1. Breaking Up Monopolies15
Breaking Up Monopolies

2. Solutions to Monopoly
Preventing monopolies by preventing anti-competitive mergers
Sherman Act (1890) – FCC, FTC and SEC
AT&T and T-Mobile (2016)
AT&T and Time Warner
Breaking up existing monopolies
“Divestiture”
Breaking up “Ma Bell” 0r Standard Oil
Lecture notes:
1982:
AT&T was split up into eight smaller companies after spending over $300 million defending itself from lawsuits and antitrust legislation.
1911:
Standard Oil controlled 91% of production and 85% of final sales of oil in the United States in In 1909, the Department of Justice sued the company for violating the Sherman Act. In 1911, the company was forced to break up into 34 independent companies with different boards of directors. The biggest two companies were Exxon and Mobil.
Reducing trade barriers:
Text: The Constitution reads, “No State shall, without the consent of Congress, lay any imposts or duties on imports or exports.” Rarely have so few words been more profound. With this simple law in place, states must compete on equal terms.
In addition, if we eliminate trade quotas and tariffs, international firms may force domestic producers to become more competitive, which will reduce monopoly power.

3. Solutions to Monopoly “Divestiture” (Sherman Act (1890)
Breaking one big company into a smaller number of “competing” companies
AT&T (1982), Standard Oil (1911)
Telecomm Act (1996)
Allows competitors to access/rent current Telecomm companies network at “forward-looking” costs (best, most efficient technology)
Ignored that: (1) local phone company’s costs based on historical costs to be recovered over 20 years
(2) Residential rates subsidized (below costs)for universal service – higher costs business rates
Lecture notes:
1982:
AT&T was split up into eight smaller companies after spending over $300 million defending itself from lawsuits and antitrust legislation.
1911:
Standard Oil controlled 91% of production and 85% of final sales of oil in the United States in In 1909, the Department of Justice sued the company for violating the Sherman Act. In 1911, the company was forced to break up into 34 independent companies with different boards of directors. The biggest two companies were Exxon and Mobil.
Reducing trade barriers:
Text: The Constitution reads, “No State shall, without the consent of Congress, lay any imposts or duties on imports or exports.” Rarely have so few words been more profound. With this simple law in place, states must compete on equal terms.
In addition, if we eliminate trade quotas and tariffs, international firms may force domestic producers to become more competitive, which will reduce monopoly power.

4. AT&T – A Short History
Alexander Graham Bell patented the telephone in 1876,
formed Bell Telephone which licensed local telephone exchanges in major US cities. AT&T was formed in 1885
In 1913 AT&T became a regulated monopoly.
had to connect competing local companies
And let the Federal Communication Commission (FCC) approve their prices and policies.

5. AT&T – A Short History
On January 1, 1984, a court forced AT&T to give up its 22 local Bell companies (Divestiture)
This established seven Regional Bell Operating Companies (RBOC).
Since that time, mergers have reduced the number of RBOCs to four: Verizon (originally Bell Atlantic, Nynex and GTE), Qwest (Qwest Communications International took over US West), BellSouth and SBC (originally Southwestern Bell and Pacific Telesys).

6. How Do We “Fix” Monopolies
Lower Barriers to Entry
Goal is to increase competition by allowing more firms to enter the market and compete against each other
AT&T Divestiture (1980)
DOJ and FCC sought to introduce competition into the local phone markets (dominated by 7 RBOCs, “baby bells”)
Required AT&T/RBOCs to lease local wirelines, switching networks, transmission satellites and local household connections at “forward” looking economic costs (which were below historical costs)

7. AT&T Before and After the Break-up

8. How Do We “Fix” Monopolies

9. After the Break Up

10. Colbert on the AT&T Break-Up

11. Natural Monopoly – Avg Cost Decrease with Increasing Size/Scale of the Firm – Divestiture Raises Avg Cost 6
Average
Total
Cost
ATC in short
run with
small factory
ATC in short
run with
medium factory
ATC in short
run with
large factory
ATC in long run
Economies
of scale
Diseconomies
of scale
$12,000
1,200
10,000
Constant returns to scale
1,000
Quantity of Cars per Day
Because fixed costs are variable in the long run, the average-total-cost curve in the short run differs from the average-total-cost curve in the long run.

12. Why Monopolies Arise The production process Natural monopoly
A single firm can produce output at a lower cost than can a larger number of producers
Natural monopoly
Arises because a single firm can supply a good or service to an entire market
At a smaller cost than could two or more firms
Economies of scale over the relevant range of output

13. Solutions to Monopoly For Natural Monopolies Price regulation
Often, we don’t want to break up firms due to large economies of scale
Don’t need to have redundant water pipes, power lines
In this case, a monopoly may be desirable, but we may still need to regulate the firm to prevent market power abuse
Lecture notes:
Breakup of a natural monopoly would actually be a bad idea. Due to economies of scale, there are some firms in which bigger really is better. If the ATC curve is downward-sloping over a large range of output, it means that a bigger firm can produce output at a lower cost than many smaller firms.
While this monopoly may be desirable (compared to competition), we still want to make sure that the firm doesn’t abuse its monopoly power by charging exorbitantly high prices. This is where price regulation comes in.

14. Economies of scale as a cause of monopoly1
Economies of scale as a cause of monopoly
Costs
Average total cost
Quantity of output
When a firm’s average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a result, a single firm can produce any given amount at the smallest cost

15. Regulatory Solution for Natural Monopoly
Image: Animated Figure 10.6
Lecture notes:
No regulation:
Unregulated monopolist sets MR = MC and produces QM at a price of PM. Since PM is greater than the average cost of producing QM units, or CM, the monopolist earns the profit shown in the green rectangle.
Regulation:
If the firm is regulated, and the price is set at marginal cost, regulators can set P = MC and the output expands to QR. In this example, since the cost of production is subject to economies of scale, the cost falls from CM to CR. This is a large improvement in efficiency. The regulated price, PR, is lower than the monopolist’s price, PM, and production increases. As a result, consumers are better off. But what happens to the monopoly? It loses profits in the amount of the red rectangle. This occurs since the average costs under the marginal-cost pricing solution, CR, are higher than the price charged by regulators, PR.

