1. Monopolies & Regulation Chapter 24 & 26

2. Monopoly  A firm that produces the entire market supply of a particular good or service. Chapter 24 & 26 2

3. Monopoly Characteristics  Single firm or seller  No close substitutes  High barriers to entry  Firm has all market power  Firm is a Price Setter  Advertising for luxury goods only  Ex: Local Electric Company Chapter 24 & 26 3

4. Market Power  The ability to alter the market price and characteristics of a good or service. Chapter 24 & 26 4

5. Monopoly Demand Curve  The demand curve facing the monopoly firm is the market demand curve for the product.  Firms with market power confront downward-sloping demand curves. Chapter 24 & 26 5

6. Demand & Price  Since the company is the industry the company can choose where on the demand curve (and at what price) they want to work. Chapter 24 & 26 6

7. The Market & Company Chapter 24 & 26 7

8. Price and Marginal Revenue  A monopoly faces a different profit maximizing situation than competitive firms.  Profit-maximization rule is the same:  Produce at that rate of output where MR = MC. Chapter 24 & 26 8

9. Profit Maximization  The point where MC = MR determines the profit maximizing quantity at a given price.  The advantage for a monopoly is that it can alter the price it charges.  The demand curve determines the quantity for each price. Chapter 24 & 26 9

10. Monopoly Profits  Sometimes increasing Price & decreasing Quantity will increase Total Revenue  Sometimes decreasing Price & increasing Quantity will increase Total Revenue  It depends on the Elasticity of the product’s demand  If demand is elastic, lower price will lead to higher TR Chapter 24 & 26 10

11. Barriers to Entry  Unless there are barriers to entry, high monopoly profits tend to attract profit-hungry entrepreneurs into the market.  These profits will be maintained as long as barriers to entry prevent any competitors from entering the market. Chapter 24 & 26 11

12. Political Power  A firm with considerable market power likely to have significant political power as well. Chapter 24 & 26 12

13. The Limits to Power  Monopolists only have absolute control of the quantity of output supplied to the market.  Monopolists must still contend with the market demand curve. Chapter 24 & 26 13

14. Price Discrimination  The sale of an identical good at different prices to different consumers by a single seller.  This has nothing to do with costs to produce Chapter 24 & 26 14

15. Price Discrimination Examples  Senior Citizens discounts  Student discounts  In-state tuition  Matinee prices  Coupons  Military discount Chapter 24 & 26 15

16. Entry Barriers  Patents  Monopoly franchises or licenses  Control/ownership of key production resources  Land, labor, capital, entrepreneurial ability  Control of distribution outlets  Well-established brand loyalty  Government regulation  Lawsuits  Acquisition of competition  Economies of scale Chapter 24 & 26 16

17. Ways to Enter a Monopoly Market  Acquisition  buy out the current company  Overcome all the entry barriers  Make a different product & “sneak in”  Money, determination (time) or ingenuity Chapter 24 & 26 17

18. Monopolies & The Economy  Generally, Monopolies lead to:  Higher prices  Less variety  Slower innovation  Lower employment Chapter 24 & 26 18

19. Monopolies & Government  Based on the bad that monopolies bring to the economy, the U.S. government is against them. Chapter 24 & 26 19

20. If A Monopoly Is Not Beneficial  The government will either:  Keep a monopoly from forming  Break up any existing monopolies  If a monopoly is beneficial to society the government may allow it to exist. If so, the government will regulate it. Chapter 24 & 26 20

21. Why Allow a Monopoly?  Society’s good  lower price from a natural monopoly  Bring products & services to people who would not get them.  Better resource allocation  Economies of Scale  Better for the environment  More Research and Development  Product standardization Chapter 24 & 26 21

22. Natural Monopolies  An industry in which one firm can produce at a lower ATC than 2 firms can.  Economies of scale act as a “natural” barrier to entry.  Examples:  local telephone services  local cable services Chapter 24 & 26 22

23. Regulating Monopolies  The government can regulate:  The prices the monopoly can charge the customer  The output of the monopoly  The quality of the products Chapter 24 & 26 23

24. Regulating Monopolies  The most common regulation of monopolies is regulating the price the monopoly can charge.  Two methods:  Socially Optimal Price  Fair-Return Price Chapter 24 & 26 24

25. Price Ceiling  The government sets the maximum price the monopoly can charge the customer.  The government then subsidizes the monopoly with direct payments for expenses & profits.  In essence, the company is a de-facto department of the government Chapter 24 & 26 25

26. Socially Optimal Pricing  Price = MC  The government forces a price cap at MC, so there is no “economic profit”.  The price is just as it “would be” if industry was Pure Competition  The government then subsidizes the monopoly with direct payments for expenses & profits.  In essence, the company is a de-facto department of the government Chapter 24 & 26 26

27. Fair-Return Pricing  Price = ATC  Extra capacity is needed for peak usage times. To build this excess capacity price needs to be higher than MC.  ATC is calculated with excess capacity to ensure enough for the high-demand times. Chapter 24 & 26 27

28. Normal Profit and Monopolies  In both cases, there is a “normal profit” allowed, as a percentage above cost. Chapter 24 & 26 28

29. Monopoly Behavior with Regulation  The problem with both regulation plans is there is no incentive to reduce costs.  Where profit is a percent of cost, the higher the costs are, the higher the profit will be.  Easy for companies to upgrade equipment  Easy to abuse Chapter 24 & 26 29

30. Costs of Regulation  Administrative costs  To create the regulations  Compliance costs  To enforce the regulations  Efficiency costs  Bad regulations & corrective measures Chapter 24 & 26 30

31. Antitrust Laws  Sherman Act (1890)  prohibits “conspiracies in restraint of trade”.  Clayton Act (1914)  prohibited price discrimination, exclusive dealing agreements, certain types of mergers, and interlocking boards of directors among competing firms.  The Federal Trade Commission Act (1914)  created the FTC to study industry structures and behavior so as to identify anti-competitive practices. Chapter 24 & 26 31

32. Objections To Anti-Trust  Punishing people for being successful  Lack of competition may not be the company’s fault  Large companies are needed to compete globally Chapter 24 & 26 32