1. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Chapter 13 Monopoly and Antitrust Policy Monopoly and Antitrust Policy

2. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Imperfect Competition and Market Power An imperfectly competitive industry is an industry in which single firms have some control over the price of their output.An imperfectly competitive industry is an industry in which single firms have some control over the price of their output. All firms in an imperfectly competitive market have one thing in common: they exercise Market power – which is the imperfectly competitive firm’s ability to raise price without losing all demand for its product.All firms in an imperfectly competitive market have one thing in common: they exercise Market power – which is the imperfectly competitive firm’s ability to raise price without losing all demand for its product. Imperfect competition DOES NOT MEAN that there is no competition in the industry- firms can differentiate their products, advertise, improve quality, cut prices etc.Imperfect competition DOES NOT MEAN that there is no competition in the industry- firms can differentiate their products, advertise, improve quality, cut prices etc. For a firm to exercise control over price of its output, it must be able to limit competition in the industryFor a firm to exercise control over price of its output, it must be able to limit competition in the industry

3. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Defining Industry Boundaries Several types of market structures exist:Several types of market structures exist: 1.Monopoly- an industry with a single firm in which entry of new firms is blocked 2. Oligopoly- an industry in which there is a small number of firms, each large enough to have an impact on market price of the output 3. Monopolistic Competition- an industry with many producers and free entry and in which firms differentiate their products The ease with which consumers can substitute for a product limits the extent to which a monopolist can exercise market power.The ease with which consumers can substitute for a product limits the extent to which a monopolist can exercise market power.

4. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Pure Monopoly A pure monopoly is an industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.A pure monopoly is an industry with a single firm that produces a product for which there are no close substitutes and in which significant barriers to entry prevent other firms from entering the industry to compete for profits.

5. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Barriers to Entry Things that prevent new firms from entering and competing in imperfectly competitive industries include:Things that prevent new firms from entering and competing in imperfectly competitive industries include: 1. Government franchises, or firms that become monopolies by virtue of a government directive 2. Patents or barriers that grant the exclusive use of the patented product or process to the inventor.

6. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Barriers to Entry 3. Economies of scale and other cost advantages enjoyed by industries that have large capital requirements. A large initial investment, or the need to embark in an expensive advertising campaign, deter would-be entrants to the industry 4. Ownership of a scarce factor of production: If production requires a particular input, and one firm owns the entire supply of that input, that firm will control the industry.

7. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Price: The 4 th Decision Variable Firms with market power must decide: 1. how much to produce, 2. how to produce it, 3. how much to demand in each input market, and 4. what price to charge for their output. - However, this does not mean that market power allows a firm to charge any price it likes - To sell its product, a firm must produce something that people want and sell it at a price they are willing to pay

8. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Price and Output Decisions in Pure Monopoly Markets To analyze monopoly behavior we assume that:To analyze monopoly behavior we assume that: 1. Entry to the market is blocked 2. Firms act to maximize profit 3. The pure monopolist buys in competitive input markets, i.e., it is a price taker in input market 4. On the cost side, a pure monopolist does not differ at all from a perfect competitor- both choose the technology that minimizes cost; hence difference arise on the revenue side (demand side) 5. The monopoly faces a known demand curve

9. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Demand in Monopoly Market In perfect competition, demand curve is a horizontal line; marginal revenue is equal to price of outputIn perfect competition, demand curve is a horizontal line; marginal revenue is equal to price of output With one firm in a monopoly market, there is no distinction between the firm and the industry;With one firm in a monopoly market, there is no distinction between the firm and the industry; In a monopoly market, the firm = the industryIn a monopoly market, the firm = the industry Hence the market demand curve is the demand curve facing the firm and total quantity supplied in the market is what the firm decides to produce.Hence the market demand curve is the demand curve facing the firm and total quantity supplied in the market is what the firm decides to produce.

10. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Demand in Monopoly Market Few more assumptions:Few more assumptions: A Monopolistic firm cannot price discriminate- it sells its products to all buyers at the same price (price discrimination means selling to different buyers or groups of consumers at different prices)A Monopolistic firm cannot price discriminate- it sells its products to all buyers at the same price (price discrimination means selling to different buyers or groups of consumers at different prices) Monopoly faces a known demand curve, i.e., firm has enough information to predict how households will react to different priceMonopoly faces a known demand curve, i.e., firm has enough information to predict how households will react to different price By knowing the demand curve it faces, the firm must simultaneously choose both quantity of output to supply and price of the output….hence a monopolist chooses the point on market demand curve where it wants to beBy knowing the demand curve it faces, the firm must simultaneously choose both quantity of output to supply and price of the output….hence a monopolist chooses the point on market demand curve where it wants to be

11. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Demand in Monopoly Market The demand curve facing a perfectly competitive firm is perfectly elastic; in a monopoly, the market demand curve is the demand curve facing the firm and the total quantity supplied in the market is what the monopoly firm decides to produceThe demand curve facing a perfectly competitive firm is perfectly elastic; in a monopoly, the market demand curve is the demand curve facing the firm and the total quantity supplied in the market is what the monopoly firm decides to produce

12. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Marginal Revenue Facing a Monopolist (1) QUANTITY (2) PRICE (3) TOTAL REVENUE (4) MARGINAL REVENUE 0$110 110$10$10 29188 38246 47284 56302 65300 7428 2222 8324 4444 9218 6666 10110 8888

13. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Marginal Revenue Curve Facing a Monopolist For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it.For a monopolist, an increase in output involves not just producing more and selling it, but also reducing the price of its output to sell it. At every level of output except one unit, a monopolist’s marginal revenue is below price.At every level of output except one unit, a monopolist’s marginal revenue is below price.

14. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Marginal Revenue and Total Revenue A monopolist’s marginal revenue curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it.A monopolist’s marginal revenue curve shows the change in total revenue that results as a firm moves along the segment of the demand curve that lies exactly above it.

15. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Price and Output Choice for a Profit- Maximizing Monopolist A profit-maximizing monopolist will raise output as long as marginal revenue exceeds marginal cost (like any other firm).A profit-maximizing monopolist will raise output as long as marginal revenue exceeds marginal cost (like any other firm). The profit-maximizing level of output is the one at whichThe profit-maximizing level of output is the one at which MR = MC. MR = MC.

16. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Absence of a Supply Curve in Monopoly A monopoly firm has no supply curve that is independent of the demand curve for its product.A monopoly firm has no supply curve that is independent of the demand curve for its product. A monopolist sets both price and quantity, and the amount of output supplied depends on both its marginal cost curve and the demand curve that it faces. A monopolist sets both price and quantity, and the amount of output supplied depends on both its marginal cost curve and the demand curve that it faces.

17. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Monopoly in the short and long run Distinction between SR and LR in monopoly is not very importantDistinction between SR and LR in monopoly is not very important There may be a possibility of the monopoly firm incurring loss in the short runThere may be a possibility of the monopoly firm incurring loss in the short run If the firm can minimize losses by operating in the short run, it will do soIf the firm can minimize losses by operating in the short run, it will do so If losses are incurred in the long run, it will go out of businessIf losses are incurred in the long run, it will go out of business

18. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Price and Output Choices for a Monopolist Suffering Losses in the Short-Run It is possible for a profit-maximizing monopolist to suffer short-run losses.It is possible for a profit-maximizing monopolist to suffer short-run losses. If the firm cannot generate enough revenue to cover total costs, it will go out of business in the long-run.If the firm cannot generate enough revenue to cover total costs, it will go out of business in the long-run.

19. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Perfect Competition and Monopoly Compared In a perfectly competitive industry in the long-run, price will be equal to long-run average cost. The market supply is the sum of all the short-run marginal cost curves of the firms in the industry.In a perfectly competitive industry in the long-run, price will be equal to long-run average cost. The market supply is the sum of all the short-run marginal cost curves of the firms in the industry.

20. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Perfect Competition and Monopoly Compared Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits.Relative to a competitively organized industry, a monopolist restricts output, charges higher prices, and earns positive profits.

21. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Collusion and Monopoly Compared Collusion is the act of working with other producers in an effort to limit competition and increase joint profits.Collusion is the act of working with other producers in an effort to limit competition and increase joint profits. When firms collude, the outcome would be exactly the same as the outcome of a monopoly in the industry. When firms collude, the outcome would be exactly the same as the outcome of a monopoly in the industry.

22. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Social Costs of Monopoly Monopoly leads to an inefficient mix of output.Monopoly leads to an inefficient mix of output. Price is above marginal cost, which means that the firm is underproducing from society’s point of view.Price is above marginal cost, which means that the firm is underproducing from society’s point of view.

23. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair The Social Costs of Monopoly The triangle ABC measures the net social gain of moving from 2,000 units to 4,000 units (or welfare loss from monopoly).The triangle ABC measures the net social gain of moving from 2,000 units to 4,000 units (or welfare loss from monopoly).

24. © 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair Price Discrimination Price discrimination means charging different prices to different buyers.Price discrimination means charging different prices to different buyers. Perfect price discrimination occurs when a firm charges the maximum amount that buyers are willing to pay for each unit.Perfect price discrimination occurs when a firm charges the maximum amount that buyers are willing to pay for each unit.