Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

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Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

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Only available with supplementary resources at additional cost

Only available with supplementary resources at additional cost

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

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Chapter 12: Regulation of Firms with Market Power

What do AT&T, Standard Oil, Verizon, Microsoft, IBM, U.S. Steel, Dupont, Bank of America, General Motors, United Airlines, Sprint, Staples, and American Airlines have in common?

Figure 12.1: Microsoft buys LinkedIn for about $26 billion in December 2016. [1]


Figure 12.2: The world’s two largest brewers agreed to merge; AB InBev bought SABMiller for more than $104 billion in 2015. Corona is one of their many brands. [2]

What do almost every electric, natural gas, water, and cable-television company have in common?

12.1 Objectives

After completing this chapter, you should:

  • Understand the basic nature of antitrust law and be able to explain how economic efficiency is enhanced through effective use of antitrust law. 
  • Be able to explain the fundamental trade-offs in the application of antitrust law.
  • Understand the purpose of regulation of businesses when the goal is to increase the economic efficiency of a "natural monopoly."
  • Understand the challenges of regulating businesses in an economically efficient manner.

In this chapter, we will consider the role of government in encouraging competitive activity when market concentration is potentially harmful as well as the role of government in regulating firms when size and the resulting market concentration are beneficial. We will begin with the harmful activity.

12.2 Antitrust Law

The design and writing of antitrust law were motivated by the intense, aggressive expansion on the part of a number of businesses over 100 years ago. Standard Oil Company, largely owned by John D. Rockefeller, played a leading role. During the latter part of the nineteenth century, Standard Oil bought refineries and oil companies throughout the country. It then convinced railroads to give it discounts that were not available to its competitors. Standard Oil eventually controlled almost ninety percent of the petroleum industry. Standard Oil then formed a “trust,” a cooperative agreement and basically a cartel, with most of the remaining independent oil firms. (A trust was a combination of firms jointly setting prices and outputs). Next, the trust closed some refinery operations, reduced output, and increased prices. The origins of antitrust law were the legal efforts to prevent such activities from occurring and ultimately to eliminate the power of a trust to engage in future similar actions – thus, the name “antitrust.”




















Figure 12.3:

Exxon Mobile oil platform in the North Sea [3]

The Standard Oil trust was broken into a number of smaller, competing firms. Those companies formed Exxon, Amoco, Chevron, and Mobil, among others. Many years later, in 1982, the same law was used to break up AT&T into eight so-called "Baby Bells," and they were forced to compete with other companies in the provision of long-distance phone service.

Antitrust law is intended to prevent a number of different practices that reduce competition and lead to economically inefficient outcomes where prices are higher than they need to be, output is less than it otherwise would be, and technological progress is slowed.

Question 12.01

Question 12.01

Can you suggest one possible part of an antitrust law that would enhance efficiency? Suggest something other than simply making single powerful companies illegal. What might be a cost of such a law?

Hover here to see the hint for Question 12.01.
Click here to see the answer to Question 12.01.

12.3 The Sherman Antitrust Act of 1890

"Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is hereby declared to be illegal."- U.S. Code, Title 15, Chapter 1, Section 1 [1]
"Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or person, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony." - U.S. Code, Title 15, Chapter 1, Section 2 [2]

The Sherman Antitrust Act is the principal antitrust law and the beginning of active law enforcement’s attempts to maintain competitive markets. The Clayton Act and the Federal Trade Commission Act of 1914, followed by the Robinson-Patman Act (1936) and the Celler-Kefauver Act (1950), supplemented the Sherman Act and helped define other potential violations. The Sherman Act declared price fixing and market allocation of shares of output illegal. The additional acts prohibited price discrimination, tying agreements, exclusive dealing, territorial restrictions, mergers, and interlocking directorships if those actions “substantially lessen competition” or “tend to create a monopoly.”

The U.S. Department of Justice and the Federal Trade Commission enforce these acts. In addition, private lawsuits brought by individuals and businesses that have been harmed help with enforcement. Violations of the laws can result in fines, prison sentences, civil penalties, prohibitions, and the regulation of future business behavior. Criminal and civil cases are brought by the Department of Justice. Civil enforcement is sought by the Federal Trade Commission. Private parties can pursue suits for monetary damages. States can also bring cases under state antitrust laws if the violations occur only within a single state.

12.4 Price Fixing

One recent antitrust case resulted in record fines of almost $30 million and prison terms for four executives. The violation was an agreement to fix prices of ready-mix concrete in Indiana. "This conspiracy cheated virtually everyone who purchased ready-mixed concrete in the Indianapolis market for nearly four years," said Scott D. Hammond, the Antitrust Division's Deputy Assistant Attorney General for Criminal Enforcement. "Regardless of whether you were a homeowner fixing your driveway, a business constructing a new facility, or a taxpayer funding a public construction project, consumers paid more than they should have because the defendants and their co-conspirators secretly met and fixed the prices of ready mixed concrete."

In another recent case, physicians in the Cincinnati area coordinated efforts to set fees that were likely above what they would have obtained from insurance companies if they had negotiated competitively with the insurers. This group’s prices of services raised costs to consumers, employers, and insurance companies.

Not all cases are local; many are national, and some are worldwide. In the late 1990s, the Department of Justice brought a suit against a worldwide vitamin cartel with over $5 billion of sales to such companies as Coca-Cola, General Mills, Kellogg, Procter & Gamble, and Tyson Foods. The cartel members had agreed on how much each member would produce, to whom it would sell, and how much they would charge. For almost the entire decade of the 1990s, anyone who took a vitamin, ate cereal, or drank milk paid more than truly competitive markets would have charged.

Figure 12.4: Products of companies involved in the worldwide vitamin cartel in the late 1990s. [4]​

The resolution ended with American, Japanese, Canadian, and European firms paying more than $850 million in fines and some senior executives going to jail. Hoffmann-La Roche and BASF AG, major worldwide drug companies, paid record individual company fines.

In each of these instances, the violations were clear. The firms had agreed to fix prices and outputs in several forms. Court interpretation of the intent of the Sherman Act has determined that price-fixing agreements and deliberate allocation of market shares among firms are illegal, regardless of the ultimate purpose.

Not all cooperative agreements are prohibited. Joint research and development projects are often allowed, particularly when there are obvious economies in doing so and when the results will allow the companies to compete more aggressively. But when the agreements are to fix prices and share the market, the results are anticompetitive and likely to result in higher prices for consumers and an economically inefficient outcome.

Question 12.02

Question 12.02

Explain what will happen to economic efficiency when two firms agree to set prices and produce a mutually agreeable level of output.

