The Power Of Microeconomics

1
The Power Of Microeconomics
2
Monopoly And Monopolistic Competition
3
Lesson 6 Colander McConnell Samuelson
Schiller Brue Nordhaus
Complete Textbook (includes both Micro-and
Macroeconomics) Microeconomics Text Only
12, 13 24, 25 9,10 24,26
12, 13 11, 12 9,10 9,11
Page Down to advance the presentation
4
A Definition Of Competition

• Competition is when everyone tries to get a
  monopoly.
• Were going to learn about monopoly as well as
  one other form of imperfect competition called
  monopolistic competition.
• We shall see that prices are generally higher and
  outputs are lower under imperfect competition
  than under perfect competition.

5

• There may be benefits to imperfect competition,
  including the exploitation of economies of scale
  to lower costs and the acceleration of
  technological change and long term growth.

• If you understand how imperfectly competitive
  markets work, you will understand better how our
  economy, and the economies of other
  industrialized nations, function.

6
The Gilded Age Of America

• Between 1870 and 1914 monopolists pretty much ran
  amuck.
• Indeed, legendary and often unscrupulous figures
  like John D. Rockefeller, Jay Gould, Cornelius
  Vanderbilt, Andrew Carnegie, and J.P. Morgan were
  able to corner the markets in everything from oil
  and steel and the railroads to kerosene, sugar,
  and salt.

7
Rockefeller

• Saw visions of riches in the fledgling oil
  industry and began to organize oil refineries.
• Using a combination of shrewd management, secret
  deals with the railroads, and an utter
  ruthlessness in crushing his competitors,
  Rockefeller was able to gain control of 95 of
  all of the pipelines and refineries in America --
  after which, of course, he promptly raised
  prices.

8
Rockefeller Invents The Trust

• Shareholders turned their shares over to
  trustees who would then manage the industry to
  maximize its profits.
• These trusts were essentially cartels
• A cartel is an organization of independent firms
  producing similar products that work together to
  raise prices and restrict output.
• This trust device worked so well that other
  industries soon imitated Rockefellers Standard
  Oil Trust to consolidate their monopoly power.

Page Down to advance the presentation
9
Antitrust Laws

• This practice so incensed the American public
  that, in 1910, the Congress passed antitrust
  laws to break up the trusts, ban cartels, and
  even regulate the prices of many of the
  industries.
• Today, the unregulated monopolies of a century
  past are rare while the monopolies that do exist
  tend to be subject to a very special form of
  price regulation.

10
Monopoly

• Exists when there is only one seller in the
  market selling a product for which there are no
  close substitutes.

• The monopolist is not a price taker as was our
  perfectly competitive firm.
• Rather, it is a price maker, meaning that it
  exerts considerable control over what the market
  price will be.
• The monopolist has this power because it also
  controls quantity supplied in the market.

Page Down to advance the presentation
11
A Quiz

• Under our assumption that the monopolist wants to
  maximize profits, where do you think the
  monopolist will set the market price?
• Hint Do you remember the profit maximizing rule
  from the last lesson?
• The Monopolist will maximize profits when
• a) P MC
• b) P is as high as possible.
• c) MR MC

Page Down to advance the presentation
12
A Quiz

• The Monopolist will maximize profits when
• a) P MC
• b) P is as high as possible.
• c) MR MC
• In the last lesson, I made the claim that all
  profit-maximizing firms will set price where the
  marginal revenue from an additional unit sold
  equals its marginal cost.

Page Down to advance the presentation
13
(1) (2) (3) (4) (5)
(6) (7) Total Total Total Marginal Marginal
Price revenue cost profit revenue
cost Quantity P TR TC TP MR MC
q () () () () () ()
0 200 0 146 -145 200 34 180
30 1 180 180 175 5 160 27 ?
25 2 160 320 200 120 120 22 100
20 3 140 420 220 200 80 21 60
30 4 120 480 250 230 40 ? 20
50 5 100 500 300 200 0 60 -20
70 6 80 480 370 ? -40 80
-60 90 7 60 420 460 -40 -80 100
-100 110 8 40 320 570 -250
Page Down to advance the presentation
14
(1) (2) (3) (4) (5)
(6) (7) Total Total Total Marginal Marginal
Price revenue cost profit revenue
cost Quantity P TR TC TP MR MC
q () () () () () ()
Questions 1. At what price and quantity are
profits maximized? 2. At this point, what is the
relationship between marginal revenue and
marginal cost?
0 200 0 146 -145 200 34 180
30 1 180 180 175 5 160 27 140
25 2 160 320 200 120 120 22 100
20 3 140 420 220 200 80 21 60
30 4 120 480 250 230 40 40 20
50 5 100 500 300 200 0 60 -20
70 6 80 480 370 110 -40 80
-60 90 7 60 420 460 -40 -80 100
-100 110 8 40 320 570 -250
Page Down to advance the presentation
15
(1) (2) (3) (4) (5)
(6) (7) Total Total Total Marginal Marginal
Price revenue cost profit revenue
cost Quantity P TR TC TP MR MC
q () () () () () ()

