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Monopolies & Regulation

Chapter 24 & 26. Monopolies & Regulation. Monopoly. A firm that produces the entire market supply of a particular good or service. Chapter 24 & 26. 2. Monopoly Characteristics. Single firm or seller No close substitutes High barriers to entry Firm has all market power

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Monopolies & Regulation

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  1. Chapter 24 & 26 Monopolies & Regulation

  2. Monopoly • A firm that produces the entire market supply of a particular good or service. Chapter 24 & 26 2

  3. Monopoly Characteristics • Single firm or seller • No close substitutes • High barriers to entry • Firm has allmarket power • Firm is a Price Setter • Advertising for luxury goods only • Ex: Local Electric Company Chapter 24 & 26 3

  4. Market Power • The ability to alter the market price and characteristics of a good or service. Chapter 24 & 26 4

  5. Monopoly Demand Curve • The demand curve facing the monopoly firm is the market demand curve for the product. • Firms with market power confront downward-sloping demand curves. Chapter 24 & 26 5

  6. Demand & Price • Since the company is the industry the company can choose where on the demand curve (and at what price) they want to work. Chapter 24 & 26 6

  7. The Market & Company Chapter 24 & 26 7

  8. Price and Marginal Revenue • A monopoly faces a different profit maximizing situation than competitive firms. • Profit-maximization rule is the same: • Produce at that rate of output where MR = MC. Chapter 24 & 26 8

  9. Profit Maximization • The point where MC = MR determines the profit maximizing quantity at a given price. • The advantage for a monopoly is that it can alter the price it charges. • The demand curve determines the quantity for each price. Chapter 24 & 26 9

  10. Monopoly Profits • Sometimes increasing Price & decreasing Quantity will increase Total Revenue • Sometimes decreasing Price & increasing Quantity will increase Total Revenue • It depends on the Elasticity of the product’s demand • If demand is elastic, lower price will lead to higher TR Chapter 24 & 26 10

  11. Barriers to Entry • Unless there are barriers to entry, high monopoly profits tend to attract profit-hungry entrepreneurs into the market. • These profits will be maintained as long as barriers to entry prevent any competitors from entering the market. Chapter 24 & 26 11

  12. Political Power • A firm with considerable market power likely to have significant political power as well. Chapter 24 & 26 12

  13. The Limits to Power • Monopolists only have absolute control of the quantity of output supplied to the market. • Monopolists must still contend with the market demand curve. Chapter 24 & 26 13

  14. Price Discrimination • The sale of an identical good at different prices to different consumers by a single seller. • This has nothing to do with costs to produce Chapter 24 & 26 14

  15. Price Discrimination Examples • Senior Citizens discounts • Student discounts • In-state tuition • Matinee prices • Coupons • Military discount Chapter 24 & 26 15

  16. Entry Barriers • Patents • Monopoly franchises or licenses • Control/ownership of key production resources • Land, labor, capital, entrepreneurial ability • Control of distribution outlets • Well-established brand loyalty • Government regulation • Lawsuits • Acquisition of competition • Economies of scale Chapter 24 & 26 16

  17. Ways to Enter a Monopoly Market • Acquisition • buy out the current company • Overcome all the entry barriers • Make a different product & “sneak in” • Money, determination (time) or ingenuity Chapter 24 & 26 17

  18. Monopolies & The Economy • Generally, Monopolies lead to: • Higher prices • Less variety • Slower innovation • Lower employment Chapter 24 & 26 18

  19. Monopolies & Government • Based on the bad that monopolies bring to the economy, the U.S. government is against them. Chapter 24 & 26 19

  20. If A Monopoly Is Not Beneficial • The government will either: • Keep a monopoly from forming • Break up any existing monopolies • If a monopoly is beneficial to society the government may allow it to exist. If so, the government will regulate it. Chapter 24 & 26 20

  21. Why Allow a Monopoly? • Society’s good • lower price from a natural monopoly • Bring products & services to people who would not get them. • Better resource allocation • Economies of Scale • Better for the environment • More Research and Development • Product standardization Chapter 24 & 26 21

  22. Natural Monopolies • An industry in which one firm can produce at a lower ATC than 2 firms can. • Economies of scale act as a “natural” barrier to entry. • Examples: • local telephone services • local cable services Chapter 24 & 26 22

  23. Regulating Monopolies • The government can regulate: • The prices the monopoly can charge the customer • The output of the monopoly • The quality of the products Chapter 24 & 26 23

  24. Regulating Monopolies • The most common regulation of monopolies is regulating the price the monopoly can charge. • Two methods: • Socially Optimal Price • Fair-Return Price Chapter 24 & 26 24

  25. Price Ceiling • The government sets the maximum price the monopoly can charge the customer. • The government then subsidizes the monopoly with direct payments for expenses & profits. • In essence, the company is a de-facto department of the government Chapter 24 & 26 25

  26. Socially Optimal Pricing • Price = MC • The government forces a price cap at MC, so there is no “economic profit”. • The price is just as it “would be” if industry was Pure Competition • The government then subsidizes the monopoly with direct payments for expenses & profits. • In essence, the company is a de-facto department of the government Chapter 24 & 26 26

  27. Fair-Return Pricing • Price = ATC • Extra capacity is needed for peak usage times. To build this excess capacity price needs to be higher than MC. • ATC is calculated with excess capacity to ensure enough for the high-demand times. Chapter 24 & 26 27

  28. Normal Profit and Monopolies • In both cases, there is a “normal profit” allowed, as a percentage above cost. Chapter 24 & 26 28

  29. Monopoly Behavior with Regulation • The problem with both regulation plans is there is no incentive to reduce costs. • Where profit is a percent of cost, the higher the costs are, the higher the profit will be. • Easy for companies to upgrade equipment • Easy to abuse Chapter 24 & 26 29

  30. Costs of Regulation • Administrative costs • To create the regulations • Compliance costs • To enforce the regulations • Efficiency costs • Bad regulations & corrective measures Chapter 24 & 26 30

  31. Antitrust Laws • Sherman Act (1890) • prohibits “conspiracies in restraint of trade”. • Clayton Act (1914) • prohibited price discrimination, exclusive dealing agreements, certain types of mergers, and interlocking boards of directors among competing firms. • The Federal Trade Commission Act (1914) • created the FTC to study industry structures and behavior so as to identify anti-competitive practices. Chapter 24 & 26 31

  32. Objections To Anti-Trust • Punishing people for being successful • Lack of competition may not be the company’s fault • Large companies are needed to compete globally Chapter 24 & 26 32

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