Hover here to see the hint for Question 12.02.
Click here to see the answer to Question 12.02.

Question 12.03

Question 12.03

Compare the outcomes (prices, outputs, profits, and economic efficiencies) of a competitive market and one in which the producers are able to act and set prices as though they were a monopoly. What would antitrust law try to accomplish?

Hover here to see the hint for Question 12.03.
Click here to see the answer to Question 12.03.

Question 12.04

Question 12.04

Assume a firm creates an effective new software application (the so-called "killer" application). Sales of the application increase rapidly and soon the firm is a large, profitable monopoly. Should antitrust law be used to change the market outcome? Why or why not?

Hover here to see the hint for Question 12.04.
Click here to see the answer to Question 12.04.

Question 12.05

Label the unregulated monopoly price on the graph below.


Question 12.06

Label the quantity produced by an unregulated monopolist.

12.5 Merger Rules

Over 1,000 mergers were considered by the Department of Justice and Federal Trade Commission in the last year. Comcast and Time Warner Cable announced plans to merge in 2014, only to announce the following year that the deal was off because the Justice Department planned to file an anti-trust lawsuit against both companies. Charter Communications ultimately acquired Time Warner Cable in May of 2016 after the FCC voted to approve the deal as long as certain conditions were met. Meanwhile, AT&T (yes, the same company forced to split up into baby bells back in the 1980s) acquired satellite TV provider DirecTV after making similar concessions to the FCC in order to gain regulatory approval. In May of 2016, Staples and Office Depot called off a deal to merge after the FTC was granted a preliminary injunction to enjoin the transaction. This was the second time the two companies tried to merge in the last two decades. Both companies have experienced intense competition from Wal-Mart and online retailers like Amazon.com. But the FTC argued that the market for office supplies would become too highly concentrated if the two firms were allowed to merge.

Mergers and agreements between companies are not illegal by themselves. There is a “rule of reason” that has been established in court cases. When the merger or acquisition results in “unreasonable” restraint of trade or competition, the event becomes illegal. The “rule of reason” means that the law can prevent monopolies if they are established for the explicit purposes of creating a monopoly. Enforcement of the law would not be reasonable if the creation of a monopoly resulted from production of unique products or the lowering of costs and prices due to economies of scale.

Figure 12.5: Two pharmaceuticals, Pfizer and Allergan, merged to form a company valued at $160 billion. Two chemical companies, Dupont and Dow Chemical Company, merged to form a company valued at $130 billion.​ [5]

In the 1980s, Pepsi wanted to buy 7-Up, and Coca-Cola wanted to buy Dr Pepper. The shares of the carbonated soft drink industry were as follows: Coca-Cola, 39 percent of sales; Pepsi, 28 percent; Dr Pepper, 7 percent; and 7-Up, 6 percent. Because the soft-drink industry was already viewed as being not very competitive and these mergers reduced competition even further, the Federal Trade Commission did not allow the mergers.



Figure 12.6: The Federal Trade Commission blocked a proposed $6.3 billion deal between two office supply giants, Staples and Office Depot, in 1997 and again in 2016. ​[6]

The definition of the appropriate market in which a company competes is a crucial issue in almost all cases. If the market were defined as all bottled drinks (including bottled waters, juices, and milk), the percentage of revenues each company has would become significantly smaller and, the mergers would have been more likely to be allowed. For example, United Airlines planned to merge with former airline US Air back in 2001 but was blocked from doing so because the Justice Department argued that the result would decrease competition in too many markets. Ultimately, American Airlines purchased US Air, completing the deal in 2015.

It is not just the truly large, nationwide corporations that are subject to antitrust law. The relevant question is how large the merging firms are relative to the size of the market in which the firms compete, regardless of the absolute size of the firms or the market. For example, the Federal Trade Commission allowed Albertsons' grocery stores and Buttrey Food and Drug Stores in Montana and Wyoming to merge only if they sold stores in areas where the merged company would dominate the grocery market.

Concentration indexes are measures of the degree of existing concentration and the amount of change in concentration used as initial pieces of evidence as to whether or not a merger will do harm. The Federal Trade Commission has, in the past, used a four-firm concentration ratio – the percentage of total sales in a market sold by the four largest firms in the market. The higher the ratio, the greater the ability to restrict output and raise prices.

The FTC now uses the Herfindahl-Hirschman index (HHI), a market concentration index that sums the squares of the market shares of all the firms in the market. This index not only reflects the market power of the four largest firms but gives greater weight to the very largest firms and includes the effects of the concentration outside of the four largest firms. Merging firms are considered in light of the degree of concentration already existing and the change in concentration that will result from a potential merger.

If the concentration ratio is still relatively low after a merger, firms may not have much market power. If the concentration is high or is significantly increased, the formation of an implicit or an explicit cartel becomes more feasible and likely. Increases in prices and decreases in output may not be logical when one firm acts alone, but if a larger merged firm has significantly greater market power, those actions may suddenly become profitable.

Even without the creation of cooperative behavior, merged firms may find that they have an increased ability to increase prices and reduce output by acting alone. For example, one of the merged firms may raise prices on its products and lose sales to the other firm. When the firms were separate entities, such action might make little sense. With a merged firm, the action becomes effective, profit-increasing price discrimination. One division now gains revenues, and a second division also gains revenues.

If entry into the industry is still relatively easy after a proposed merger, an increased concentration may not indicate an ability to control output and prices. Part of the consideration of whether a merger is allowed is based on how timely and easy entry is and whether or not that entry will prevent actions to raise prices and lower outputs. In fact, relatively easy entry may in and of itself deter a merger as there may be no potential gains possible from the merger.

Question 12.07

Question 12.07

Suppose two firms want to merge in order to save costs. Charter Communications and Time Warner Cable are recent examples in the cable TV and broadband internet industry. Also suppose that they will be able to lower costs of providing services by 30 percent. Should antitrust law stop the merger? Why or why not? Should Ford and BMW merge? Should CNN and Fox News?

Hover here to see the hint for Question 12.07.
Click here to see the answer to Question 12.07.

The real goal of antitrust law is to enhance economic efficiency by influencing market structure. It is designed to discourage monopoly and reduce the pricing power of oligopolies. The greater the number of firms in a market, the more difficult collusion is and the more difficult it is to detect or prevent firms from deviating from a cartel-set monopoly price. With many firms, it is more likely that the outcome of the market will be closer to a perfectly competitive outcome.

If mergers can generate lower costs by better using capital and other resources, then such a merger is desirable not only to the companies involved but for the entire economy. In fact, the lowering of marginal costs will actually result in lower prices and higher outputs if the market remains relatively competitive. If a merger creates a more effective competitor out of two weak ones, the market, while becoming more concentrated, also becomes more competitive.