0 200 0 146 -145 200 34 180 30
1 180 180 175 5 160 27 140
25 2 160 320 200 120 120 22 100
20 3 140 420 220 200 80 21 60
30 4 120 480 250 230 40 40 20
50 5 100 500 300 200 0 60 -20
70 6 80 480 370 110 -40 80
-60 90 7 60 420 460 -40 -80 100
-100 110 8 40 320 570 -250
Page Down to advance the presentation
16
(1) (2) (3) (4) (5)
(6) (7) Total Total Total Marginal Marginal
Price revenue cost profit revenue
cost Quantity P TR TC TP MR MC
q () () () () () ()
0 200 0 146 -145 200 34 180 30
1 180 180 175 5 160 27 140
25 2 160 320 200 120 120 22 100
20 3 140 420 220 200 80 21 60
30 4 120 480 250 230 40 40 20
50 5 100 500 300 200 0 60 -20
70 6 80 480 370 110 -40 80
-60 90 7 60 420 460 -40 -80 100
-100 110 8 40 320 570 -250
Page Down to advance the presentation
17
/q
200 100 0 -150
MC
175
G
120
AC
F
E
MRMC
q
2 4 6
8 10
MR
Page Down to advance the presentation
18
Monopoly Pricing
P
S
A
Pm
B
C
Pe
E
F
D
Q
Qe
Qm
How much is the dead weight loss and how much
income is redistributed from consumers to the
monopolist because of monopoly pricing?
a) The loss in allocative efficiency or dead
weight loss equals C plus E. The rectangle of
consumer surplus B is transferred to the
monopolist. b) The loss in allocative efficiency
or dead weight loss equals D plus E. The
rectangle of consumer surplus BC is transferred
to the monopolist. c) I skipped the last lecture
and havent got a clue.
Page Down to advance the presentation
19
Monopoly Pricing
P
S
A
Pm
B
C
Pe
E
F
D
Q
Qe
Qm
How much is the dead weight loss and how much
income is redistributed from consumers to the
monopolist because of monopoly pricing?
a) The loss in allocative efficiency or dead
weight loss equals C plus E. The rectangle of
consumer surplus B is transferred to the
monopolist. b) The loss in allocative efficiency
or dead weight loss equals D plus E. The
rectangle of consumer surplus BC is transferred
to the monopolist. c) I skipped the last lecture
and havent got a clue.
Page Down to advance the presentation
20
Public Policy

• So you can see that monopoly is both inefficient
  and redistributes income in a way that many would
  describe as unfair.
• The question for public policy is what to do
  about monopoly, and the answer is not as easy as
  you might think.

21
1
2
Long-run ATC
Long-run ATC
Unit costs
Unit costs
Output
Output
4
3
Long-run ATC
Long-run ATC
Unit costs
Unit costs
Page Down to advance the presentation
Output
Output
22
Natural Monopoly
Unit Costs
Long-run ATC
Output
Page Down to advance the presentation
23

• Now suppose some irate Congressman decides to
  launch a crusade against monopoly and sponsors
  antitrust legislation to break up every monopoly
  into many small firms.
• Is this a good idea?

Page Down to advance the presentation
24
A Good Idea?

• Breaking up some monopolies might be a very good
  idea indeed.
• However, breaking a natural monopoly up into many
  small firms is likely to be a very bad idea.
• This is because each of the smaller firms will
  produce at a significantly higher unit cost than
  the monopolist.

25
Each Of The Smaller Firms

• Will be unable to achieve the same minimum
  efficient scale as the monopolist.
• Thus, while this artificially created competitive
  market may indeed yield a competitive price where
  P equals MC, it may also be the case that this
  price is well above the natural monopolists one.
  
• In Websters Dictionary, that might well be used
  as an example of irony.

Page Down to advance the presentation
26
Price Regulation

• So if breaking up a natural monopoly is a bad
  idea, what can you do to address public policy
  concerns?
• Well, another approach is price regulation.
• But again, you have to be really careful about
  where price should be set.

