1
Economics
6th edition
Chapter 15
1
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Monopoly and Antitrust
Policy
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Chap 14 Quiz
3) The three most significant barriers to entry are economies of
scale, zero long-term profits, and government-imposed barriers.
False  3 barriers are:
1. Economies of scale
2. Ownership of key input
3. Govt-imposed barriers (e.g., patent, tariff)
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5
Chap 14 Quiz
5) Price leadership is a form of explicit collusion in which one firm
in an oligopoly announces a price change and the other firms in
the industry match the change.
False  It is implicit collusion. Explicit collusion is illegal;
however, if managers can find way to signal each other
regarding price, could stay within the law.
Collusion = an agreement among firms to charge the same
price or other not to compete
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6
Chap 14 Quiz
6) A member of a cartel like OPEC has an incentive to agree to a
low cartel production level and then produce more than its quota.
True  B/c OPEC has unequal members, smaller members
have the incentive to cheat (produce over quota) and reap
more profit while oil price is higher (due to the agreed-upon
low production level).
Cartel = a group of firms/countries that collude by agreeing to
restrict output to increase prices and profits
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Chapter Outline
15.1 Is Any Firm Ever Really a Monopoly?
15.2 Where Do Monopolies Come From?
15.3 How Does a Monopoly Choose Price and Output?
15.4 Does Monopoly Reduce Economic Efficiency?
15.5 Government Policy Toward Monopoly
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15.1 Is Any Firm Ever Really a
Monopoly?
Define 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 competition 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.
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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 not 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.
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Making the Connection: Is the NCAA a
Monopoly?
The NCAA governs college athletics
at more than 1,200 institutions.
Harvard economist Robert Barro
claims the NCAA is effectively a
monopoly, using its monopoly
power to decrease/eliminate what
student-athletes receive for their
athletic efforts.
Various antitrust lawsuits have been
brought against the NCAA over
time, some resulting in greater
television access and even
compensation for some athletes.
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Or is it a cartel?
11
Table 12.1 The Four Market Structures
More
Competitive
Less
Competitive
Perfect
Competition
Monopolistic
Competition
Oligopoly
Monopoly
Identical
Differentiated
Identical or
differentiated
Unique
Ease of entry
High
High
Low
Entry blocked
Examples of
industries
 Growing
wheat
 Poultry
farming
 Clothing stores
 Restaurants
 Manufacturing
computers
 Manufacturing
automobiles
 First-class mail
delivery
 Providing tap
water
Type of
product
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12
15.2 Where Do Monopolies Come
From?
Explain the four main reasons monopolies arise.
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 to entry are:
1. Government restrictions on entry
2. Control of a key resource
3. Network externalities
4. Natural monopoly
vs. Oligopoly
1. Govt-imposed barriers
2. Ownership of key input
3. Economies of scale
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13
1. Government Restrictions on
Entry (1 of 2)
In the U.S., governments block entry in two main ways:
a. Patents, copyrights, & trademarks
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 is filed with the government.
Copyrights provide the exclusive right to produce and sell
creative works like books and films.
Trademark grants a firm legal protection against other firms using
its product’s name
WHY? -- These all protect producers and encourage innovation
and creativity, since without them, firms might not be able to
substantially profit from their endeavors.
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1. Government Restrictions on
Entry (2 of 2)
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 even operate these firms as a public enterprise.
• A U.S. example of this is the U.S. Postal Service.
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Making the Connection: Does Hasbro
Have a Monopoly on Monopoly?
Hasbro is the multinational American
company that owns Monopoly—originally
trademarked by Parker Brothers in 1935.
• Unlike patents and copyrights,
trademarks never expire.
Without the trademark, other firms could
market similar games with the same title,
diluting Hasbro’s profits.
• In the 1970s, a Californian economics
professor started selling a game called
Anti-Monopoly. Hasbro sued the
professor; eventually the two parties
reached a licensing agreement.
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2. Control of a Key Resource
Until 1940s, the Aluminum Company of America (Alcoa) either
owned or had long-term contracts for almost all the world’s supply
of bauxite, the mineral from which we obtain aluminum.
• Such control over a key resource served as a substantial
barrier to entry for additional firms.
• Demobilization after WWII led to new firms entering aluminum
market.
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. Also, NFL teams own or have long-term
leases on large stadiums in major cities necessary to host games.
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17
Making the Connection: Are Diamond
Profits Forever?
The most famous monopoly based on
control of a raw material is De Beers.
De Beers sought to control as much
of the supply of diamonds as possible,
so it could keep prices high.
• But by 2000, new competitors had
eroded De Beers’ control of the
world’s diamond production to 40
percent.
To maintain its monopoly power, De
Beers introduced the “Forevermark”
brand for its diamonds.
Do you think this marketing strategy
will work?
