Microeconomics ECON 2302 Spring 2011 Marilyn Spencer, Ph.D. Professor of Economics Chapter 14

Junior Achievement REMINDERS  Teacher’s Evaluation Form must be faxed to JA by the teacher, as soon as you’ve finished your visits.  confidential report due via before class, April 20.  Bring this to class: signed Verification Form due at the beginning of class, April 20.

Extra Credit REMINDER  Attend the Friday, Nov. 12, 2 p.m. lecture given by Daniel Hamermesh, “Beauty Pays,” in Bay Hall 103; be sure to sign in.  a short summary of the microeconomic implications (approx. 100 words) to me before class, Nov points possible

CHAPTER 14 Monopoly and Antitrust Policy Until 2008, Time Warner Cable was the only provider of cable TV in Manhattan; Time Warner had a monopoly.

CHAPTER 14 Monopoly and Antitrust Policy 14.1Is Any Firm Ever really a Monopoly? Define monopoly. 14.2Where Do Monopolies Come From? Explain the four main reasons monopolies arise. 14.3How Does a Monopoly Choose Price and Output? Explain how a monopoly chooses price and output. 14.4Does Monopoly Reduce Economic Efficiency? Use a graph to illustrate how a monopoly affects economic efficiency Government Policy toward Monopoly Discuss government policies toward monopoly. Chapter Outline and Learning Objectives

Monopoly A firm that is the only seller of a good or service that does not have a close substitute. Is Any Firm Ever Really a Monopoly? Define monopoly LEARNING OBJECTIVE

Is the Xbox 360 a Close Substitute for the PlayStation 3? Making the Connection To many gamers, Microsoft’s Xbox is a better deal than PlayStation 3. With consumers apparently viewing the two systems primarily as game consoles, the Xbox had a significant advantage because it was priced $100 less than the PS3.

1.A government blocks the entry of more than one firm into a market. 2.One firm has control of a key resource necessary to produce a good. 3.There are important network externalities in supplying the good or service. 4.Economies of scale are so large that one firm has a natural monopoly. Where Do Monopolies Come From? To have a monopoly, barriers to entering the market must be so high that no other firms can enter. Barriers to entry may be high enough to keep out competing firms for four main reasons: Explain the four main reasons monopolies arise LEARNING OBJECTIVE

A.By granting a patent or copyright to an individual or firm, giving it the exclusive right to produce a product. B.By granting a firm a public franchise, making it the exclusive legal provider of a good or service. 1. In the US, governments block entry in 2 main ways: Where Do Monopolies Come From? 1. Entry Blocked by Government Action

A. Patents and Copyrights Patent The exclusive right to a product for a period of 20 years from the date the product is invented. Copyright A government-granted exclusive right to produce and sell a creation. B. Public Franchises Public franchise A government designation that a firm is the only legal provider of a good or service. Where Do Monopolies Come From? Entry Blocked by Government Action, cont.

The End of the Christmas Plant Monopoly Making the Connection At one time, the Ecke family had a monopoly on growing poinsettias, but many new firms entered the industry. After a university researcher discovered the technique for growing poinsettias, new firms quickly entered the industry, and the price of poinsettias plummeted. Soon consumers could purchase them for as little as three for $10. At those prices, the Ecke family’s firm was unable to earn economic profits.

Another way for a firm to become a monopoly is by controlling a key resource. 3. Network Externalities Network externalities A situation in which the usefulness of a product increases with the number of consumers who use it. Where Do Monopolies Come From? 2. Control of a Key Resource

Are Diamond Profits Forever? The De Beers Diamond Monopoly Making the Connection De Beers promoted the sentimental value of diamonds as a way to maintain its position in the diamond market. Whether consumers will pay attention to brands on diamonds remains to be seen, although through 2009, the branding strategy had helped De Beers maintain its 40 percent share of the diamond market.

4. Natural Monopoly Natural monopoly A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms. Where Do Monopolies Come From?

