Real-World Competition and
Technology
Chapter 14
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Laugher Curve
Q. What is a recent economics graduate's
usual question in his first job?
A. "What'll you have on your burger, sir?"
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The Goals of Real-World Firms
It is reasonable to assume that all firms are
concerned about profits.
 But are they profit maximizers?

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Short-Run versus Long-Run
Profits
Firms care about both short-run and longrun profit.
 They must be profit maximizers in the short
run as well as the long run.

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Short-Run versus Long-Run
Profits

Any expenditures on good will and good
reputation can reduce short-run profits but
increase long-run profits.
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The Problem With Profit
Maximization

Problems with the profit maximization
model when applied to the real world:
Decision-makers’ income is often a cost to the
firm.
 Most real-world production takes place in
large corporations rather than in owneroperated businesses.

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Manager’s Incentives
Managers' incentives are not always to
maximize the firm's profit.
 Self-interested decision makers have little
incentive to hold down their pay unless
someone sees to it that they do.

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Manager’s Incentives

Most firms put pressure on managers to
make at least a predesignated level of
profit.
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Need for Monitoring

The monitoring problem – the need to
oversee employees to see that their
actions are in the best interest of the firm.
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Need for Monitoring

Incentive-compatible contract – a
contract in which the incentives of each of
the two parties to the contract correspond
as closely as possible.
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Need for Monitoring

Self-interested managers are only
interested in maximizing the firm’s profit if
the structure of the firm requires them to do
so.
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Need for Monitoring

High-level managers can pay themselves
very well when appropriate monitoring is
not in place.
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What Do Real-World Firms
Maximize?
Some real-world firms focus on maximizing
profits.
 Others emphasize growth in sales or costreductions to increase long-run profits.

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What Do Real-World Firms
Maximize?

Lazy monopolists – firms that do not push
for efficiency, but merely enjoy the position
they are already in – do nothing at all.
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The Lazy Monopolist and
X-Inefficiency
Lazy monopolists are not profit
maximizers.
 They make just enough profit so that the
stockholders won’t complain.
 But do not push as hard as they could to
keep their costs down.

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The Lazy Monopolist and
X-Inefficiency

The result is what economists call Xinefficiency – firms operating far less
efficiently than they could technically.
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The Lazy Monopolist and
X-Inefficiency
Such firms have monopoly positions, but
they do not make large monopoly profits.
 They simply make a normal level of profit
because inefficiencies cause their costs to
rise.

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The Lazy Monopolist and
X-Inefficiency

Competitive pressures faced by lazy
monopolies places a limit on their laziness.
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True Cost Efficiency and the
Lazy Monopolist
Cost
per unit
MC
PM
CLM
ATC
(Producing
efficiently)
B
A
CM
MR
0
McGraw-Hill/Irwin
ATC
(Producing
inefficiently)
QM
D
Quantity
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How Competition Limits the
Lazy Monopolist
If all firms in the industry are inefficient,
they can remain profitable.
 New firms or international competition can
push lazy monopolies to be more
competitive.

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How Competition Limits the
Lazy Monopolist

Corporate takeovers, or simply the threat
of a takeover, can improve a firm’s
efficiency.

Corporate takeover – another firm or a group
of individuals issues a tender offer to gain
control and to install it own managers.
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How Competition Limits the
Lazy Monopolist

The threat of a corporate takeover provides
competitive pressure on firms to maximize
profits.
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How Competition Limits the
Lazy Monopolist

Nonprofit organizations (hospitals,
universities, libraries, and jails) often
display lazy monopolist tendencies.
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Motivations for Efficiency
Other Than the Profit Motive

Some individuals simply derive pleasure
from efficiently run organizations.
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Fight between Competitive and
Monopolistic Forces
Real-world competition is a process.
 It is a fight between the forces of
monopolization and the forces of
competition.

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How Monopolistic Forces
Affect Perfect Competition
Monopolistic forces affect perfect
competition.
 Laws have been enacted that prevent firms
from charging too low a price!

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How Monopolistic Forces
Affect Perfect Competition

The U.S. has a myriad of laws, regulations,
and programs that prevent agricultural
markets from working competitively.
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Economic Insights and RealWord Competition
Competitive markets only exist if suppliers
or consumers don’t collude.
 Collusion occurs when the cost of colluding
is less than the amount gained from
colluding.

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Economic Insights and RealWord Competition
Colluding suppliers seldom claim that the
reason for the restrictions is to increase
their income.
 They couch their arguments for restrictions
in terms of the public’s good.

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Movement Away From
Competitive Markets
Price
S
PL
A
PM
B
C
D
0
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L
M
Quantity
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How Competitive Forces Affect
Monopoly

Competition is so strong that it makes
perfect monopolies as rare as pure
competition.
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How Competitive Forces Affect
Monopoly
Competitive forces work to break down
monopoly.
 It is almost impossible to prevent other
firms from entering the market.

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Breaking Down Monopoly

Would-be entrants try to break down a
monopoly through political or economic
forces.
They could lobby to change the law protecting
the monopoly.
 They could develop a similar product without
violating a patent.

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Reverse Engineering

Another way competitors gather
information about competing products is
reverse engineering.

