Monopoly

Outline

•Pure monopoly

•Barriers to entry

•Monopoly compared to competition

•Natural monopoly

•The regulatory dilemma

•Monopolistic competition

Pure monopolyA “pure” monopoly is a market structure

in which a single seller accounts for

100 percent of market sales.

Pure monopolies are hard to find in the real world.

Economists and judges as a rule believe a 90 percent

market share is sufficient to constitute an “effective”

monopoly.

Figure 9.1

Cost and Revenue per Unit

Pm

AC

Qm

MR

ACMCAC Industry

demand

Notice the monopolist earns an economic profit equal to the shaded are. Question is: Should this situation not be ripe for entry of new firms?

Not if there are factors which impede entry of new

firms.

Barriers to entry: 2 definitions

1. “[A]nything which creates a disadvantage for potential entrants vis à vis established firms. The height of the barriers is measured by the extent to which, in the long run, established firms can elevate their selling prices above minimal average cost . . . without inducing potential entrants to enter” [Joe Bain, Industrial Organization, 2nd ed., p. 252].

2. Barriers to entry into a market . . . can be defined to be socially undesirable limitations to entry of resources which are due to protection of resource owners already in the market” [Christian von Weizsäcker, Barriers to Entry, p. 13].

Examples of barriers to entry

Absolute cost advantages

Examples: Alcoa had access to low cost hydroelectric power in Pacific NW; Weyerhauser procured extraction rights to tracts of Douglas fir in 1901; International petroleum majors (Texaco, SOCAL, BP, et al) formed a pipeline consortium in California.

Economies of scale: Dominant firm may enjoy cost advantages due to realization of scale economies in production, distribution, capital raising, or sales promotion.

Barriers due to control of wholesale, retail distribution systems

Examples: Control of wholesale diamond distribution by DeBeers; Control of advantageous retail shelf space by Proctor and Gamble, Kellogs.

Barriers due to patents, copyrights, trademarks, and other legal barriers

Examples: Xerox’s patent on xerography; Polaroid’s patent on instamatic photography

Barriers due to product differentiation/brand power

Examples: Cigarettes, pain relievers, designer jeans, athletic wear, batteries, soft drinks

Strategic BarriersAlcoa’s restrictive covenants with hydroelectric suppliers.

Standard Oil’s “secret rebate” policy with the railroad companies.

“Lease-only” policy of IBM, United Shoe Machinery, International Salt

IBM’s continual design modification was designed to forestall entry of firms such as Calcomp that marketed plug-compatible peripherals—e.g.,tapes and line printers.

Microsoft charges PC makers a royalty for every computer shipped—regardless of whether the machine has a Windows operating system installed.

Microsoft requires that Explorer icon appear on desktop in initial boot up sequence.

                                               

The Microsoft case

Microsoft Corporation v. U.S. 530 U.S. 1301 (2000)

The Antitrust Division of the DOJ won Sherman section 1

and section 2 convictions against the software giant.

The key element in the case was the so-called

“applications barrier to entry.”

The applications barrier in the Microsoft case

Hear audio explanation (wav)

“[T]he applications barrier would prevent an aspiring entrant into the relevant market from drawing a significant number of customers away from a dominant incumbent even if the incumbent priced its products substantially above competitive levels for a significant period of time.”

Judge Jackson stated in his Finding of Fact:

Proprietary control of “application program interfaces” keeps software developers in the Microsoft tent.

“These are synapses at which the developer of an application can connect to invoke pre-fabricated blocks of code in the operating system. These blocks of code in turn perform crucial tasks, such as displaying text on the computer screen. Because it supports applications while interacting more closely with the PC system's hardware, the operating system is said to serve as a ‘platform.’” Judge Jackson’s Finding of Fact

The middleware threat

Mr. Gates viewed middleware (the Java programming language and

Netscape browser software) as rival platforms for ISV’s. Gates feared middleware would bring down the

applications barrier.

