Defining a Monopoly
A monopoly is a market structure in which one single firm serves the entire market, where there are no close substitutes. Given that there is one sole firm that serves the entire market, this firm has significant market power. The demand curve of the market is also the monopolists demand curve. If no regulations or legal restrictions existed, the monopolistic firm would be able to charge whatever price they want. If this is the case, Price (P) multiplied by the number of quantities sold (Q) equal the total revenue (TR) for that product. If the firm charges too high of price the consumers only other options, since there are not close substitutes, would be to buy nothing at all. It is important to determine the type of market structure when trying to determine if a firm is a monopoly.
There are four sources that create monopoly power:
Economies of scale: When long-run average costs decrease as the output increases. This can hold true for many technologies.
Economies of scope: When the total cost of producing two products within one firm is cheaper than if the two products were produced by two separate firms. Economies of scope exist in many firms. It is a monopoly when companies use this to gain greater market control and smaller firms are not able to gain the same advantage.
Cost Complementary: When the marginal cost of producing one output is decreased when the output of another product is increased. The firms who have cost complementary have a cost advantage over single firms. This is an extreme case of how one can become a monopoly.
Patents and Other Legal Barriers: A patent gives the inventor sole rights to sell their product for a certain period of time. Patents rarely lead to monopoly because once the patent expires competitors can develop close substitutes.
In a monopoly there is no supply curve, so the firm decides how much of a product they should produce. They base this off marginal revenue. To maximize profits, a monopolistic firm should produce output, where marginal revenue equals marginal cost: MR (Q1) = MC (Q1). In a monopoly marginal revenue is less than the price because in order to sell more, the firm must lower its prices. The revenue will not increase by the price because the firm had to lower their price. It is important to note that, not all monopolies may have positive profits, this depends on where the demand lies in relation to the average total cost curve. In the short-run, they may even experience losses.
In the real-world, there generally is not just one firm that controls an entire industry, but there are smaller firms with close substitutes. However, having significant market power can constitute a monopoly.
Monopolies can be unbeneficial to society. Deadweight loss of a monopoly is defined as the consumer and producer surplus that is lost due to the monopolist charging a price that is excess of the marginal cost.
How do we prevent monopolies?
The Sherman Antitrust Act was passed in 1890 in response to price fixing. This helped to prevent firms from becoming a monopoly because they were seen as harmful to society. The U.S. Department of Justice's (DOJ) Antitrust division helps to promote competition and to block potential monopolies that are harmful to the public.
Examples of Monopolies
Furukawa Electric Co. is a supplier of automotive wire harnesses and similar products, which is located in Tokyo. The wire harnesses are electrical systems to help control electrical components in cars. Executives were accused and pleaded guilty to price-fixing and bid-rigging involving the sale of parts to automobile manufacturers. Automobile manufacturers in the United States paid noncompetitive and high prices for these parts in the cars sold to customers in the U.S. The DOJ said these type of actions caused harm to the United States and our economy system. The three executives involved had agreed in meetings and conversations, to coordinate price adjustments made by U.S. auto manufacturers.
The Department of Justice blocked AT&T's attempt to acquire T-Mobile back in August 2011. The DOJ's said the acquisition would have lessened competition in the industry of mobile wireless telecommunication services in the United States. An acquisition would have resulted in higher prices, poorer quality, and less innovation in this industry. There are millions of customers who use AT&T and T-Mobile and this acquisition would have not been in there best interest. There are three industries who currently make up 90% of the market, AT&T, T-Mobile and Verizon. This potential acquisition would have one less competitor and only making AT&T stronger and closer to a monopoly status in this industry.
Multiple Choice Questions:
1. Which of the following is an example of one of the four sources that create monopoly power?
A. Firm A produces computer hard drives and buys the monitors from Firm K. They bundle the hard drive and monitor and sell them. It is cheaper for them to buy the monitors from Firm K.
B. Firm A produces computer hard drives and monitors. As production of the hard drives and monitors increase Firm A's long-run average costs continue to increase.
C. Firm A produces computer hard drives and buys the monitors from Firm K. They bundle the hard drive and monitor and sell them. After some research, they find that it is cheaper to produce the monitors themselves and decide to do so.
D. Firm A seeks a patent for their hard drives because of the top speed and incredible memory, no other firm produces the same type of hard drive. Firm A is denied the patent.
2. According to the DOJ, which of the following reasons is a reason to block a potential acquisition?
A. poor quality
B. less innovation
C. higher prices
D. all of the above
3. A local store sells batteries and they are the only ones available, so everyone in the community goes to them for their battery needs. If the price of a battery is $75 and the store sells 110 batteries, the total revenue for the local stores for batteries would be .
A. $8,140
B. $8,250
C. $8,360
D. $7,500
4. What is the relationship between a market's demand curve and a monopolists (who produces that particular product) demand curve?
A. The industry's demand curve is to the right of the monopolist's demand curve.
B. The monopolists' demand curve is to the right of the industry's demand curve.
C. There is no demand curve.
D. They are the same.
5. Which of the following is an example of a monopoly?
A. A local gas station in town X. The next gas station is 10 miles away in town Z.
B. A Pharmaceutical company who sells a name brand drug, X. The patent for drug X expired 5 months ago.
C. Firm X who controls 94% of the market. Firm Y and Z have 3% market power.
D. A local cable company.
Answers:
C - This is an example of economies of scope.
D - The Department of Justice recently blocked AT&T from acquiring T-Mobile due to all of these things.
B - In a monopoly, the total revenue = P*Q. In this example, $75*110 = $8,250.
D - In a monopoly, the market demand curve and the monopolist's demand curve are the same because there are no close substitutes.
C - The other examples have close substitutes, in which consumers can choose from. In the real-world, firms who control significant market power have monopoly characteristics.
References:
Baye, Michael R. "Monopoly." Managerial Economics and Business Strategy. 2010. pp 277-293.
Profit maximizing markup - When a firm has market power (monopoly, oligopoly, monopolistic completion) they have the ability to decide what price to charge. Two of important concepts of profit maximizing markup is 1) the more elastic a product, the less markup because there are more substitutes available and 2) the higher marginal cost, the higher the mark up because a firm needs to make a profit.
