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RUNNING HEAD: THE WONK MONOPOLY

The Wonk Monopoly Debra Johnson Principles of Microeconomics Instructor: Greg Kropkowski July 1, 2013

RUNNING HEAD: THE WONK MONOPOLY

A monopoly is an industry with a single firm that produces a product for which there are no close substitutes, and in which significant barriers to entry prevent other firms from entering the industry to compete for profits. A monopoly has no other firms with which to compete, but it is still constrained by market demand. To be successful, the firm still has to produce something that people want. A monopoly must choose both price and quantity of output simultaneously because the amount that it will be able to sell depends upon the price it sets. If the price is too high, it will sell nothing. A monopoly sets price to maximize profit, significantly above average costs, and the firm usually earns economic profits. Less and charging more to earn positive profits are not likely to be in the best interests of consumers. THE SHERMAN ANTI-TRUST ACT Trusts and monopolies are concentrations of economic power in the hands of a few. Economists believe that such control injures both individuals and the public because it leads to anticompetitive practices in an effort to obtain or maintain total control. Anticompetitive practices then lead to price controls and diminished individual initiative. These results in turn cause markets to stagnate and depress economic growth. The Sherman Act is divided into three sections. Section 1 delineates and prohibits specific means of anticompetitive conduct, and Section 2 deals with end results that are anticompetitive in nature. Sections 1 and 2 supplements each other in an effort to outlaw all types of anticompetitive conduct. Congress designed the supplementary relationship to prevent businesses from violating the spirit of the Act, while technically remaining within the letter of the law. Section 3 simply extends the provisions of Section 1 to U.S. territories and the District of Columbia. (LII (n.d.)).

RUNNING HEAD: THE WONK MONOPOLY Because the courts found certain activities to fall outside the scope of the Sherman Antitrust Act, Congress passed the Clayton Antitrust Act of 1914 to further widen its scope. For example, the Clayton Act added the following practices to the list of impermissible activities: price discrimination between different purchasers, if such discrimination tends to create a monopoly; exclusive dealing agreements; tying arrangements; and mergers and acquisitions that substantially reduce market competition. (LII (n.d.)). The Robinson-Patman Act of 1936 amended the Clayton Act. The amendment aimed to outlaw certain practices in which manufacturers discriminated in price between equally-situated distributers to decrease competition. (LII (n.d.)). MONOPOLIES AND CONSUMERS Monopoly produces less output and charges a higher price than a competitively organized industry if no large economies of scale exist for the monopoly. Note the way in which barriers to entry can allow monopolists to persist over time. At this point producing less and charging more to earn positive profits are not likely to be in the best interests of consumers. (Case, Fair, Oster, 2009). p.273. Monopolies negatively impact an economy because the manufacturer has no incentive to innovate, and provide new and improved products. This was once true of cable companies. It was expensive to lay new cable causing residents any choice but to accept the cable company's service and prices. However, disruptive technology is the worst enemy of monopolies. Dish TV, iPads, and Netflix have created a new type of entertainment service that doesn't rely on cable to deliver movies and TV programming. The same thing happened with land-line telephones. Amadao, 2010).

RUNNING HEAD: THE WONK MONOPOLY Monopolies can create inflation. Since they can set any price they choose, they will raise costs to consumers. This is known as cost-push inflation. A good example of how this works is OPEC, or the Organization of Petroleum Exporting Countries. The twelve oil exporting countries in OPEC now control the price of 46% of the oil produced in the world. However, this is not a true monopoly, but more of a cartel. First, most of the oil is produced by one country, Saudi Arabia. It has a far greater ability to affect the price by itself by raising or lowering output. Second, the price set by OPEC must be agreed to by all its members. Even if they agree to it, some may try to undercut the price to gain a little extra market share. It is difficult to enforce the OPEC price. However, the countries within OPEC still make more per barrel of oil than they did before OPEC. (Amadao, 2010). RENT-SEEKING BEHAVIOR Potential monopolists can do many things to protect their profits. One obvious approach is to push the government to impose restrictions on competition. A classic example is the behavior of taxicab driver organizations in New York and other large cities. To operate a cab legally in New York City, you need a license. The city tightly controls the number of licenses available. If entry into the taxi business were open, competition would hold down cab fares to the cost of operating cabs. However, cab drivers have become a powerful lobbying force and have muscled the city into restricting the number of licenses issued. This restriction keeps fares high and preserves monopoly profits. (Case, Fair, Oster, 2009). p.273. This kind of behavior, in which households or firms take action to preserve positive profits, is called rent-seeking behavior. Rent is the return to a factor of production in strictly limited supply. Rent-seeking behavior has two important implications. (Case, Fair, Oster, 2009). p.273.

