2. Monopoly Outline Pure monopoly Barriers to entry Monopoly compared to competition Natural monopoly The regulatory dilemma Monopolistic competition

3. Pure monopoly A “pure” monopoly is a market structure in which a single seller accounts for 100 percent of market sales.

4. 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.

5. Figure 9.1

6. 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.

7. 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, 2 nd 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].

8. 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.

9. 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

10. Strategic Barriers Alcoa’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.

11. The Microsoft case Microsoft Corporation v. U.SMicrosoft 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.”section 1section 2

12. The applications barrier in the Microsoft case Hear audio explanation (wav)audio explanation “[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:Finding of Fact

13. 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 Finding of Fact

14. 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. applications barrier Hear Brown’s comments (wav)Brown’s comments

15. 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. applications barrier

16. 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.

17. 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)audio explanation 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.

18. Output 0 PMPM PCPC QMQM QCQC MC = AC Market Demand MR A B EH Price, Cost Monopoly compared to Competition Notice that for each additional unit produced between Q M and Q C, Demand (marginal benefit) is higher than marginal cost.

19. PriceQuantityEcon  Consumer Surplus Dead Weight Comp- etition PCPC QCQC zeroP C AEzero Monopoly PMPM QMQM P C P M BHP M ABBHE Results summarized

20. 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.

21. Quantity Price, Cost 0 LMC LAC D = AR MR PCPC PMPM A B q = 1/100Q c QMQM * 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).

22. Professor, What do you mean by the term “regulatory dilemma” I refer to the dilemma confronting regulators (e.g., public service commissioners) as they go about the task of subjecting firms covered by their legislative mandate to rate-of- return regulation.

23. We will use some simple graphs to illustrate 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.

24. MWHs $ 0 MR LAC LMC PMPM QMQM QCQC CMCM    Case 1: Unregulated Monopoly D = AR

25. MWHs $ 0 LAC LMC MR D = AR Case 2: Marginal Cost Pricing   QCQC PCPC C1C1 

26. Recall the necessary condition for socially efficient resource allocation: P = MC Hence: Option 2 is optimal on social efficiency criteria. Why not select option 2 and subsidize the regulated firm by amount C 1  P C ?

27. 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?

28. MWHs $ 0 LAC LMC MR QAQA PAPA   Option 3: Average Cost Pricing

29. Option PriceQuantity Dead Weight Loss given by area Econ Profit given by area 1PMPM QMQM  P M  C M 2PCPC QCQC 0 (C 1  P C ) 3PAPA QAQA  0 Comparing the results

30. 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

31. The monopolistic competitor faces a downward sloping, but very elastic, demand curve.

32. Short run equilibrium in monopolistic competition

33. Long Run Equilibrium in Monopolistic Competition Dollars per Unit of Output P E Q E Output D F MR F MC AC (b) Long-Run Equilibrium: the Firm Earns Zero Economic Profit