Networks - Networks are links that connect different points geographically or in economic space. When a firm builds a network, the benefit from economies of scale and it also creates a barrier of entry for other firms.
Penetration pricing - This is when a firm charges a low price at first in order to increase their customer base and gain a following. This is only done on the short-term to gain customers and the firm doesn't expect to make a profit.
Transfer pricing - This is when a firm sets a price in which an upstream division of the firms sells an input to a downstream division of that same firm. Cisco had transferred costs to one of their oversees division to help reduce their taxes and gain a better overall profit for the company.
Predatory Pricing - Where a firm temporarily sets its prices below the marginal cost. The purpose of this is to drive competitors out of the market. The Amazon Kindle actually costs more than what Amazon is selling for. This is a good example of predatory pricing. However, they are still making profits from other sources of revenue such as advertising.
Raising Rivals Costs - When a firm increases the costs of competitive firm to gain an advantage.
Price Matching - When a firm says they promise to match any lower prices offered by a competitor. This is done with a lot of different stores. Price matching can be argued that is not good for the customer because it could potentially result in monopoly prices.
Randomized Pricing - When a firm tries to hide pricing information from consumers and competitors. They do this by varying the price and they try to reduce the customer's incentive to go elsewhere to find a better deal. This is harder for a customer to determine the true price.
Oligopoly
An oligopoly is a market structure in which there are few sellers, all of whom are relatively large and have homogeneous products. There are barriers to entry for a seller in an oligopoly. Examples of oligopolies in today's society are auto manufacturers (GM, Ford) and oil companies (BP, Chevron).
An oligopoly would be very difficult to manage. Managers must make decisions that rely on the actions that will be taken by other firms. The decisions that are made will have impact on another firm.
Cournot Oligopoly - This is where firms produce either homogeneous or different products. The firms believe that their rivals will maintain a constant output no matter how they change their own output.
Stackelberg - A primary difference in this type of oligopoly compared to others is that there is a leader/follower relationship. The leader will determine the output first and the followers will make decisions based on the leaders decision. The leader will know how the followers will react and will make the most profitable decision for their firm. Although both will make profits, the leader will make the most profit since they are the first ones to make the decision.
Bertrand - This type of oligopoly will have few firms and many customers. There will be barriers to entry. The difference in this type is the pricing of the products. Firms produce the same product at a constant marginal cost. Firms will complete based on price. They will set a price based on how their competitors set their own price. In this type, customers should have perfect information.
Market Failures
Market failures happens when a market is not able to provide the socially efficient quantities of goods. This can happen through negative externalities, public goods, rent seeking and anti-competitive market power.
Monopolies and Antitrust - Firms with market power have the ability to set their price above marginal cost, such as a monopoly. A monopoly produces less than the socially efficient quantity because they enjoy deadweight loss.
Externalities - A negative externality is the costs borne by parties who are not involved in the production or consumption of a good. The most common example is pollution.
Public Goods - They are non-rival and non-exclusionary. Examples of public goods are clean air and street lights.
Rent-Seeking - Selfishly motivated efforts aimed at influencing another party's decision.
Concentration Indexes
A concentration ratio is a measure of total output produced in a particular industry by the number of firms in that industry. Common measures are the C4 (measures 4 largest firms in industry) and C8 (measures 8 largest firms in industry). Concentration rations can be used to determine whether an industry consists of a few large number of firms or many smaller firms. It also shows the market control the largest firms of the industry have on that market. One of the problems with the concentration ratios is that they don't' use all of the firms in an industry.
Four-Firm Concentration Ratio - measures total market share of the four largest firms in an industry. The higher the ration the less competition the industry has and the smaller the ratio the closer it is to perfect competition.
Herfindal-Hirschman Index - A common measure of market concentration. The higher the index the closer the firm is to monopoly status. The highest index is 10,000, which is total monopoly. The smaller the HHI is the closer it is to perfect competition.
Lerner Index - This measures a firm's market power. When the Lerner Index = 0, the firm has no market power. The closer the index is to 1, the higher the firm's markup.
Auctions
An auction is where buyers complete with each other to gain the right of a good or service. There are different types of auctions.
English auction - This is the most common when people think of an auction. Bidders know the bides of other potential buyers and they can increase (or not bid) based on this information. The bidder who gets the product or service is the last bidder to bid. A "silent" auction is a type of English auction. Instead of an auctioneer calling out prices, bidders place their name and bid on a paper in front of the item. All potential bidders are able to see the price others are willing to pay. The best bidding strategy for an English auction is to bid on the item, incrementally, until you have reached the maximum you are willing to spend or you have won the bid.
First-price, sealed bid auction - This is a type of auction in which bidders put their bid on a piece of paper. The auctioneer awards the person with the highest bid and they pay the bid they submit. In this type of auction bidders only receive one chance and must evaluate their bid carefully. Their decision is also based on their assumption of what they think other bidders will bid.
Second-price, sealed bid - This type of auction is when bidders submit simultaneously bids. The auctioneer awards the item to the highest bidder, but pay the amount bid by the second-highest bidder. The best strategy in this type of auction is to submit a bid based on your maximum willingness to pay for the item.
Dutch - This is the opposite of an English bid in which the auctioneer begins with a high asking price and gradually reduces the asking price until a bidder is willing to pay the price of that item. November 27, 2011 AT&T attempted acquisition of T-Mobile
In August 2011, the Department of Justice filed an anti-trust civil lawsuit to block AT&T's attempt to acquire T-Mobile. The department argued that the acquisition would lessen competition in mobile wireless telecommunication services across the United States. If the acquisition would have gone through, this would have resulted in higher prices, fewer choices for consumers, fewer innovative products and poorer quality services. The department's argument said that millions of consumers use the mobile services and the acquisition would have not been in the best interest of the consumer. The acquisition would also eliminate competition. Currently AT&T, T-Mobile, Spring and Verizon account for more than 90% of mobile wireless connections. If the merger would have continued, this would have eliminated one competitor and AT&T would have become closer to monopoly status in this market.