16. Marginal Cost Pricing At P = MC Solutions? French approach
The monopolist experiences a loss
MC < ATC, so P < ATC (results in losses)
Solutions?
Government subsidies given to the firm
Set P = ATC at the P = MC output level
Government ownership of the firm
French approach
Set P=MC => subsidize ∆ (ATC-MC) from taxes
Lecture notes:
Why is this bad?
Subsidies come from the government, which taxes YOU! So you now have lower prices, but now have to pay higher taxes to subsidize the firm!
Government ownership creates many more problems, which we will see next.

17. Government Failure Government intervention Free market
Can eliminate the profit motive and the necessity to innovate and improve efficiency
Free market
Firms under MC pricing have no incentive to lower costs.
Price Caps:
Set maximum price to recover costs (P+ATC)
Adjust price over time for efficiency
P(next year) = P(today) – Average Industry Productivity
Often better than government intervention and changing incentives for a firm
Lecture notes:
It all comes down to incentives. The government can always “bail itself out,” so it has no incentive to be efficient, keep costs down, or fire bad employees. A private firm has to take care of its own expenses and has the incentive to find and eliminate inefficiencies.

18. Conclusion
While competitive markets generally bring about welfare-enhancing outcomes for society, monopolies often do the opposite
Government seeks to limit monopoly outcomes and promote competitive markets
Perfectly competitive markets and monopoly are market structures at opposite extremes
Most economic activity takes place between these two alternatives
Lecture notes:
You can think that we often talk about perfect competition (PC) and pure monopoly in the theoretical sense because they are very rare (by strict definition and assumptions) in real life. Many firms have some competitive characteristics and some monopolistic characteristics. This will be studied in the upcoming chapters.

19. Natural Barriers to Entry
Economies of scale
“Bigger is better” (more cost-efficient)
This is due to the ATC being downward- sloping over a large range of output
Lower costs  lower prices
Car production, electricity production, mail delivery
Natural monopoly
A monopoly exists because a single large firm has lower costs than any potential competitor
In addition, breaking up the firm into multiple competitors may increase costs as well
Lecture notes:
Economies of scale
Recall this definition from Chapter 8. Average costs fall as output increases. Which do you think can be done at an OVERALL lower cost? One hundred car producers making 10 cars each or two car producers making 500 cars each? A total of 1,000 cars is made in each case, but due to the nature of the cost structure of car production which exhibits economies of scale, average costs fall with output increases and two firms producing more cars will have overall lower costs.
Natural monopoly
It’s just “natural” to have a monopoly since it provides the lowest (most efficient) costs. Realize however, that a monopoly (natural or not) will enjoy significant market power and may not pass cost savings to consumers in the form of lower prices. Natural monopolies (such as electric companies) are often regulated by the government to prevent abuse of market power.

20. Summary
Monopolies
Market structure characterized by a single seller who produces a well-defined product with few good substitutes
Operate in a market with high barriers to entry, the chief source of market power.
May earn long run profits
Perfectly competitive firms are price takers. Monopolists are price makers.

21. Summary
Like perfectly competitive firms, a monopoly tries to maximize its profits.
Same profit maximizing rule of MR = MC is used.
From an efficiency standpoint, the monopolist charges too much and produces too little.
Since the output of the monopolist is smaller than would exist in a competitive market, the outcome also results in deadweight loss.

22. Summary Government grants of monopoly power encourage rent seeking
There are four potential solutions to the problem of monopoly
First, the government may break up firms to restore a competitive market
Second, government can promote open markets by reducing trade barriers
Third, the government can regulate a monopolist’s ability to charge excessive prices
Finally, there are circumstances in which it is better to leave the monopolist alone
Lecture notes:
The government may want to leave a monopoly alone if the costs of intervention are greater than the benefits of intervention.

23. Practice What You Know
Which of the following firms will most likely be a natural monopoly?
A grocery store
A cable TV company
A gas station
A barbershop
Clicker Question
Correct answer: B
Town utilities (cable, gas, electricity, water) usually are natural monopolies due to their cost structure.

24. Practice What You Know
Which of the following most accurately describes a patent?
An incentive to innovate
A profit-sharing mechanism
A redistribution of wealth
An original invention
Clicker Question
Correct answer: A
Be careful. The patent is not the invention itself. The patent protects your invention and allows you to gain temporary monopoly status on your invention.

25. Practice What You Know What is true for a profit-maximizing monopoly?
P = MR = MC
P = MR > MC
P > MR = MC
P > MR > MC
Clicker Question
Correct answer: C
Any firm wants to sell output where MR = MC.
However, in monopoly, P > MR.
In competition, we have P = MR = MC.

26. Practice What You Know
What is the reason for monopoly deadweight loss (relative to perfect competition)?
The monopolist faces a downward sloping demand curve
People boycott monopolies more often
The monopolist sells less output at a higher price
The monopolist has no competitors
Clicker Question
Correct answer: C
With monopoly, we don’t maximize gains from trade by reaching the same equilibrium that a competitive market reaches.

27. Practice What You Know
A monopolist will have negative profits and exit the industry in the long run if:
A new competitor enters the industry
Demand becomes more elastic
Price < ATC
A monopolist never has negative profits
Clicker Question
Correct answer: C
A monopolist can still earn negative profits. Maybe demand for the product is low, or the firm’s costs are too high.