Quiz 12: Monopoly and Monopsony

Monopoly Concepts. Indicate whether each of the following statements is true or false, and explain why. A. The Justice Department generally concerns itself with significant or flagrant offenses under the Sherman Act, as well as with mergers for monopoly covered by Section 7 of the Clayton Act. B. When a single seller is confronted in a market by many small buyers, monopsony power enables the buyers to obtain lower prices than those that would prevail in a competitive market. C. A natural monopoly results when the profit-maximizing output level occurs at a point where long-run average costs are declining. D. Downward-sloping industry demand curves characterize both perfectly competitive markets and monopoly markets. E. A decrease in the price elasticity of demand would follow an increase in monopoly power.

Describe the monopoly market structure and provide some examples.

Natural Monopoly. On May 12, 2000, the two daily newspapers in Denver, Colorado, filed an application with the U.S. Department of Justice for approval of a joint operating agreement. The application was filed by The E.W. Scripps Company, whose subsidiary, the Denver Publishing Company, published the Rocky Mountain News, and the MediaNews Group, Inc., whose subsidiary, the Denver Post Corporation, published the Denver Post. Under the proposed arrangement, printing and commercial operations of both newspapers were to be handled by a new entity, the "Denver Newspaper Agency", owned by the parties in equal shares. This type of joint operating agreement provides for the complete independence of the news and editorial departments of the two newspapers. The rationale for such an arrangement, as provided for under the Newspaper Preservation Act, is to preserve multiple independent editorial voices in towns and cities too small to support two or more newspapers. The Act requires joint operating arrangements, such as that proposed by the Denver newspapers, to obtain the prior written consent of the Attorney General of the United States in order to qualify for the antitrust exemption provided by the Act. Scripps initiated discussions for a joint operating agreement after determining that the News would probably fail without such an arrangement. In their petition to the Justice department, the newspapers argued that the News had sustained $123 million in net operating losses while the financially stronger Post had reaped $200 million in profits during the 1990s. This was a crucial point in favor of the joint operating agreement application because the Attorney General must find that one of the publications is a failing newspaper and that approval of the arrangement is necessary to maintain the independent editorial content of both newspapers. Like any business, newspapers cannot survive without a respectable bottom line. In commenting on the joint operating agreement application, Attorney General Janet Reno noted that Denver was one of only five major American cities still served by competing daily newspapers. The other four are Boston, Chicago, New York, and Washington, DC. Of course these other four cities are not comparable in size to Denver; they're much bigger. None of those four cities can lay claim to two newspapers that are more or less equally matched and strive after the same audience. A. Use the natural monopoly concept to explain why there is not a single city in the United States that still supports two independently owned and evenly matched, high-quality newspapers that vie for the same broad base of readership. B. On Friday, January 5, 2001, Attorney General Reno gave the green light to a 50-year joint operating agreement between News and its longtime rival, the Post. Starting January 22, 2001, the publishing operations of the News and the Post were consolidated. At the time the joint operating agreement was formed, neither news organization would speculate on job losses or advertising and circulation rate increases from the deal. Based upon your knowledge of natural monopoly, would you predict an increase or decrease in prices following establishment of the joint operating agreement? Would you expect newspaper production (and employment) to rise or fall? Why?

From a social standpoint, what is the problem with monopoly?

Price Fixing. An antitrust case launched more than a decade ago sent tremors throughout the academic community. Over the 1989-1991 period, the U.S. Department of Justice (DOJ) investigated a number of highly selective private colleges for price fixing. The investigation focused on "overlap group" meetings comprised of about half of the most selective private colleges and universities in the United States. The group included 23 colleges, from small liberal arts schools like Colby, Vassar, and Middlebury to larger research universities like Princeton and MIT. DOJ found that when students applied to more than one of the 23 institutions, school officials met to coordinate the exact calculation of such students' financial need. Although all of the overlap colleges attempted to use the same need formula, difficult-to-interpret information from students and parents introduced some variation into their actual need calculations. DOJ alleged that the meetings enabled the colleges to collude on higher tuition and to increase their tuition revenue. The colleges defended their meetings, saying that they needed coordination to fully cover the needs of students from low-income families. Although colleges want capable needy students to add diversity to their student body, no college can afford a disproportionate share of needy students simply because it makes relatively generous need calculations. Although the colleges denied DOJ's price-fixing allegation, they discontinued their annual meetings in 1991. A. How would you determine if the overlap college meetings resulted in price fixing? B. If price fixing did indeed occur at these meetings, which laws might be violated?

