing Scheme Government enforced Barriers Economies of scale and other cost advantages Ownership of a scarce factor of production Any Illegal ways to sustain market power

Price: The Fourth Decision Variable Firms with market power must decide: how much to produce, how to produce it, how much to demand in each input market, and what price to charge for their output.

Price and Output Decisions in Pure Monopoly Markets Profit-maximizing firm Very powerful entry barriers Competitive input markets The monopolistic firm cannot price discriminate The monopoly faces a known demand curve

Marginal Revenue Facing a Monopolist (1) QUANTITY (2) PRICE (3) TOTAL REVENUE (4) MARGINAL REVENUE $11 - 1 10 $10 2 9 18 8 3 24 6 4 7 28 5 30 -2 -4 -6 -8

Marginal Revenue Curve Facing a Monopolist For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it. At every level of output except one unit, a monopolist’s marginal revenue is below price.

Marginal Revenue and Total Revenue A monopolist’s marginal revenue curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it.

Price and Output Choice for a Profit-Maximizing Monopolist A profit-maximizing monopolist will raise output as long as marginal revenue exceeds marginal cost (like any other firm). The profit-maximizing level of output is the one at which MR = MC.

The Absence of a Supply Curve in Monopoly A monopolist sets both price and quantity, and the amount of output supplied depends on both its marginal cost curve and the demand curve that it faces.

Perfect Competition and Monopoly Compared Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits.

Collusion and Monopoly Compared Collusion is the act of working with other producers in an effort to limit competition and increase joint profits. When firms collude, the outcome would be exactly the same as the outcome of a monopoly in the industry.

The Social Costs of Monopoly Monopoly leads to an inefficient mix of output. Price is above marginal cost, which means that the firm is underproducing from society’s point of view.

The Social Costs of Monopoly The triangle ABC measures the net social gain of moving from 2,000 units to 4,000 units (or welfare loss from monopoly).

Rent-Seeking Behavior Rent-seeking behavior refers to actions taken by households or firms to preserve positive profits. A rational owner would be willing to pay any amount less than the entire rectangle PmACPc to prevent those positive profits from being eliminated as a result of entry.

Government Failure The idea of rent-seeking behavior introduces the notion of government failure, in which the government becomes the tool of the rent-seeker, and the allocation of resources is made even less efficient than before.

Ch. 12. Regulation and Antitrust Policy A trust is an arrangement in which shareholders of independent firms agree to give up their stock in exchange for trust certificates that entitle them to a share of the trust’s common profits. A group of trustees then operates the trust as a monopoly, controlling output and setting price.

Landmark Antitrust Legislation Congress began to formulate antitrust legislation in 1887, when it created the Interstate Commerce Commission (ICC) to oversee and correct abuses in the railroad industry. In 1890, Congress passed the Sherman Act, which declared every contract or conspiracy to restrain trade among states or nations illegal; and any attempt at monopoly, successful or not, a misdemeanor.

Landmark Antitrust Legislation The rule of reason is a criterion introduced by the Supreme Court in 1911 to determine whether a particular action was illegal (“unreasonable”) or legal (“reasonable”) within the terms of the Sherman Act.

Landmark Antitrust Legislation The Clayton Act, passed by Congress in 1914, strengthened the Sherman Act and clarified the rule of reason. The act outlawed specific monopolistic behaviors such as tying contracts, price discrimination, and unlimited mergers.

Landmark Antitrust Legislation The Federal Trade Commission (FTC), created by Congress in 1914, was established to investigate the structure and behavior of firms engaging in interstate commerce, to determine what constitutes unlawful “unfair” behavior , and to issue cease-and-desist orders to those found in violation of antitrust law.

The Enforcement of Antitrust Law The Wheeler-Lea Act (1938) extended the language of the Federal Trade Commission Act to include “deceptive” as well as “unfair” methods of competition. The Antirust Division (of the Department of Justice) is one of two federal agencies empowered to act against those in violation of antitrust laws. It initiates action against those who violate antitrust laws and decides which cases to prosecute and against whom to bring criminal charges.

The Enforcement of Antitrust Law The courts are empowered to impose a number of remedies if they find that antitrust law has been violated. Consent decrees are formal agreements on remedies between all the parties to an antitrust case that must be approved by the courts. Consent decrees can be signed before, during, or after a trial.

Natural Monopoly A natural monopoly is an industry that realizes such large economies of scale in producing its product that single-firm production of that good or service is most efficient.

Natural Monopoly With one firm producing 500,000 units, average cost is $1 per unit. With five firms each producing 100,000 units, average cost is $5 per unit.