November 20, 2011 Should all businesses try to be a monopoly?
After doing some research about monopolies I had come across a book by Milind Lele called, "Monopoly Rules: How to Find, Capture, and Control the Most Lucrative Markets in Any Business." He argues that a company must have a monopoly at some point in time in order to have long-term success. There are two dimensions to a monopoly, space and time. Space can be either tangible or intangible. One example of intangible space is emotional involvement, in which customers are committed to one brand such as Apple. His view of monopoly is an "ownable space for a useful period of time."
He argues that most think of monopoly as the old school definition. Old school meaning, monopolistic companies are large, doing something illegal, and have to be regulated by the government. However, this new definition of monopoly is "smaller, perfectly legal, and focusing on specific, often narrow, areas of markets." An example that comes to mind would be the iPad or iPod. These Apple products can be seen as having monopolistic characteristics, such as they were the leaders in the industry. At the time when they had come out, before substitutes were developed, people would buy them no matter what the price was and they held the market power for that particular product.
Although, I have not read the whole book, it is a very interesting approach to thinking of monopolies in a new the current day.
Lele, Milind. "Monopoly Rules: How to Find, Capture, and Control the Most Lucrative Markets in Any Business." 8/2005.
November 13, 2011 A Deadly Monopoly
One way in which firms can become a monopoly is through patents. Patents are intellectual property, in which it gives the inventor the rights to exclusively sell a product. A common example of a type of firm with this type of power are pharmaceutical companies.
This article was forwarded to me by another student, which I found very interesting. Harriet Washington has written a book called, "Deadly Monopolies," in which she talks about pharmaceutical companies and how their patents can be ethically questionable. In the 1980s, the Supreme Court had ruled that there could be patents on human made microorganisms, such as tissues, genes, and cells. Currently, there are approximately 40,000 patents on genes. We would think that pharmaceutical companies are here to help cure different diseases, further medicine and help society, but she argues that they can be deadly. Pharmaceutical companies are about making a profit, not about the well being of society. The reason why pharmaceutical companies can become a monopoly on certain drugs, etc, is because of patents. As I stated above, patents give the inventor the right to sell the product exclusively. They can set their own price. It also prevents competition because they have ownership until their patent expires. In this book, she says that some of the human tissue patents are without a patients consent. To me, this is questionably ethical. It becomes a fine line when a company has monopolistic characteristics and they are controlling aspects of human life. I think there should be further principals and guidelines by the States and government to possibly control this and define it better.
When asked about well-known commercial slogans, one that always comes to mind is the De Beers slogan, "A Diamond is Forever." De Beers has made a long-lasting impression on customers with their slogan being over 50 years old, which is very rare for any company. De Beers also controls 2/3 of the rough (uncut) diamonds. With a monopoly status and unbeatable slogan, De Beers was meant for success.
How did De Beers become a monopoly? There are many different areas, in which De Beers has risen to this level, but I'm only going to talk a little about price fixing and production. De Beers made everyone believe that diamonds were scare and because they are scare we should pay a high price for them. They achieved this through their marketing and operation strategies. De Beers has closely monitored the supply of diamonds, which helped them achieve monopoly status. They also needed to control all aspects of distribution and have set standardized prices, which have also helped them to achieve success. De Beers convinced producers that the market needed to be regulated in order for them to maintain high prices and profits. Being able to control the pricing, also meant that they are able to control profits as well. There is no relation between the price of diamonds and their production. The markup value from production to the prices in the store are considerably higher
Markups on Gemstones (1985)
Stage of Distribution
Markup (%)
Average value of 0.5 carat gem ($/carat)
Cost of mining
$60
Mine sales
67%
$100
Dealers of rough gems
20%
$120
Cutting units
100%
$240
Wholesale dealers
15%
$276
Retail
100%
$552
De Beers is not able to operate in the United States because of the antitrust laws, but they are still able to sell to manufacturers through their London office.
Source of Table: G. Ariovich, "The Economics of Diamond Price Movements," Managerial and Decision Sciences 6, no 4 (1985): 236
Article Source: D. Bergenstock, JM Maskulka, "The De Beers Diamond Story: Are Diamonds Forver?" Business Horizons (2001).
October 26, 2011 More on modern day monopolies
When you think of monopolies, or at least when I think of them, you think back to the early 1900s, when you had the railroad or oil monopolies. However, some argue that there are more modern day monopolies than you think, but it’s really the government who can determine if a company is actually a monopoly.
A characteristic of a monopoly is a company who has significant market power in the industry and has an effect on the prices that are set. A lot of the current day monopolies are technology companies. One of them listed in this article is Microsoft, which I had briefly discussed early, but here are a few more that can be considered a modern day monopoly or at least have some characteristics of them.
Netflix was listed because of their digital video streaming helped a 61% market share. However, due to the recent controversy with Netflix with their changes in video streaming and price changes, I do not think they would be considered on this list anymore. However, if leadership presented their changes in a better fashion, I feel like they would hold a significant portion of the market share.
Apple’s iTunes store is perhaps one the most well-known digital music stores. They hold a 70% market share in their industry. Their closest competition is Amazon, but they hold less than 10%. An investigation by the Justice Department was conducted in 2011 stating iTunes is a monopoly. The reason for the lawsuit is in 2004, iTunes had blocked RealNetwork’s Harmony software, which downloaded songs, to be transferred to the iPod. Apple had requested the judge to dismiss these claims.
Google in March 2011, held the majority of 90% market share. In the early 1990s there were several different search engines, but that changed when Google, Yahoo and MSN took over in the mid-2000s. Google’s search engines were shown to have better results along with their branding, which helped them gain the majority of market share.
October 20, 2011 A modern day social networking monopoly?
I found this link while searching for modern day monopolies. Even though it's someone's opinion, I found it very interesting.
Is Facebook a natural monopoly? I think some could argue yes. Although, natural monopolies are different than monopolies I still find it relevant to this topic. A natural monopoly is where a firm can supply a market's entire demand for a good or services at a lower price than other firms. A natural monopoly appears, well, naturally. When it is natural, the economy is better off and more efficient having that company available. Some will argue whether we are actually better off with Facebook, but that's a whole different discussion.