27
A Regulated Monopoly
a) Set price at Point A where PMC. b) Set price
at Point B where MRMC. c) Set price at point C
where PAC.
B
Pm Pf Pr 0
C
ATC
Price and costs (dollars)
A
MC
MR
Qm Qf Qr
Page Down to advance the presentation
Quantity
28
A Regulated Monopoly
Monopoly Price
B
Pm Pf Pr 0
PAC
C
ATC
Price and costs (dollars)
A
MC
MR
Qm Qf Qr
Page Down to advance the presentation
Quantity
29
A Regulated Monopoly
Monopoly Price
B
Pm Pf Pr 0
C
ATC
Price and costs (dollars)
A
MC
MR
Qm Qf Qr
Page Down to advance the presentation
Quantity
30
A Regulated Monopoly
Monopoly Price
B
Pm Pf Pr 0
PAC
C
ATC
Price and costs (dollars)
A
MC
MR
Qm Qf Qr
Page Down to advance the presentation
Quantity
31
An Important Rule

• This rule has been used for decades to regulate
  prices in natural monopoly industries ranging
  from electricity, gas, and water to the
  railroads, telephone, and even cable TV.

32
Not A Perfect Solution

• There is never any free lunch in economics, only
  hard choices.
• Because even though the P AC rule seems to
  solve a lot of problems with monopoly, it can
  also create additional problems.

33
X-Inefficiency
Unit costs (dollars)
PAC
P1
Average Total Costs--Efficient Production
Q
Page Down to advance the presentation
Quantity
34
X-Inefficiency
Average Total Costs
Unit costs (dollars)
Page Down to advance the presentation
Quantity
35
Cost Plus Pricing

• Under the P equals AC rule, you are basically
  guaranteed the recovery of any costs that you
  incur.
• In fact, thats why this type of regulation is
  known as cost-plus pricing.

Page Down to advance the presentation
36
Do You See The Problem?

• Under cost-plus pricing, regulated industries no
  longer have the incentive to minimize costs and
  therefore maximize profits.
• Instead, there is a perverse incentive to
  increase costs for the benefit of the executives
  operating the firm.

37
The X-inefficiency Theory Predicts

• Executives in regulated industries will tend to
  hire more staff, buy thicker carpets, build
  larger offices, and engage in more business
  travel than they otherwise would under strict
  profit maximization.
• What do you think such behavior would do to the
  observed average total cost curve AND the
  regulated price?

Page Down to advance the presentation
38
X-Inefficiency
Unit costs (dollars)
PAC
P1
Average Total Costs--Efficient Production
Q
Page Down to advance the presentation
Quantity
39
The Punch Line

• In some cases, any increase in allocative
  efficiency achieved by regulating a monopolist
  might be more than offset by an increase in
  X-inefficiency due to cost-plus pricing.

Page Down to advance the presentation
40
The Broader Point

• Monopoly and the appropriate public policy
  response raises many thorny issues.
• Let me leave you with one last issue before we
  move on to monopolistic competition.
• This has to do with the effect of industry
  structure on another key measure of market
  performance known as dynamic efficiency.

41
Dynamic Efficiency

• Dynamic efficiency measures the rate of
  technological change and innovation in an
  industry.

42
Are Monopolies Bad?

• The question first raised by Harvard economist
  Joseph Schumpeter is whether monopolies are
  likely to outperform competitive industries in
  the dynamic efficiency dimension.
• If the answer is yes, then perhaps we should just
  leave monopolies alone.

Page Down to advance the presentation
43
Joseph Shumpeters Argument

• Since monopolists are likely to earn a much
  higher level of economic profit than competitive
  industries, they will have much deeper pockets to
  engage in longer term strategic activities such
  as research and development.
• They will also have a much bigger cash fund with
  which to make investments to speed the diffusion
  of the technology.

Page Down to advance the presentation
44
The Counter Argument

• While the monopolist may have deep pockets to
  spend on developing new technologies, that same
  monopolist has little incentive in the absence of
  competitors to introduce the technology so
  technological progress is actually slowed.

Page Down to advance the presentation
45
The Touchtone Phone

• Some critics claim that the phone monopoly AT T
  invented the touch tone phone in its research arm
  of Bell Laboratories.
• Nonetheless, it waited years before ever
  bothering to introduce it because it faced no
  competition.

46
We Cant Settle This Here

• This debate provides yet an additional layer of
  complexity to thinking through the public policy
  implications of economic theory.
• Lets turn to an even more complex beast that
  of monopolistic competition.

Click here to go to part 2 of the presentation
47
End Of Part 1
Lecturer Peter Navarro Multimedia Designer Ron
Kahr Female Voiceover Ashley West Leonard