Microeconomics Chapter 15 Monopolies

Where is consumer surplus on a graph? Producer surplus?

Below the demand curve and above the market price. So, the higher the price, the smaller the consumer surplus. Producer surplus is above the supply curve and below the market price

Barriers to entry that make a monopoly possible #4: Economies of scale are so large that a firm has a natural monopoly

Economies of scale exist when a firm's long-run average costs falls as it increases the quantity of output it produces. 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 two or more firms. This means there is only room in the market for one firm. See the graph of 506. This mostly occurs in firms where fixed cost are very large relative to varaible cost (ex. Duke Energy must make a substantial investment in machinery, but once they make that investment that marginal cost of producing another kilowatt of electrcity is very small.) An example of a natural (non artificial monopoly occuring is if two firms are competing, one expands and thus lowers its average total cost, and ends up putting its competitor out of business

Why do governments create antitrust laws?

Because monopolies reduce consumer surplus and economic efficentcy. Antitust laws aim to eliminate collusion and promote competiton among firms

A monopoly exist because barriers to enter the market are so high that other firms cannot enter. What are four reasons why this is the case?

1. Government actions block the entry of more than one firm into the market 2. One firm has control of a key resource necessary to produce the good 3. There are important "network externalities" in supplying the good or service 4. Econcomies of scale are so large that one firm has a natural monopoly

Barriers to entry that make a monopoly possible #1: Government actions block entry

1. Granting a patent, copyright, or trademark to an individual or firm, giving it the exclusive right to produce a product: Patents gives a firm the exclusive right to produce a product for a period of 20 years (suppose to increase research and development). After a patent wears off, a firm's profits were dramatically drop as generic brands become avaliable, such as is the case with drugs. Copyright protection covers books, films, and pieces of music; it last over the creator's lifetime, and the creator's heirs retain the rights for 70 years after their death. 2. Public Franchises: This a government designation that a firm is the only legal provider of a good or service. This is often the case for electricity, natural gas, and water providors.

What are the three guidelines DOJ uses to allow or oppose a merger?

1. Market Definiton: Market consist of all firms making products that consumers view as close substitutes. DOJ identifies close substitutes by looking at the price increase. If profits decrease when price is increased, then the market is defined narrowly enough. Ex. Mars and Hersey increase prices and their profits decrease, then DOJ broadens their definition to snacks. If profits were to decline from a price increase in this market, then this is the relevant market. 2. Measure of Concentration: A market is concentrated if a relatively small # of firms have a large share of total shares in the market. A merger between firms in a market that is already concentrated is very likely to increase market power. Therefore, A merger in a lowly concentrated market is likley gonna be ignored by DOJ. The DOJ measures concentration with the HHI, whcih squares the market shares of each firm in the industry and adds up the value of the squares. (ex. 1 firm with a 100 percent market share; 100^2=10,000) 3. Merger standards: Increases in economic efficentcy will be taken into account and can lead to approval of a merger that would otherwise be opposed, but that requires proving inefficencies exsist in each of the two merging firms.

What are two factors that federal regulators deal with when evaluating horizontal mergers?

1. The extent of the market: The government judges this based on whether or not there are close substitutes for the two merging companies being produced by other firms. Ex. If Hersey and Mars are merging, and the government considers them to be part of the candy industry, they will control too much of the market and the government will likely block it. If they consider them to be part of the snack industry, including things like chips and drinks, they will likely not hold enough of that market for the government to oppose it. The government would go with the former marke, because chips and dirnks are not close substitutes to candy 2. Possible Increases in economic efficentcy: Sometimes two companies that are better at some things and weaker at others can make up for each other's inefricentcys by merging. This merger would be best for suppliers and consumers

How do monopolies reduce efficiency/allocative efficentcy compared to a perfectly competitive market?

Allocative efficiency is when production represents consumer preferences. In particular, as with a perfectly competitve firm, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal product of producing it. This makes it possible for customers to buy a product at the price that it cost to marginally produce it. Monopolies stop producing at a point that is well above the marginal cost, so consumers are unable to buy some units that they would be willing to pay a price that is higher than marginal cost for. The monopoly stops producing at a point above marginal cost because its profit is greater if it restricts output and forces its price up. In this sense, they produce at the profit-maximizing level of output but not at the level of output that is efficent for society.

Barriers to entry that make a monopoly possible #2: Control of a key resource

Examples include sports teams that have exclusive rights to a stadium in a city, and the aluminum company that once owned a necessary input to make aluminum

What is the difference between vertical and horizontal mergers?

Horizontal mergers are between two firms in the same industry. Vertical mergers are between two firms in different industries. The government is more concerned with horizontal margers because they are more likely to increase market power, raising prices and reducing output (becoming more like a monopoly)

What has a greater economic surplus, a monopoly or a perfectly competitive industry?

Perfectly competitive

How do monopolies affect consumer surplus? Producer surplus? Deadweight loss?

Reduces consumer surplus and increases producer surplus. Also causes a deadweight loss, which represents a reduction in economic efficiency. See graph on 512

How does a monopoly maximize profit

See the graph on 509 As long as the marginal cost of selling one more unit is less than the marginal revenue, the firm should sell additional subscriptions because its adding profit. Eventually, marginal cost will equal marginal revenue, and they should stop at that point because this is their profit-maximizing quantity of units. They should then charge the price at which customers are demanding the profit-maximizing quantity

What is market power?

The ability of a firm to charge a price that is greater than marginal cost. Many firms have this ability, even if they are not a monopoly; the only firms that do not have it are perfectly competive firms, which charge at equal to marginal cost; because few firms are perfectly competive, some loss of efficentcy occurs in the market for nearly every good or service. However, prices in the US are still close to marginal cost, so the effect of market power is small

What effect does market power have on technological change?

The excess money that firms make from charging a price that is greater than the market price is used to develop new technology and products

A monopoly's demand curve is the same as...

The market demand curve for the product.

What is a monopoly?

The only seller of a good or service that does not have any close substitutes. Since it has no close substitutes, it can ignore the actions of all other firms (ex. Duke Energy is not worrying about a candle company). Other factors, such as if there is only one restaurant in town, influence whether or not something is a monopoly. For a monopoly to exist, barriers must be so high that other firms cannot enter the market.

Barriers to entry that make a monopoly possible #3: Network externalities

This is a characteristic of a product in which its usefulness increases with the number of consumers that use it. If a product can attract a few customers initally, it can attract more customers as its product's value increases by more people using it, which attracts more customers.

Why does a monopoly's demand curve and marginal revenue curve slope downward?

When a firm cuts its price... - It will sell more units of the product - The firm receives less revenue from each unit than it would have received at a higher price See graph on page 508 Time Warner is the only cable provider in a city. It has 10 potential customers. If it charges a price of 60 it won't sell any subscriptions, 2 if it charges 54, and so on. Their total revenue is the number they sale multiplied by the price. The average revenue is the total revenue divided by the number they sale. The marginal revenue will tell them how much its revenue will increase if it cuts the price to sell one more subscription. After a certain point, it will not be worth it to sell an additonal subcription, because the additonal money from that new subcriber will not make up for the lost revenue from selling the subcriptions up until that point at a lesser price (ex. If they cut their price from 42 to 39 they will get one more subscriber, going from 6 to 7. Its revenue will increase by 39 for the 7th subcribor, but it will lose 3 per person for the first six customers, for a total for 18. So the marginal revenue on the 7th subscription ends up being 21.