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3. Network Externalities
Network externalities– a characteristic of a product in which its
usefulness 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 product to continue to increase, along with
the price it can charge since it would be difficult for new firms to
enter the market and compete away profits.
But consumers may be locked into an inferior product through
path dependence (e.g., QWERTY keyboards).
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4. 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 than can two or more firms.
Natural monopolies are most likely when fixed costs are very large
relative to variable costs.
• Example: A firm producing electricity must make a substantial
investment in production and distribution infrastructure (e.g.,
hydroelectric dam, power lines/sub station systems); once the
investment is made, the marginal cost of producing another
hour of electricity is low for that firm.
Economies of scale – when a firm’s long-run average cost falls as it increases
the quantity of output
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Figure 15.1 Average Total Cost Curve for a Natural Monopoly
In the market for
electricity delivery, a
single firm (point A)
can deliver
electricity at a lower
cost than can two
firms (point B).
Only “room” in
market for one firm.
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A monopoly is a seller of a product
A) with many substitutes.
B) without a close substitute.
C) with a perfectly inelastic demand.
D) without a well-defined demand curve.
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B
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Peet's Coffee and Teas produces some flavorful varieties of Peet's
brand coffee. Is Peet's a monopoly?
A) Yes, there are no substitutes to Peet's coffee.
B) No, although Peet's coffee is a unique product, there are many
different brands of coffee that are very close substitutes.
C) Yes, Peet's is the only supplier of Peet's coffee in a market
where there are high barriers to entry.
D) No, Peet's is not a monopoly because there are many
branches of Peet's.
B
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Which one of the following about a monopoly is false?
A) A monopoly could make profits in the long run.
B) A monopoly could break even in the long run.
C) A monopoly must have some kind of government privilege or
government imposed barrier to maintain its monopoly.
D) A monopoly status could be temporary.
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C
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15.3 How Does a Monopoly Choose
Price and Output?
Explain how a monopoly chooses price and output.
In our study of oligopoly, we abandoned the idea of marginal cost
and marginal revenue, because the strategic interaction between
firms overrode these concepts.
But monopolists have no competitors and hence no concern about
strategic interactions.
• They seek to maximize profit by choosing a quantity to
produce, just like perfect and monopolistic competitors.
In fact, monopolists act very much like monopolistic competitors:
they face a downward sloping demand curve.
• The difference is that barriers to entry will prevent other firms
from competing away their economic profit.
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Figure 15.2
Calculating a
Monopoly’s
Revenue (1
of 2)
Subscribers
per Month
(Q)
Price
(P)
Total
Revenue
Average
Revenue
Marginal 25
Revenue
(TR = P × Q)
(AR = TR/Q)
(MR = ∆TR/∆Q)
0
$60
$0
–
–
1
57
57
$57
$57
2
54
108
54
51
3
51
153
51
45
4
48
192
48
39
5
45
225
45
33
6
42
252
42
27
7
39
273
39
21
8
36
288
36
15
9
33
297
33
9
10
30
300
30
3
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 all calculated in the usual manner.
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Figure 15.2
Calculating a
Monopoly’s
Revenue (2
of 2)
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As the monopolist decreases price to expand output, two effects occur:
1. Revenue increases from selling an extra unit of output.
2. Revenue decreases, because the price reduction is shared with existing
customers.
So marginal revenue is always below demand for a monopolist.
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Figure 15.3 Profit-Maximizing Price and Output for a Monopoly (1 of 2)
The monopolist maximizes profit by producing the quantity where the
additional revenue from the last unit (marginal revenue) just equals the
additional cost incurred from its production (marginal cost).
MC = MR determines quantity for a monopolist.
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Figure 15.3 Profit-Maximizing Price and Output for a Monopoly (2 of 2)
At this quantity,
• The demand curve determines price, and
• The average total cost (ATC) curve determines average cost.
Profit is the difference between these (P–ATC), times quantity (Q).
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Monopoly – Compared to other market
structures
• Maximizes profit at MR = MC
• Same as perfect and monopolistic competition
• Monopoly’s demand curve is the same as the market demand
curve for the product.
• Different than perfect and monopolistic competition
• Monopolies are price makers
• Perfect competition – price takers
• No distinction b/w short run and long run for a monopoly and
consequently monopolists can continue to earn profits in the
long run (b/c blocked entry to new firms)
• Different than perfect and monopolistic competition
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30
Because a monopoly's demand curve is the same as the market
demand curve for its product
A) the monopoly's marginal revenue equals its price.
B) the monopoly is a price taker.
C
C) the monopoly must lower its price to sell more of its product.
D) the monopoly's average total cost always falls as it increases
its output.
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31
Microsoft hires marketing and sales specialists to decide what
prices it should set for its products, whereas a wealthy corn farmer
in Iowa, who sells his output in the world commodity market, does
not. Why is this so?
