MicroEconomics theory and application 12th by browning an zupan chapter 15

Prepared by Dr. Della Lee Sue, Marist College

MICROECONOMICS: Theory & Applications
Chapter 15: Using Noncompetitive Market Models
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
12th Edition, Copyright 2015

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.


Learning Objectives





Determine the relative magnitude of the deadweight loss of
monopoly.
Ascertain the extent to which, if any, monopolies suppress
innovations.
Explore whether government intervention can promote
efficiency in the case of natural monopoly.
Explore the concepts of iterated dominance and
commitment in the context of game theory models.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

2

Determine the relative magnitude of the deadweight loss of monopoly.

15.1 THE SIZE OF THE DEADWEIGHT
LOSS OF MONOPOLY

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

3


Figure 15.1 - The Size of the
Deadweight Loss of Monopoly

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

4


Why Are the Estimates of the
Deadweight Loss Not Large?


Estimates of the deadweight loss of monopoly in relation to
GNP are not large.



Reasons:
 Deadweight loss is compared to the size of the whole
economy (GNP), not to the size of the monopolized

sector.
 There are few, if any, pure monopolies in the U.S.
 We cannot measure the restriction in output in any
industry, only actual output.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

5


Other Possible Deadweight Losses of
Monopoly


Two undesirable consequences of monopoly:
 Restriction of output
 Redistribution of income in favor of the owner of the
monopoly



Other effects:
 In the absence of competition with other firms, the
monopolist is under less pressure to minimize
(production) cost.
 A monopoly may incur other costs (in addition to
production costs) to ensure continuation of its monopoly
power.
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

6


Ascertain the extent to which, if any, monopolies suppress innovations.

15.2 DO MONOPOLIES SUPPRESS
INVENTIONS?

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

7


Do Monopolies Suppress Inventions?


Worthwhile invention: one that allows a firm to produce a
higher-quality product at an unchanged cost or to produce
the same-quality product at a lower cost.



Different industry structures:





Competitive conditions: initial firm can gain until other firms copy
it

A worthwhile invention can be profitable for a monopolist.

Conclusions:



Profit incentives lead to the introduction of wortwhile inventions.
Monopoly power does not necessarily suppress inventions.

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

8


Figure 15.2 – Monopoly and Inventions

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

9


Explore whether government intervention can promote efficiency in the
case of natural monopoly.

15.3 NATURAL MONOPOLY

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

10

Natural Monopoly


the case in which the average cost of a single enterprise
declines over the entire range of market demand



Production cost if minimized if one firm supplies the entire
output for the industry



Economies of scale extend to very high output levels.

(continued)

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

11


Natural Monopoly

(continued)



Dilemma:

 Efficiency in production results from one supplier
 Lack of competition may lead to less output and higher
prices



Alternatives for public policy makers:
 Do nothing and let the monopoly produce unregulated
 Regulate the monopoly
 Governmental ownership and operation of the facility
 Allow the government to accept competitive bids from
potential firms for the right to operate the facility
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

12


Figure 15.3 -Natural Monopoly

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

13


Regulation of Natural Monopoly:
Theory


Public utilities – public agencies charged with regulating
natural monopolies



Two pricing approaches:
 Average-cost pricing: AC=demand curve
 Marginal-cost pricing: MC=demand curve



Average-cost pricing is more practical
 Output is greater and price is lower than if the monopoly
were unregulated
 Monopoly’s owners receive no profit
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

14


Figure 15.4 - Regulation of Natural
Monopoly

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

15


Regulation of Natural Monopoly:
Practice


Practice: reliance on the rate of return on invested capital (accounting
profit) earned by a monopoly because complete knowledge of cost and
demand conditions is unattainable



Issues:
 The monopolist’s incentive to minimize cost is diminished.
 Regulated rates reduces the incentive to engage in research and
development activities designed to develop new services or new
products.



Conclusions:
 Regulation is not ideal
 Alternatives are likewise unattractive

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

16


Application 15.2 - Regulating Natural
Monopoly through Public Ownership





Example: United States Postal Service (USPS)
Objective: P=AC, not profit maximization
Profit is constrained to equal zero
Incentive to innovate and/or to encourage cost-minimization
is attenuated

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

17


Explore the concepts of iterated dominance and commitment in the
context of game theory models.

15.4 MORE ON GAME THEORY:
ITERATED DOMINANCE AND
COMMITMENT
Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

18


Iterated Dominance


Iterated dominance – the concept of eliminating any
strategy that is inferior to or dominated by another strategy



Nash equilibrium

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

19


Table 15.1

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

20


Commitment


Commitment – the strategy of adopting a particular course
of action, constraining one’s choice of strategies, in order to
increase your equilibrium payoff



Effectiveness depends on credibility
Appearance: competitive pricing
Reality: allows two sellers to overcome the prisoner’s
dilemma with the consumer being charges the highest
possible price to the benefit of the two sellers.





Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

21


Table 15.2

(continued)

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

22


Table 15.3

Copyright © 2015 John Wiley & Sons, Inc. All rights reserved.

23