Courts have interpreted antitrust law enforcement to be applied in a "reasonable" fashion, and because of that, interpretation is often the subject of significant court disputes. If a company grows large and tends to dominate an entire industry simply because it is better at what it does than any other firm, antitrust does not interfere. In fact, we should want to encourage such innovation and growth. In many cases, prices may even be kept below the monopoly price due to the potential attraction of competitors.

The issue is a difficult one. If the mergers lower costs or enhance quality, then they improve our material well being and we should encourage them. If they increase market power, there is no potential competition, and there are no or few technical efficiencies to be gained, then mergers should be opposed. It is not always easy to tell.

Question 12.08

Mergers can sometimes be socially beneficial if they do which of the following?

A

Reduce competition in the market

B

Enhance the quality of the products

C

Increase costs

D

Increase market pricing power of oligopolies

Question 12.09

Question 12.09

What if new methods of distributing movies online to personal computers are created? A number of companies are offering the service. The company that produces the dominant operating system enters the market by creating its own built-in software. It is automatically included as part of its operating system and does not create a separate, identifiable charge. Other movie software can still be used and is compatible. What difference does it make if other movie software is no longer compatible? If the dominant operating system company is guilty of violating antitrust law, what is the proper remedy?

Hover here to see the hint for Question 12.09.
Click here to see the answer to Question 12.09.

Question 12.10

Question 12.10

What should antitrust law do when two major firms representing substantial portions of a market propose to merge? The firms argue that combining the two firms will allow the firms to provide the same total services at lower cost and improve the quality more rapidly with the combined research and development division.

Hover here to see the hint for Question 12.10.
Click here to see the answer to Question 12.10.

Question 12.11

Question 12.11

Suppose a company produces a computer operating system that the vast majority of personal, educational, and businesses users purchase. Should antitrust law be used to divide the company into smaller divisions that would compete with one another?

Hover here to see the hint for Question 12.11.
Click here to see the answer to Question 12.11.

Question 12.12

Question 12.12

Suppose that Amazon wants to increase its market share in the streaming video market by merging with Hulu, claiming that this will expand the services available to customers and lower the costs of providing these services. Do you think this merger is likely to be challenged by the Federal Trade Commission? What methods might the FTC use to decide?

Hover here to see the hint for Question 12.12.
Click here to see the answer to Question 12.12.

Question 12.13

Question 12.13

Why do we need antitrust laws? What is the goal of antitrust laws?

Hover here to see the hint for Question 12.13.
Click here to see the answer to Question 12.13.

Question 12.14

Question 12.14

Who enforces antitrust laws? What are the consequences of violating antitrust laws?

Hover here to see the hint for Question 12.14.
Click here to see the answer to Question 12.14.

12.6 Other Issues

Antitrust law is even more challenging to apply in other cases. Price fixing is illegal under all circumstances. Mergers are subject to rules of reason.

Predatory pricing is an example of a difficult issue for courts to settle, as it falls in between price fixing and mergers. Predatory pricing means lowering prices with the purpose of driving competitors out of a market and then reducing output and raising prices. If prices are below marginal costs, or below average variable costs, there may be some evidence of predatory pricing. But it may also indicate simply aggressive competition to attract new customers. It would not be rational to prevent companies from aggressively competing against one another.

Question 12.15

Question 12.15

Can you explain why prices below average variable costs or below marginal cost might be predatory pricing?

Hover here to see the hint for Question 12.15.
Click here to see the answer to Question 12.15.

Price discrimination, when it expands monopoly power, is illegal. Tying agreements – that is, forcing the consumer to buy two products at the same time since products are tied to each other –are illegal when they expand monopoly power. Exclusive contracts, which refer to, limiting a distributor from selling the products of a different manufacturer and preventing a manufacturer from buying inputs from a different supplier, are illegal when competition is harmed. The deliberate establishment of barriers to entry simply for the purpose of preventing entry is illegal. In each instance, there are trade-offs between increased quality of output or reduced costs and the resulting increased market power.

Microsoft. A recent antitrust case pursued by the U.S. Department of Justice was against Microsoft. The case has been heard in Federal Court, appealed, and is now settled; the initial court decision was that Microsoft possesses monopoly power in operating systems and uses predatory pricing, tying, and other methods to achieve a monopoly in the market for browsers.

The original remedy, proposed by the court, was to break Microsoft into two different companies: one to develop and sell its operating system (Windows) and the second to create and sell the software applications such as word processing, presentation software, browsers, and spreadsheets.

The U.S. government, through the Department of Justice, argues that Microsoft has a significant barrier to entry in its economies of scale. The costs of the initial development and design of the software are immense, and the marginal costs of producing one more copy of any of its applications are quite small. Those marginal costs are perhaps even close to zero if electronic copies are distributed. Thus, average costs fall as output expands and it becomes difficult for new competitors to enter the industry and sell products.

In addition, some industries experience “network economies.” As more and more people use Microsoft operating products, the benefits to users increase. For example, most people would not be very interested in using a word-processing program that no one else has. But if the program is common, users can share files with many people. Thus, the more users (that is, the larger the company), the more productive the product will be, the greater the demand, and perhaps the higher the price.



Figure 12.7: Department of Justice: Microsoft set a predatory price for Internet Explorer. “Microsoft set a “better than free” price for Internet Explorer for the specific purpose, and with the effect, of weakening browser rivals and thereby maintaining its operating system monopoly.


​[7]

When Microsoft created its own Internet browser (Internet Explorer), it offered it for free. The government antitrust case claims that this was an attempt to eliminate competing companies' products (Netscape Navigator, for example) and to expand its monopoly powers. Microsoft has now combined its browser into its operating system and, if one buys the operating system, purchasers will also get the browser. The government case is that this is illegal tying, with the goal of expanding its monopoly into other markets, that is, the market for browsers.

Microsoft argued that while it does have a large portion of the market for operating systems, it is subject to competition from potential new operating systems. It also argued that the Internet Explorer browser is an integral part of a high-quality operating system and is not a separate product. Therefore, it cannot be illegally tying products.

Question 12.16

A firm engaged in predatory pricing will set its price in which of the following ways?

A

Below the marginal cost

B

Below the average variable cost in the short run

C

Below the average cost to drive out competition and then increase price

D

Below the marginal cost even if it has many competitors and is a price taker


Question 12.17

Question 12.17

What is the purpose of antitrust law? Explain in your own words

Hover here to see the hint for Question 12.17.
Click here to see the answer to Question 12.17.