It is a little challenging when trying to analyze Facebook's monopolistic characteristics using the definition of monopoly, as monopoly tends to talk about accounting costs (actual $$). In Facebook's case, you need to take a different approach. One of the characteristics of monopoly is economies of scope, where it is less expensive to produce two goods/services than it is to produce the good/services separately by separate firms. I would agree with what the author says in his article, that people don't necessarily want a lot of options when it comes to some social networking sites. A lot of time and effort goes into keeping up with personal social networking sites. If there were numerous sites, not only is it harder to manage, but your family and friends may not use the same site. It is actually more efficient to have one primary site, which is Facebook.
There are still competitors in social networking, but Facebook has pretty well blown out its competition. There are more than 800 million active users on Facebook and more than 50% of the active users log on to Facebook in a given day. Facebook has users all over the world and of every age group. There are a lot of third party sites that use and rely on Facebook to reach out to audiences. If you go to any company website or group, there is a "Like us on Facebook" link. It is much easier for companies to reach out to their customers or new audiences when there is a single platform to use versus multiple platforms.
October 16, 2011 A brief history of U.S. monopolies and United States vs. Microsoft
Monopolies have been around for many years. In order to prevent monopolies the Sherman Antitrust Act was passed in 1890 in response to price fixing. Although, when it was first passed it was not completely enforced. At first, they had used the act to distinguish between good monopolies versus bad. It was not until the President Teddy Roosevelt was in office that the act was put into use. The act has been referenced in many cases such as, the American Tobacco Company and Microsoft.
The development of the railroad system is one case of monopoly in U.S. history. Railroads was a much more efficient way to transport materials such as steel, oil, etc. This also helped industries expand their business because they were able to reach other markets across the U.S. The freight railway was imperative for companies to expand their business and the railroad companies knew that. Various freight companies merged together and forced out other potential competitors. The railroads set their own price, creating a monopoly. Since the railroad system was very important to many business owners, they had to take the current price. In 1887, the Interstate Commerce Commission was established, which was meant for railroad companies to publicly post their rates and the rates must be reasonable, but it was vague as to what reasonable rates really meant.
In the 1980s, Congress had deregulated the railroad companies because they were struggling. This resulted four railroad companies controlling the majority of the freight traffic. Since then, there have been significant rate increases, where the customers have no other option, but to accept the new prices because there is no other competition available. This past summer, the Surface Transportation Board, which oversees the freight rail industry, have started to investigate the current practices and may begin to change some of the policies in regards to competition in the freight industry. This is a positive step towards eliminating the monopoly problem with the freight rail industry.
Another popular monopoly case, was the United States versus Microsoft Corp. The case argued that Microsoft was violating the Sherman Antitrust Act and displaying acts of a monopoly. The Microsoft operating system was the most widely used operating system and seen on almost all computers. The U.S. courts argued that Microsoft was a monopoly and enjoyed monopoly power. Their reasons were 1) market share for the operating system is large, 2) and because of the high market share there were barriers to entry and 3) because of the barriers to entry customers do not have a lot of alternatives. In the early 2000s the case was dropped and that the U.S. no longer wanted to breakup Microsoft. The U.s Court released a fact of findings on the case, which had no real verdict, but Microsoft had to share its application programming interfaces with third party companies.
Now almost, a decade later, it could be argued that Microsoft is still a monopoly. However, I don't believe there is a good argument for this. The reviews of Microsoft's recent operating system, Windows Vista, have not been all that outstanding. All the while, Apple Inc, has been receiving good reviews on their operating system. However, Microsoft may have a monopoly in other areas, such as Microsoft Outlook, in which a lot of companies are using this as their primary e-mail application. Although, I still don't see this as a monopoly because there are still other alternatives available.
October 5, 2011 Defining Monopolies
To begin to understand monopolies in the modern day, we must first define what a monopoly is, how one becomes a monopoly and a brief history of monopolies. Over the next couple of weeks, I will begin discussing these things, before I start discussing monopolies in today's society.
What exactly is a monopoly? A monopoly is defined as a market structure in which a single firm serves an entire market for a good that has no close substitutes. Being the sole seller of a good or service gives the firm a much greater market power than if there were many competing firms in the industry. Basically, it means they have no competition!
Now, how does one obtain monopolistic power? There are four sources in monopoly power according to Michael Baye's Manager Economics and Business Strategy textbook, which create a barrier to entry for other firms to enter into the market, thus creating monopolistic power for the one firm.
Economies of Scale: This happens when a first's average long-term costs decrease as their output of a good or service increases, also known as being very efficient. It can be seen as wasteful and more expensive to have many competitors in particular industries. An example includes utility companies.
Economies of Scope: It is less expensive to produce two goods/services than it is to produce the goods/services separately by separate firms, also know as being efficient for that particular firm. This alone does not make a firm to have monopoly power because there are many firms in many industries who are already doing this. It can become monopolistic because economies of scope are "encouraged" by larger firms. It is harder for the smaller firms to obtain the money for economies of scope.
Cost Complementarity: This exists in a multi-product good/service firm. Cost complementarity is when the production of one good/service decreases the cost of another good/service. This can be harmful to single product firms because they have less capital and money to produce an additional good or service.
Patents and Other Legal Barriers: A patent is intellectual property, in which it gives the inventor the rights to exclusively sell a product. An example of this is pharmaceutical companies.
Some additional sources that could potentially create monopoly power for firms is to buy out or merge with its competitors or become a government granted monopoly.
From the definition above it sounds like monopolies are just large firms, which are not always the case. An easy example is your local utility company such as water or electric. Because the utility company is the sole seller in the area it gives it greater market power in the region. The only other option is you go without water!
Now that we have a pretty good definition of what a monopoly is and how one can become a monopoly, next will look at some brief history.