FIGURE 14-1 Average Total Cost Curve for a Natural Monopoly Natural Monopoly With a natural monopoly, the average total cost curve is still falling when it crosses the demand curve (point A). If only one firm is producing electric power in the market, and it produces where average cost intersects the demand curve, average total cost will equal $0.04 per kilowatt-hour of electricity produced. If the market is divided between two firms, each producing 15 billion kilowatt-hours, the average cost of producing electricity rises to $0.06 per kilowatt-hour (point B). In this case, if one firm expands production, it can move down the average total cost curve, lower its price, and drive the other firm out of business.

Solved Problem 14-2 Is the OpenTable Web Site a Natural Monopoly? OpenTable is a Web site that allows people to make restaurant reservations online. At this point, there’s no other technology or easy solution for making Web reservations.

 The good thing. It sells more units of the product.  The bad thing. It receives less revenue from each unit than it would have received at the higher price. How Does a Monopoly Choose Price and Output? Marginal Revenue Once Again: When a firm cuts the price of a product, one good thing happens, and one bad thing happens: Explain how a monopoly chooses price and output LEARNING OBJECTIVE

Marginal Revenue Once Again FIGURE 14-2 Calculating a Monopoly’s Revenue Time Warner Cable faces a downward-sloping D curve for subscriptions to basic cable. To sell more subscriptions, it must cut P. When this happens, it gains revenue from selling more subscriptions but loses revenue from selling at a lower P the subscriptions that it could have sold at a higher P. The firm’s MR is the change in revenue from selling another subscription. We can calculate MR by subtracting the revenue lost as a result of a price cut from the revenue gained. The table shows that Time Warner’s MR is < P for every subscription sold after the first subscription. Therefore, Time Warner’s MR curve will be below its D curve.

Profit Maximization for a Monopolist FIGURE 14-3 Profit-Maximizing Price and Output for a Monopoly Panel (a) shows that to maximize , Time Warner should sell subscriptions up to the point where the MR from selling the last subscription equals its MC (point A). In panel (b), the green box represents Time Warner’s profits. Time Warner’s profit equals $12 × 6 = $72.

Finding the Profit-Maximizing Price and Output for a Monopolist Solved Problem 14-3 PRICEQUANTITY TOTAL REVENUE MARGINAL REVENUE (MR = ΔTR/ΔQ) TOTAL COST MARGINAL COST (MC = ΔTC/ΔQ) $173$51–$56– 16464$1363$ Don’t Let This Happen to YOU! Don’t Assume That Charging a Higher Price Is Always More Profitable for a Monopolist

FIGURE 14-4 What Happens If a Perfectly Competitive Industry Becomes a Monopoly? Does Monopoly Reduce Economic Efficiency? Comparing Monopoly and Perfect Competition Use a graph to illustrate how a monopoly affects economic efficiency LEARNING OBJECTIVE In panel (b), the perfectly competitive television industry became a monopoly. As a result, the equilibrium Q falls, and the equilibrium P rises. In panel (a), the market for television sets is perfectly competitive, and P and Q are determined by the intersection of the demand and supply curves.

FIGURE 14-5 The Inefficiency of Monopoly Does Monopoly Reduce Economic Efficiency? Measuring the Efficiency Losses from Monopoly A monopoly charges a higher price, P M, and produces a smaller quantity, Q M, than a perfectly competitive industry, which charges price P C and produces Q C. The higher P reduces CS by the area equal to the rectangle A and the triangle B. Some of the reduction in CS is captured by the monopoly as PS, and some becomes DWL, which is the area equal to triangles B and C.

1.Monopoly causes a reduction in consumer surplus. 2.Monopoly causes an increase in producer surplus. 3.Monopoly causes a deadweight loss, which represents a reduction in economic efficiency. Does Monopoly Reduce Economic Efficiency? Measuring the Efficiency Losses from Monopoly We can summarize the effects of monopoly as follows:

Market power The ability of a firm to charge a price greater than marginal cost. Market Power and Technological Change The introduction of new products requires firms to spend funds on research and development. Because firms with market power are more likely to earn economic profits than are perfectly competitive firms, they are also more likely to carry out research and development and introduce new products. How Large Are the Efficiency Losses Due to Monopoly?

