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Regulating Monopolies
Lecture 9


Market Entry Barriers


Market Entry Barriers - prevents competitors from entering the market

1. Economies of scale - Natural monopoly.

  • Firm has to be large to obtain low per-unit cost.
  • Firm has very large fixed costs.
  • A new firm entering this market would need substantial amounts of capital to reach this low-cost production level.
    • Usually supplies the whole market.
    • Examples: Local phone service, electricity, natural gas, and rail roads.
      • Large amount of equipment & infrastructure required.
      • More convenient - imagine 12 electric power stations competing in one city. Each has its own power lines, power substations, etc. This would be a mess.
Economies of Scale
Economies of Scale

2. Legal Barriers

  1. Licensing - oldest form of protection.
    • Protects businesses from competition.
      • Doctors.
      • Legal services.
      • Taxicabs.
      • Funeral homes, etc.
    • Sometimes the license has little costs, while other cases, they are expensive.
      • Ex: Taxicabs in New York City.
        • The # of taxi licenses are fixed.
        • Licenses can sold/traded.
        • Market price of license > $100,000.
  2. Patents - most countries have them.
    • U.S. - gives the exclusive right to produce product for 17 years
    • Benefits - encourages costly scientific research.
    • Costs - higher prices to consumers until patent expires.

3. A firm controls an essential resource.

  • Example: Before World War II
    • Aluminum Company of America controlled the supply of bauxite.
    • Other firms could not produce aluminum cheaply without bauxite.
  • Example: DeBeers Corporation of South Africa.
    • Controls 80 to 85% of the world's supply of diamonds.
    • "Diamond is forever."

4. Unfair competition:

  • Example: Standard Oil - John Rockefeller.
  • Came into a small town and charge a price below cost.
  • Drove competitors out of business.
  • Standard Oil would buy these businesses for cents on the dollar and consolidate them into Standard Oil.
  • With no competition, Standard Oil charged monopoly prices.
  • Standard Oil moved to the next town
  • Controlled 90% of U.S. oil market.
Blue arrow Given enough time, technology allows new firms to circumvent the high barriers and drive economic profits to zero.

Example - Cell phone technology opened telecommunications market to competition.


The Case of Monopoly


1. Pure monopoly - a firm is sole producer of a product.
  • Characteristics.
    1. Single seller of a product.
      • The demand for the monopolist's product is the market demand curve.
      • A one firm industry.
    2. No close substitutes for the product.
      • You either buy the product from him or you don't.
    3. A monopolist can exert control over the price.
      • He decreases production level and market price increases.
    4. Other firms are prevented from entering the market, because of high barriers.
      • No competition.

2. Price and output under monopoly.

  • Monopolists expands output when MR > MC.
  • Profits are maximized at MR = MC.
  • Unregulated monopolist: Market price, P* and production level, Q*.
    • P* > ATC*, therefore monopolist earns economic profits.
    • High entry barriers prevent competition.
    • Monopolist earns long-run profits.
  • Price gouging
    • Monopolist charges the price, where MR = MC.
    • He does not raise price further, because profits fall.
  • Monopolies may not earn long-run economic profits.
    • Patents for products that consumers do not want.
A Monopolist
A monopolist is earning profit


  • Monopolies may earn economic profits in the long run.
  • Buying these company stocks may not be profitable, because the monopoly value is already captured in the stock price.
    • Early bird - unless you are the first person to buy the stock when economic profits began.
Blue arrow These firms may not be good investments.

Why Monopolies Are Bad


Could include gov., because gov. has a monopoly over certain services.
  1. Little competition limits the options to consumers.
    • You either buy the product from the monopolist or you go without.
  2. Reduced competition results in allocative inefficiency.
    • Consumers value the products more highly than what it costs to produce them.
      • P* > ATC.
      • Firms are earning economic profits.
  3. Consumers are not able to direct monopolies to serve their interests.
    • Bad service.
    • No incentive to improve products, etc.
  4. Gov. grants of monopoly encourage rent seeking.
    • Rent seeking behavior - gov. officials takes cash & assets from private companies & people.
    • Russia:
      • Companies bribe public officials, then officials grant licenses to those businesses, restricting competition.
    • U.S.
      • Corporations funnel campaign money to Congressmen.
      • Congress passes laws favorable to corporations.

Government Policy Alternatives


Policies are ranked from the economically best to the worse.

1. Reduce regulations that create market barriers

  • Tariffs - tax on imported goods.
  • Quotas - limit # of imported units.
  • Licensing requirements.
  • These policies protect monopolies from international competition.

2. Government can "ideally" regulate natural monopolies.

  • Two pricing methods
    • Average Cost Pricing
    • Marginal Cost Pricing

Example 1 - Unregulated monopolist produces at MC = MR, so the market price is P* and output is Q*

  • Average Cost Pricing - the gov. sets the price where the demand curve intersects the long-run ATC.
    • The price is lower ( P~< P*).
    • The quantity produced is higher (Q~ > Q*).
    • The firm earns zero economic profit in long run.
    • Social welfare improves.
    • Allocative inefficient.
      • Price does not equal MC.
A Monopolist - Average Cost Pricing
Average cost pricing

Example 2 - Unregulated monopolist produces at MC = MR, so the market price is P* and output is Q*.

  • Marginal Cost Pricing - the gov. sets the price where the demand curve intersects the MC.
    • The price is the lowest (P~ < P*).
    • The quantity produced is the highest (Q~ > Q*).
    • The same social welfare as a competitive market.
    • Allocative efficient.
      • P = MC.
    • The firm earns a loss in long run
  • Ramsey Pricing
    • Regulated monopoly charges two prices
      • Unit charge is where P = MC
      • Fixed charge - take the monopolist's loss and divide evenly among consumers
        • The loss is the red square
A Monopolist - Marginal Cost Pricing
Marginal cost pricing

3. Antitrust policies - government breaks up monopolies

  • Increase the number of firms in a market.
    • Ex: Government broke Standard Oil into several companies
      • Amoco Corporation
      • Chevron Corporation
      • Exxon Corporation
      • Mobile Corporation
    • Prevent companies from merging that may reduce competition.
    • Prosecute firms engaging in collusive behavior.
    • Do not breakup natural monopolies!
      • Per-unit costs will be higher with more firms.
      • 1984, AT&T was broken down into five baby bells.
      • A large monopoly broken down into 5 smaller regional monopolies.

4. Gov. can take over monopoly.

  • Maybe worse than a private firm monopoly.
    • No profit motive.
    • No incentives to minimize costs and satisfy consumers.
    • Taxpayers could end up subsidizing it.
    • Example - U.S. Postal Service - facing intense competition (e-mail, faxes, other mail carriers), so this agency is good.

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