A) because Microsoft is large enough to hire the best people in the
field
B) because Microsoft could potentially lose sales if it sets prices
indiscriminately
C) because the wealthy corn farmer is a price taker who chooses
his optimal output independently of market price but Microsoft's
optimal output depends on the price it selects
D) because unlike Microsoft, the wealthy corn farmer is probably a
monopolist
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C
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15.4 Does Monopoly Reduce Economic
Efficiency?
Use a graph to illustrate how a monopoly affects economic efficiency.
Suppose that a market could be characterized by either perfect
competition or monopoly. Which would be better?
Thought experiment: suppose the market for smartphones is
perfectly competitive, then one firm buys up all of the smartphones
in the country.
What would happen to:
• Price of smartphones?
• Quantity of smartphones traded?
• The net benefit of consumers (i.e. consumer surplus)?
• The net benefit of producers (i.e. producer surplus)?
• The net benefit of all of society (i.e. economic surplus)?
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Figure 15.4 What Happens if a Perfectly Competitive Industry Becomes
a Monopoly? (1 of 2)
The market for smartphones is initially perfectly competitive.
• Price is PC, quantity traded is QC.
In (b), the market is supplied by a single firm. Since the single firm
is made up of all of the smaller firms, the marginal cost curve for
this new firm is identical to the old supply curve.
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Figure 15.4 What Happens if a Perfectly Competitive Industry Becomes a
Monopoly (2 of 2)
But the new firm maximizes market profit, producing the quantity where
marginal cost equals marginal revenue (MC = MR).
This quantity (QM) is lower than the competitive quantity (QC)…
… and the firm charges the corresponding price on the demand curve,
PM. This price is higher than the competitive price, PC.
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35
Measuring the Efficiency Losses from
Monopoly
Fewer smartphones will be traded at a higher price.
• Consumer surplus will fall (with the higher price).
• Producer surplus must rise, otherwise the firm would have
chosen the perfectly competitive price and quantity.
Could the increase in producer surplus offset the decrease in
consumer surplus?
• No! Perfectly competitive markets maximized the economic
(total) surplus in a market; if fewer trades take place, the
economic surplus must fall.
What is term for losses due to inefficiency?
Deadweight loss = the reduction in economic surplus resulting
from a market not being in competitive equilibrium
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Figure 15.5 The Inefficiency of Monopoly
With the higher monopoly
price, consumer surplus
decreases by the areas
A+B.
Producer surplus falls by C,
but rises by A; an overall
increase.
Area A is simply a transfer of
surplus: neither inherently
good nor bad.
But areas B and C are lost
surpluses: deadweight loss.
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How Large Are the Efficiency Losses?
There are relatively few monopolies, so the loss of economic
efficiency due to monopolies must be relatively small.
• But many firms have market power: the ability of a firm to
charge a price greater than marginal cost.
• In fact, the only firms that do not have market power are
perfectly competitive firms, and perfect competition is rare.
Economists estimate that overall, the loss of efficiency in the
United States due to market power is probably less than 1 percent
of total U.S. production—about $500 per person annually.
• Why so low? Most firms face a relatively large degree of
competition, resulting in prices much closer to marginal cost
than we would see with monopolies.
• So deadweight loss due to market power is relatively small.
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38
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.
• This drive affects both large firms—who reinvest profits in the
hope of making larger future profits—and small firms—who
hope to obtain profits for themselves.
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.
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15.5 Government Policy Toward
Monopoly
Discuss government policies 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 large 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.
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Table 15.1 Important U.S. Antitrust Laws
In the 1870s and
1880s, several
“trusts” had formed:
boards of trustees
that oversaw the
operation of several
firms in an industry
and enforced
collusive agreements.
The federal
government
responded with
antitrust laws to limit
anti-competitive
behavior.
Date Enacted by
Law
Congress
Sherman Act 1890
Clayton Act
1914
Federal Trade 1914
Commission
Act
Robinson–
Patman Act
1936
Cellar–
1950
Kefauver Act
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Purpose
Prohibited “restraint of
trade,” including price
fixing and collusion. Also
outlawed monopolization.
Prohibited firms from
buying stock in
competitors and from
having directors serve on
the boards of competing
firms.
Established the Federal
Trade Commission (FTC)
to help administer antitrust
laws.
Prohibited firms from
charging buyers different
prices if the result would
reduce competition.
Toughened restrictions on
mergers by prohibiting any
mergers that would
reduce competition.
Making the Connection: Did Apple’s
e-Book Pricing Violate the Law? (1 of 2)
When Apple introduced the iPad
in 2010, the prices of new ebooks and bestsellers increased
from $9.99 to $12.99 or $14.99.
• Agency-pricing model
• The Justice Department
claimed that Apple had
organized an agreement with
five large book publishers to
raise the price of e-books in
“an old-fashioned, straightforward price-fixing
agreement.”