RUNNING HEAD: THE WONK MONOPOLY First, this behavior consumes resources. Lobbying and building barriers to entry are not costless activities. Lobbyists' wages, expenses of the regulatory bureaucracy and the like must be paid. Periodically faced with the prospect that the city of New York will issue new taxi licenses, cab owners and drivers have become so well organized that they can bring the city to a standstill with a strike or even a limited action. Indeed, positive profits may be completely consumed through rent-seeking behavior that produces nothing of social value; all it does is help to preserve the current distribution of income. (Case, Fair, Oster, 2009). p.273. Second, the frequency of rent-seeking behavior leads us to another view of government. Consider only the role that government might play in helping to achieve an efficient allocation of resources in the face of market failurein this case, failures that arise from imperfect market structure. Consider the measures government might take to ensure that resources are efficiently allocated when monopoly power arises. The idea of rent-seeking behavior introduces the notion of government failure, in which the government becomes the tool of the rent seeker and the allocation of resources is made even less efficient than before. (Case, Fair, Oster, 2009). p.275. MARGINAL REVENUE, MONOPOLY The change in total revenue resulting from a change in the quantity of output sold. Marginal revenue indicates how much extra revenue a monopoly receives for selling an extra unit of output. It is found by dividing the change in total revenue by the change in the quantity of output. Marginal revenue is the slope of the total revenue curve and is one of two revenue concepts derived from total revenue. The other is average revenue. To maximize profit, a monopoly equates marginal revenue and marginal cost. Marginal revenue is the extra revenue generated when a monopoly sells one more unit of output. It plays a key role in the profit-maximizing decision of a monopoly relative to marginal

RUNNING HEAD: THE WONK MONOPOLY cost. A monopoly maximizes profit by equating marginal revenue, the extra revenue generated from production, with marginal cost, the extra cost of production. If these two marginals are not equal, then profit can be increased by producing more or less output. The relation between marginal revenue and the quantity of output produced depends on market structure. For a perfectly competitive firm, marginal revenue is equal to price and average revenue, all three of which are constant. For a monopoly, monopolistically competitive, or oligopoly firm, marginal revenue is less than average revenue and price, all three of which decrease with larger quantities of output. The constant or decreasing nature of marginal revenue is a prime indication of the market control of a firm. MARGINAL REVENUE, MONOPOLISTIC COMPETITION The change in total revenue resulting from a change in the quantity of output sold. Marginal revenue indicates how much extra revenue a monopolistically competitive firm receives for selling an extra unit of output. It is found by dividing the change in total revenue by the change in the quantity of output. Marginal revenue is the slope of the total revenue curve and is one of two revenue concepts derived from total revenue. The other is average revenue. To maximize profit, a monopolistically competitive firm equates marginal revenue and marginal cost. (Kaplan, 2008). Marginal revenue is the extra revenue generated when a monopolistically competitive firm sells one more unit of output. It plays a key role in the profit-maximizing decision of a monopolistically competitive firm relative to marginal cost. A monopolistically competitive firm maximizes profit by equating marginal revenue, the extra revenue generated from production, with marginal cost, the extra cost of production. If these two marginals are not equal, then profit can be increased by producing more or less output. (Kaplan, 2008).

RUNNING HEAD: THE WONK MONOPOLY The relation between marginal revenue and the quantity of output produced depends on market structure. For a perfectly competitive firm, marginal revenue is equal to price and average revenue, all three of which are constant. For a monopoly, monopolistically competitive, or oligopoly firm, marginal revenue is less than average revenue and price, all three of which decrease with larger quantities of output. The constant or decreasing nature of marginal revenue is a prime indication of the market control of a firm. (Kaplan, 2008). OLIGOPOLY An oligopoly is an industry that is dominated by a few firms that display highly coordinated behavior. Examples of oligopoly include the auto and oil industries, and many commodity producers such as coffee, copper and other minerals. Should the Wonks change their business structure; an oligopoly might be a choice that consumers can live with. But can the Wonks? (Case, Fair, Oster, 2009). p.262. Producing less and charging more to earn positive profits are not likely to be in the best interests of consumers.

RUNNING HEAD: THE WONK MONOPOLY References Amadao, K. (2012). How Monopolies Affect the US Economy. About.com, New York Times Company. Retrieved from: http://useconomy.about.com/od/glossary/g/monopoly.htm Kaplan, J. (1999). Principles of Microeconomics, Marginal Revenue, Monopolistic Competition. Retrieved from: http://spot.colorado.edu/~kaplan/econ2010/section11/section11main.html Legal Information Institute (n.d.). Antitrust. Sherman Antitrust Act. Retrieved from: http://www.law.cornell.edu/wex/antitrust

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