12.7 Regulating Natural Monopolies



Figure 12.8: Hoover Dam has a generating capacity of over 2,000 megawatts and a yearly average of 4.5 billion kilowatt-hours to serve the annual electrical needs of nearly 8 million people in Arizona, southern California, and southern Nevada. [8]​

There may be instances where competition will not work to achieve economic efficiency. If large firms can produce in a more technically efficient manner than smaller firms, it may be appropriate in those cases to allow the firms to exist and not apply antitrust law. But a different type of regulation may be necessary if we are to have economically efficient outcomes. There are other instances in which the industries themselves ask for and design regulation, resulting in reduced competitive pressures.

Throughout much of the 20th century, the number of regulations grew. Airlines, phones, trucking, banking and finance, cable television, water, gas,  electric producers, and more were subject to price, entry, and quality restrictions. In the late 1970s, a trend toward deregulation began and continues. Phone, airline, trucking, finance and banking, and electricity deregulation are prime examples.

12.8 The Natural Monopoly

A natural monopoly is a firm that can produce a product for an entire market at a lower cost than a market with many producers can. Electricity, water, phone lines, and cable television are good examples. If much of the costs of providing the service are fixed, then the larger the output, the lower the average cost.

It is much more expensive to install and maintain two or three sets of telephone lines, cable TV wires, water pipes, and electric wires running throughout the city than to have a single set of lines, wires, and pipes.



Figure 12.9: Natural Monopoly (AC3) producing 3000m, three typical firms (AC2).

In those situations, smaller firms simply cannot produce at average costs as low as those attained by a much larger firm. For example, in Figure 12.9, "AC" and "MC" represent the long-run average and marginal costs facing firms in an industry with significant economies of scale. "AC1" represents the typical firm if there are a large number of firms, say 10, in the industry, each firm producing 300 million kilowatt-hours of electricity per year. "AC2" represents the typical firm if there are three firms in the industry with each one producing 1,000 million kilowatts per year, and "AC3" represents the only firm if there were a monopoly producing 3 billion kilowatt-hours per year.

That large firm can, in fact, drive small firms out of business by building a large plant and pricing just above its average cost (10 cents). The small firms cannot afford to continue to produce at prices significantly below their costs. Once the potential competitors are no longer in the market, the single remaining firm has the power to raise prices to a level that allows the firm to reach its profit-maximizing level of output. Perhaps that price will even be above the price that would be charged by the small firms.

If we want to deliver electricity to all of the buildings in a city, for example, at the lowest possible cost, it does make sense for a single firm to provide that service (that is, a firm represented by AC3 in Figure 12.9.) However, we probably do not want that firm to charge whatever price it wishes and produce whatever amount it finds appropriate. Think about what would happen in the market if there were ten competitive firms of the size represented by AC1 in Figure 12.10.

Figure 12.10: What would happen in the market if there were ten competitive firms of the size represented by AC1?​

The answer is shown in Figure 12.11. Competing firms would force prices to the minimum average cost, and we would find the industry quantity by looking at the market demand curve. (The industry supply curve is not drawn in Figure 12.11, but it would be the horizontal summation of the individual firms' supply curves, that is, the firms' marginal cost curves.)

Figure 12.11: What would happen in the market if there were ten competitive firms of the size represented by AC1?​

Now, think about what would happen if there were only one firm of the size represented by AC3. The result should look like that shown in Figure 12.12. The single firm will face the market demand curve and produce where marginal cost equals marginal revenue. The cost curves (AC3 and MC3) have been redrawn so that they can be compared to the market demand curve, and a marginal revenue curve has been added. The marginal revenue curve is derived from the market demand curve in the same way we derived the monopoly marginal revenue curve. The result, in this case, is that less is produced and the price charged is actually above the price charged by the group of small firms. However, the cost of producing electricity is less than in the competitive market.

Figure 12.12: What would happen if there were only one firm of the size represented by AC3?​​​


The competitive market would set a price of $1.00 per kilowatt-hour and produce 3000 million kilowatt-hours of electricity. A single producer will produce about 2,500 million kilowatts and charge a price of about $1.20 per kilowatt-hour.

Question 12.18

Label the unregulated monopoly price on the graph below.


Question 12.19

In the figures below, the first graph represents individual firms and the second the market as a whole. If there are 100 competitive firms of the size represented by AC1, how much does an individual competitive firm produce?

question description
A

1.1m

B

70m

C

80m

D

90m

E

110m


Question 12.20

In the figures below, the first graph represents individual firms and the second the market as a whole. If there are 100 competitive firms of the size represented by AC1, what is the perfectly competitive industry price?

question description
A

$100

B

$93

C

$80

D

$50

E

$30


Question 12.21

In the figures below, the first graph represents individual firms and the second the market as a whole. If there are 100 competitive firms of the size represented by AC1, what is the perfectly competitive industry output?

question description
A

70m

B

80m

C

90m

D

110m

E

130m


Question 12.22

In the figures below, the first graph represents individual firms and the second the market as a whole. If there is only one single firm of the size represented by AC3, how much will it produce and what price will it charge?

question description
A

70m, above $100

B

80m, $100

C

90m, $93

D

110m, $80

E

130m, $50

Question 12.23

Question 12.23

Which outcome is the preferred one? The competitive result or the monopoly result?

Hover here to see the hint for Question 12.23.
Click here to see the answer to Question 12.23.

12.9 Policy Options

One policy option is to permit the monopoly to exist and establish a regulatory agency to improve on the monopoly outcome. The regulators are legally allowed to set prices and in return allow the electricity monopoly to exist. Suppose that the cost conditions are as shown in Figure 12.13. There are economies of scale. Average cost falls as output expands, and marginal cost is below average cost at all levels of output. See if you can determine what a monopolist will do if left to his or her own devices. Think about what a regulator ought to do in order to maximize the allocative efficiency of this market.

Figure 12.13: What will a monopolist do if left to his or her own devices?​

The monopolist is going to produce where marginal cost equals marginal revenue and charge a price that results in all of that production being sold (see Figure 12.14).

Figure 12.14: What would you do if you were a regulator interested in maximizing economic efficiency?​

A perfectly competitive market will result in a price equal to marginal cost, with each firm producing where average cost is minimized and where there are no economic profits. Thus, the regulator might consider establishing a price equal to either marginal cost or average cost. If the regulator sets price equal to marginal cost, the quantity produced will be determined where marginal cost crosses the demand curve. The reasoning is that below that level of production, the firm can expand and earn increased profits. Beyond that level of production, marginal cost will be above marginal revenue, as the firm would have to lower prices in order to get more customers. Some regulators will set prices equal to marginal cost and then allow the utility to charge a fixed monthly fee in order to get the service.  That allows the utility to make normal profits and still be setting prices equal to marginal costs.

