Micro Chapter 11
Price-Searcher Markets with High
Entry Barriers
6 Learning Goals
1) Name the reasons why entry barriers can be
high
2) Characterize and explain the output decisions
of a monopoly firm
3) Identify the characteristics of an oligopoly
market
4) Explain the output decisions of an oligopoly
firm
5) List the problems caused by high entry barriers
6) Consider government policies that can
counteract the problems caused by high entry
barriers
Why are Entry Barriers
Sometimes High?
1.
2.
3.
4.
Q11.1 A monopoly is most likely to emerge in a
market when
the producers in the market have U-shaped
average total cost curves.
the price elasticity of demand for the product is
high.
the cost of entry and exit into the market is low.
economies of scale are large relative to market
demand.
Q11.2 The U.S. Postal Service has a monopoly on
the delivery of first-class mail due to
1. economies of scale.
2. a lack of initiative on the part of competing
firms.
3. legal barriers limiting entry.
4. control over an essential resource.
An entry barrier is something that
prevents you from opening a
business in a particular industry
Preventions:
(1) Sometimes you just need to start as a
really big firm (example: nuclear power
plant)
(2) Another firm may have a license or
patent that precludes you (example:
USPS)
(3) Somebody else owns the vital resource
Entry barriers create market power
If no new firms can enter the market to
steal customers and profits, the existing
firms behave differently
Characteristics of
Monopoly
Similar to monopolistic competition,
the firm now decides price and
output
The firm is the market (i.e. market demand
curve = firm demand curve)
Continue to produce as long as MR > MC
Price and Output Under Monopoly
• The monopolist will reduce price
and expand output as long as
MR > MC.
• The monopolist will raise price
and reduce output whenever
MR < MC.
• Output level q will result … and
price P (along the demand curve)
will be charged.
• At output q the average total cost
is C.
• As P > C (price > ATC) the firm
is making economic profits equal
to the area PABC.
Price
MC
Economic
profits
ATC
A
P
B
C
d
MR < MC
MR > MC
MR
q
Quantity/time
Q11.3 Because monopolists are protected by
high barriers to entry,
they may be able to earn long-run economic
profits.
2. they will minimize the per-unit cost of producing
their output.
3. they will price their product at marginal cost.
4. they seek economic profit; however they are not
able to earn it in the long run.
1.
If there is no substitute, why not
set price at $1 million?
The firm will set price according to market
demand (i.e. willingness to pay)
In the SR the firm can earn positive
economic profit
Will LR profits be pushed to zero?
No, because of entry barriers
No new firm can enter and take profit
away
Whenever the cost of a first-class stamp is raised, the U.S.
Postal Service (USPS) undertakes a new advertising
campaign. I doubt that advertising will help much, at least
not in the part of its business involving letters and bills. The
problem is that the long-run cost of transmitting paper
documents is rising, while the long-run cost of transmitting
electrons (fax, e-mails, electronic funds transfers) is falling.
The cost of a one-minute fax has fallen below 10 cents at the
same time that stamp prices have risen. Until the 1980s, we
mailed checks every month for the phone, electricity, gas,
and mortgage. We now have these all directly debited; it’s
easier, and the companies save money this way, too. The
only hope for the USPS in the long run is in its lines of
business where goods must be sent: parcels and express
mail. Whether it is efficient enough to compete in these
areas with FedEx, UPS, DHL, and others is another question.
Q: The USPS has a monopoly on sending letters. Why
doesn’t that monopoly guarantee it economic profits forever?
Is the monopolist guaranteed SR
and LR profit?
