Market Power

1
Market Power Monopolization

• Issues in Monopolization
• Market Power
• Ability to raise price unilaterally profitably
  above competitive (zero-profit) levels
• Fairly won (innovation, scale efficiencies) or
  ill-gotten gains?
• Law does not attack all firms/markets where
  market power is present

2

• Real world firms have some market power
• Cases of obvious monopoly are rare
• in between world -- btw comp monop
• Q Where in this in between world does
  antitrust become relevant?
• A Where damage from market power is
  sufficiently large

3
Significant Insignificant Degrees of Market
Power

• Are there methods which measure the damage from
  market power?
• Figure 4.1 of Kaserman Mayo

4
A Measure of Market Power

• Lerner Index ? (P MC) / P
• Measures the markup over cost as of P
• Note profit max gt MR MC
• MR P(1 1/ ?)
• ? 1/ ?
• So the lerner index, or profit-maximizing markup,
  is inversely proportional to the firms
  elasticity of demand

5

• Forms of Monopolizing Practices
• merger for monopoly
• acquisition of productive assets of rivals
• limit pricing
• Deter entrants by pricing just low enough to make
  entry appear unprofitable
• predatory pricing
• Price below cost to bankrupt/scare rivals
• raising rivals cost
• Legal or contractual subterfuge deny rivals
  access to essential facilities
• tacit collusion vague form of price fixing

6
Merger for Monopoly

• Historical Cases of Merger for Monopoly
• American Tobacco (J.B. Duke)
• Standard Oil (J. D. Rockefeller)
• U.S. Steel (J. P. Morgan)
• 1st two were broken up by govt antitrust action
  U.S. Steel narrowly escaped
• Note oddly, the latter was the most cartel-like
  in appearance Std Oil clearly achieved
  significant efficiencies but was the ruthless
  Microsoft of its era

7
The Dominant Firm Model

• Let a firm DF have monopolizing ambitions
• Let there N identical firms in the market
• Same costs, no differentiation in output
• The DF acquires N/2 firms through merger
• Call the remaining firms the competitive fringe
• Model
• Find the profit max Q P of the DF
• Find the output of the competitive fringe
• Assess relative profitability of the two market
  segments

8
Price and Output in a Market with a Dominant Firm
9
Mechanics of the DF Model

• 1. The DF treats comp fringe as price takers
• 2. It creates its own demand curve, DNet, by
  subtracting the output supplied by fringe firms
  at each price from the market demand curve
• 3. Find MRNet associated with DNet and equate
  MRNet with MCDF
• 4. This determines its quantity and price QDF
  PDF
• 5. Find fringe output at PDF on the fringe
  supply curve fringe output DF output is, by
  construction, total output in the market as given
  on the market demand curve

10
Outcomes in the DF Model

• 1. The dominant firm reduces the output from
  what it would produce had it acted as a price
  taker (from QC/2).
• 2. The competitive fringe increases output in
  response to the price increase (from QC/2 to
  Qff).
• 3. The profits of the competitive firms
  therefore rise by more than those of the dominant
  firm (in toto or on a per plant basis).

11
The DFs Degree of Market Power

• In general, ? (P MC) / P 1 / ?
• For DF, ? 1 / ?net
• ? s / ? (1-s) Ef
• (see appx in KM for derivation)
• N is the elasticity of D
• ?net is the elasticity of Dnet
• s is the DFs market share
• Ef is the supply elasticity of the fringe firms

12
DFs Market Power, cont

• ? s / ? (1-s) Ef
• ? is the profit maximizing markup over MC
• ? increases when
• s increases
• ? decreases
• Ef decreases
• For the DF to have significant market power, all
  3 conditions must be in place
• Not easy to manage, particularly in the LR

13
Implications of the DF Model for Merger for
Monopoly

• 1. Consider owner of individual plant
• The profits of an independent plant owner are
  greater than the contribution of the identical
  plant to the profits of the DF
• As in a cartel, it is better to free ride on the
  output-restricting, price enhancing decisions of
  industry rivals. Let them cut back on output,
  and capitalize on the price increase that results
  by increasing output in response.

14
Implications of the DF Model for MFM, continued

• 2. Merger for monopoly will be very difficult to
  achieve on a sequential firm by firm basis.
• The DF is willing to pay each firm its capital
  costs plus the additional profits earned by the
  dominant firm as a result of the merger. But
  since the profits earned by the firm if it stays
  outside the dominant firm are higher, once it is
  clear that the intent of the merger is to cut
  back on output an raise price, no one will accept
  the DFs merger offer.

15
Implications of DF for MFM, continued

• 3. The problem of sequential merger in the
  merger for monopoly case can be overcome with a
  take-it-or-leave-it tender offer.
• If the choice is to remain in a competitive
  market or to be part of the dominant firm, the
  latter is more profitable. (Above, the choice
  was between being a fringe firm coexisting with a
  dominant firm, or being merged.)
• This is what J.P. Morgan accomplished in merging
  66 of steel market capacity into U.S. Steel in
  1901.

16
Implications of DF for MFM, continued

• 4. There are profit opportunities for potential
  entrants.
• The model thus predicts that the market share of
  the dominant firm will decline over time.
• Again, this is what happened to U.S. Steel. By
  1920 its market share had fallen to 46 by 1925
  to 42. Note that this took roughly a
  quarter-century the long run is often slow in
  coming. In the meantime, U.S. Steel -- and its
  competitors -- both enjoyed super-normal profits.

17
Summary of the DF Model

• Merger for monopoly may represent a profit
  opportunity
• The DFs market power increases with mkt share,
  decreases with demand elasticity and supply
  elasticity of the competitive fringe
• With identical costs, competitive fringe plants
  get a higher rate of profit than DF
• Sequential merger is a dubious strategy
• LR entry possibilities exist unless checked by
  barriers
• Ownership strategies undermine the competitive
  model we are less sure that cost and demand
  conditions yield a unique equilibrium, except
  where cheap entry and exit undermines the MFM
  strategy. Trust-busting may have merit to deter
  MFM preserve competitive outcomes.