In this case, the price equals marginal cost, but the firm will be making an economic loss as the price is below average cost. While marginal cost pricing makes a great deal of sense from the point of view of allocative efficiency, no self-respecting, profit-maximizing firm will want to enter the industry. Price is less than average cost. The firm could earn more in other industries and, eventually, the firm will exit the industry.

What about setting price equal to average cost? The firm will produce where economic profits are zero. The firm will earn normal profits. There are incentives to continue to operate. In addition, the firm will produce more than an unregulated monopoly would produce. However, the result is not allocatively efficient. The price of electricity is above the marginal cost and society would benefit from even more production.

Figure 12.15: How much would the regulated producer produce at each regulated price? Why?​

To summarize, the unregulated producer would produce where marginal cost equals marginal revenue. That amount is shown in Figure 12.15. A regulated firm, forced to charge a price no higher than the average cost, would not make economic profits but would be earning normal profits. At that price, it could sell any amount between zero and the amount where price would have to be lowered to sell more. (That is the point where the average cost curve crosses the demand curve.)

Figure 12.16: Why would the regulated firm not produce more than where either marginal cost or average cost crosses the demand curve?​

Once the maximum price is set at either the average cost or marginal cost, that price also becomes the marginal revenue. That is, it is the marginal revenue up to the quantity where the firm will have to lower the price even more to sell more. At those points, marginal revenue becomes less than marginal cost, and it makes no sense for the firm to expand.

Graphing Question 12.01

Graphing Question 12.02

Graphing Question 12.03

Graphing Question 12.04

12.9.1 Problems with Average Cost Pricing 

Average cost pricing creates incentives for undesirable behavior. If price is set equal to average cost, a regulated firm knows that it will be reimbursed for all costs and thus loses the incentive to reduce its costs. It may not use the latest cost-saving devices, it may pay for tickets to sporting events for executives as part of public relations, or it may pay higher salaries than it has to in order to keep high-quality executives. (This problem has been approached in some states by using incentives for public utilities to reduce costs. Once the prices are set, if the utility is able to reduce costs, it is permitted to keep all or part of the cost savings as economic profits.)

12.9.2 The Process of Regulation

It is clearly in the interest of the firms being regulated to influence the regulation process. Even though the ultimate goal of regulation is to benefit consumers, firms themselves have powerful incentives to involve themselves in the process. In many cases, those incentives are more powerful than consumers' motivations. You and I, as individuals, will pay a few dollars more to a poorly regulated industry, but individual firms in the industry stand to gain millions of dollars of profits and income if they can influence the regulatory process favorably.

12.9.3 The Demise of Regulation 

Technology is changing. The telephone, airline, and electricity industries are good examples. When technology that lowers costs of providing the services is created, the primary reason for regulation disappears. Technological advances have reduced costs of smaller, competing firms providing long-distance service, for example. Instead of an agency determining the correct price, competitors can do so through the process of maximizing profits.

In the electricity industry, technology has been created that permits producers to send electricity over long distances. Thus, there can be competition, even among large producers.

Airline industry regulation was designed to hold fares down in small markets and on short flights and subsidize those fares through higher fares for flights in and out of large markets and over long distances. At its end in the late 1970s, airlines and airline customers were plagued by long delays in approval of new flights and new competition. Not every problem has been solved. There is still a lack of significant competition in many airports, but prices have come down, and many more flights are offered in major airports. 

Question 12.24

Consider a profit-maximizing firm with significant economies of scale that is subject to marginal cost pricing regulation. The regulation will produce ______________ production from the standpoint of economic efficiency and the firm will ______________ economic profits.

A

Too much; not earn

B

The correct amount; not earn

C

Too much; earn

D

Too little; earn

E

Too little; not earn


Question 12.25

A profit-maximizing firm facing economies of scale that is subject to average cost pricing regulation will produce ______________ from the standpoint of economic efficiency and ______________ economic profits.

A

The correct amount; earn

B

The correct amount; not earn

C

Too much; not earn

D

Too little; earn

E

Too little; not earn

Question 12.26

Question 12.26

What would a group of competing firms, perhaps trucking firms or airlines, do if they could influence the regulation of their industries?

Hover here to see the hint for Question 12.26.
Click here to see the answer to Question 12.26.


Question 12.27

Question 12.27

Compare the alternative methods of setting prices for regulated, natural monopolies and make an argument as to which is the best alternative.

Hover here to see the hint for Question 12.27.
Click here to see the answer to Question 12.27.


Question 12.28

Suppose regulators of a natural monopoly want to regulate prices such that the monopoly will earn normal profits. The regulator should set prices equal to ________.

A

Marginal cost

B

Average cost

C

The price that would be charged in a perfectly competitive market

D

Marginal revenue

E

A level that will result in the monopolist producing the quantity where average costs are at a minimum


Question 12.29

Regulators of a natural monopoly concerned most with economic efficiency will set prices equal to ________.

A

Marginal cost

B

Average cost

C

The price that would be charged in a perfectly competitive market

D

Marginal revenue

E

A level that will result in the monopolist producing the quantity where average costs are at a minimum


Question 12.30

In the figure below, what are the regulated monopoly price and quantity when regulators use average cost pricing?

question description
A

$20, 70

B

$70, 30

C

$50, 40

D

$40, 50

E

$30, 60


Question 12.31

In the figure below, what is the price a regulated monopoly will charge when regulators use marginal cost pricing?

question description
A

$20

B

$30

C

$40

D

$50

E

$70


Question 12.32

In the figure below, what is the quantity the regulated monopoly produces when regulators use marginal cost pricing?

question description
A

30

B

40

C

50

D

60

E

70


Question 12.33

What quantity will a regulated monopoly produce when regulators are using average cost pricing?

question description
A

40

B

60

C

20

D

0


Question 12.34

What is the total cost of a regulated monopoly when regulators are using average cost pricing?

question description
A

$600

B

$800

C

$1200

D

$1000

E

$2000


Question 12.35

What is the average cost of producing 20 units?

question description
A

$0

B

$10

C

$20

D

$50

E

About $30


Question 12.36

What is the average cost of producing 60 units?

question description
A

$10

B

$50

C

$30

D

$20

E

More than $50


Question 12.37

In the figure below, what is the regulated monopoly price when regulators use average cost pricing?

question description
A

$0

B

$5

C

$10

D

$40

E

More than $40


Question 12.38

Label the difference between the unregulated (Qm) monopoly quantity and perfectly competitive industry quantity (Qpc) on the graph.


Question 12.39

Label the economic profit per unit for an unregulated monopoly on the graph.


