Theory of Monopoly and Competitive Conditions

1. Purchasing Monopoly The theory of monopoly presumes the condition of monopoly, much as theory of competition presumes the condition of competition. Neither theory seriously attempts to explain how these conditions arise, and so they are more aptly named the theory of pricing under monopoly and the theory of pricing under competitive conditions.

2. The Profit of Monopolization Implicit assumption that monopoly already exists. Assume that only one entrepreneur seeks to profit from the conversion of a competitive industry to a monopoly. Barriers to entry play no important role so the task faced by this one monopolizer is not one of purchasing a legal barrier to competition but of purchasing the power to set price in the face of unblockaded entry.

4. The profit to monopolization (per period), then, can be thought to vary between depending on the payment required to keep “price-reducing” capacity in other industries. The minimum subtraction from standard monopoly profit is the forgone competitive rent .

5. If QEQM can be kept out only by paying owners a significant fraction of the monopoly rent they forgo by refraining from entering the monopolized industry, then the amount that must be subtracted from standard monopoly profit to calculate the profit to monopolization is larger. The maximum subtraction adds the forgone monopoly rent of potential entrants, , to the amount that must be subtracted.

6. The Propensity to Monopoly The tendency to monopoly is thus a function of the difference between the rents to monopoly and to competition. Ceteris paribus, the more inelastic the market demand, the greater is the monopoly rent, and the more elastic is the supply, the smaller is the competitive rent. Figure 10.2 shows the intersection of D’ at the right angled kink of yields a positive monopoly rent in combination with a zero competitive rent.

9. A reasonable pattern of acquisition prices requires the monopolizer to pay more to acquire competitive assets the closer he is to completing the monopolization of the industry. At the very beginning of the acquisition process, the probability of successful monopolization is close enough to zero that the price paid for specialized assets should be no greater than their value under competitive conditions. At the end of the monopolization process the price paid should be very close to the monopoly rent.

10. The path of capacity acquisition prices might approximate line PCB in Figure 10.3. The return to monopolization is then area PCPMDG minus area AGB. To the extent that there is rivalry to monopolize the target industry, the line PCB will approach line PMB, so that the return to monopolization is even more likely to be negative.

12. Estimating the Welfare Loss from Monopolization In Harberger-type estimates, the deviation in an industry’s profit rate from the average of manufacturing profit rates, or some such measure, is used as an index of the deviation of monopoly price from competitive price. In Figure 10.4, we use D’ and PCES’ to representdemand and supply for a Harberger study of the deadweight loss of monopoly.

13. The deadweight loss triangle is . Harberger theoretically indexes the size of this triangle by vertical line AC, with AC empirically estimated from recorded profit rates. However, in the present analysis, recorded profit rates reflect the difference between the vertically and horizontally shaded areas . If monopoly is the source of higher recorded profit rates, the empirical estimate of AC must understate the real magnitude of AC and, therefore, of the deadweight loss triangle.

14. The Risks of monopolization A departure from the “easy monopolization” assumptions with which we started makes it clear that attempts to monopolize are fraught with risks of various kinds. Some of the risks of monopolization, and some of the costs of deterring entry, can be offset by abandoning the purely private approach in favor of securing government aid. Entry barriers imposed and policed by the government present a formidable hurdle to the reentry or new entry of capacity.