Natural Monopoly

1
Natural Monopoly

• Natural Monopoly an industry in which economies
  of scale are so important that only one firm can
  survive.
• See Example 1 on page 29-2.

2
Unregulated Natural Monopoly

• An unregulated natural monopoly would attempt to
  maximize profits by producing the quantity of
  output where marginal revenue equals marginal
  cost.

3
Unregulated Natural Monopoly
4
Optimal Quantity

• The optimal quantity of output occurs where price
  equals marginal cost (and thus where marginal
  social benefit equals marginal social cost).

5
Optimal Quantity
6
Deadweight Loss

• Producing the profit-maximizing quantity of
  output causes a deadweight loss.
• The deadweight loss is equal to the area between
  the demand curve and the marginal cost curve for
  the amount of underproduction.

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Deadweight Loss
8
Regulating Natural Monopoly

• If a natural monopoly is regulated to produce the
  optimal quantity of output, the firm will suffer
  an economic loss.
• To keep the firm operating would require a
  government subsidy to the firm to eliminate the
  economic loss.

9
Subsidy to Achieve Optimal Quantity
10
Zero Economic Profit

• To avoid the need for a subsidy, natural
  monopolies are often regulated to earn zero
  economic profit (a normal rate of return). This
  leads to problems
• 1. The natural monopoly lacks incentives to
  control costs.
• 2. The regulators may not be able to obtain
  accurate information.

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Theories of Regulation

• 1. Public interest theory. This theory holds
  that regulation serves the public interest.
• Assumes that elected officials are always
  motivated to act in ways that serve the public
  interest.
• A great deal of government regulation does not
  seem to be serving the public interest.

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Theories of Regulation

• 2. Capture theory. This theory holds that the
  regulatory agency will be captured (controlled)
  by the industry being regulated.
• The firms in the regulated industry have a
  special interest in the policies of the
  regulatory agency.
• Regulations may be used to serve the best
  interest of the regulated industry.
• See Example 3 on page 29-6.

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Theories of Regulation

• 3. Public choice theory. This theory holds that
  regulation serves the best interest of the
  government regulators.
• Regulators would favor a regulatory approach that
  led to more regulatory power and a growing budget
  for the regulatory agency.

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Costs of Regulation

• Regulations impose costs on the economy
• 1. Costs of the regulatory agency.
• The costs to operate regulatory agencies are paid
  by the taxpayers.
• See the table on page 29-6.

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Costs of Regulation

• 2. Costs to the regulated firms of complying
  with the regulations.
• These costs add to a companys cost of production
  and are ultimately paid by the consumers.
• See Example 5 on page 29-7.

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Costs of Regulation

• 3. Inefficiency costs if the regulations reduce
  competition.
• Regulation often reduces competition in the
  regulated industry. A lack of competition leads
  to higher prices for consumers.
• See Example 6 on page 29-7.

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Costs of Regulation

• 4. Costs of unintended consequences of
  regulations.
• Regulations intended to accomplish a desirable
  goal may have unintended consequences that are
  undesirable.
• See Examples 7 and 8 on pp. 29-7 and 29-8.

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Deregulation

• Deregulation will usually result in lower prices
  due to increased competition.
• See Examples 9A and 9B on page 29-8.
• Deregulation can be politically difficult to
  accomplish.
• Those who benefit from the regulation will act as
  a special-interest group to fight deregulation.

19
Antitrust Law

• Antitrust law legislation intended to prohibit
  attempts to monopolize markets or engage in
  anti-competitive behavior.
• 1. The Sherman Act (1890).
• 2. The Clayton Act (1914).
• 3. The Federal Trade Commission Act (1914).

20
Sherman Act

• Section 1 prohibits contracts, combinations, and
  conspiracies in restraint of trade.
• Section 2 prohibits persons from monopolizing, or
  attempting to monopolize, a market.

21
Sherman Act

• The Supreme Court has interpreted the Sherman Act
  as only prohibiting behavior that unreasonably
  restrains trade.
• Certain actions are held to always be
  unreasonable restraints of trade and thus are
  illegal per se.
• See Example 11 on page 29-9.

22
Sherman Act

• Actions that are held not to be per se violations
  of the Sherman Act are judged under the rule of
  reason.
• See Example 12 on page 29-9.

23
Clayton Act

• The Clayton Act prohibits certain specific
  actions if the effect of the actions is to
  substantially lessen competition or tend to
  create a monopoly.
• Section 3 of the Clayton Act restricts tying
  agreements and exclusive dealing agreements.
• Section 7 of the Clayton Act restricts mergers.

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Types of Mergers

• Whether a proposed merger will be judged to
  substantially lessen competition or tend to
  create a monopoly depends largely on the type of
  merger proposed
• 1. Horizontal merger a merger of firms
  competing in the same product market.
• 2. Vertical merger a merger of firms in the
  same industry, but not at the same stage in the
  production process.

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Types of Mergers

• 3. Conglomerate merger a merger of firms that
  are not in the same industry.
• Example 13 A merger of General Motors and Ford
  Motor Company would be a horizontal merger. A
  merger of General Motors and Goodyear Tire and
  Rubber Company would by a vertical merger. A
  merger of General Motors and Tonka Toys would be
  a conglomerate merger.

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Antitrust Law

• Today, the antitrust laws are enforced by the
  Federal Trade Commission and by the Antitrust
  Division of the Department of Justice.
• Private parties who suffer damages caused by
  antitrust violations may sue the violator and
  recover three times the damages proved.