Question 12.40

Label the economic profit per unit for a perfectly competitive firm which sets price equal to marginal cost on the graph below.


Question 12.41

The purpose of government regulation of natural monopolies is to do which of the following?

A

To allow monopolies to exist

B

To allow monopolies to exist when they can produce at higher costs

C

To allow monopolies to exist when they can produce at lower costs

D

To not allow monopolies to exist because they always fail

Question 12.42

Question 12.42

How does a monopoly choose its price and output? How does this compare to the price and output in a competitive industry? Which one benefits consumers more?

Hover here to see the hint for Question 12.42.
Click here to see the answer to Question 12.42.

Question 12.43

Question 12.43

Use a diagram to show that it is possible for a merger to reduce the price and increase output in the industry if the merger is able to reduce the marginal cost, compared to a merger where there is no reduction in the marginal cost.

Hover here to see the hint for Question 12.43.
Click here to see the answer to Question 12.43.

Question 12.44

Question 12.44

Use a diagram to show that it is possible for a merger to reduce the marginal cost but still end up with a price that is higher and output that is lower than the price and output in a perfectly competitive industry.

Hover here to see the hint for Question 12.44.
Click here to see the answer to Question 12.44.

Question 12.45

Question 12.45

Why would firms that propose mergers claim that a merger will make them more efficient and lower their costs? How does this influence the decision by the Federal Trade Commission and Department of Justice to approve the merger?

Hover here to see the hint for Question 12.45.
Click here to see the answer to Question 12.45.

Question 12.46

In the figure below, what quantity will the monopoly produce?

question description
A

20

B

40

C

60

D

80

E

0


Question 12.47

In the figure below, what price will the unregulated monopoly charge?

question description
A

8

B

15

C

18

D

22

E

25


Question 12.48

In the figure below, what is the value of the marginal cost and marginal revenue when the quantity is at 40?

question description
A

$8, $8

B

$15, $0

C

$18, $15

D

$20, $16

E

$15, $22


Question 12.49

Suppose that the government decides to regulate the natural monopoly and imposes a price ceiling of $40, which means the monopoly cannot charge more than $40. What price will this monopoly now charge?

question description
A

$20

B

$30

C

$40

D

$50

E

$70


Question 12.50

There are 1000 competitive firms of the size represented by AC1, and AC2 represents the only firm if there were a monopoly. In the figure below, what quantity will the perfectly competitive industry produce?

question description
A

50m

B

50b

C

60b

D

100b

E

150b


Question 12.51

There are 1000 competitive firms of the size represented by AC1, and AC2 represents the only firm if there were a monopoly. In the figure below, what price will the perfectly competitive industry charge in the long run?

question description
A

$70

B

$60

C

$50

D

$40

E

Less than $40


Question 12.52

There are 1000 competitive firms of the size represented by AC1, and AC2 represents the only firm if there were a monopoly. In the figure below, what is the difference in the monopoly’s output and the perfectly competitive industry’s output?

question description
A

5b

B

15b

C

20b

D

25b

E

30b


Question 12.53

There are 1000 competitive firms of the size represented by AC1, and AC2 represents the only firm if there were a monopoly. In the figure below, how much more will a monopoly charge compared to the perfectly competitive industry?

question description
A

$10

B

$20

C

$30

D

$40

E

No difference


Question 12.54

Question 12.54

What is the purpose of government regulation of natural monopolies? Explain in your own words.

Hover here to see the hint for Question 12.54.
Click here to see the answer to Question 12.54.


Question 12.55

The reason to regulate a natural monopoly is that a natural monopoly ______________ produce an economically efficient amount of output, ______________ charge a higher price than the perfectly competitive industry, and ______________ have lower average costs than a perfectly competitive industry.

A

Will not; may; will

B

Will; will; will

C

Will not; will not; will not

D

Will not; will; will

E

Will; will not; may

Question 12.56

Question 12.56

Why would there ever be doubt about using antitrust law to force monopolistic or oligopolistic markets to be competitive?

Hover here to see the hint for Question 12.56.
Click here to see the answer to Question 12.56.

12.10 Summary

  • AT&T, Standard Oil, Verizon, Microsoft, IBM, U.S. Steel, Dupont, Bank of America, General Motors, United Airlines, Sprint, and American Airlines, Staples, Office Depot, CitiGroup, JPMorgan Chase, Credit Suisse Group AG, Deutsche Bank AG, American Express are firms that have been involved in antitrust court cases or have been in mergers examined by the U.S. Department of Justice.
  • The goal of antitrust policy is to make markets competitive, but at the same time, antitrust enforcement agencies recognize that concentration may grow with economies of scale and innovative business activity. 
  • Antitrust law focuses on preventing price fixing, mergers, predatory pricing, tying of products, and other practices when those activities reduce the competitiveness of a market.
  • Electricity, natural gas, water, and cable-TV companies are natural monopolies and are regulated by federal, state, or local regulatory agencies.
  • The goal of natural monopoly regulation is to allow a monopoly to exist when cost conditions are such that a large firm can produce at lower costs and to encourage them to produce an amount that is closer to economic efficiency than they would produce on their own.
  • There is unlikely to be one price that will result in the firm continuing to produce at a technically and allocatively efficient level of output.
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12.11 Key Concepts

  • Antitrust law
  • Mergers
  • Predatory pricing
  • Barriers to entry
  • Natural monopoly regulation
  • Marginal cost pricing
  • Average cost pricing

12.12 Glossary

Antitrust law: Legislation that restricts deliberate formation of monopolies and prevents firms from engaging in anticompetitive practices.

Average cost pricing: A price, set by a regulator of a natural monopoly, equal to average cost at the corresponding quantity demanded.

Concentration ratio: A four-firm concentration ratio is the percentage of industry sales sold by the four largest firms in the industry. Other similar measures that indicate the degree of market power and competitiveness are often used.

Marginal cost pricing: A price, set by a regulator of a natural monopoly, equal to marginal cost at the corresponding quantity demanded.

Natural monopoly: A firm that can produce at a lower average cost per unit of output than a number of smaller firms producing a similar amount of total output.

Predatory pricing: A firm that lowers prices with the purpose of driving competitors out of a market, increasing its own market power, and eventually reducing output and raising prices is engaging in predatory pricing.






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Answer Keys

Answer to Question 12.01

There are a number of possible answers, most of which are discussed below. One obvious answer is to prevent mergers. A second might be to make price agreements among companies illegal. The costs of such laws include the administrative costs, but more important in the case of mergers is the prevention of some mergers that might increase competition or lower costs or enhance quality of the output.

Click here to return to Question 12.01.