References:
Baye, Michael R, "Monopoly." Managerial Economics and Business Strategy. 2010. pp 277-281. http://www.linfo.org/monopoly.html
Monopoly by Amy Kitzman
December 6, 2011
Final Summary
Defining a Monopoly
A monopoly is a market structure in which one single firm serves the entire market, where there are no close substitutes. Given that there is one sole firm that serves the entire market, this firm has significant market power. The demand curve of the market is also the monopolists demand curve. If no regulations or legal restrictions existed, the monopolistic firm would be able to charge whatever price they want. If this is the case, Price (P) multiplied by the number of quantities sold (Q) equal the total revenue (TR) for that product. If the firm charges too high of price the consumers only other options, since there are not close substitutes, would be to buy nothing at all. It is important to determine the type of market structure when trying to determine if a firm is a monopoly.
There are four sources that create monopoly power:
In a monopoly there is no supply curve, so the firm decides how much of a product they should produce. They base this off marginal revenue. To maximize profits, a monopolistic firm should produce output, where marginal revenue equals marginal cost: MR (Q1) = MC (Q1). In a monopoly marginal revenue is less than the price because in order to sell more, the firm must lower its prices. The revenue will not increase by the price because the firm had to lower their price. It is important to note that, not all monopolies may have positive profits, this depends on where the demand lies in relation to the average total cost curve. In the short-run, they may even experience losses.
In the real-world, there generally is not just one firm that controls an entire industry, but there are smaller firms with close substitutes. However, having significant market power can constitute a monopoly.
Monopolies can be unbeneficial to society. Deadweight loss of a monopoly is defined as the consumer and producer surplus that is lost due to the monopolist charging a price that is excess of the marginal cost.
How do we prevent monopolies?
The Sherman Antitrust Act was passed in 1890 in response to price fixing. This helped to prevent firms from becoming a monopoly because they were seen as harmful to society. The U.S. Department of Justice's (DOJ) Antitrust division helps to promote competition and to block potential monopolies that are harmful to the public.
Examples of Monopolies
Furukawa Electric Co. is a supplier of automotive wire harnesses and similar products, which is located in Tokyo. The wire harnesses are electrical systems to help control electrical components in cars. Executives were accused and pleaded guilty to price-fixing and bid-rigging involving the sale of parts to automobile manufacturers. Automobile manufacturers in the United States paid noncompetitive and high prices for these parts in the cars sold to customers in the U.S. The DOJ said these type of actions caused harm to the United States and our economy system. The three executives involved had agreed in meetings and conversations, to coordinate price adjustments made by U.S. auto manufacturers.
The Department of Justice blocked AT&T's attempt to acquire T-Mobile back in August 2011. The DOJ's said the acquisition would have lessened competition in the industry of mobile wireless telecommunication services in the United States. An acquisition would have resulted in higher prices, poorer quality, and less innovation in this industry. There are millions of customers who use AT&T and T-Mobile and this acquisition would have not been in there best interest. There are three industries who currently make up 90% of the market, AT&T, T-Mobile and Verizon. This potential acquisition would have one less competitor and only making AT&T stronger and closer to a monopoly status in this industry.
Multiple Choice Questions:
1. Which of the following is an example of one of the four sources that create monopoly power?
A. Firm A produces computer hard drives and buys the monitors from Firm K. They bundle the hard drive and monitor and sell them. It is cheaper for them to buy the monitors from Firm K.
B. Firm A produces computer hard drives and monitors. As production of the hard drives and monitors increase Firm A's long-run average costs continue to increase.
C. Firm A produces computer hard drives and buys the monitors from Firm K. They bundle the hard drive and monitor and sell them. After some research, they find that it is cheaper to produce the monitors themselves and decide to do so.
D. Firm A seeks a patent for their hard drives because of the top speed and incredible memory, no other firm produces the same type of hard drive. Firm A is denied the patent.
2. According to the DOJ, which of the following reasons is a reason to block a potential acquisition?
A. poor quality
B. less innovation
C. higher prices
D. all of the above
3. A local store sells batteries and they are the only ones available, so everyone in the community goes to them for their battery needs. If the price of a battery is $75 and the store sells 110 batteries, the total revenue for the local stores for batteries would be .
A. $8,140
B. $8,250
C. $8,360
D. $7,500
4. What is the relationship between a market's demand curve and a monopolists (who produces that particular product) demand curve?
A. The industry's demand curve is to the right of the monopolist's demand curve.
B. The monopolists' demand curve is to the right of the industry's demand curve.
C. There is no demand curve.
D. They are the same.
5. Which of the following is an example of a monopoly?
A. A local gas station in town X. The next gas station is 10 miles away in town Z.
B. A Pharmaceutical company who sells a name brand drug, X. The patent for drug X expired 5 months ago.
C. Firm X who controls 94% of the market. Firm Y and Z have 3% market power.
D. A local cable company.
Answers:
References:
- Baye, Michael R. "Monopoly." Managerial Economics and Business Strategy. 2010. pp 277-293.
- Beattie, Andrew. "A History of U.S. Monopolies." 2010. http://www.investopedia.com/articles/economics/08/hammer-antitrust.asp#axzz1fl84wXzq
- The Linux Information Project. "Monopoly: A Brief Introduction." 2006. http://www.linfo.org/monopoly.html
- The Department of Justice. "Furukawa Electric Co. Ltd. and Three Executives Agree to Plead Guilty to Automobile Parts Price-Fixing and Bid-Rigging Conspiracy." September 29, 2011. http://www.justice.gov/atr/public/press_releases/2011/275503.htm
- The Department of Justice. " Justice Department Files Antitrust Lawsuit to Block AT&T's Acquisition of T-Mobile." August 31, 2011. http://www.justice.gov/atr/public/press_releases/2011/274615.htm
SummariesPricing - Profit maximizing markup. Also, Networks, Penetration pricing, Transfer pricing, limit pricing, predatory pricing, raising rivals costs price matching, randomized pricing
Profit maximizing markup - When a firm has market power (monopoly, oligopoly, monopolistic completion) they have the ability to decide what price to charge. Two of important concepts of profit maximizing markup is 1) the more elastic a product, the less markup because there are more substitutes available and 2) the higher marginal cost, the higher the mark up because a firm needs to make a profit.
