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price under average cost reguladon as higher than that under sheer unregulated monopoly, our theory by no means compels this conclusion, h only says that costs will rise if firms lack profit incentives to keep them down. Whether rising costs will push price above the unregulated monopoly price is an empirical question rather than a theoretical one. Oddly enough, the United States went through nearly a half-century of utility reguladon before Nobel Prize winning economist George Sdgler pioneered the empirical study of regulations- Stigler found no significant differences in the prices of regulated and unregulated utilities, a residt since replicated by many other researchers using different methodologies. Furthermore, if utility regulation truly limits monopoly power, then the price of utility stocks should have fallen with the onset of reguladon. When we look at the facts however, we find that stock prices, far from falling, actually rose. In sum, utility regulation seems to accomplish litde more than giving consumers a false sense of protection..

In any case, even if delivery of electric power or .local telephone service is a natural monopoly, power generation and long distance telephone service are certainly not. Why regulators should block entry and shield these aspects of udlity operations from new competition is a matter of politics, not economics.

Another proposal, more commonly implemented in Europe than in the United States, is the outright nationalization of the industry. This proposal adds to the worst effects of the others a few drawbacks ofits own. Like regulated natural monopolies, nationalized industries lack incentives to control costs and to produce where P = MC. But their most striking feature is their deep politicizadon. Politicians approve the management and all major decisions regarding product price, worker incentives, output location, product assortment, investment policies, working conditions and die like.

How does the performance of these politicized concerns compare with private companies? Economists Joseph Monsen and Kenneth Walters supply some data in a recent empirical study.2 Comparing nationalized companies with similar private firms, Monsen and Walters report that nationalized concerns had lower sales, profit, output, and taxes per employee. Operadng expenses and vrages per dollar of sales were higher, while sales per dollar of investment were lower. Sales per employee also grew at slower rates. Although many nationalized industries are shielded from foreign compedtion by tariff or other barriers, nearly all except the oil companies lost


Although the Post Office is one of the few nationalized American concerns, local government monopolies are common. For example, because of political pressure from public employee unions, many municipal govemments are banned by law from allowing private companies to collect trash, fight fires, maintain roads, or supply any number of other local services even if private concerns can demonstrably accomplish these tasks cheaper and better. Even in localities where the municipal authorities are legally free to take competitive bids, opposition by government employee unions is frequendy so vehement that few ever do so.

MONOPOLY POWER AND BARRIERS TO ENTTIY We emphasize that significant long run monopoly power requires notjust the presence of one (or perhaps a small number of firms) alone, but rather the presence of barriers to entry. Suppose in Figure XIX that a single firm is the sole supplier of widgets and the long run market demand curve is Dn,. The marginal revenue associated with this curve is MRm-With entry barriers the price will be as weve seen. But suppose also that a large number of other firms are firee to enter the industry with the average total cost curve indicated at left in the diagram. Then the effective demand curve faced by the monopolist now becomes perfecdy elastic at Pc- To see this, imagine that the monopolist attempts to charge I above Pc . Then in the absence of entry barriers, other firms can and will enter to take the monofxilists market away. This process will stop only when the monopolists long run price is Pc or less. In other words, a monopolist vwthout significant entry barriers may gain neither

Fig. XIX Potential Entry increases Elasticity

ATcV ]\ / ATC„

substantial long run monopoly profits nor a price much in excess of marginal cost.

On the other hand, should the government block entry by competitors, \ ivould be immediateh back with the classical monopoly soludon at Nonetheless, throughout the remainder of this book, we will consider monopoly to mean monopoly supported by insuperable entry barriers.


Almost everyone has heard stories about the big drug companies suppressing \- wonder drugs so they can sell more of their profitable but inferior old drugs, or about the oil compjmies buying up the patents to miracle carburetors which drastically cut the demand for gasoline. Nonetheless, even when the patent period expires and the invention can be produced by anyone, the suppressed inventions ne\-er appear. The reason is that all such stories are folklore; in genend, suppressing invendons is not profitable.

We can easily dispose of the compeddve case. Imagine that a superior strain of wheat which doubles yields per plant is discovered. Should a price-taking farmer plant it? Of course he should. A doubHng of yields per plant, will cut the farmers average total cost in half. Therefore, from the cost side, the farmer will introduce rather than suppress the invention. Moreover, since the price will be the same whether an individual pricetaking farmer plants the new su-ain or not, no incentives appear on the re\enue side for withholding it. The improved strain irill Therefore be introduced. In fact, the history of agriculture is replete with such improvements even though they often reduce farm incomes. (Consult the Farm Problem in Section IV ifyou dont remember why.)

