Monopoly Outline • Pure monopoly • Barriers to entry • Monopoly compared to competition • Natural monopoly • The regulatory dilemma • Monopolistic competition
Pure monopoly A “pure” monopoly is a market structure in which a single seller accounts for 100 percent of market sales.
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.
Figure 9. 1
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.
Barriers to entry: 2 definitions 1. “[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, 2 nd ed. , p. 252]. 2. 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].
Examples of barriers to entry üAbsolute cost advantages Examples: 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. üEconomies of scale: Dominant firm may enjoy cost advantages due to realization of scale economies in production, distribution, capital raising, or sales promotion.
üBarriers due to control of wholesale, retail distribution systems Examples: Control of wholesale diamond distribution by De. Beers; Control of advantageous retail shelf space by Proctor and Gamble, Kellogs. üBarriers due to patents, copyrights, trademarks, and other legal barriers Examples: Xerox’s patent on xerography; Polaroid’s patent on instamatic photography üBarriers due to product differentiation/brand power Examples: Cigarettes, pain relievers, designer jeans, athletic wear, batteries, soft drinks
Strategic Barriers üAlcoa’s restrictive covenants with hydroelectric suppliers. üStandard Oil’s “secret rebate” policy with the railroad companies. ü“Lease-only” policy of IBM, United Shoe Machinery, International Salt üIBM’s continual design modification was designed to forestall entry of firms such as Calcomp that marketed plugcompatible peripherals—e. g. , tapes and line printers. üMicrosoft charges PC makers a royalty for every computer shipped—regardless of whether the machine has a Windows operating system installed. üMicrosoft requires that Explorer icon appear on desktop in initial boot up sequence.
The Microsoft case Microsoft Corporation v. U. S. 530 U. S. 1301 (2000) The Antitrust Division of the DOJ won Sherman section 1 and section 2 convictions against the software giant. The key element in the case was the so-called “applications barrier to entry. ”
The applications barrier in the Microsoft case Hear audio explanation (wav) Judge Jackson stated in his Finding of Fact: “[T]he applications barrier would prevent an aspiring entrant into the relevant market from drawing a significant number of customers away from a dominant incumbent even if the incumbent priced its products substantially above competitive levels for a significant period of time. ”
Proprietary control of “application program interfaces” keeps software developers in the Microsoft tent. “These are synapses at which the developer of an application can connect to invoke pre-fabricated blocks of code in the operating system. These blocks of code in turn perform crucial tasks, such as displaying text on the computer screen. Because it supports applications while interacting more closely with the PC system's hardware, the operating system is said to serve as a ‘platform. ’” Judge Jackson’s Finding of Fact
The middleware threat Mr. Gates viewed middleware (the Java programming language and Netscape browser software) as rival platforms for ISV’s. Gates feared middleware would bring down the applications barrier. Hear Brown’s comments (wav)
Evidence of ‘willful acquisition and maintenance. . . “ The government alleged that Microsoft designed its licensing agreements with OEM’s and IAP’s so as to preserve the applications barrier. This was also its objective in giving away Internet Explorer for free.
The OEM Channel • Licensing agreements with Original Equipment Makers (OEM’s) stipulated pre-installation of Internet explorer. • Internet Explorer icon must appear on the desktop after the initial boot-up sequence. • OEM’s prohibited from pre-installing Netscape browser software.
The IAP Channel • Microsoft offered IAP’s valuable “real estate” on the Windows desktop in exchange for their agreement to distribute Internet Explorer exclusively. Hear audio explanation (wav) • If an IAP was already under contract to pay Netscape a certain amount for browser licenses, Microsoft offered to compensate the IAP the amount it owed Netscape. • Microsoft also reduced the referral fees that IAPs paid when users signed up for their services using the Internet Referral Server in Windows in exchange for the IAPs' efforts to convert their installed bases of subscribers from Navigator to Internet Explorer.
Price, Cost A PM Monopoly compared to Competition Market Demand B H PC Notice that for each additional unit produced between QM and QC, Demand (marginal benefit) is higher than marginal cost. E MC = AC MR 0 QM QC Output
Results summarized Price Quantity Econ Consumer Surplus Dead Weight Competition PC QC zero PCAE zero Monopoly PM QM PCPMBH PMAB BHE
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.
q is the hypothetical output of a single sellers in a competitive market (100 sellers). *Price that yields a normal profit to the competitive firm exceed MC by vertical distance AB LMC A LAC Price, Cost PC PM B D = AR MR 0 q = 1/100 Qc QM Quantity
Professor, What do you mean by the term “regulatory dilemma” I refer to the dilemma confronting regulators (e. g. , public service commissioners) as they go about the task of subjecting firms covered by their legislative mandate to rate-ofreturn regulation.
Horns of the Dilemma The socially efficient regulatory regime does not provide the regulated firm a “fair” return to shareholder equity. We will use some simple graphs to illustrate 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. ”
$ Case 1: Unregulated Monopoly PM CM D = AR LMC MR 0 QM LAC QC MWHs
$ Case 2: Marginal Cost Pricing D = AR C 1 PC LMC MR 0 LAC QC MWHs
Recall the necessary condition for socially efficient resource allocation: P = MC Hence: • Option 2 is optimal on social efficiency criteria. • Why not select option 2 and subsidize the regulated firm by amount C 1 PC?
Subsidies give rise to problems of distributional equity. For example, suppose that gas companies were subsidized from general tax revenues—does this not amount to an income transfer from taxpayers to gas users?
$ Option 3: Average Cost Pricing PA LMC MR 0 LAC QA MWHs
Comparing the results Option Dead Weight Loss Price Quantity given by area Econ Profit given by area 1 PM QM PM CM 2 PC QC 0 (C 1 PC) 3 PA QA 0
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.
The monopolistic competitor faces a downward sloping, but very elastic, demand curve.
Short run equilibrium in monopolistic competition
Long Run Equilibrium in Monopolistic Competition Dollars per Unit of Output MC AC PE MRF QE DF Output (b) Long-Run Equilibrium: the Firm Earns Zero Economic Profit