Hear Brown’s comments (wav)

Evidence of ‘willful acquisition and maintenance . . . “

The government alleged that Microsoft designed its licensing agreements with OEM’s and IAP’s so as to preserve the applications barrier. This was also its

objective in giving away Internet Explorer for free.

The OEM Channel

•Licensing agreements with Original Equipment Makers (OEM’s) stipulated pre-installation of Internet explorer.

• Internet Explorer icon must appear on the desktop after the initial boot-up sequence.

•OEM’s prohibited from pre-installing Netscape browser software.

The IAP Channel

• Microsoft offered IAP’s valuable “real estate” on the Windows desktop in exchange for their agreement to distribute Internet Explorer exclusively. Hear audio explanation (wav)

• If an IAP was already under contract to pay Netscape a certain amount for browser licenses, Microsoft offered to compensate the IAP the amount it owed Netscape.

• Microsoft also reduced the referral fees that IAPs paid when users signed up for their services using the Internet Referral Server in Windows in exchange for the IAPs' efforts to convert their installed bases of subscribers from Navigator to Internet Explorer.

Output0

PM

PC

QM QC

MC = AC

MarketDemand

MR

A

B

EH

Price, Cost Monopoly compared to Competition

Notice that for each additional unit produced between QM and QC, Demand (marginal benefit) is higher than marginal cost.

Price Quantity

Econ

Consumer Surplus

DeadWeight

Comp-etition

PC QC zero PCAE zero

Monopoly

PM QM PCPMBH PMAB BHE

Results summarized

Dead weight is a measure of loss due to resource misallocation

—it is equal to the surplus lost to

consumers which is not captured by the

producer.

Quantity

Pri

ce, C

ost

0

LMC

LAC

D = AR

MR

PC

PM

A

B

q = 1/100QcQM

*Price that yields a normal profit to the competitive firm exceed MC by vertical distance AB

q is the hypothetical output of a single sellers in a competitive market (100 sellers).

Professor,What do you

mean by the term

“regulatory dilemma”

I refer to the dilemmaconfronting regulators

(e.g., public service commissioners) as

they go about the task of subjecting firms

coveredby their legislative mandate to rate-of-return regulation.

We will use some simple graphs toillustrate that marginal cost pricing

will, in the case of sustainable natural monopoly, saddle the regulated firm with losses. The Courts have ruled

that the regulated firm must receive a return on shareholder equity that is

“fair.”

Horns of the Dilemma

The socially efficient regulatory regime does not provide the regulated firm a “fair” return to shareholder equity.

MWHs

$

0

MR

LAC

LMC

PM

QMQC

CM

Case 1: Unregulated Monopoly

D = AR

MWHs

$

0

LAC

LMCMR

D = AR

Case 2: Marginal Cost Pricing

QC

PC

C1

Recall the necessary condition

for socially efficient resource

allocation: P = MC

Hence:

•Option 2 is optimal on social efficiencycriteria.

•Why not select option 2 and subsidize the regulated firm by amount C1PC?

Subsidies give rise to problems of distributional equity. For example, suppose that gas companies were

subsidized from general tax revenues—does this not amount to an income

transfer from taxpayers to gas users?

MWHs

$

0

LAC

LMCMR

QA

PA

Option 3: Average Cost Pricing

Option

Price Quantity

Dead Weight

Loss given

by area

EconProfit given

by area

1 PM QM PMCM

2 PC QC 0 (C1PC)

3 PA QA 0

Comparing the results

Monopolistic Competition

Examples: Women’s shoes, snack foods, furniture, carpet, bathroom fixtures, men’s suits, cold cuts.

A market structure featuring a relatively

large number of sellers and a differentiated

product/service

The monopolistic competitor faces a

downward sloping, but very elastic, demand

curve.

Short run equilibrium in monopolistic competition

Dollars per Unit of Output

PAC

MC AC

DFMRF

Q Output(a) The Firm Earns Excess Profit

Long Run Equilibrium in Monopolistic Competition

Dollars per Unit of Output

PE

QE Output

DFMRF

MCAC

(b) Long-Run Equilibrium:the Firm Earns Zero Economic Profit