Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Chapter 15. Monopoly and Antitrust Policy
Instructor: JINKOOK LEE
Department of Economics / Texas A&M University
ECON 202 504
Principles of Microeconomics
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Monopoly and Barrier to Entry
Monopoly: A firm that is the only seller of a good or service that does not
have a close substitute.
To have a monopoly, barriers to entering the market must be so high that
no other firms can enter.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Examples of Monopoly in College Station
Mergers and Government Policy
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Examples of Monopoly in College Station
Mergers and Government Policy
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Monopoly and Barrier to Entry
Barrier to entry: Anything that keeps new firms from entering an industry
in which firms are earning economic profits.
A. Economies of Scale → Natural monopoly
Natural monopoly: economies of scale are so large that one firm can supply the
entire market at a lower average total cost than can two or more firms.
B. Ownership of a Key Input: occupying raw materials
C. Government-Imposed Barriers: a patent, copyright, public franchise
D. Network Externalities: the usefulness of a product increases with the
number of consumers who use it.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Marginal revenue
In perfectly competitive markets, firms are price takers.
they face horizontal demand curves.
Price = MR
In all other markets (including monopoly), firms are price makers.
they face a downward-sloping demand curve and a downward-sloping
marginal revenue curve.
Price > MR
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Marginal revenue
In a monopoly market, a monopoly’s demand curve is the same as the
market demand curve for the product.
Calculating a Monopoly’s Revenue
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Marginal revenue
In a monopoly market, a monopoly’s demand curve is the same as the
market demand curve for the product.
A Monopoly’s Demand and MR Curve
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Profit Maximization
A monopoly should sell a good up to the point where MR = MC .
(point A) MR=MC=$27
(point B) profit-maximizing quantity=6, profit-maximizing price=$42.
at the quantity of 6, ATC=$30.
maximized profit=($42 − $30) × 6 = $72.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Price and Quantity from Monopoly and Perfect Competition
A monopoly will produce less and charge a higher price than would a
perfectly competitive industry producing the same good.
the industry supply curve becomes the monopolist’s marginal cost curve.
the monopolist reduces output to where marginal revenue equals marginal
cost (QM ).
the monopolist raises the price from PC to PM .
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Efficiency Losses from Monopoly
How does monopoly affect consumers, producers, and the efficiency of the
economy?
A monopoly charges a higher price (PM ), and produces a smaller quantity
(QM ) than a perfectly competitive industry (PC , QC ).
Monopoly decrease consumer
surplus by A + B.
Monopoly increase producer
surplus by A − C .
Monopoly causes a
deadweight loss (B + C ),
which represents a reduction
in economic efficiency.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Mergers: The Trade-off between Market Power and Efficiency
The federal government regulates mergers because mergers allow firms to
have significant market power with which they can raise prices and reduce
output.
Market power: the ability of a firm to charge a price greater than marginal
cost.
Horizontal merger: a merger between firms in the same industry.
Vertical merger: a merger between firms at different stages of production
of a good.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Mergers and Government Policy
Two factors can complicate regulating horizontal mergers:
A. The “market” that firms are in is not always clear.
In practice, the government defines the relevant market on the basis of
whether there are close substitutes for the products being made by
the merging firms.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Mergers and Government Policy
B. The newly merged firm might be more efficient.
Suppose that all the firms in a perfectly competitive industry are merging to
form a monopoly.
If costs are unaffected by the merger
Price rises (PC to PM )
Quantity falls (QC to QM )
Consumer surplus declines, and a
loss of economic efficiency results.
If the monopoly has lower costs
Price falls (PC to PMerge )
Quantity rises (QC to QMerge )
Consumers are better off and
economic efficiency is improved.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Mergers and Government Policy
The newest (modified in 2010) the guidelines for regulations have three
main parts
A. Market Definition: A market consists of all firms making products that
consumers view as close substitutes, which can be identified by looking at
the effect of a price increase.
Beginning with a narrow definition of the industry, we identify the
relevant market involved in a proposed merger if profits increase after a
price increase.
If profits increase, we consider a broader definition by continuing the
process until a market has been identified (i.e. profits decrease).
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Mergers and Government Policy
B. Measure of Concentration:A market is concentrated if a relatively
small number of firms have a large share of total sales in the market.
The higher a market’s concentration, the likelier a merger between
firms in the industry will increase market power.
The Herfindahl-Hirschman Index (HHI) of concentration squares the
market shares of each firm in the industry and adds up their values.
2 firms, each with a 50 % market share: HHI = 502 + 502 = 5, 000
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Mergers and Government Policy
C. Merger Standards: The Department of Justice and the FTC use the
HHI calculation for a market to evaluate proposed horizontal mergers.
Postmerger HHI below 1,500
These markets are not concentrated, so mergers in them are not challenged.
Postmerger HHI between 1,500 and 2,500
These markets are moderately concentrated.
Increase in HHI by less than 100 probably will not be challenged.
Increase in HHI by more than 100 may be challenged.
Postmerger HHI above 2,500
These markets are highly concentrated.
Increase in HHI by less than 100 points will not be challenged.
Increase in HHI by 100 to 200 points may be challenged.
Increase in HHI by more than 200 points will likely be challenged.
Monopoly and Barrier to Entry
Profit Maximization
Economic Efficiency
Mergers and Government Policy
Regulating a Natural Monopoly
Local or state regulatory commissions usually set the prices for natural
monopolies.
Without government regulation
Price is PM , Quantity is QM .
To achieve economic efficiency
Price is PE , Quantity is QE .
PE < ATC .
Monopoly suffer a loss.
monopoly will not continue to produce if it suffers a loss.
government regulators set a price equal to average cost (PR = ATC ).
The resulting production (QR ) will be below the efficient level (QE ).