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41
Making the Connection: Did Apple’s
e-Book Pricing Violate the Law? (2 of 2)
At trial, Apple defended its
pricing by claiming it was using
an agency pricing model similar
to their iTunes store: publishers
set the price, and Apple kept 30
percent of the sales revenue.
• The judge sided with the DOJ:
Apple did indeed conspire
with publishers to raise ebook prices.
• An appeals court agreed in
2015, calling the price-fixing
“the supreme evil of antitrust”.
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42
Figure 15.6 A Merger That Makes Consumers Better Off
(1 of 2)
Antitrust laws also cover mergers;
particularly horizontal mergers:
mergers between firms in the same
industry (as opposed to vertical
mergers between two firms at
different stages of the production
process).
• Such mergers are likely to
enhance firms’ market power.
The graph shows such a merger,
increasing the price from the
competitive price (PC) to the
monopoly price (PM) and resulting
in deadweight loss.
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43
Figure 15.6 A Merger That Makes Consumers Better Off
(2 of 2)
Firms seeking to merge typically
argue that the resulting larger
firm will have lower costs and
hence be able to produce more
efficiently.
• Then even if they charge the
(new) monopoly price, the
result is an improvement for
consumers.
However, costs may not
decrease by as much as the
firms claim, resulting in
consumers being worse off.
• Economists with the FTC
and Department of Justice
review potential mergers one
by one.
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44
45
DOJ and FTC Merger Guidelines
Economists and lawyers at the Department of Justice and the
Federal Trade Commission have developed guidelines for
themselves and firms to use in evaluating whether a potential
merger is acceptable.
These include:
1. Market definition
2. Measure of concentration
3. Merger standards
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1. Market Definition
Suppose Hershey Foods sought to merge with Mars Inc.
• In what market do these firms compete? The market for candy?
The market for snacks? The market for all food?
The more broadly defined the market, the smaller (and more
harmless) the merger appears.
To determine the appropriate scope of the market, the government
tries to determine which goods are close substitutes for those
produced by the firms.
• The “appropriate market” is defined as the smallest market
containing the firms’ products for which an overall price rise
within the market would result in total market profits increasing.
• (If profits would decrease, there must be adequate substitutes
available; hence the market is too narrowly defined.)
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2. Measure of Concentration
A market is concentrated if a relatively small number of firms have
a large share of total sales in the market.
To determine if a market is concentrated, the government uses the
Herfindahl-Hirschman Index (HHI) created by squaring the
percentage market shares of each firm and adding up the results.
Some examples are given below:
Firm market shares
Formula
HHI
100%
1002
10,000
50%, 50%
502 + 502
5,000
30%, 30%, 20%, 20%
302 + 302 + 202 + 202
2,600
10%, 10%, …, 10%
10 × 102
1,000
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Table 15.2 Federal Government Standards for Horizontal
Mergers
Value of the HerfindahlHirschman Index (HHI) of Amount by Which the Merger Antitrust Action by Federal
a Market after a Merger
Increases the HHI
Regulators
Less than 1,500
Increase doesn’t matter
Between 1,500 and 2,500
Fewer than 100 points
Between 1,500 and 2,500
More than 100 points
Greater than 2,500
Fewer than 100 points
Greater than 2,500
Between 100 and 200 points
Greater than 2,500
More than 200 points
Merger will be allowed.
Merger is unlikely to be
challenged.
Merger may be challenged.
Merger is unlikely to be
challenged.
Merger may be challenged.
Merger is likely to be
challenged.
Based on the calculated HHI values, the DOJ and FTC apply the
standards above to decide whether to challenge a merger.
• Firms having their merger applications challenged must satisfy the
DOJ and FTC that their merger would result in substantial efficiency
gains. The burden of proof is on the merging firms.
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49
Regulating Natural Monopolies
Natural monopolies have the potential to serve customers more
cheaply than multiple firms. But the usual market forces that drive
price down do not exist.
Local and/or state regulatory commissions typically set prices for
these natural monopolies, instead of allowing the firms to set their
own price.
But that raises the question: what price should the regulators
choose?
• A price that makes the monopoly make zero profit?
• The efficient price that would maximize consumer welfare and
total economic surplus?
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Figure 15.7 Regulating a Natural Monopoly (1 of 2)
If the natural monopoly were not subject to regulation, it would
choose quantity QM and price PM (where MR = MC).
Efficiency (MC = MB) suggests a price of PE. But then the firm
makes a loss since its ATC is above PE.
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50
Figure 15.7 Regulating a Natural Monopoly (2 of 2)
A typical compromise is to allow the firm to charge a price where it
can make zero economic profit: PR. The resulting quantity QR is
hopefully close to the efficient level, keeping deadweight loss
small.
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