1. MICROECONOMICS: Theory & Applications
Chapter 15: Using Noncompetitive Market Models
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
11th Edition, Copyright 2012
PowerPoint prepared by Della L. Sue, Marist College

2. Learning Objectives
Determine the relative magnitude of the deadweight loss of monopoly.
Ascertain the extent to which, if any, monopolies suppress innovations.
Explore whether government intervention can promote efficiency in the case of natural monopoly.
Explore the concepts of iterated dominance and commitment in the context of game theory models.
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3. Figure 15.1 - The Size of the Deadweight Loss of Monopoly
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4. Why Are the Estimates of the Deadweight Loss Not Large?
Estimates of the deadweight loss of monopoly in relation to GNP are not large.
Reasons:
Deadweight loss is compared to the size of the whole economy (GNP), not to the size of the monopoly
There are few, if any, pure monopolies in the U.S.
We cannot measure the restriction in output in any industry, only actual output.
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John Wiley & Sons, Inc.

5. Other Possible Deadweight Losses of Monopoly
2 undesirable consequences of monopoly:
Restriction of output
Redistribution of income in favor of the owner of the monopoly
Other effects:
In the absence of competition with other firms, the monopolist is under less pressure to minimize (production) cost.
A monopoly may incur other costs (in addition to production costs) to ensure continuation of its monopoly power.
Copyright 2012
John Wiley & Sons, Inc.

6. Do Monopolies Suppress Inventions?
Worthwhile invention: one that allows a firm to produce a higher-quality product at an unchanged cost or to produce the same-quality product at a lower cost.
Different industry structures:
Competitive conditions: initial firm can gain until other firms copy it
A worthwhile invention can be profitable for a monopolist.
Conclusion: monopoly power does not necessarily suppress inventions
Copyright 2012
John Wiley & Sons, Inc.

7. Figure 15.2 – Monopoly and Inventions
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8. Natural Monopoly
Natural monopoly – the case in which the average cost of a single enterprise declines over the entire range of market demand
Economies of scale extend to very high output levels.
Dilemma:
Efficiency in production results from one supplier
Lack of competition may lead to less output and higher prices
Alternatives for public policy makers:
Do nothing and let the monopoly produce unregulated
Regulate the monopoly
Governmental ownership and operation of the facility
Allow the government to accept competitive bids from potential firms for the right to operate the facility
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John Wiley & Sons, Inc.

9. Figure 14.3 -Natural Monopoly
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10. Regulation of Natural Monopoly: Theory
Public utilities – public agencies charged with regulating natural monopolies
Two pricing approaches:
Average-cost pricing: AC=demand curve
Marginal-cost pricing: MC=demand curve
Average-cost pricing is more practical
Output is greater and price is lower than if the monopoly were unregulated
Monopoly’s owners receive no profit
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John Wiley & Sons, Inc.

11. Figure 15.4 - Regulation of Natural Monopoly
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12. Regulation of Natural Monopoly: Practice
Practice: reliance on the rate of return on invested capital (accounting profit) earned by a monopoly because complete knowledge of cost and demand conditions is unattainable
Issues:
The monopolist’s incentive to minimize cost is diminished.
Regulated rates reduces the incentive to engage in research and development activities designed to develop new services or new products.
Conclusion:
Regulation is not ideal
Alternatives are likewise unattractive
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13. Regulating Natural Monopoly through Public Ownership
Example: United States Postal Service (USPS)
Objective: P=AC, not profit maximization
Profit is constrained to equal zero
Incentive to innovate and/or to encourage cost-minimization is attenuated
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14. More on Game Theory: Iterated Dominance
Iterated dominance – the concept of eliminating any strategy that is inferior to or dominated by another strategy
Nash equilibrium
(continued)
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15. Table 15.1 - More on Game Theory: Iterated Dominance (continued)
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16. More on Game Theory: Commitment
Commitment – the strategy of adopting a particular course of action, constraining one’s choice of strategies, in order to increase your equilibrium payoff
Appearance: competitive pricing
Reality: allows two sellers to overcome the prisoner’s dilemma with the consumer being charges the highest possible price to the benefit of the two sellers.
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17. Table 15.2 - More on Game Theory: Commitment
(continued)
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18. Table 15.3 - More on Game Theory: Commitment (continued)
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19. Copyright © 2012 John Wiley & Sons, Inc. All rights reserved
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Copyright 2012
John Wiley & Sons, Inc.