1. © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Fernando & Yvonn Quijano Prepared by: Chapter 14 Monopoly and Antitrust Policy

2. 2 of 33 © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. Time Warner Rules Manhattan 14.1Define monopoly. 14.2Explain the four main reasons monopolies arise. 14.3Explain how a monopoly chooses price and output. 14.4Use a graph to illustrate how a monopoly affects economic efficiency. 14.5Discuss government policies toward monopoly. Learning Objectives In this chapter, we will develop an economic model of monopoly that can help us analyze how such firms affect the economy.

3. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 3 of 32 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? Learning Objective 14.1

4. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 4 of 32 Learning Objective 14.1 Is Xbox 360 a Close Substitute for PlayStation 3? Making the Connection To many gamers, PlayStation 3 is a close substitute for Xbox.

5. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 5 of 32 1 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? Learning Objective 14.2 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:

6. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 6 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 14.2 Entry Blocked by Government Action In the United States, government blocks entry in two main ways:

7. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 7 of 32 Where Do Monopolies Come From? Learning Objective 14.2 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.

8. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 8 of 32 Learning Objective 14.2 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.

9. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 9 of 32 Where Do Monopolies Come From? Learning Objective 14.2 Control of a Key Resource Another way for a firm to become a monopoly is by controlling a key resource. Network Externalities Network externalities The situation where the usefulness of a product increases with the number of consumers who use it.

10. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 10 of 32 Learning Objective 14.2 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.

11. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 11 of 32 Where Do Monopolies Come From? Learning Objective 14.2 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.

12. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 12 of 32 Learning Objective 14.2 FIGURE 14-1 Average Total Cost Curve for a Natural Monopoly Where Do Monopolies Come From? Natural Monopoly

13. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 13 of 32 Solved Problem 14-2 Is the “Proxy Business” a Natural Monopoly? Learning Objective 14-2

14. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 14 of 32 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? Learning Objective 14.3 Marginal Revenue Once Again When a firm cuts the price of a product, one good thing happens, and one bad thing happens:

15. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 15 of 32 How Does a Monopoly Choose Price and Output? Learning Objective 14.3 Marginal Revenue Once Again FIGURE 14-2 Calculating a Monopoly’s Revenue

16. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 16 of 32 How Does a Monopoly Choose Price and Output? Learning Objective 14.3 Profit Maximization for a Monopolist FIGURE 14-3 Profit-Maximizing Price and Output for a Monopoly

17. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 17 of 32 Finding the Profit-Maximizing Price and Output for a Monopolist Learning Objective 14-3 Solved Problem 14-3 PRICEQUANTITYTOTAL REVENUE MARGINAL REVENUE (MR = ΔTR/ΔQ)TOTAL COST MARGINAL COST (MC = ΔTC/ΔQ) $173$51–$56– 16464$1363$7 1557511718 146849809 1379179010 12896510111 Don’t Let This Happen to YOU! Don’t Assume That Charging a Higher Price Is Always More Profitable for a Monopolist

18. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 18 of 32 Learning Objective 14.4 FIGURE 14-4 What Happens If a Perfectly Competitive Industry Becomes a Monopoly? Does Monopoly Reduce Economic Efficiency? Comparing Monopoly and Perfect Competition

19. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 19 of 32 Learning Objective 14.4 FIGURE 14-5 The Inefficiency of Monopoly Does Monopoly Reduce Economic Efficiency? Measuring the Efficiency Losses from Monopoly

20. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 20 of 32 Learning Objective 14.4 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:

21. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 21 of 32 Learning Objective 14.4 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. Does Monopoly Reduce Economic Efficiency? How Large Are the Efficiency Losses Due to Monopoly?

22. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 22 of 32 Government Policy toward Monopoly Learning Objective 14.5 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.

23. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 23 of 32 Government Policy toward Monopoly Learning Objective 14.5 Antitrust Laws and Antitrust Enforcement Table 14-1 Important U.S. Antitrust Laws LAWDATEPURPOSE Sherman Act1890Prohibited “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.

24. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 24 of 32 Learning Objective 14.5 Horizontal merger A merger between firms in the same industry. Vertical merger A merger between firms at different stages of production of a good. Government Policy toward Monopoly Mergers: The Trade-off between Market Power and Efficiency

25. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 25 of 32 Learning Objective 14.5 FIGURE 14-6 A Merger That Makes Consumers Better Off Government Policy toward Monopoly Mergers: The Trade-off between Market Power and Efficiency

26. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 26 of 32 Learning Objective 14.5 1 Market definition 2 Measure of concentration 3 Merger standards Market Definition A market consists of all firms making products that consumers view as close substitutes. Government Policy toward Monopoly The Department of Justice and Federal Trade Commission Merger Guidelines The guidelines have three main parts:

27. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 27 of 32 Learning Objective 14.5 1 firm, with 100% market share (a monopoly): HHI = 100 2 = 10,000 Measure of Concentration 2 firms, each with a 50% market share: HHI = 50 2 + 50 2 = 5,000 4 firms, with market shares of 30%, 30%, 20%, and 20%: HHI = 30 2 + 30 2 + 20 2 + 20 2 = 2,600 10 firms, each with market shares of 10%: HHI = 10 (10 2 ) = 1,000 Government Policy toward Monopoly The Department of Justice and Federal Trade Commission Merger Guidelines

28. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 28 of 32 Learning Objective 14.5 Post-merger HHI below 1,000. These markets are not concentrated, so mergers in them are not challenged. Merger Standards Post-merger HHI between 1,000 and 1,800. These markets are moderately concentrated. Mergers that raise the HHI by less than 100 probably will not be challenged. Mergers that raise the HHI by more than 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. Government Policy toward Monopoly The Department of Justice and Federal Trade Commission Merger Guidelines

29. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 29 of 32 Learning Objective 14.5 Should the Government Prevent Banks from Becoming Too Big? Making the Connection

30. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 30 of 32 Learning Objective 14.5 FIGURE 14-7 Regulating a Natural Monopoly Government Policy toward Monopoly Regulating Natural Monopolies

31. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 31 of 32 An Inside LOOK As Barriers Fall, Will Cable TV Competition Rise? Cable Guys

32. Chapter 14: Monopoly and Antitrust Policy © 2008 Prentice Hall Business Publishing Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 2e. 32 of 32 Antitrust laws Collusion Copyright Horizontal merger Market power Monopoly Natural monopoly Network externalities Patent Public franchise Vertical merger K e y T e r m s