1. © 2010 Pearson Education CanadaChapter 9 - 1 Chapter 9 Monopoly Rules © 2010 Pearson Education Canada

2. Chapter 9 - 2 Monopoly Rules Government Regulation, Competition, and the Law

3. © 2010 Pearson Education CanadaChapter 9 - 3 LEARNING OBJECTIVES 9.1Describe natural monopolies and explain the challenge they create for policymakers 9.2Explain how strategic interaction between competitors complicates business decisions, creating two smart choices 9.3Explain why cartels form and why they are unstable and illegal continued…

4. © 2010 Pearson Education CanadaChapter 9 - 4 9.4Explain arguments for and against government regulation, and describe three of its forms 9.5Differentiate between the public-interest view and the capture view of government regulation

5. © 2010 Pearson Education CanadaChapter 9 - 5 SIZE MATTERS NATURAL MONOPOLY & REGULATION Natural monopolies create a challenge for policymakers — gain the low-cost efficiencies of economies of scale, but avoid the inefficiencies of monopoly’s restricted output and higher price.

6. © 2010 Pearson Education CanadaChapter 9 - 6 NATURAL MONOPOLY & REGULATION Economies of scale average total costs fall as quantity of output increases Natural monopoly technology allows only single seller to achieve lowest average total cost Policies governments use for natural monopoly – public ownership – regulation continued…

7. © 2010 Pearson Education CanadaChapter 9 - 7 Crown corporations publicly owned businesses in Canada – BC Hydro – Canada Post – Canadian Broadcasting Corporation (CBC) – GO Transit – Hydro-Québec – Saskatchewan Liquor and Gaming Authority – Via Rail continued…

8. © 2010 Pearson Education CanadaChapter 9 - 8 Regulated private monopoly – banks – air transportation, including airports – railway and road transportation across borders – telephone, telegraph and cable systems – grain elevators, feed and seed mills – uranium mining and processing – fisheries as a natural resource continued…

9. © 2010 Pearson Education CanadaChapter 9 - 9 Public ownership and regulation achieve economies of scale, but lack of competition weakens incentives to reduce costs or innovate Rate of return regulation set price allowing regulated monopoly to just cover average total costs and normal profits

10. © 2010 Pearson Education CanadaChapter 9 - 10 COOPERATE OR CHEAT? PRISONERS’ DILEMMA AND CARTELS Strategic interaction among competitors complicates business decisions, creating two smart choices — one based on trust and the other based on non-trust.

11. © 2010 Pearson Education CanadaChapter 9 - 11 PRISONERS’ DILEMMA AND CARTELS Game theory mathematical tool for understanding how players make decisions, taking into account what they expect rivals to do Prisoners’ dilemma game with two players who must each make a strategic choice, where results depend on other player’s choice Nash equilibrium outcome of game where each player makes own best choice given the choice of the other player continued…

12. © 2010 Pearson Education CanadaChapter 9 - 12 Two smart choices exist in prisoners’ dilemma game: one based on nontrust and one based on trust continued…

13. © 2010 Pearson Education CanadaChapter 9 - 13 Figure 9.1 THE PRISONERS’ DILEMMA OF BONNIE & CLYDE

14. © 2010 Pearson Education CanadaChapter 9 - 14 If other player cannot be trusted, smart choice is cheat/confess – all players driven to Nash equilibrium outcome where everyone cheats/confesses If other player can be trusted, smart choice is cooperate/deny – all players driven to equilibrium outcome where everyone cooperates/denies continued…

15. © 2010 Pearson Education CanadaChapter 9 - 15 Prisoners’ “dilemma” is – each player (prisoner) is motivated to cheat (confess) – yet each would be better off if they could trust each other to cooperate (deny) continued…

16. © 2010 Pearson Education CanadaChapter 9 - 16 C-WORDS EVERYWHERE CARTELS, COLLUSION, CHEATING,COMPETITION (LAW) Cartels collude to raise prices and restrict output to increase economic profits. Cartels are unstable because members can increase individual profits by cheating on others.

17. © 2010 Pearson Education CanadaChapter 9 - 17 CARTELS, COLLUSION, CHEATING, COMPETITION (LAW) Collusion conspiracy to cheat or deceive others Cartel association of suppliers formed to maintain high prices and restrict competition – OPEC (Organization of Petroleum Exporting Countries) continued…

18. © 2010 Pearson Education CanadaChapter 9 - 18 “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” — Adam Smith, 1776

19. © 2010 Pearson Education CanadaChapter 9 - 19 Desirable competitive behaviour – active attempts to increase profits and gain market power of monopoly – hard to distinguish from undesirable collusive behaviour continued…

20. © 2010 Pearson Education CanadaChapter 9 - 20 The Competition Act (1986) – “to maintain and encourage competition in Canada in order to promote the efficiency and adaptability of the Canadian economy” – to prevent anti-competitive business behaviour – raises expected costs to business of price fixing (by prison time, fines, legal prohibition) relative to expected benefits (profits) continued…

21. © 2010 Pearson Education CanadaChapter 9 - 21 Criminal offences – punished by prison time, fines – price fixing, bid rigging, false/ misleading advertising Civil offences – punished by fines, legal prohibitions – mergers, abusing dominant market position, lessening competition continued…

22. © 2010 Pearson Education CanadaChapter 9 - 22 Competition Tribunal for civil offenses weighs costs of lessening competition against benefits of any increased efficiencies If mergers that reduce competition also provide economies of scale, may be approved for promoting “efficiency and adaptability”

23. © 2010 Pearson Education CanadaChapter 9 - 23 MASTER OR SERVANT? REGULATORY AGENCIES IN CANADA The discipline of market competition eventually eliminates dangerous products, but in the process people may be harmed. Three major forms of government regulation in Canada address this problem.

