Reading: Monopoly and Antitrust Policy

Government Policy Toward Monopoly

Monopoly

Monopoly is a market structure consisting of a firm that is the only seller of a good or service that does not have a close substitute

Monopoly exists at the opposite end of the spectrum to perfect competition

We study monopolies for two reasons:

1. Some firms truly are monopolists, so it is important to understand how they behave

2. Firms might collude in order to act like a monopolist; knowing how monopolies act helps us to identify these firms

Do Monopolies Really Exist

Suppose you live in a small town with only one pizzeria. Is that pizzeria a monopoly?

1. It has competition from other fast-food restaurants
2. It has competition from grocery stores that provide pizzas for you to cook at home

If you consider these alternatives to be close substitutes for pizzeria pizza, then the pizza restaurant is a monopoly

If you do not consider these alternatives to be close substitutes for pizzeria pizza, then the pizza restaurant is a monopoly

Regardless, the pizzeria’s unique position may afford it some monopoly power to raise prices, and obtain economic profit.  

Where Do Monopolies Come From?

For a firm to exist as a monopoly, there must be barriers to entry preventing other firms coming in and competing with it.

The four main reasons for these barriers are:
1. Government restrictions on entry
2. Control of a key resource
3. Network externalities
4. Natural monopoly

Government Restrictions on Entry

In the United States, governments block entry in two ways:
a. Patents and copyrights

Newly developed products like drugs are frequently granted patents, the exclusive right to produce a product for a period of 20 years from the date the patent was filed with the government

Similarly, copyrights provide the exclusive right to produce and sell creative works like books and films.

Patents and copyrights encourage innovation and creativity, since without them, firms would be able to substantially profit from endeavors.

In the U.S., governments block entry in two main ways:
b. Public franchises

A government designation that a firm is the only legal provider of a good or service is known as a public franchise. These might exist, for example, in electricity or water markets.

Sometimes (more commonly in Europe than the U.S.) governments operate these firms as a public enterprise.

- An example of this is the U.S. Postal Service.  

Control of a Key Resource

For many years, the Aluminum Company of America (Alcoa) either owned or had long-term contracts for almost all of the world’s supply of bauxite, the mineral from which we obtain aluminum.

- Such control over a key resource served as substantial barrier to entry for additional firms.

The National Football League (NFL) acts as a monopoly in this manner too: it ensures that the majority of the world’s best football players are under contract to the NFL, and unable to be used for another potential league.

Network Externalities

Economists refer to network externalities as a product characteristics whereby the usefulness of a product increases with the number of consumers who use it.

Examples:    Auction sites (like Ebay)
           Computer operating systems (like Windows
           Social networking sites (like Facebook) 

These network externalities can set off a virtuous cycle for a firm, allowing the value of its products to continue to increase, along with the price it can charge.

But consumers may be locked into an inferior product. 

Average Total Cost Curve for a Natural Monopoly

A natural monopoly occurs when economies of scale are so large that one firm can supply the entire market at a lower average total cost can two or more firms.

In the market for electricity delivery, a single firm (point A) can deliver electricity at a lower cost than can two firms (point B).

Natural monopolies are most likely when fixed costs are high.

Calculating a Monopoly’s Revenue

Time Warner Cable is a monopolist in a local market for cable television services.

The first two columns of the table show the market demand curve, which is also Comcast’s demand curve.

Total, average, and marginal revenue are calculated in the usual manner.

A monopolist decreases price to expand output, two effects occur:

1. Revenue increases from selling an extra unit of output.

2. Revenue decreases, because price reduction is shared with existing customers.

So marginal revenue is always below demand for a monopolist.

Long Run Profits for a Monopoly

Since there are barriers to entry, additional firms cannot enter the market.

- So there is no distinction between short run and long run for a monopoly

Then unlike for monopolistic competition, we expect monopolists to continue to earn profits in the long run.

An Argument in Favor of Market Power

Market power may produce some benefit for an economy: the prospect of market power (and the resulting economic profits) drives firms to innovate, creating new products and services.

The Austrian economist Joseph Schumpeter claimed that this drive would create a “gale of creative destruction” that would eventually benefit consumers more than increased price competition.

- This helps to explain governmental ambivalence regarding large firms with market power

Government Policy Toward Monopoly

Because monopolies reduce consumer surplus and economic efficiency, governments regulate their behavior.

- Many governments try to stop firms from colluding, and seek to prevent mergers and acquisitions creating larger firms, through antitrust laws.

Collusion: An agreement among firms to charge the same price or otherwise not to compete.

Antitrust laws: Laws aimed at eliminating collusion and promoting competition among firms