Chapter 24 (11 Micro)
Price-Searcher Markets with High Entry Barriers
OUTLINE
I. Why Are Entry Barriers Sometimes High?
A. Entry Barriers
2. Government Licensing
4. Control Over an Essential Resource
II. Characteristics of Monopoly
A. Monopoly
1. Monopoly is a market with:
2. Only a few markets exist with only one seller but it is worth studying.
a. Help us understand markets with few sellers.
B. Price and Output Under Monopoly
1.
2. Monopolists will expand output until marginal revenue equals marginal cost.
a. The monopolist will charge the price on the demand curve consistent with that
output.
C. Profits Under Monopoly
2. Sometimes demand and costs
profit.
III. The Characteristics of an Oligopoly
A. Characteristics of Oligopoly
1. Small number of rival firms.
3. Substantial economies of scale.
5. Products may be either identical or differentiated.
IV. Price and Output in the Case of Oligopoly
A. Price and Output Under Oligopoly
1. No general theory exists for price and output under oligopoly.
a. If the firms operated independently, they would drive down the price to the per
230 Chapter 24 (11 Micro)/Price-Searcher Markets with High Entry Barriers
b. If the firms colluded perfectly, the price would rise to the monopoly price level.
c. The outcome is usually between these two extreme outcomes.
B. Incentive to Collude and Cheat
1. Oligopolists have a strong incentive to collude and raise their prices.
3. This conflict makes collusive agreements difficult to maintain.
C. Obstacles to Collusion
2. When it is difficult to detect and eliminate price cuts, collusion is less attractive.
4. Unstable demand conditions are an obstacle to collusion.
5. Vigorous antitrust action increases the cost of collusion.
V. Market Power and Profit: The Early Bird Catches the Worm
A. Market Power and Profit
1. Just because a firm earns economic profit does not mean that buying stock in that
firm will be more profitable.
a. This is because the value will be capitalized into the stock price.
VI. Defects of Markets with High Entry Barriers
A. When entry barriers are high ad there are few, if any alternative suppliers, the
discipline of market forces is weakened.
B. Reduced competition results in allocative inefficiency.
C. Government grants of monopoly encourage rent seeking.
VII. Policy Alternatives When Entry Barriers Are High
A. Natural Monopoly
1. A natural monopoly exists when long-run average costs continue to decline as firm
size increases, over the entire market demand.
a. A larger firm always has lower costs.
b. Ex: Local phone service
B. Policy Alternatives
2. Relax regulations that limit entry and trade.
4. Supply market with government production.
C. Problems with Government Intervention
1. Problems with regulation:
a. Lack of information.
2. Problem with government production:
a. Fewer incentives to minimize costs and satisfy consumers.
D. Putting it all Together
1. Intervening into these markets with government policy may not create an attractive
outcome.
a. When feasible, reduction of artificial entry barriers is the most attractive
alternative.
VIII. The Competitive Process in the Real World
A. Competitive forces are present even markets with high entry barriers.
OBJECTIVES
This chapter covers the traditional monopoly (price searcher with high barriers to entry) model and
policy issues that relate to it. Profit-maximizing decision making under monopoly is analyzed. A
monopolist will restrict output and raise prices to the level consistent with profit maximization. This
chapter should be used in conjunction with the earlier chapters on low barriers to entry. Most
instructors will particularly want to compare and contrast expected outcomes under monopoly with
those under price taking.
The theory of oligopoly is also developed and analyzed. To understand oligopoly, one must
understand both the pressures toward and limits on collusive business behavior. Potential rivals can
gain if they can collude, restrict output, and raise price. However, collusion has its costs. Collusion
will not be successful when the number of rival firms is large, when secret price cuts by colluding
action also suffers from shortcomings. Economic theory suggests that regulatory commissions often
lack both the ability and the incentive to impose price-quality standards consistent with allocative
efficiency. Similarly, government-operated firms may fail to meet our conditions of ideal efficiency
since the managers of such firms can often sacrifice efficiency for personal and political objectives.