Networks - Networks are links that connect different points geographically or in economic space. When a firm builds a network, the benefit from economies of scale and it also creates a barrier of entry for other firms.
Penetration pricing - This is when a firm charges a low price at first in order to increase their customer base and gain a following. This is only done on the short-term to gain customers and the firm doesn't expect to make a profit.
Transfer pricing - This is when a firm sets a price in which an upstream division of the firms sells an input to a downstream division of that same firm. Cisco had transferred costs to one of their oversees division to help reduce their taxes and gain a better overall profit for the company.
Predatory Pricing - Where a firm temporarily sets its prices below the marginal cost. The purpose of this is to drive competitors out of the market. The Amazon Kindle actually costs more than what Amazon is selling for. This is a good example of predatory pricing. However, they are still making profits from other sources of revenue such as advertising.
Raising Rivals Costs - When a firm increases the costs of competitive firm to gain an advantage.
Price Matching - When a firm says they promise to match any lower prices offered by a competitor. This is done with a lot of different stores. Price matching can be argued that is not good for the customer because it could potentially result in monopoly prices.
Randomized Pricing - When a firm tries to hide pricing information from consumers and competitors. They do this by varying the price and they try to reduce the customer's incentive to go elsewhere to find a better deal. This is harder for a customer to determine the true price.
Oligopoly
An oligopoly is a market structure in which there are few sellers, all of whom are relatively large and have homogeneous products. There are barriers to entry for a seller in an oligopoly. Examples of oligopolies in today's society are auto manufacturers (GM, Ford) and oil companies (BP, Chevron).
An oligopoly would be very difficult to manage. Managers must make decisions that rely on the actions that will be taken by other firms. The decisions that are made will have impact on another firm.
Cournot Oligopoly - This is where firms produce either homogeneous or different products. The firms believe that their rivals will maintain a constant output no matter how they change their own output.
Stackelberg - A primary difference in this type of oligopoly compared to others is that there is a leader/follower relationship. The leader will determine the output first and the followers will make decisions based on the leaders decision. The leader will know how the followers will react and will make the most profitable decision for their firm. Although both will make profits, the leader will make the most profit since they are the first ones to make the decision.
Bertrand - This type of oligopoly will have few firms and many customers. There will be barriers to entry. The difference in this type is the pricing of the products. Firms produce the same product at a constant marginal cost. Firms will complete based on price. They will set a price based on how their competitors set their own price. In this type, customers should have perfect information.
Market Failures
Market failures happens when a market is not able to provide the socially efficient quantities of goods. This can happen through negative externalities, public goods, rent seeking and anti-competitive market power.
Monopolies and Antitrust - Firms with market power have the ability to set their price above marginal cost, such as a monopoly. A monopoly produces less than the socially efficient quantity because they enjoy deadweight loss.
Externalities - A negative externality is the costs borne by parties who are not involved in the production or consumption of a good. The most common example is pollution.
Public Goods - They are non-rival and non-exclusionary. Examples of public goods are clean air and street lights.
Rent-Seeking - Selfishly motivated efforts aimed at influencing another party's decision.
Concentration Indexes
A concentration ratio is a measure of total output produced in a particular industry by the number of firms in that industry. Common measures are the C4 (measures 4 largest firms in industry) and C8 (measures 8 largest firms in industry). Concentration rations can be used to determine whether an industry consists of a few large number of firms or many smaller firms. It also shows the market control the largest firms of the industry have on that market. One of the problems with the concentration ratios is that they don't' use all of the firms in an industry.
Four-Firm Concentration Ratio - measures total market share of the four largest firms in an industry. The higher the ration the less competition the industry has and the smaller the ratio the closer it is to perfect competition.
Herfindal-Hirschman Index - A common measure of market concentration. The higher the index the closer the firm is to monopoly status. The highest index is 10,000, which is total monopoly. The smaller the HHI is the closer it is to perfect competition.
Lerner Index - This measures a firm's market power. When the Lerner Index = 0, the firm has no market power. The closer the index is to 1, the higher the firm's markup.
Auctions
An auction is where buyers complete with each other to gain the right of a good or service. There are different types of auctions.
English auction - This is the most common when people think of an auction. Bidders know the bides of other potential buyers and they can increase (or not bid) based on this information. The bidder who gets the product or service is the last bidder to bid. A "silent" auction is a type of English auction. Instead of an auctioneer calling out prices, bidders place their name and bid on a paper in front of the item. All potential bidders are able to see the price others are willing to pay. The best bidding strategy for an English auction is to bid on the item, incrementally, until you have reached the maximum you are willing to spend or you have won the bid.
First-price, sealed bid auction - This is a type of auction in which bidders put their bid on a piece of paper. The auctioneer awards the person with the highest bid and they pay the bid they submit. In this type of auction bidders only receive one chance and must evaluate their bid carefully. Their decision is also based on their assumption of what they think other bidders will bid.
Second-price, sealed bid - This type of auction is when bidders submit simultaneously bids. The auctioneer awards the item to the highest bidder, but pay the amount bid by the second-highest bidder. The best strategy in this type of auction is to submit a bid based on your maximum willingness to pay for the item.
Dutch - This is the opposite of an English bid in which the auctioneer begins with a high asking price and gradually reduces the asking price until a bidder is willing to pay the price of that item.
November 27, 2011
AT&T attempted acquisition of T-Mobile
In August 2011, the Department of Justice filed an anti-trust civil lawsuit to block AT&T's attempt to acquire T-Mobile. The department argued that the acquisition would lessen competition in mobile wireless telecommunication services across the United States. If the acquisition would have gone through, this would have resulted in higher prices, fewer choices for consumers, fewer innovative products and poorer quality services. The department's argument said that millions of consumers use the mobile services and the acquisition would have not been in the best interest of the consumer. The acquisition would also eliminate competition. Currently AT&T, T-Mobile, Spring and Verizon account for more than 90% of mobile wireless connections. If the merger would have continued, this would have eliminated one competitor and AT&T would have become closer to monopoly status in this market.
http://www.justice.gov/atr/public/press_releases/2011/274615.htm
November 20, 2011
Should all businesses try to be a monopoly?