Why are both industry and firm demand curves downward sloping in monopoly markets?

Tying Contracts. In a celebrated case tried during 1998, The Department of Justice charged Microsoft Corporation with a wide range of anticompetitive behavior. Among the charges leveled by the DOJ was the allegation that Microsoft illegally "bundled" the sale of its Microsoft Explorer Internet browser software with its basic Windows operating system. DOJ alleged that by offering a free browser program, Microsoft was able to extend its operating system monopoly and "substantially lessen competition and tend to create a monopoly" in the browser market by undercutting rival Netscape Communications, Inc. Microsoft retorted that it had the right to innovate and broaden the capability of its operating system software over time. Moreover, Microsoft noted that Netscape distributed its rival Internet browser software Netscape Navigator free to customers, and that it was merely meeting the competition by offering its own free browser program. A. Explain how Microsoft's bundling of free Internet browser software with its Windows operating system could violate U.S. antitrust laws, and be sure to mention which laws in particular might be violated. B. Who was right in this case? In other words, did Microsoft's bundling of Microsoft Explorer with Windows extend its operating system monopoly and "substantially lessen competition and tend to create a monopoly" in the browser market?

Give an example of monopoly in the labor market. Discuss such a monopoly's effect on wage rates and on inflation.

Monopoly Price-Output Decision. Calvin's Barber Shops, Inc., has a monopoly on barbershop services provided on the south side of Chicago because of restrictive licensing requirements, and not because of superior operating efficiency. As a monopoly, Calvin's provides all industry output. For simplicity, assume that Calvin's operates a chain of barbershops and that each shop has an average cost-minimizing activity level of 750 haircuts per week, with Marginal Cost Average Total Cost $20 per haircut. Assume that demand and marginal revenue curves for haircuts in the south side of Chicago market are P = $80 - $0. 0008 Q MR = $80 - $0. 0016 Q where P is price per unit, MR is marginal revenue, and Q is total firm output (haircuts). A. Calculate the monopoly profit-maximizing price-output combination, and the competitive market long-run equilibrium activity level. B. Calculate monopoly profits, and discusses the "monopoly problem" from a social perspective in this instance.

Given the difficulties encountered with utility regulation, it has been suggested that nationalization might lead to a more socially optimal allocation of resources. Do you agree? Why or why not?

Deadweight Loss from Monopoly. The Onondaga County Resource Recovery (OCRRA) system assumed responsibility for solid waste management on November 1, 1990, for 33 of the 35 municipalities in Onondaga County, New York. OCRRA is a nonprofit public benefit corporation similar to the New York State Thruway Authority. It is not an arm of county government. Its board of directors is comprised of volunteers who develop programs and policies for the management of solid waste. The OCRRA board is responsible for adopting a budget that ensures there will be sufficient revenues to cover expenditures. It does not rely on county taxes. OCRRA has implemented an aggressive series of programs promoting waste reduction and recycling where markets exist to create new products. While a number of communities struggle to surpass the 20 percent recycling mark, Onondaga County's households and commercial outlets currently recycle more than 67 percent of the waste that once was buried in landfills. Converting nonrecyclable waste into energy (electricity) is also a top priority. To show the deadweight loss from monopoly problem, assume that monthly OCRRA's market supply and demand conditions are Q S = - 2 , 000 , 000 + 10 , 000 P (Market Supply) Q D = 1 , 750 , 000 - 5 , 000 P (Market Demand) where Q is the number of customers served, and P is the market price of annual trash hauling and recycling service. A. Graph and calculate the equilibrium price-output solution. How much consumer surplus, producer surplus, and social welfare are produced at this activity level? B. Use the graph to help you determine the deadweight loss for consumers and the producer if the market is run by unregulated profit-maximizing monopoly. (Note: If monopoly market demand is P = $350 - $0.0002Q, then the monopolist's MR = $350 - $0.0004Q.)

Antitrust statutes in the United States have been used to attack monopolization by big business. Does labor monopolization by giant unions have the same potential for the misallocation of economic resources?