SR and LR profit can be positive, negative,
or zero
Illustration of Monopoly and a
change in market structure:
This market moved from nearly perfect
competition to monopoly overnight
Watch video: Forrest Gump-monopoly
The Characteristics of an
Oligopoly
The key characteristic is interdependence
among firms which leads to strategic
behavior
Watch video: Primetime-game theory
Game theory is often used to
analyze oligopolies
John Nash won the Nobel prize in
economics for his pioneering work that
was later used in this area
Watch video: A Beautiful Mind-Nash
equilibrium
Recall the other 3 industries:
A perfectly competitive firm is not
concerned about any other firm
A monopolist doesn’t have another firm to
consider
A monopolistically competitive firm is only
somewhat concerned about what other
firms are doing
An oligopoly firm is greatly
concerned about what the other
firms in the industry are doing
Each firm will base part of its own
decisions on what they think other firms
are doing or will do
Our clothes dryer died yesterday, so we went out
shopping for a new one. I said we should go to
Sears, but my wife thought that Sears carries only
its own brand (Kenmore) of appliances. I thought
that that was no longer true, and I was correct: A
few years ago, Sears began carrying all major
brands and trying to compete with the discount
appliance stores. Why did Sears switch strategies
after so many years of advertising Sears and
Kenmore together? The company increasingly saw
its prices being undercut by discounters as
customers insisted on shopping based on price
instead of on brand loyalty. The only way Sears
could maintain its sales against the competition
was to offer a full range of choices.
Q: If you had a small appliance store offering
exclusively Maytag appliances and saw places like
Sears expanding to offer many different brands,
what would you try to do to stay in business?
Watch video: Princess Bride-game theory
Watch video of strategic behavior (also
known as prisoner’s dilemma): Golden
Balls gameshow-prisoner’s dilemma
Price and Output under
Oligopoly
The federal government is seeking public comments on
proposals that would allow airlines to impose surcharges on
fares at peak business hours at the nation’s busiest airports.
Why don’t the airlines just raise these fares themselves,
since they are free to do so? The problem is that they often
do try to raise fares, but without success. In the last two
weeks, two airlines have successively tried to increase
discount fares by $20 per ticket, only to back down when
they found that the other oligopolists did not follow their price
increases. If the oligopolists can get the government to state
that raising fares is justified as a way of reducing congestion
at busy times and places, it is more likely that airlines
generally will go along with price increases. A government
statement would provide the “cover” industry members need
to justify raising their prices at the same time; it would
prevent competition between them.
Q: Assume all airlines initially charged $20 more. Describe
what you think would happen to prices over time.
Each analysis really becomes a
case-study because:
Sometimes oligopolists will act like
perfectly competitive firms
Sometimes they’ll act like monopolists
Many times they switch between the two
(act one way for awhile then another)
Ceteris paribus, what would make
a firm better off?
A higher price for its product
How could this be achieved?
If output were kept low, price would
generally rise
Would one firm voluntarily or even have an
incentive to keep output low?
Probably not because the other firms
would increase production, lower price,
and steal customers
What if the firms jointly agreed to
keep production low?
This would generally be good for all firms
But the incentive to cheat would be so
great that the agreement probably
wouldn’t last long
Watch video: 20/20-diamond cartel
Q11.4 When members of an oligopolistic industry agree to
collude, raising their product price substantially above average
cost, the passage of time (months and years)
is usually needed for the members to solidify their
cooperation.
2. usually results in finer control of prices and markets by the
group and larger profit margins.
3. is likely to erode the agreement, as ways to cheat are
developed by some participants and new entry is
encouraged by the high price.
4. seldom has any impact on the agreement, as long as the
participants maintain high profit levels as a result of the
agreement.
1.
Q11.5 The two conflicting tendencies that a firm has in an
oligopolistic industry are
the incentive to cheat to maximize joint profits and the
incentive to raise prices.
2. the incentive to cheat and avoid collusion and the incentive
to raise price to maximize the firm's share of profits.
3. the incentive to increase output in order to minimize per-unit
costs and the incentive to reduce price in order to maximize
joint profit.
4. the incentive to cooperate to maximize joint profits and the
incentive to cheat on the agreement in order to increase the
firm's share of the profit.
1.
Defects of Markets with
High Entry Barriers
Generally, the outcomes of
monopoly and oligopoly are not as
desirable as with perfect
competition
Output is lower
Price is higher
Some gains from trade are not realized
Variety is lower
Policy Alternatives When
Entry Barriers are High
Four options to “fix” the industry:
1) Antitrust Policy (Sherman Act, Clayton
Act, FTC, etc)
2) Reduce artificial barriers
3) Regulate price and output
4) Government production
Problem with government production:
Watch video: Stossel Macro Clip 15competition and efficiency of government
Question Answers:
11.1 = 4
11.2 = 3
11.3 = 1
11.4 = 3
11.5 = 4