Government Policy toward Monopoly Antitrust Laws and Antitrust Enforcement Collusion An agreement among firms to charge the same price or otherwise not to compete. Antitrust laws Laws aimed at eliminating collusion and promoting competition among firms. Discuss government policies toward monopoly LEARNING OBJECTIVE

LAWDATEPURPOSE Sherman Act1890 Prohibited “restraint of trade,” including price fixing and collusion. Also outlawed monopolization. Clayton Act1914Prohibited firms from buying stock in competitors and from having directors serve on the boards of competing firms. Federal Trade Commission Act 1914Established the Federal Trade Commission (FTC) to help administer antitrust laws. Robinson-Patman Act1936Prohibited charging buyers different prices if the result would reduce competition. Cellar-Kefauver Act1950Toughened restrictions on mergers by prohibiting any mergers that would reduce competition. Antitrust Laws and Antitrust Enforcement Table 14-1 Important U.S. Antitrust Laws

Horizontal merger A merger between firms in the same industry. Vertical merger A merger between firms at different stages of production of a good. Mergers: The Trade-off between Market Power and Efficiency

FIGURE 14-6 A Merger That Makes Consumers Better Off Mergers: The Trade-off between Market Power and Efficiency This figure shows the result of all the firms in a perfectly competitive industry merging to form a monopoly. If the monopoly has lower costs than the perfectly competitive firms, as shown by the marginal cost curve shifting to MC after the merger, it is possible that the price will actually decline from P C to P Merge and that output will increase from Q C to Q Merge following the merger.

1.Market definition 2.Measure of concentration 3.Merger standards 1. Market Definition A market consists of all firms making products that consumers view as close substitutes. The Department of Justice and FTC Merger Guidelines The guidelines have three main parts:

1 firm, with 100 percent market share (a monopoly): HHI = = 10, Measure of Concentration 2 firms, each with a 50 percent market share: HHI = = 5,000 4 firms, with market shares of 30 percent, 30 percent, 20 percent, and 20 percent: HHI = = 2, firms, each with market shares of 10 percent: HHI = 10 x (10 2 ) = 1,000 The Department of Justice and FTC Merger Guidelines, cont.

Post-merger HHI below 1,000. These markets are not concentrated, so mergers in them are not challenged. 3. Merger Standards Post-merger HHI between 1,000 and 1,800. These markets are moderately concentrated. Mergers that raise the HHI by < 100 probably will not be challenged. Mergers that raise the HHI by > 100 may be challenged. Post-merger HHI above 1,800. These markets are highly concentrated. Mergers that increase the HHI by less than 50 points will not be challenged. Mergers that increase the HHI by 50 to 100 points may be challenged. Mergers that increase the HHI by more than 100 points will be challenged. The Department of Justice and FTC Merger Guidelines, cont.

Have Google and Microsoft Violated the Antitrust Laws? Making the Connection Does Google’s monopoly power harm consumers? The debate over the government’s role in promoting competition seems certain to continue.

FIGURE 14-7 Regulating a Natural Monopoly Government Policy toward Monopoly Regulating Natural Monopolies A natural monopoly that is not subject to government regulation will charge a price = P M and produce Q M. If government regulators want economic efficiency, they will set the regulated price = P E, and the monopoly will produce Q E. Unfortunately, P E is < ATC, and the monopoly will suffer a loss, shown by the shaded rectangle. Because the monopoly will not continue to produce in the LR if it suffers a loss, government regulators set a price = ATC, which is P R in the figure.

The End of the Cable TV Monopoly? AN INSIDE LOOK >> Competition lowers the price of cable TV and increases economic efficiency.

Antitrust laws Collusion Copyright Horizontal merger Market power Monopoly Natural monopoly Network externalities Patent Public franchise Vertical merger KEY TERMS