Economics The University of Connecticut RICHARD N. LANGLOIS COMPETITION AND MONOPOLY

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1 Economics 1000 Essentials of Economics 1 RICHARD N. LANGLOIS MODULE 6: COMPETITION AND MONOPOLY The University of Connecticut

2 Competition as a process. 2 A popular meaning of competition is playing to win. When economists use the term competition they mean a state of affairs. A large number of buyers and sellers. Full information. Sellers produce a homogenous product. Costless mobility of resources.

3 Competition as a process. 3 But real-world competition is a constant adjustment process. Illustration: shoppers waiting at the checkout.

4 The pressures of competition. 4 Sellers. Face a downward sloping demand curve. Price > opportunity cost, which invites competition from rivals. Example. Slice of pie costs 50 cents to produce. Vendor sells the pie for $1.50.

5 The pressures of competition. 5 P $1.50 Price D.50 Cost Q

6 The margins of competition. 6 Price. Quality. Cost. Innovation

7 Creative destruction. 7 [T]he problem that is usually being visualized is how capitalism administers existing structures, Joseph A. Schumpeter ( ), author of Capitalism, Socialism, and Democracy (1942) whereas the relevant problem is how it creates and destroys them

8 Creative destruction. 8 Joseph A. Schumpeter ( ), author of Capitalism, Socialism, and Democracy (1942) competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance) competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives. This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door, and so much more important that it becomes a matter of comparative indifference whether competition in the ordinary sense functions more or less promptly; the powerful lever that in the long run expands output and brings down prices is in any case made of other stuff

9 Creative destruction. 9

10 Monopoly. 11 Two systems of belief about monopoly. Spontaneous monopoly. Natural tendency for monopolies to arise and persist. Need for active antitrust policy. Interventionist monopoly. Competition tends to eliminate market power unless there are structural barriers. True monopoly is a creature of the state.

11 Monopoly. 12 Sources of monopoly. Natural monopoly. Because of economies of scale, only one firm fits in a market. Example: cable TV. Example: network effects and software. But: franchise bidding. But: which stages of production have the economies of scale?

12 Monopoly. 13 Sources of monopoly. Ownership of a scarce input. DeBeers and diamond mines. A property right to exclude. Patents t and intellectual t l property rights. The Postal Monopoly statute.

13 Taxi medallions. 14 Average Annual Medallion Prices 1947, 1950, 1952, 1959, 1960 and annually since Source: Schaller Consulting. 13,257 medallions

14 Taxi medallions. 15 $/med S P 2 P 1 D D 13,257 # medallions

15 Taxi medallions. 13,257 medallions 16 Since the start t of 2008, while the stock market was going through its worst decline since the Great Depression, the price of a corporate medallion has jumped 28%, to $766,000; the price of an individual id one has risen 33%, to $572,000. Source: USA Today

16 Analysis of monopoly. 17 $/Q P m Firm s demand d curve is the market demand d curve. Monopolist chooses Q m to make producer surplus as big as possible. Demand curve determines monopoly price Pm. cost D Q m Q/t

17 Analysis of monopoly. 18 $/Q Not true that a monopolist can set any price it wants. Why? Suppose monopolist lowers price. P 1 P 2 Loss in revenue from lowering price to existing (inframarginal) customers. Gain in revenue from attracting new customers. Revenue is P*Q Q/t No price discrimination. Q 1 Q 2 No price

18 What s wrong with monopoly? 19 $/Q A competitive industry would drive price down to cost, implying an output of Q c. Producer surplus (profit) would be zero. CS Shaded area is consumer surplus. P c cost D Q c Q/t

19 What s wrong with monopoly? 20 CS $/Q Monopoly restricts output and raises price relative to the competitive benchmark. Some consumers surplus becomes producer s surplus (profit). P m Is this what is wrong with monopoly? PS P c cost Transfers of surplus can be regressive or progressive. D Q m Q c Q/t

20 What s wrong with monopoly? 21 $/Q Monopoly restricts output and raises price relative to the competitive benchmark. CS PS As a result, some potentially beneficial gains from trade don t take place. P m Total surplus is diminished by the extent of the deadweight-loss triangle. P c DWL cost Total (social) surplus us is CS + PS. D Q m Q c Q/t