24. © 2010 Pearson Education CanadaChapter 9 - 24 REGULATORY AGENCIES IN CANADA Caveat emptor (“let the buyer beware”) — buyer alone responsible for checking quality of products before purchasing Certain products — nuclear power, medicines, poisonous insecticides — regulated by government because average consumer not capable of knowing product’s quality Major forms of government regulation in Canada – government departments, government-appointed agencies/boards – professional self-governing bodies

25. © 2010 Pearson Education CanadaChapter 9 - 25 PICK YOUR POISON MARKET FAILURE OR GOVERNMENT FAILURE? Two views of government regulation. Public-interest view suggests government actions improve market failure outcomes. Capture view suggests government actions produce government failure.

26. © 2010 Pearson Education CanadaChapter 9 - 26 MARKET FAILURE & GOVERNMENT FAILURE Public-interest view government regulation eliminates waste, achieves efficiency, promotes public interest Capture view government regulation benefits regulated businesses, not public interest Evidence mixed on government regulation — some supports public-interest view, some supports capture view Most economists agree Competition Act serves public interest well continued…

27. © 2010 Pearson Education CanadaChapter 9 - 27 Government failure regulation fails to serve public interest, instead benefits industry being regulated – market outcome, even with monopoly power, may be better than government regulation outcome if significant government failure – government outcome, especially with public interest regulation, may be better than market outcome if significant market failure

28. © 2010 Pearson Education CanadaChapter 9 - 28 Chapter 9 Refresh Slides

29. © 2010 Pearson Education CanadaChapter 9 - 29 NATURAL MONOPOLY & REGULATION 1.What is a natural monopoly, and how does it help consumers? 2.If you were to manage a regulated private monopoly (like New Brunswick Power) governed by rate of return regulation, explain the incentives you would personally face for delivering electricity at the lowest cost to consumers. continued…

30. © 2010 Pearson Education CanadaChapter 9 - 30 3.Identify one regulated private monopoly you buy services from. Find out from its website everything you can about its costs and the regulations under which it operates. Do you think its services could be improved? Explain your answer.

31. © 2010 Pearson Education CanadaChapter 9 - 31 PRISONERS’ DILEMMA & CARTELS 1.Describe the scenario for the prisoners’ dilemma. 2.What is a Nash equilibrium? 3.Explain the tension in the key insight of game theory.

32. © 2010 Pearson Education CanadaChapter 9 - 32 CARTELS, COLLUSION, CHEATING, COMPETITION 1.What is a cartel? 2.Explain the two kinds of anti-competitive offences in the 1986 Competition Act. continued…

33. © 2010 Pearson Education CanadaChapter 9 - 33 3.Construct a payoff matrix (similar to Figure 9.1) for two oil companies forming a cartel, where the single strategic choice is to collude (stick to an agreement to restrict output and raise prices) or to cheat on the agreement. Your payoffs should be made-up numbers of the expected $ profits of each combination of player choices. Explain the difference between the Nash equilibrium of the game and the outcome that would be best for the two oil companies.

34. © 2010 Pearson Education CanadaChapter 9 - 34 REGULATORY AGENCIES IN CANADA 1.What are the three forms of regulation in Canada? 2.Explain the arguments for and against the principle of caveat emptor. continued…

35. © 2010 Pearson Education CanadaChapter 9 - 35 REGULATORY AGENCIES IN CANADA 3.Suppose you are a successful dairy farmer recruited to serve on the Canadian Dairy Commission. You understand well the industry from a producer’s perspective, but your mandate is to regulate the industry in the public interest, where the public consists mostly of consumers. What conflicts might you face in doing your job?

36. © 2010 Pearson Education CanadaChapter 9 - 36 MARKET FAILURE OR GOVERNMENT FAILURE 1.Explain the public-interest and capture views of government regulation. 2.If a previously regulated industry is deregulated, and we observe that prices rise and output falls, which view of government regulation does that evidence support? Explain why. continued…

37. © 2010 Pearson Education CanadaChapter 9 - 37 MARKET FAILURE OR GOVERNMENT FAILURE 3.In Chapter 5, we observed that a conservative politician on the political right might tend to value efficiency more than equity, while a left-leaning politician might value equity more than efficiency. Which of the two views on government regulation — public-interest or capture — do you think a conservative politician is more likely to hold? Which view is a left-leaning politician more likely to hold? Explain your answers.