monopolies & regulation chapter 24 & 26. monopoly a firm that produces the entire market...
TRANSCRIPT
Monopolies & Regulation
Chapter 24 & 26
Monopoly
A firm that produces the entire market supply of a particular good or service.
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Monopoly Characteristics Single firm or seller No close substitutes High barriers to entry Firm has all market power Firm is a Price Setter Advertising for luxury goods only
Ex: Local Electric Company
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Market Power
The ability to alter the market price and characteristics of a good or service.
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Monopoly Demand Curve
The demand curve facing the monopoly firm is the market demand curve for the product.
Firms with market power confront downward-sloping demand curves.
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Demand & Price
Since the company is the industry the company can choose where on the demand curve (and at what price) they want to work.
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The Market & Company
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Price and Marginal Revenue
A monopoly faces a different profit maximizing situation than competitive firms.
Profit-maximization rule is the same: Produce at that rate of output where MR = MC.
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Profit Maximization The point where MC = MR determines the
profit maximizing quantity at a given price.
The advantage for a monopoly is that it can alter the price it charges. The demand curve determines the quantity for each
price.
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Monopoly Profits Sometimes increasing Price & decreasing Quantity
will increase Total Revenue Sometimes decreasing Price & increasing Quantity
will increase Total Revenue
It depends on the Elasticity of the product’s demand If demand is elastic, lower price will lead to higher TR
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Barriers to Entry Unless there are barriers to entry, high
monopoly profits tend to attract profit-hungry entrepreneurs into the market.
These profits will be maintained as long as barriers to entry prevent any competitors from entering the market.
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Political Power
A firm with considerable market power likely to have significant political power as well.
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The Limits to Power
Monopolists only have absolute control of the quantity of output supplied to the market.
Monopolists must still contend with the market demand curve.
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Price Discrimination
The sale of an identical good at different prices to different consumers by a single seller.
This has nothing to do with costs to produce
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Price Discrimination Examples Senior Citizens discounts Student discounts In-state tuition Matinee prices Coupons Military discount
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Entry Barriers Patents Monopoly franchises or licenses Control/ownership of key production resources
Land, labor, capital, entrepreneurial ability Control of distribution outlets Well-established brand loyalty Government regulation Lawsuits Acquisition of competition Economies of scale
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Ways to Enter a Monopoly Market Acquisition
buy out the current company Overcome all the entry barriers Make a different product & “sneak in”
Money, determination (time) or ingenuity
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Monopolies & The Economy Generally, Monopolies lead to:
Higher prices Less variety Slower innovation Lower employment
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Monopolies & Government
Based on the bad that monopolies bring to the economy, the U.S. government is against them.
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If A Monopoly Is Not Beneficial The government will either:
Keep a monopoly from forming Break up any existing monopolies
If a monopoly is beneficial to society the government may allow it to exist. If so, the government will regulate it.
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Why Allow a Monopoly? Society’s good
lower price from a natural monopoly Bring products & services to people who would not
get them. Better resource allocation
Economies of Scale Better for the environment More Research and Development Product standardization
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Natural Monopolies An industry in which one firm can produce at a lower
ATC than 2 firms can. Economies of scale act as a “natural” barrier to entry.
Examples: local telephone services local cable services
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Regulating Monopolies The government can regulate:
The prices the monopoly can charge the customer The output of the monopoly The quality of the products
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Regulating Monopolies The most common regulation of monopolies is
regulating the price the monopoly can charge.
Two methods: Socially Optimal Price Fair-Return Price
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Price Ceiling The government sets the maximum price the
monopoly can charge the customer. The government then subsidizes the monopoly with
direct payments for expenses & profits.
In essence, the company is a de-facto department of the government
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Socially Optimal Pricing Price = MC
The government forces a price cap at MC, so there is no “economic profit”. The price is just as it “would be” if industry was Pure
Competition The government then subsidizes the monopoly with
direct payments for expenses & profits. In essence, the company is a de-facto department of
the government
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Fair-Return Pricing Price = ATC
Extra capacity is needed for peak usage times. To build this excess capacity price needs to be higher than MC.
ATC is calculated with excess capacity to ensure enough for the high-demand times.
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Normal Profit and Monopolies
In both cases, there is a “normal profit” allowed, as a percentage above cost.
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Monopoly Behavior with Regulation
The problem with both regulation plans is there is no incentive to reduce costs.
Where profit is a percent of cost, the higher the costs are, the higher the profit will be. Easy for companies to upgrade equipment Easy to abuse
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Costs of Regulation Administrative costs
To create the regulations Compliance costs
To enforce the regulations Efficiency costs
Bad regulations & corrective measures
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Antitrust Laws Sherman Act (1890)
prohibits “conspiracies in restraint of trade”. Clayton Act (1914)
prohibited price discrimination, exclusive dealing agreements, certain types of mergers, and interlocking boards of directors among competing firms.
The Federal Trade Commission Act (1914) created the FTC to study industry structures and
behavior so as to identify anti-competitive practices.
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Objections To Anti-Trust
Punishing people for being successful Lack of competition may not be the
company’s fault Large companies are needed to compete
globally
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