1. © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. Fernando & Yvonn Quijano Prepared by: Chapter 9 Monopoly and Antitrust Policy

2. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 2 of 32 1 By granting a patent or copyright to an individual or firm, giving it the exclusive right to produce a product. 2 By granting a firm a public franchise, making it the exclusive legal provider of a good or service. Where Do Monopolies Come From? Learning Objective 9.2 Entry Blocked by Government Action In the United States, government blocks entry in two main ways:

3. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 3 of 32 Where Do Monopolies Come From? Learning Objective 9.2 Entry Blocked by Government Action 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. Public Franchises Public franchise A designation by the government that a firm is the only legal provider of a good or service.

4. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 4 of 32 Where Do Monopolies Come From? Learning Objective 9.2 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.

5. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 5 of 32 Learning Objective 9.2 FIGURE 9-1 Average Total Cost Curve for a Natural Monopoly Where Do Monopolies Come From? Natural Monopoly

6. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 6 of 32 Learning Objective 9.5 Regulating a Natural Monopoly Government Policy toward Monopoly Regulating Natural Monopolies 1. (Euro) Setting Price = MC (Competitive Solution) or 2. (US) Setting Price = ATC (Rate-of-Return

7. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 7 of 32 What are the options for pricing with a Natural Monopoly? 1.Set Price = MC 1.Advantages 1.Perfectly Competitive Market Solution 2.No Deadweight Loss 2.Disadvantages 1.MC < ATC (Since ATC is still falling) 2.Firm won’t be able to survive (can’t cover costs) 1.Will need to subsidize firm with taxes 1.Taxes created Deadweight Losses in other (taxed) markets

8. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 8 of 32 What are the options for pricing with a Natural Monopoly? 1.Set Price = ATC 1.Advantages 1.Firm can cover costs of production 1.No need for subsidies and no tax distortions in other (taxed) markets 2.Disadvantages 1.Deadweight Loss 1.Since Consumer’s MV > Supplier’s MC 2.But “it’s less” Deadweight Loss than in an unregulated (monopoly) market 2.Creates incentives for the regulated firm to not efficiently manage their costs as they can pass it on to consumers (Averech-Johnson effect) 1.Nicer/larger offices, higher salaries, newer equipment 3.No incentive to reduce costs through technological innovation

9. Chapter 9: Monopoly and Antitrust Policy © 2009 Prentice Hall Business Publishing Essentials of Economics Hubbard/O’Brien, 2e. 9 of 32 Price Caps Rate-of-Return Regulation 1.Requires the “regulated” company to submit cost data, demand models/forecasts and rate proposals to the UTC/PUC any time they “want” to change rates Price Caps 1. Rates initially established by ROR (see above) 2. Rate changes are allowed within an interval - New Rate = ROR_rate + inflation – average productivity for the industry - Incentive for efficient cost management - beat the industry average -> higher profit