Answer to Question 12.02

When firms agree to set prices and produce a mutually agreeable level of output, economic efficiency will likely be reduced. We know this because firms wouldn’t bother trying to agree on a price unless they were trying to increase it. They can only increase price by also agreeing to produce less. If they were willing to produce more at a lower price without the agreement, we know that the marginal cost of those units would be less than the marginal benefit (the price consumers were willing to pay), so economic efficiency falls.

Click here to return to Question 12.02.











Answer to Question 12.03

When markets are competitive, firms accept the market price and will produce more, putting downward pressure on price until price is equal to each firm’s marginal cost. If marginal cost is above average total cost, firms will enter, increasing supply until price is equal to the minimum of average cost. If price is equal to average total cost, economic profits are zero. A monopolist and firms attempting to act like monopolists would restrict quantity so that marginal cost is equal to marginal revenue and since price is greater than marginal revenue, price will be above marginal cost. This means that the monopolist will make positive economic profit. Given that price is above marginal cost for the monopoly, the outcome will not be allocatively efficient. Antitrust law should try to create a more competitive industry in which price is closer to marginal cost, and the industry comes closer to allocative efficiency.

Click here to return to Question 12.03.



Answer to Question 12.04

The rewards of the new application function as an incentive for firms to create new products – the “killer” applications. However, the reason the applications are called “killer” is that the competition will be killed. The conflict, in this case, is that the market is working to encourage innovation, but once the monopoly is created, the outcome will not be economically efficient. If, however, the firm knows in advance that it will not make monopoly profits, it may not be motivated to create the application in the first place.

Click here to return to Question 12.04.












Answer to Question 12.07

The issues are the cost savings versus the increased market power that can be used by the resulting merged company. The analysis of the trade-offs is not easy to make. Clearly, there are gains and increased technical efficiencies from this type of merger. However, if the merger significantly decreases competition and makes an implicit or explicit cartel a much more likely outcome, allocative efficiency will suffer.

Click here to return to Question 12.07.













Answer to Question 12.09

There are no easy answers. The company has a monopoly in operating systems, perhaps because it is an effective system. The advantages to users are that it is widely used and there are many applications. However, to expand the monopoly to another product does not make sense. The firm should not be allowed to provide the movie distribution system as part of its operating system.

If the company makes competing movie distribution software incompatible with its operating system, there is a further loss of competition.

A number of possible solutions might work. Prohibit the company from producing movie distribution software. Require that the company sell movie distribution software separately. Require that the company offer the alternative competing movie distribution software. Split the firm into two companies – an operating system company and a movie distribution software (and other applications) company.

Click here to return to Question 12.09.









Answer to Question 12.10

There are advantages of the lower costs, but the disadvantage is the increased likelihood of higher prices and lower output. The answer ultimately depends upon how easy entry is and how much competition remains in the industry.

Click here to return to Question 12.10.














Answer to Question 12.11

The company has grown into a monopoly because it is doing what consumers demand. It may well earn economic profits for some time and may produce at less than an economically efficient output. The trade-off is the provision of a new effective product with the possibility that for some time the firm may not offer the product at an economically efficient price or output level.

Click here to return to Question 12.11.













Answer to Question 12.12

The Federal Trade Commission uses the concentration index approach; currently, they use the sum of squares of firms’ market shares before and after the merger and how much the merger would increase the market concentrations and thus lower competition. If the merger substantially increases market concentrations, it is likely to be challenged. As of May 2016, the streaming video market has three major players: Netflix with 53% share, Amazon with 25% and Hulu with 13%. To calculate the concentration index, you need the sum of the squares of market shares, (53)2+(25)2+ (13)2 = 3603, which is already greater than 2500 and therefore already considered a highly concentrated market. After the merger, the market would become even more concentrated, and the index would increase to (53)2+(38)2= 4253, more than 200 points. Therefore, it is very likely to be challenged.
Sources: Department of Justice and Federal Trade Commission Horizontal Merger Guidelines:
https://www.ftc.gov/sites/default/files/attachments/merger-review/100819hmg.pdf
Roger Cheng, "Netflix leads a streaming video market that's close to peaking," cnet.com, May 25, 2016.

Click here to return to Question 12.12.







Answer to Question 12.13

Antitrust laws are designed to maintain competitive markets that provide the lowest prices and most efficient level of output. During the latter part of the nineteenth century, Standard Oil bought refineries and oil companies throughout the country. Standard Oil eventually controlled almost ninety percent of the petroleum industry. Standard Oil then formed a “trust,” a cooperative agreement and basically a cartel, with most of the remaining independent oil firms. (A trust was a combination of firms jointly setting prices and outputs.) Next, the trust closed some refinery operations, reduced output, and increased prices. The origins of antitrust law were the legal efforts to prevent such activities from occurring and ultimately to eliminate the power of a trust to engage in future similar actions.

Click here to return to Question 12.13.










Answer to Question 12.14

The acts are enforced by the U.S. Department of Justice, the Federal Trade Commission, and private suits by individuals and businesses that have been harmed. Violations of the laws can result in fines, prison sentences, civil penalties, prohibitions, and the regulation of future business behavior. Criminal and civil cases are brought by the Department of Justice. Civil enforcement is sought by the Federal Trade Commission. Private parties can pursue suits for monetary damages. States can also bring cases under state antitrust laws for cases that occur only within a single state. 

Click here to return to Question 12.14.











Answer to Question 12.15

Firms would not produce a level of output where price is below marginal cost or where price is below variable average cost if they are profit-maximizing in the short run. However, if the firm saw that it could discourage competitors and then raise its price and lower output to maximize profits and earn economic profits after competing firms were forced out of the market, it might do so.

Click here to return to Question 12.15.













Answer to Question 12.17

The purpose of antitrust law is to increase economic efficiency by influencing market structure. Antitrust law is intended to both discourage monopolies when the effects are anticompetitive and reduce the ability of oligopolies to collude. Ultimately, the goal of antitrust law is to increase the likelihood that market outcomes will be closer to those of a perfectly competitive industry.

Click here to return to Question 12.17.













Answer to Question 12.23

There is not an obvious answer. The dilemma, of course, is that the monopoly faces lower average costs and could produce the product using fewer resources. However, it will not produce the economically efficient amount – it will not be allocatively efficient and may not be technically efficient.

Click here to return to Question 12.23.












Answer to Question 12.26

If the regulated firms can influence regulation, they would obviously prefer higher prices and producing amounts that maximize profits. In addition, firms may try to prevent price competition and entry into the industry in order to protect economic profits.

Click here to return to Question 12.26.













