Econ 100 Lecture 5-2

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Econ 100Lecture 5-2

• Market Failure
• Monopoly
• 10-26-10

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Departures from Perfect Competition

• Market structural problems
• Monopoly single supplier/seller
• Monopsony single buyer
• Oligopoly few sellers
• Externalities
• Public goods positive externalities (free
  riders)
• Negative Externalities

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Departures from the Competitive Market Assumptions

• No buyer or seller has market power
• Information costs are minimal
• Product quality is known and products are
  homogenous
• No legal/cost barriers to entry
• Close substitutes
• No externalities positive or negative

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Monopoly

• Features
• Single seller, i.e., a price-searcher
• May be the result of
• Legal barriers to entry, e.g., med school
• Economies of scale, i.e., efficient for only 1
  firm to operate (e.g., public utilities)
• Information costs are high
• determining product quality is costly

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Wikipedias Definition

• A monopoly (from Greek mono(µ???), alone or
  single pol? (p???), to sell)
• Only one provider of a product or service in a
  particular market.
• Lack of economic competition for the good or
  service that they provide and a lack of viable
  substitute goods.
• Distinguished from monopsony, in which there is
  only one buyer of a product or service
• Distinguished from a cartel (a form of
  oligopoly), in which several providers act
  together to coordinate services, prices or sale
  of goods.

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Whats Different?

• The profit maximizing rule for both a monopolist
  and a competitive firm is the same
• Choose output level such that MRev MCost
• Difference is
• For a competitive firm price MRev
• As it takes price as given
• For a monopolist
• Each successive unit supplied/sold lowers the
  price (avg rev) and marginal revenue (MRev)

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An Example
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In Words

• For a price-searcher
• Amount supplied has a negative effect on the
  price received, i.e., average (or per-unit) price
  falls with each additional unit sold
• Therefore, if Average Revenue (Demand Curve) is
  falling, then Marginal Revenue is falling and is
  falling faster than AR
• MR is below AR

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Whats the Impact on Market Efficiency?

• DWLoss as higher P lower Q
• Transfer from CS to PS

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Monopolies and Market Efficiency

• A monopoly will sell
• a lower quantity of goods
• at a higher price than firms would in a purely
  competitive market.
• Monopoly will secure monopoly profits by
  appropriating some or all of the consumer
  surplus

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A Couple of Questions

• Is the monopolist earning an economic profit?

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A Couple of Questions

• What is the demand elasticity at the Monopolists
  Profit-Max?

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Demand Elasticity

• As long as the price elasticity of demand for
  most customers is less than one in absolute
  value,
• firm increases its prices it then receives more
  money for fewer goods.
• With a price increase, price elasticity tends to
  rise, and
• in the optimum case above it will be greater than
  one for most customers.

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A Couple of Questions

• Since the Monopolist is earning an economic
  profit, why arent other firms entering the
  market and dissipating the economic rent?

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Possible Answers

• Barriers to entry
• Legal barriers entry is prohibited by
  legislation
• Medical Profession
• Accreditation contrast to law schools/entry
• Pharmaceuticals
• Patents
• Airline hubs
• Regulated number of gates

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Possible Answers

• Unique Costs
• High fixed costs
• Generally industrial e.g., automotive (big 3
  before globalization), airlines
• Economies-of-scale are so large
• natural monopolies public utilities
  (telecomm, electricity, energy)

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Possible Answers

• No/few close substitutes
• unique resources
• diamonds, mining industries

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Examples of Monopolies

• Examples of alleged and legal monopolies
• The salt commission, a legal monopoly in China
  formed in 758.
• British East India Company created as a legal
  trading monopoly in 1600.
• Dutch East India Company created as a legal
  trading monopoly in 1602.
• U.S. Steel anti-trust prosecution failed in
  1911.
• Standard Oil broken up in 1911.
• National Football League survived anti-trust
  lawsuit in the 1960s, convicted of being an
  illegal monopoly in the 1980s.
• Major League Baseball survived U.S. anti-trust
  litigation in 1922, though its special status is
  still in dispute as of 2007.
• United Aircraft and Transport Corporation
  aircraft manufacturer holding company forced to
  divest itself of airlines in 1934.
• American Telephone Telegraph
  telecommunications giant broken up in 1982.
• Microsoft settled anti-trust litigation in the
  U.S. in 2001 fined by the European Commission in
  2004, which was upheld for the most part by the
  Court of First Instance of the European
  Communities in 2007.
• De Beers settled charges of price fixing in the
  diamond trade in the 2000s.
• Apple Inc., Accused of forming a Vertical
  Monopoly, with iPod, iTunes, iTunes Music Store,
  and the FairPlay DRM System.

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The Downside to Monopolies

• Negative aspects
• tend to become less efficient and innovative over
  time,
• "complacent giants", do not have to be efficient
  or innovative to compete in the marketplace.
• On the Other Hand
• Loss of efficiency can raise a potential
  competitor's value enough to overcome market
  entry barriers, or provide incentive for research
  and investment into new alternatives.
• The theory of contestable markets argues that in
  some circumstances (private) monopolies are
  forced to behave as if there were competition
  because of the risk of losing their monopoly to
  new entrants.
• This is likely to happen where a market's
  barriers to entry are low.
• Availability in the longer term of substitutes in
  other markets. For example, a canal monopoly,
  while worth a great deal in the late eighteenth
  century United Kingdom, was worth much less in
  the late nineteenth century because of the
  introduction of railways as a substitute.

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Upside to Monopolies?

• Positive aspects
• Some argue that it can be good to allow a firm to
  attempt to monopolize a market, since practices
  such as dumping can benefit consumers in the
  short term and once the firm grows too big, it
  can be dealt with via regulation. When monopolies
  are not broken through the open market, often a
  government will step in, either to regulate the
  monopoly, turn it into a publicly owned monopoly,
  or forcibly break it up (see Antitrust law).
  Public utilities, often being natural monopolies
  and less susceptible to efficient breakup, are
  often strongly regulated or publicly owned. ATT
  and Standard Oil are debatable examples of the
  breakup of a private monopoly. When ATT was
  broken up into the "Baby Bell" components, MCI,
  Sprint, and other companies were able to compete
  effectively in the long distance phone market and
  began to take phone traffic from the less
  efficient ATT.