Monopoly

1. Monopoly • Outline • Pure monopoly • Barriers to entry • Monopoly compared to competition • Natural monopoly • The regulatory dilemma • Monopolistic competition

2. Pure monopoly A “pure” monopoly is a market structure in which a single seller accounts for 100 percent of market sales.

3. Pure monopolies are hard to find in the real world. Economists and judges as a rule believe a 90 percent market share is sufficient to constitute an “effective” monopoly.

4. Figure 9.1

5. Notice the monopolist earns an economic profit equal to the shaded are. Question is: Should this situation not be ripe for entry of new firms? Not if there are factors which impede entry of new firms.

6. Barriers to entry: 2 definitions • “[A]nything which creates a disadvantage for potential entrants vis à vis established firms. The height of the barriers is measured by the extent to which, in the long run, established firms can elevate their selling prices above minimal average cost . . . without inducing potential entrants to enter” [Joe Bain, Industrial Organization, 2nd ed., p. 252]. • Barriers to entry into a market . . . can be defined to be socially undesirable limitations to entry of resources which are due to protection of resource owners already in the market” [Christian von Weizsäcker, Barriers to Entry, p. 13].

7. Examples of barriers to entry • Absolute cost advantagesExamples: Alcoa had access to low cost hydroelectric power in Pacific NW; Weyerhauser procured extraction rights to tracts of Douglas fir in 1901; International petroleum majors (Texaco, SOCAL, BP, et al) formed a pipeline consortium in California. • Economies of scale: Dominant firm may enjoy cost advantages due to realization of scale economies in production, distribution, capital raising, or sales promotion.

8. Barriers due to control of wholesale, retail distribution systemsExamples: Control of wholesale diamond distribution by DeBeers; Control of advantageous retail shelf space by Proctor and Gamble, Kellogs. • Barriers due to patents, copyrights, trademarks, and other legal barriersExamples: Xerox’s patent on xerography; Polaroid’s patent on instamatic photography • Barriers due to product differentiation/brand powerExamples: Cigarettes, pain relievers, designer jeans, athletic wear, batteries, soft drinks

9. Strategic Barriers • Alcoa’s restrictive covenants with hydroelectric suppliers. • Standard Oil’s “secret rebate” policy with the railroad companies. • “Lease-only” policy of IBM, United Shoe Machinery, International Salt • IBM’s continual design modification was designed to forestall entry of firms such as Calcomp that marketed plug-compatible peripherals—e.g.,tapes and line printers. • Microsoft charges PC makers a royalty for every computer shipped—regardless of whether the machine has a Windows operating system installed. • Microsoft requires that Explorer icon appear on desktop in initial boot up sequence.

10. Monopoly compared to Competition Price, Cost A MarketDemand Notice that for each additional unit produced between QM and QC, Demand (marginal benefit) is higher than marginal cost. B PM H E PC MC = AC MR QM 0 QC Output

11. Results summarized

12. Dead weight is a measure of loss due to resource misallocation—it is equal to the surplus lost to consumers which is not captured by the producer.

13. *Price that yields a normal profit to the competitive firm exceed MC by vertical distance AB q is the hypothetical output of a single sellers in a competitive market (100 sellers). LMC Natural Monopoly A LAC PC PM Price, Cost B D = AR MR 0 QM q = 1/100Qc Quantity

14. The Regulatory Dilemma I refer to the dilemmaconfronting regulators(e.g., public service commissioners) as they go about the task of subjecting firms coveredby their legislative mandate to rate-of-return regulation. Professor, What do you mean by the term “regulatory dilemma”

15. The horns of the dilemma The socially efficient regulatory regime does not provide a fair return to the regulated firm We will use some simple graphs toillustrate that marginal cost pricing will, in the case of sustainable natural monopoly, saddle the regulated firm with losses. The Courts have ruled that the regulated firm must receive a return on shareholder equity that is “fair.”

16. $ Case 1: Unregulated Monopoly  PM  D = AR CM   LAC LMC MR 0 QC QM MWHs

17. $ Case 2: Marginal Cost Pricing D = AR  C1 LAC   PC LMC MR 0 QC MWHs

18. Recall the necessary conditionfor socially efficient resourceallocation: P = MC • Hence: • Option 2 is optimalon social efficiencycriteria. • Why not select option2 and subsidize the regulated firm by amountC1PC? Subsidies give rise to problems of distributional equity. For example, suppose that gas companies were subsidies from general tax revenues—does this not amount to an income transfer

19. $ Option 3: Average Cost Pricing  PA  LAC  LMC MR 0 QA MWHs

20. Comparing the results

21. Monopolistic Competition A market structure featuring a relatively large number of sellers and a differentiated product/service Examples: Women’s shoes, snack foods, furniture, carpet, bathroom fixtures, men’s suits, cold cuts.

22. The monopolistic competitor faces a downward sloping, but very elastic, demand curve.

23. Short run equilibrium in monopolistic competition

24. Long Run Equilibrium in Monopolistic Competition D o l l a r s p e r U n i t o f O u t p u t A C M C P E M R D F F Q E O u t p u t ( b ) L o n g - R u n E q u i l i b r i u m: t h e F i r m E a r n s Z e r o E c o n o m i c P r o f i t