After doing some research about monopolies I had come across a book by Milind Lele called, "Monopoly Rules: How to Find, Capture, and Control the Most Lucrative Markets in Any Business." He argues that a company must have a monopoly at some point in time in order to have long-term success. There are two dimensions to a monopoly, space and time. Space can be either tangible or intangible. One example of intangible space is emotional involvement, in which customers are committed to one brand such as Apple. His view of monopoly is an "ownable space for a useful period of time."
He argues that most think of monopoly as the old school definition. Old school meaning, monopolistic companies are large, doing something illegal, and have to be regulated by the government. However, this new definition of monopoly is "smaller, perfectly legal, and focusing on specific, often narrow, areas of markets." An example that comes to mind would be the iPad or iPod. These Apple products can be seen as having monopolistic characteristics, such as they were the leaders in the industry. At the time when they had come out, before substitutes were developed, people would buy them no matter what the price was and they held the market power for that particular product.
Although, I have not read the whole book, it is a very interesting approach to thinking of monopolies in a new the current day.
Lele, Milind. "Monopoly Rules: How to Find, Capture, and Control the Most Lucrative Markets in Any Business." 8/2005.
November 13, 2011
A Deadly Monopoly
One way in which firms can become a monopoly is through patents. Patents are intellectual property, in which it gives the inventor the rights to exclusively sell a product. A common example of a type of firm with this type of power are pharmaceutical companies.
This article was forwarded to me by another student, which I found very interesting. Harriet Washington has written a book called, "Deadly Monopolies," in which she talks about pharmaceutical companies and how their patents can be ethically questionable. In the 1980s, the Supreme Court had ruled that there could be patents on human made microorganisms, such as tissues, genes, and cells. Currently, there are approximately 40,000 patents on genes. We would think that pharmaceutical companies are here to help cure different diseases, further medicine and help society, but she argues that they can be deadly. Pharmaceutical companies are about making a profit, not about the well being of society. The reason why pharmaceutical companies can become a monopoly on certain drugs, etc, is because of patents. As I stated above, patents give the inventor the right to sell the product exclusively. They can set their own price. It also prevents competition because they have ownership until their patent expires. In this book, she says that some of the human tissue patents are without a patients consent. To me, this is questionably ethical. It becomes a fine line when a company has monopolistic characteristics and they are controlling aspects of human life. I think there should be further principals and guidelines by the States and government to possibly control this and define it better.
http://www.npr.org/2011/10/24/141429392/deadly-monopolies-patenting-the-human-body
November 6, 2011
A Diamonds are forever monopoly
When asked about well-known commercial slogans, one that always comes to mind is the De Beers slogan, "A Diamond is Forever." De Beers has made a long-lasting impression on customers with their slogan being over 50 years old, which is very rare for any company. De Beers also controls 2/3 of the rough (uncut) diamonds. With a monopoly status and unbeatable slogan, De Beers was meant for success.
How did De Beers become a monopoly? There are many different areas, in which De Beers has risen to this level, but I'm only going to talk a little about price fixing and production. De Beers made everyone believe that diamonds were scare and because they are scare we should pay a high price for them. They achieved this through their marketing and operation strategies. De Beers has closely monitored the supply of diamonds, which helped them achieve monopoly status. They also needed to control all aspects of distribution and have set standardized prices, which have also helped them to achieve success. De Beers convinced producers that the market needed to be regulated in order for them to maintain high prices and profits. Being able to control the pricing, also meant that they are able to control profits as well. There is no relation between the price of diamonds and their production. The markup value from production to the prices in the store are considerably higher
Markups on Gemstones (1985)
De Beers is not able to operate in the United States because of the antitrust laws, but they are still able to sell to manufacturers through their London office.
Source of Table: G. Ariovich, "The Economics of Diamond Price Movements," Managerial and Decision Sciences 6, no 4 (1985): 236
Article Source: D. Bergenstock, JM Maskulka, "The De Beers Diamond Story: Are Diamonds Forver?" Business Horizons (2001).
October 26, 2011
More on modern day monopolies
When you think of monopolies, or at least when I think of them, you think back to the early 1900s, when you had the railroad or oil monopolies. However, some argue that there are more modern day monopolies than you think, but it’s really the government who can determine if a company is actually a monopoly.
A characteristic of a monopoly is a company who has significant market power in the industry and has an effect on the prices that are set. A lot of the current day monopolies are technology companies. One of them listed in this article is Microsoft, which I had briefly discussed early, but here are a few more that can be considered a modern day monopoly or at least have some characteristics of them.
Netflix was listed because of their digital video streaming helped a 61% market share. However, due to the recent controversy with Netflix with their changes in video streaming and price changes, I do not think they would be considered on this list anymore. However, if leadership presented their changes in a better fashion, I feel like they would hold a significant portion of the market share.
Apple’s iTunes store is perhaps one the most well-known digital music stores. They hold a 70% market share in their industry. Their closest competition is Amazon, but they hold less than 10%. An investigation by the Justice Department was conducted in 2011 stating iTunes is a monopoly. The reason for the lawsuit is in 2004, iTunes had blocked RealNetwork’s Harmony software, which downloaded songs, to be transferred to the iPod. Apple had requested the judge to dismiss these claims.
Google in March 2011, held the majority of 90% market share. In the early 1990s there were several different search engines, but that changed when Google, Yahoo and MSN took over in the mid-2000s. Google’s search engines were shown to have better results along with their branding, which helped them gain the majority of market share.
http://247wallst.com/2011/03/22/the-new-generation-of-american-monopolies/
October 20, 2011
A modern day social networking monopoly?
I found this link while searching for modern day monopolies. Even though it's someone's opinion, I found it very interesting.
Is Facebook a natural monopoly? I think some could argue yes. Although, natural monopolies are different than monopolies I still find it relevant to this topic. A natural monopoly is where a firm can supply a market's entire demand for a good or services at a lower price than other firms. A natural monopoly appears, well, naturally. When it is natural, the economy is better off and more efficient having that company available. Some will argue whether we are actually better off with Facebook, but that's a whole different discussion.