Now lets consider a monopolist selling car batteries. Suppose he disco\ers a new battery which lasts twice as long, but which costs no more to produce than batteries built with the current technology. If he suppresses the invention, he will sell more of the inferior old batteries. Should he suppress it in order to protect sales of old batteries? To see that he should not, we can apply a small trick. Instead of following the impact of the invention on the demand for old batteries, lets just

consider the demand for car starts in Figure XX. True to our purpose of concentrating on the essentials, well consider only the case of a constant average total cost monopolist.

The figure displays the average and marginal costs of car starts under the old technology as and MC respectively. (Why are marginal cost and average total cost equal?) If the new battery gives twice the number of starts as the old but costs the same to produce, then the cost per start, which is to say the average total cost, wUl be half that of the old. As a result, the average total cost curve of the new battery, , is half as high as the old average total cost curve, Of course, since the average total cost is constant, the marginal cost of a start with the new battery, MC is equal to it.

From here out it isjust a matter of determining which of the two technologies will yield the monopolist the greater profit. Under the old technology, the monopolist will sell Q units at a price of P. His profit in this case will consist of areas A - B. Under the new technology, the monopolist would charge the lower, price of P and sell the greater output of Q. Profit in this situation would be areas -t- C. In the figure we see that + exceeds -t- A, so the monopolist will produce the new technology and pass some of the savings along to consumers in the form of lower prices.

Fig. XX The Demand for Car Starts

1. Sliglcr. Gcoige and Friedland. Claire, "Wliat Can Ilegulatois Rrgulan.-:- TIk- Case of Elcciiicit\-. oiinial of Law and Economics. (Ociobci. 1962) pp.J.15

2. Monscn, R. Joseph and Walters. Kcnncih D.. Naiionali?rd Compaiiif (N>iv Voi k: .McGr.w - Hill. 1983)

, Competitive Firm


t arm-Up Questions for Section \T

Price-searchers are: (a) firms witJiout demand curves (b) firms seHing imo downward sloping demand curves (c) firms who dont knovv what price to charge (d) firms with MR curves lying below demand curves (e) both (b) and (d).

B. Monopolists with typical "U" shaped cost curves strive to sell: (a) where MR = 0 (b) where = 1.0 (c) somewhere in the inelastic pordon (d) where MR is the greatest (e) none of these.

C. Monopolists produce so diat: (a) is minimized (b) MR = MC and P equals or exceeds AVC in the short run and P equals or exceeds in die long run (c) P = MR (d) all of these.

D. Monopoly arises because: (a) monopolists " are especially greedy (b) entry is blocked(c) price

is greater than MC (d) firms seek profits.

E. Monopoly is inefficient because: (a) producdon is not at minimum (b) MR doesnt equal MC (c) P < MC (d) added resources would be more valuable to societ) as inputs into the monop-

" olized industry than where they are currently being used (c) both (c) and (d).

F Entry barriers can arise because: a) economies of scale may be large reladve to demand (b) the government shields some sellers firom compeddon

(c) business does not seek profits vigorously enough

(d) MR < MC (e) P > MC (f) opdons (a) and (b) only.

G. Price discriminadon means: (a) charging minorities higher prices (b) paying minorities lower wages (c) both (a) and (b) (d) charging different prices to different groups (e) charging 11 different prices to different groups when costs are the same.

H. A natural monopoly is characterized by: (a) inelastic industry demand (b) elastic industry demand (c) large economies of scale in relation to industry demand (d) losses at any level of output (e) none of the above.

1. Marginal cost regulation of a natural monop

oly involves: (a) a subsidv (b) a price less than the average total cost (c) a tendeiicv for the average total cost curve to shift ujjward (d) inefficiency (e) all of the above.

J. Regulation of a natural monopoly b) means of

average cost regulation does not involve: (a) a subsidy (b) inefficiency (c) a tendency for the average total cost curve to shift upward (d) equilibrium output at tbe point of intersection between the demand curve and the firms average total cost curve (e) marginal cost less than a\erage total cost.

K. Which of the following is likely to occur under monopoly? (a) price greater than marginal cost (b) long run profits (c) inefficiency (d) a reladvely small output (e) all of the above.

L. Under monopoly which of the following is correct? (a) MR lies below AR (b) MR = MC at die equilibrium output (c) AR = P (d) AR is greater than MC (e) all of the above.

M. A firm which wants to maximize its total revenue would try to sell where: (a) elasticity of

demand is zero......(b) margiiiJ revenue

equals zero (c) marginal revenue equals one (d) marginal revenue is as large as possible (e) marginal revenue equals minus infinity.

N. Ifthe marginal benefit (.MB) of added production in a certain indusuy is greater than marginal cost (MC), then: (a) we would want more production in this industry (b) die industry is inefficient (c) resources are not flowing to their highest valued uses (d) all of the above (e) none of tbe above.

O. A monopolists profit maximizing output occurs: (a) at the same output as a competitive indusu-y (b) where MR = MC (c) where TR is maximized (d) where TC is at a minimum (e) where TC is at a maximum.

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