1. Minimum Efficient Scale (MES)..The lower the output at which production becomes efficient the lower the barrier to entry.

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1 Econ 10 Lecture Monopoly & Imperfect Competition Page Minimum Efficient Scale (MES)..The lower the output at which production becomes efficient the lower the barrier to entry. Average Cost High MES => High Barrier to Entry Low MES AC Scale of Output, Q However, even if the industry exhibits low MES new firms might be kept out by: 2. Brand proliferation: say that some consumers purchase randomly... if there are a small number of firms, then a new firm can enter and pick up a sizable share of the market merely because consumers will switch to the new brand... but if one or two manufacturers put out a lot of brands (like the soap companies), the total share of the market that can be captured falls. (Cf. old Soviet Union selling one brand Soap. ) 3. Advertising: established firms attempt to shift cost curves for entering firms up by advertising... creating product identification. (e.g., Coke, Pepsi, designer soft drinks trying to establish a market niche.) 1.4. Types of Collusion: Case Studies in Oligopoly : Cartels Cartels often have written rules and penalties that the parties have agreed to, plus a staffed organization to see that the rules are followed. Almost every conceivable device has been tried at some point and many still persist. Western Europe has a long history of cartels, some of which have been organized and enforced by the state itself.

2 Econ 10 Lecture Monopoly & Imperfect Competition Page 28 Full Cartels control all aspects -- pricing, output, product mix, investment, and profit pooling-- much as a genuine unified monopoly firm would. This requires large staffs and complete information. Even such thorough cartels may break down or need revising, but while in existence, they usually exert strong control. OPEC: The Organization of Petroleum Exporting Countries is an excellent example of a cartel. It consists mainly of the oil-rich Middle East Arab countries. It achieved startling success, first in by rasing the world price of oil from about $3 to $11 in the space of six months, and then in 1979 by raising it to about $30. Few cartels in history have matched OPEC's extent of price multiple, which reached 10 in 1979 and was nearly sustained until in 1985 the price fell from $28 to below $15. It has generally stayed in the $12 to $20 range since then ($18 in January 97), with the exception of the period during the Gulf Crisis in No cartel in history has remotely approached the colossal volume of OPEC's profits and total economic impact. Yet OPEC is not actually a tightly knit, unified cartel, because there are deep divisions among its members. Some members have vast reserves of cheap oil: Saudi Arabia in particular produces oil at little more than $3 per barrel and it does not need to maximize short-run returns. At the other extreme, several high-cost producers (such as

3 Econ 10 Lecture Monopoly & Imperfect Competition Page 29 Nigeria) need high prices, and they also need the funds more urgently. OPEC meetings to set quotas usually involve clashes, reflecting these differences. Saudi Arabia and the small Persian Gulf states usually seek restrained production, but at prices which do not strain relations with western importing countries such as the U. S. The high cost, short-run oriented nations instead seek high prices and maximum quotas for themselves, which they routinely violate in practice by over-producing. In addition, Iran and Iraq, traditional enemies, have each demanded to have a quota larger than the other. There are large producing nations outside of OPEC, so the OPEC is not only internally divided but also not even a majority of world oil production. Even so, OPEC's years of varying success have been astonishing. Syndicates, or Marketing Cartels are less complete cartels that handle all its members' sales and manage their revenues. These cartels control every aspect but profit pooling and investment, and these it can control indirectly. Cigarette industry traditionally has been very highly concentrated. In the 1930s for example there were 3 dominant firms: R. J. Reynolds, Liggett & Myers and American Tobacco which together controlled over 90 percent of the market. Using theory of monopoly, one would predict:

4 Econ 10 Lecture Monopoly & Imperfect Competition Page The companies would avoid competing with each other either in tobacco buying or in pricing of cigarettes. 2. Would also be able to predict substantial profit over many years. These things have happened: The companies conspired to buy tobacco at auction without bidding against one another. They followed a uniform high price policy for the sale of cigarettes (high relative to cost). In fact, in June, 1931, in depth of Depression and in face of lowest leaf prices in 25 years, the big 3 all raised their prices! <This looks like the theory of monopoly at work, right?> But here the theory begins to break down: Smokers shifted in large numbers to cheaper brands made by other companies. Ultimately prices fell well below the May, 1931, levels as the big 3 tried to regain their market shares. They have never to this day been successful in gaining as large a share as held in May, However, profits of big 3 have remained high, and there is still a lack of competition in the leaf market. Also, until recently, there has been a lack of serious cigarette price competition in past 30 years. But the Theory of Monopoly does not explain the enormous expenditure on advertising, on advertising particular brand names. This is an intense form of nonprice competition... and an attempt to raise barriers to entry. In the decade of the 1980's even during a period of relatively low price inflation, cigarette companies were able to raise prices at a rate well in

5 Econ 10 Lecture Monopoly & Imperfect Competition Page 31 excess of inflation. In fact, cigarette prices rose so rapidly in the 1980s that some smaller companies, such as Liggett in Durham, sucessfully introduced generic cigarettes and took significant market share from the large, heavily advertised brands. In turn, the larger companies were forced to respond with generic brands of their own Controls Specialized Controls keep control of entry in many industries. Definite standards are set that limit the number of competitors in an industry. The commercial banking industry, for example, is regulated by chartering. New entrants must make a positive case that more banking services are needed and that they meet high standards of probity. (So much for that requirement!) Over 20 states prohibit branching by a bank into more than one physical location. There have been restrictions on pricing; interest rates on savings were limited; and interest could not be paid on demand deposits until recent years. Despite some loosening since 1970, banking controls are still powerful. Various "professions" --medicine, law, and accounting, for example-- have entry restrictions of some kind. Others-- beauticians, barbers, and morticians, for example-- are controlled by state licensing laws. The restrictions often underpin effective price fixing by the professionals' associations.