Thus, when monopoly power is based on the efficiency of large-scale production (relative to the
Chapter 24 (11 Micro)/Price-Searcher Markets with High Entry Barriers 233
IMPORTANT POINTS AND TEACHING SUGGESTIONS
1. Although the definition of a monopolist is not without ambiguity, the narrowness of product
line and market area is a necessary characteristic. For example, the local power company
2. Students generally believe that a monopolist necessarily earns economic profit. This is not
question 3 could be used as the focal point for a classroom discussion of the pricing policies of
a monopolist.
4. Exhibits 1 and 2 illustrate the mechanics of profit maximization under monopoly. Of course,
the monopolist will expand output until MR = MC. At this output rate, the monopolist will
5. From the standpoint of economic efficiency, monopoly (high barriers to entry) presents several
6. The text discussion of the economics of regulation deals with both (a) what a regulatory agency
should do and (b) what it is likely to do. Since a regulatory agency will lack information on
costs as a function of output, approximating the ideal textbook solution is not easily
7. There is good reason to expect that a government-operated monopoly will be cost-inefficient,
particularly in the long run. Competition from rivals is not present to force the firm to operate
efficiently. Taxpayers, who are the major beneficiaries of greater efficiency, are generally both
uninformed and unorganized. The political process fails to give taxpayers much incentive to
8. During the inflation-plagued 1970s, regulation based on historical cost sometimes imposed a
very unfavorable profit ceiling on public utilities. In a few cases, public utilities had difficulty
9. Locks are a good way of illustrating barriers to entry. You use locks as a barrier against others
rights are a form of such societal locks to keep others from stealing. One role for government
10. In discussing market power in Chapters 23 and 24, it is important to note that the definition of
the relevant market is often crucial in antitrust cases. The prosecution always argues for the
11. It is important to note that it is possible for there to be fewer firms and, at the same time, more
13. Exhibit 6 can be used to illustrate the conflict between (a) the interests of the firm and (b) the
interests of the industry. When a firm lowers its price, it attracts both (a) new purchasers of the
14. Review the conditions under which oligopolists are most (least) likely to collude successfully
(from their viewpoint). This is the heart of oligopoly theory.
15. When property rights are established, a long-run rate of profit that reflects monopoly power
will be capitalized into the value of an asset. For example, if licensing enabled a liquor store
owner to earn economic profit, and if licenses were exchangeable, the price of licenses would
16. Remind students that the same principles of monopoly and collusion now being talked about
17. nt to show its
18. Game 1 shows how widely prices can vary under different market structures.
GAMES
1. Four Markets for Widgets
Type: In-Class demonstration
Topics: market structure and price
Textbook: Chapter 23 Price-Searcher Markets with High Entry Barriers
Materials Needed: 7 volunteers, money ($2.50 $4.00)
Time: 15 minutes
Class limitations: works in any class with more than 15 students
Purpose
This illustrates how different market structures can result in wide differences in price for the
consumer. It also shows how communication can increase oligopoly profits. The opportunity to
win real money creates great student interest.
Instructions
Divide the class into four groups. Group A consists of one student (the first volunteer.) Group B
consists of the next three volunteers. Group C consists of the other three volunteers. Group D is
the rest of the class.
236 Chapter 24 (11 Micro)/Price-Searcher Markets with High Entry Barriers
Group B represents an oligopoly. This group can communicate with each other and can examine
jointly, and may make agreements to share profits. The professor will buy one widget from Group
B. The professor is willing to pay up to $1.00 for this widget, but will buy it from the lowest
bidder.
Common answers and points for discussion
The monopolist will bid $1, the maximum willingness to pay.
The colluding oligopolists usually each bid $1. They often will reach a profit-sharing agreement.
The oligopolists who do not communicate will have a lower winning bid. They also display large
variation in the individual bids. Typically the bids range from a low of $0.25 to nearly a dollar.
Chapter 24 (11 Micro)/Price-Searcher Markets with High Entry Barriers 237
HINTS FOR ANSWERING CRITICAL ANALYSIS QUESTIONS
1. The statement is true. Profits cannot exist in the long run without barriers to entry because
2. Compared to competition, monopoly results in less production and exchange. At the lower
4. The formation of the monopoly will result in higher liquor prices and a smaller output. Illustrate
this graphically. Current members of the retail liquor trade association will gain. However, if
14. a. The total revenue numbers are: $60, $110, $150, $180, $200, $210. The marginal revenue