Wealth Transfer Problem. The Organization of the Petroleum Exporting Countries (OPEC) was formed on September 14, 1960, in Baghdad, Iraq. The current membership is comprised of five founding members plus six others: Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela. OPEC's stated mission is "to bring stability and harmony to the oil market by adjusting their oil output to help ensure a balance between supply and demand." At least twice a year, OPEC members meet to adjust OPEC's output level in light of anticipated oil market developments. OPEC's 11 members collectively supply about 40 percent of the world's oil output and possess more than three-quarters of the world's total proven crude oil reserves. To demonstrate the deadweight loss from monopoly problem, imagine that market supply and demand conditions for crude oil are Q S = 2 P (Market Supply) Q D = 180 ? 4 P (Market Demand) where Q is barrels of oil per day (in millions) and P is the market price of oil. A. Graph and calculate the equilibrium price-output solution. How much consumer surplus, producer surplus, and social welfare is produced at this activity level? B. Use the graph to calculate the amount of consumer surplus transferred to the monopoly producer following a change from a competitive market to a monopoly market. How much is the net gain in producer surplus?

When will an increase in the minimum wage increase employment income for unskilled laborers? When will it cause this income to fall? Based on your experience, which is more likely?

Monopoly Profits. Portland Fluid Control, Inc., (PFC) is a major supplier of reverse osmosis and ultrafiltration equipment, which helps industrial and commercial customers achieve improved production processes and a cleaner work environment. The company has recently introduced a new line of ceramic filters that enjoy patent protection. Relevant cost and revenue relations for this product are as follows: TR = $300 Q - $0. 001 Q 2 MR = ? TR/ ? Q = $300 - $0. 002 Q TC = $9 , 000 , 000 + $20 Q + $0. 0004 Q 2 MC = ? TC/ ? Q = $20 + $0. 0008 Q where TR is total revenue, Q is output, MR is marginal revenue, TC is total cost, including a riskadjusted normal rate of return on investment, and MC is marginal cost. A. Compute PFC's optimal monopoly price-output combination. B. Compute monopoly profits and the optimal profit margin at this profit-maximizing activity level.

Explain why state tax rates on personal income vary more on a state-by-state basis than do corresponding tax rates on corporate income.

Monopoly Versus Competitive Market Equilibrium. During recent years, MicroChips Corp. has enjoyed substantial economic profits derived from patents covering a wide range of inventions and innovations for microprocessors used in high-performance desktop computers. A recent introduction, the Penultimate, has proven especially profitable. Market demand and marginal revenue relations for the product are as follows: P = $5 , 500 ? $0. 005 Q MR = ? TR/ ? Q = $5 , 500 ? $0. 01 Q Fixed costs are nil because research and development expenses have been fully amortized during previous periods. Average variable costs are constant at $4,500 per unit. A. Calculate the profit-maximizing price-output combination and economic profits if MicroChips enjoys an effective monopoly because of patent protection. B. Calculate the price-output combination and total economic profits that would result if competitors offer clones that make the market perfectly competitive.

Do the U.S. antitrust statutes protect competition or competitors? What is the difference?

Monopoly-Monopsony Confrontation. Safecard Corporation offers a unique service. The company notifies credit card issuers after being informed that a subscriber's credit card has been lost or stolen. The Safecard service is sold to card issuers on an annual subscription basis. Relevant revenue and cost relations for the service are as follows: TR = $5 Q ? $0. 00001 Q 2 MR = ? TR/ ? Q = $5 ? $0. 00002 Q TC = $50 , 000 + $0. 5 Q + $0. 000005 Q 2 MC = ? TC/ ? Q = $0. 5 + $0. 00001 Q where TR is total revenue, Q is output measured in terms of the number of subscriptions in force, MR is marginal revenue, TC is total cost, including a risk-adjusted normal rate of return on investment, and MC is marginal cost. A. If Safecard has a monopoly in this market, calculate the profit-maximizing price-output combination and optimal total profit. B. Calculate Safecard's optimal price, output, and profits if credit card issuers effectively exert monopsony power and force a perfectly competitive equilibrium in this market.

Describe the economic effects of countervailing power, and cite examples of markets in which countervailing power is observed.