Answer to Question 12.27

The dilemma is the trade-off between maintaining the economically efficient amount of production and allowing firms to earn normal profits so that they will stay in the industry. Average cost pricing is often a compromise – better than a monopoly’s price, but not as efficient as marginal cost pricing. Other solutions are to allow firms to earn revenue from some other source, and then require marginal cost pricing. The desired result is enough revenue to provide normal profits and incentives for the firms to produce the allocatively efficient amounts.

Click here to return to Question 12.27.












Answer to Question 12.42

Just like any other firm, the monopoly is assumed to maximize its profits by setting marginal revenue equal to marginal cost and producing at that level of output while setting the price as high as possible on the demand curve at that level of output. However, the resulting price may be higher and output lower than in a competitive market, making consumers worse off in the case of a monopoly.

Click here to return to Question 12.42.













Answer to Question 12.43

In the figure below, the marginal cost, MC1, is the MC before the merger and also after the merger when the merger does not reduce the marginal cost. The MC2 is the MC after the merger when the merger reduced the marginal cost and thus improved efficiency. The result is that in the second case, price Pm2 is lower than Ppc and Pm1, that is, the price in a perfectly competitive industry and also the price in the merger when there are no cost improvements. The output is higher in the second merger; Qm2 is higher then Qpc and Qm1, that is quantity in a perfectly competitive industry and the quantity in the merger with no cost improvements.

 P1m > P2m > Ppc > PM
QM > Qpc > Q2m > Q1m

 Click here to return to Question 12.43.










Answer to Question 12.44

In the figure below, MC2 is lower than MC1, but it is not enough to make the price of the new merged firm lower than the price in the perfectly competitive industry. The merged firm is not as efficient as the competitive industry, and consumers are hurt by the higher price when the firms merge.

P1m > P2m > P3M > Ppc (PM = P3M, price of merged firms)
Qpc > Q3M > Q2m > Q2m (Q3M = QM, quantity of merged firms)

Click here to return to Question 12.44.











Answer to Question 12.45

While it might seem that it does not benefit firms to claim that they could be more efficient by merging, it is exactly what the Federal Trade Commission and the Department of Justice are looking for to justify a merger. So it will be in the interest of firms that want to get the approval of the Federal Trade Commission and the Department of Justice to convince those institutions of the benefits of the merger to the consumer – that is, the possibility of having a lower price and higher quantity of output produced after the merger is formed.

Click here to return to Question 12.45.












Answer to Question 12.54

The goal of regulation of natural monopolies is to allow a monopoly to exist when cost conditions are such that a single large firm can produce at lower costs. That is the case in most industries that we consider to be public utilities: natural gas, water, sewage, electricity, and in some instances, phone service. The regulatory agencies try to ensure that the firms produce levels of output that approximate the economically efficient levels of output.

Click here to return to Question 12.54.













Answer to Question 12.56

Companies may have become monopolies because they were innovative and creative and are meeting consumers' needs. Oligopolies may exist because of economies of scale that permit production of goods at lower costs than more competitive structures. In other words, there are a variety of possible outcomes where the dominating firm or firms respond in ways in which economic efficiency is enhanced, even though the outcomes could theoretically be improved.

Click here to return to Question 12.56.










Image Credits

[1] Image courtesy of Elekes Andor under CC BY-SA 4.0.

Image courtesy of LPS.1 under CC0 Public Domain.

[2] Image courtesy of N-Lange.de under CC BY-SA 3.0.

[3] Image courtesy of Southgeist under CC BY 2.0.

[4] Image courtesy of Smash the Iron Cage under CC BY-SA 4.0.

Image courtesy of Danny B. under CC BY-SA 3.0.

Image courtesy of Evan-Amos in the Public Domain.

Image courtesy of Fkbowen under CC BY-SA 4.0.

[5] Image courtesy of Acdx under CC BY-SA 3.0.

Image courtesy of Psychonaught in the Public Domain.

[6] Image courtesy of Anthony92931 under CC BY-SA 3.0.

Image courtesy of Lizsummers under CC BY 3.0.

[7] Image courtesy of Kamuisuki under CC BY-SA 3.0.

Image courtesy of Microsoft in the Public Domain.

[8] Image courtesy of Shawn Hartley under CC BY-SA 3.0.

Legislation that restricts deliberate formation of monopolies and prevents firms from engaging in anticompetitive practices.
A group of firms who have legally agreed to work together often in ways that will reduce competition among those firms.
A group of firms who have agreed formally or informally to work together in ways that will in essence, create the advantages of being a monopoly.
Recall that perfect competition is used as a benchmark, so how can we create an environment that is more like that?
What are the benefits of competition?
Study Figure 12.8. How would a monopolist price? What price would prevail in a competitive market?
Think about the benefits and costs over time of allowing firms to reap the rewards of innovation.
A four-firm concentration ratio is the percentage of industry sales sold by the four largest firms in the industry.
Think of the benefits versus the costs of going from many companies to just a few.
Creating barriers to entry can give extra market power to the firm which can produce less and charge higher prices. Regulators should lower barriers to entry and allow consumers a choice.
Merger firms creates more market power to firm and thus firm will produce less and charge more.
A firm that has no competition could achieve that by creating a unique product which customers value and can maintain that position if there are barriers to entry that prevent other firms from entering. However, the lack of competition has a price.
Concentration index is calculated using the sum of squares
Who do these laws protect? When did it become necessary to protect this group?
Two institutions.
A firm that lowers prices with the purpose of driving competitors out of a market, increasing its own market power, and eventually reducing output and raising prices is engaging in predatory pricing.
Firms want to set prices as high as possible and cover their costs at minimum, so they make a positive or zero economic profit. They must gain something for being willing to make negative profits temporarily.
Think of the origins of the antitrust law. It became a law when some firms became very big and were eliminating their competition by merging with them.
A firm that can produce at a lower average cost per unit of output than a number of smaller firms producing a similar amount of total output.
The costs and benefits of a monopoly need to be compared.
A price, set by a regulator of a natural monopoly, equal to marginal cost at the corresponding quantity demanded.
A price, set by a regulator of a natural monopoly, equal to average cost at the corresponding quantity demanded.
Just like any firm they want to maximize their profits and whatever can help them maintain market power.
The goal is to increase competition, but not to eliminate the monopoly. The regulation should get firm closer to a competitive industry output without removing all incentives to produce.
The goal of any firm is to maximize profits.
Find the profit-maximizing monopoly’s quantities.
Find the profit-maximizing monopoly’s quantities.
What is the goal of these firms and how can they achieve it?
Natural monopolies are able to produce at a lower average cost simply because of their “nature” of being a single large firm compared to many smaller firms.
Over time, the benefits and costs to consumers of certain markets structure can change.