They buy another firm’s product, disassemble
it, figure out what is so special about it, and
then copy it within the limits of the law.
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Competition and Natural
Monopolies
Natural monopolies can make large profits.
 New technologies can compete with and
undermine natural monopolies.
 Many natural monopolies are regulated.

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Regulating Natural
Monopolies
Regulated natural monopolies have been
given the exclusive right to operate in the
industry.
 In return, the price they charge and the
services they provide are regulated by
regulatory boards.

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Regulating Natural
Monopolies
Regulated monopolies are allowed to
charge a fair price.
 A fair price includes all costs plus a
normal return on capital investment (a
normal profit, but no excess profit).

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Regulating Natural
Monopolies
Allowing firms to earn a normal profit
means they can pass on to consumers all
cost increases.
 As a result, regulated monopolists have
little or no incentive to hold down costs.

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Regulating Natural
Monopolies
Regulatory boards must screen every cost
to determine which costs are appropriate
and which are not.
 The regulatory process itself becomes
extremely bureaucratic, which increases
the cost.

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Regulating Natural
Monopolies

Some economists argue that no regulation
is desirable, and that society would be
better served by direct competition.
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Deregulating Natural
Monopolies

Many former natural monopolies are being
deregulated.
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Deregulating Natural
Monopolies
In the 1980 and 1990s deregulation and
competitive supply of both electric and
phone service grew.
 Many states have opened their electricity
markets to multiple providers.

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Deregulating Natural
Monopolies
To say that the electric power industry has
been deregulated is not quite correct.
 Only the portions of the market where
competition is likely to exist are being
deregulated.

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How Firms Protect Their
Monopolies

Firms protect their monopolies by
advertising and lobbying, producing
products as nearly unique as possible, or
by charging low prices.
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Cost-Benefit Analysis of
Creating and Maintaining
Monopolies
Monopolies are expensive to create and
maintain.
 Firms will buy monopoly until the marginal
cost of maintaining the monopoly equals
the marginal benefit.

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Cost-Benefit Analysis of
Creating and Maintaining
Monopolies

The higher the cost of maintaining a
monopoly, the less monopoly firms will
“buy”.
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Establishing Market Position
In winner-take-all markets, the initial
competition is on establishing market
position.
 The winner who achieves a monopoly can
charge significantly higher prices without
facing competition.

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Technology

Technological development has been a
driving force in the economy in recent
years.

Technological development – the discovery of
new or improved products or methods of
production.
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Technology, Efficiency, and
Market Structure
Technological advance requires market
incentives.
 Globalization provides an incentive to
develop new technology.
 The world market is significantly larger
than a domestic one.

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Technology, Efficiency, and
Market Structure
Market structures that best promote
technological change are dynamically
efficient.
 Dynamic efficiency – the market's ability
to promote technological change.

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Technology, Efficiency, and
Market Structure

Viewed in this manner, oligopoly provides
the best structure for technological
advance.
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Perfect Competition and
Technology
Perfectly competitive firms have no
incentive to develop new technologies.
 They earn no profits to fund research.
 Even if they did innovate, competitors
would gain from the new technology
without having to pay for it.

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Monopolistic Competition and
Technology
Because of market power, monopolistic
competition is more conducive to
technological change.
 But they also lack long-term profits.
 Easy entry limits their ability to recoup their
investment in new technology.

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Monopoly and Technology
Monopolists have the profits but seldom
have the incentive to innovate.
 Their market is protected from entry, so the
easiest path is the lazy monopolist path.

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Oligopoly and Technology

Oligopoly is the market structure most
economists feel is most conducive to
technological change.
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Oligopoly and Technology
Because they receive ongoing economic
profit, oligopolists have the money to carry
out research and development.
 The belief that its competitors are
innovating, forces them to do so as well.

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Oligopoly and Technology
Not all economists agree that oligopoly is
conducive to technological change.
 They argue that conditions of entry, rather
than market structure determine
technological progress.

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Network Externalities,
Standards, and Technological
Lock-in

Network externalities, standards, and
technological lock-in support the view that
technology determines market structure.
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Network Externalities,
Standards, and Technological
Lock-in

A network externality occurs when
greater use of a product increases the
benefit of that product to everyone.
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Network Externalities,
Standards, and Technological
Lock-in

Network externalities are important to
market structure because they can lead to
the development of industry standards.
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Standards and Winner-TakesAll Industries

Network externalities increase the
likelihood that an industry becomes a
winner-takes-all industry.
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Standards and Winner-TakesAll Industries

The firm that gets its standard accepted as
the industry standard gains an enormous
advantage over other firms - it dominates
the market.
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First Mover Advantage
There is a strong incentive to be first in the
market since their standard may become
the industry standard.
 The first-mover advantage helps explain
the high stock prices of start-up technology
companies.

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Technological Lock-In
Technological lock-in – when prior use of
a technology make the adoption of
subsequent technology difficult.
 Standards can be inefficient and yet be
maintained by the first-mover advantage.

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Technological Lock-In
Some economists argue that government
involvement is necessary to protect the
economy and the consumer.
 This is called the nudging hand
approach – government keeps the initial
competition fair.

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Technological Lock-In
Those who see the competitive process as
central are less likely to support such a role
for government.
 Each case must be decided on its own
merits.

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Real-World Competition and
Technology
End of Chapter 14
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