It is a little challenging when trying to analyze Facebook's monopolistic characteristics using the definition of monopoly, as monopoly tends to talk about accounting costs (actual $$). In Facebook's case, you need to take a different approach. One of the characteristics of monopoly is economies of scope, where it is less expensive to produce two goods/services than it is to produce the good/services separately by separate firms. I would agree with what the author says in his article, that people don't necessarily want a lot of options when it comes to some social networking sites. A lot of time and effort goes into keeping up with personal social networking sites. If there were numerous sites, not only is it harder to manage, but your family and friends may not use the same site. It is actually more efficient to have one primary site, which is Facebook.
There are still competitors in social networking, but Facebook has pretty well blown out its competition. There are more than 800 million active users on Facebook and more than 50% of the active users log on to Facebook in a given day. Facebook has users all over the world and of every age group. There are a lot of third party sites that use and rely on Facebook to reach out to audiences. If you go to any company website or group, there is a "Like us on Facebook" link. It is much easier for companies to reach out to their customers or new audiences when there is a single platform to use versus multiple platforms.
I think it is clear that Facebook is a cultural phenomenon and is going to be around for a very long time. I don't believe it was Facebook's intention to become a monopoly, but it somehow is now naturally, at least in my opinion.
http://www.embracingchaos.com/2011/07/google-and-facebook%E2%80%99s-natural-monopoly-in-social-networks.html
October 16, 2011
A brief history of U.S. monopolies and United States vs. Microsoft
Monopolies have been around for many years. In order to prevent monopolies the Sherman Antitrust Act was passed in 1890 in response to price fixing. Although, when it was first passed it was not completely enforced. At first, they had used the act to distinguish between good monopolies versus bad. It was not until the President Teddy Roosevelt was in office that the act was put into use. The act has been referenced in many cases such as, the American Tobacco Company and Microsoft.
The development of the railroad system is one case of monopoly in U.S. history. Railroads was a much more efficient way to transport materials such as steel, oil, etc. This also helped industries expand their business because they were able to reach other markets across the U.S. The freight railway was imperative for companies to expand their business and the railroad companies knew that. Various freight companies merged together and forced out other potential competitors. The railroads set their own price, creating a monopoly. Since the railroad system was very important to many business owners, they had to take the current price. In 1887, the Interstate Commerce Commission was established, which was meant for railroad companies to publicly post their rates and the rates must be reasonable, but it was vague as to what reasonable rates really meant.
In the 1980s, Congress had deregulated the railroad companies because they were struggling. This resulted four railroad companies controlling the majority of the freight traffic. Since then, there have been significant rate increases, where the customers have no other option, but to accept the new prices because there is no other competition available. This past summer, the Surface Transportation Board, which oversees the freight rail industry, have started to investigate the current practices and may begin to change some of the policies in regards to competition in the freight industry. This is a positive step towards eliminating the monopoly problem with the freight rail industry.
Another popular monopoly case, was the United States versus Microsoft Corp. The case argued that Microsoft was violating the Sherman Antitrust Act and displaying acts of a monopoly. The Microsoft operating system was the most widely used operating system and seen on almost all computers. The U.S. courts argued that Microsoft was a monopoly and enjoyed monopoly power. Their reasons were 1) market share for the operating system is large, 2) and because of the high market share there were barriers to entry and 3) because of the barriers to entry customers do not have a lot of alternatives. In the early 2000s the case was dropped and that the U.S. no longer wanted to breakup Microsoft. The U.s Court released a fact of findings on the case, which had no real verdict, but Microsoft had to share its application programming interfaces with third party companies.
Now almost, a decade later, it could be argued that Microsoft is still a monopoly. However, I don't believe there is a good argument for this. The reviews of Microsoft's recent operating system, Windows Vista, have not been all that outstanding. All the while, Apple Inc, has been receiving good reviews on their operating system. However, Microsoft may have a monopoly in other areas, such as Microsoft Outlook, in which a lot of companies are using this as their primary e-mail application. Although, I still don't see this as a monopoly because there are still other alternatives available.
References:
http://www.investopedia.com/articles/economics/08/hammer-antitrust.asp#axzz1ZOg8hheS
http://www.usnews.com/usnews/documents/docpages/document_page51.htm
http://www-cs-faculty.stanford.edu/~eroberts/cs201/projects/corporate-monopolies/development_rrmon.html
http://thehill.com/blogs/congress-blog/politics/171457-reform-needed-to-end-the-railroad-pricing-monopoly
http://www.justice.gov/atr/cases/f3800/msjudgex.htm#iii
http://www.pcworld.com/article/139458/eight_years_later_is_microsoft_still_a_monopoly.html
October 5, 2011
Defining Monopolies
To begin to understand monopolies in the modern day, we must first define what a monopoly is, how one becomes a monopoly and a brief history of monopolies. Over the next couple of weeks, I will begin discussing these things, before I start discussing monopolies in today's society.
What exactly is a monopoly? A monopoly is defined as a market structure in which a single firm serves an entire market for a good that has no close substitutes. Being the sole seller of a good or service gives the firm a much greater market power than if there were many competing firms in the industry. Basically, it means they have no competition!
Now, how does one obtain monopolistic power? There are four sources in monopoly power according to Michael Baye's Manager Economics and Business Strategy textbook, which create a barrier to entry for other firms to enter into the market, thus creating monopolistic power for the one firm.
Some additional sources that could potentially create monopoly power for firms is to buy out or merge with its competitors or become a government granted monopoly.
From the definition above it sounds like monopolies are just large firms, which are not always the case. An easy example is your local utility company such as water or electric. Because the utility company is the sole seller in the area it gives it greater market power in the region. The only other option is you go without water!
Now that we have a pretty good definition of what a monopoly is and how one can become a monopoly, next will look at some brief history.
References:
Baye, Michael R, "Monopoly." Managerial Economics and Business Strategy. 2010. pp 277-281.
http://www.linfo.org/monopoly.html