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2013 Pearson Education, Inc. Publishing as Prentice Hall

CHAPTER 15 | Monopoly and AntitrustPolicy

Chapter Summary and Learning Objectives

15.1 Is Any Firm Ever Really a Monopoly? (pages 488489)

Define monopoly.A monopoly exists only in the rare situation in which a firm is producing a good orservice for which there are no close substitutes. A narrow definition of monopoly that some economistsuse is that a firm has a monopoly if it can ignore the actions of all other firms. Many economists favor abroader definition of monopoly. Under the broader definition, a firm has a monopoly if no other firms areselling a substitute close enough that the firms economic profits are competed away in the long run.

15.2 Where Do Monopolies Come From? (pages 489495)

Explain the four main reasons monopolies arise.To have a monopoly, barriers to entering the marketmust be so high that no other firms can enter. Barriers to entry may be high enough to keep out competingfirms for four main reasons: (1) A government blocks the entry of more than one firm into a market byissuing a patent,which is the exclusive right to a product for twenty years, or a copyright,which is theexclusive right to produce and sell a creation, or giving a firm a public franchise,which is the right to bethe only legal provider of a good or service; (2) one firm has control of a key raw material necessary toproduce a good; (3) there are important network externalities in supplying the good or service; or (4)economies of scale are so large that one firm has a natural monopoly. Network externalities refer to thesituation where the usefulness of a product increases with the number of consumers who use it. A naturalmonopoly is a situation in which economies of scale are so large that one firm can supply the entiremarket at a lower average cost than can two or more firms.

15.3 How Does a Monopoly Choose Price and Output? (pages 496499)

Explain how a monopoly chooses price and output.Monopolists face downward-sloping demand andmarginal revenue curves, and like all other firms, maximize profit by producing where marginal revenueequals marginal cost. Unlike a perfect competitor, a monopolist that earns economic profits does not facethe entry of new firms into the market. Therefore, a monopolist can earn economic profits even in thelong run.

15.4 Does Monopoly Reduce Economic Efficiency? (pages 500503)

Use a graph to illustrate how a monopoly affects economic efficiency. Compared with a perfectlycompetitive industry, a monopoly charges a higher price and produces less, which reduces consumer

surplus and economic efficiency. Some loss of economic efficiency will occur whenever firms havemarket power and can charge a price greater than marginal cost. The total loss of economic efficiency inthe U.S. economy due to market power is small, however, because true monopolies are very rare. In mostindustries, competition will keep price much closer to marginal cost than would be the case in amonopoly.

15.5 Government Policy toward Monopoly (pages 503509)

Discuss government policies toward monopoly. Because monopolies reduce consumer surplus andeconomic efficiency, most governments regulate monopolies. Firms that are not monopolies have an

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CHAPTER 15 | Monopoly and Antitrust Policy


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incentive to avoid competition by colluding, or agreeing to charge the same price or otherwise not tocompete. In the United States, antitrust laws are aimed at deterring monopoly, eliminating collusion, andpromoting competition among firms. The Antitrust Division of the U.S. Department of Justice and theFederal Trade Commission share responsibility for enforcing the antitrust laws, including regulatingmergers between firms. A horizontal merger is a merger between firms in the same industry. A verticalmerger is a merger between firms at different stages of production of a good. Local governments regulate

the prices charged by natural monopolies.

Chapter Review

Chapter Opener: Is Cable Television a Monopoly? (page 487)

A firm needs a license from the city government to enter a local cable television market. Until 2008, TimeWarner Cable, a division of the Time Warner Company, was the only provider of cable television inManhattan; it had a monopoly in this market. There are few monopoly firms in the United States becausewhen a firm earns economic profits, other firms have an incentive to enter the market. Therefore, it isvery difficult for a firm to remain the only provider of a good or service.

Is Any Firm Ever Really a Monopoly? (pages 488489)Learning Objective: Define monopoly.

A monopoly is a firm that is the only seller of a good or service that does not have a close substitute. Anarrow definition of monopoly is that a firm is a monopoly if it can ignore the actions of other firms.Broadly defined, a firm is a monopoly if it can retain economic profits in the long run.

Study Hint

Reading throughMaking the ConnectionIs Google a Monopoly may help you determine whether a givencompany is truly a monopoly. The key point here is whether other search engines can effectively competewith Google. In early 2011, Microsoft filed a complaint with the European Commission that Google was usingits dominant position as an Internet search engine to exclude competitors. But is Google a monopoly? Googleis not the only Internet search option available: Yahoo has operated a search engine, and Microsoft operatesthe Bing search engine, in addition to other small search engines. However, Google has a market share of 70percent in the United States and 90 percent in Europe. With this high market share, can other search enginescompete with Google? The debate around this question is likely to continue.

Extra Solved Problem15.1Is the Cable Television Monopoly Over?

Supports Learning Objective 15.1: Define monopoly.

Comcast is the largest cable provider in the United States, with 24 million subscribers. Throughout thesecond half of the twentieth century, municipalities often contracted with a single cable provider, andresidents had to choose whether to buy cable from that cable company or simply go without access tocable television. In the late 1990s, changes in legislation and the development of new technologiesopened the door for companies to provide services that could compete with traditional cable companies.With the emergence of Dish Network, DirecTV, fiber optic cable, Internet cable, and Web sites like

15.1

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CHAPTER 15 | Monopoly and Antitrust Policy 395

YouTube and Hulu that offer full-length movies and television shows for free, the monopoly positionComcast once held began to erode.

Source: http://biz.yahoo.com/ic/13/13034.html

a. What is the definition of monopoly?b. Are cable television companies such as Comcast monopolies?

Solving the ProblemStep 1: Review the chapter material.

This problem is about the definition of monopoly, so you may want to review the section IsAny Firm Ever Really a Monopoly? which begins on page 488 in the textbook.

Step 2: Answer question (a) by defining monopoly.

A monopoly is the only seller of a good or service that does not have a close substitute.Step 3: Answer question (b) by explaining whether Comcast is a monopoly.

The key to identifying a firm as a monopoly is determining whether the good or service itoffers has close substitutes. Applying a narrow definition of monopoly, Comcast is amonopoly if one can demonstrate Comcast can ignore other firms prices. Although this wastrue at one time, Comcast cannot ignore the prices competitors charge now that they can offercustomers comparable services. A broader definition of monopoly would consider Comcastto be a monopoly, even if there are substitutes for its service, if it can earn long-run economicprofits. Using this definition, it is too early to state that Comcast and other cable televisioncompanies have lost their monopoly status. But it will be increasingly difficult for cablecompanies to earn economic profits as more firms offer similar services in the future.

Where Do Monopolies Come From? (pages 489495)Learning Objective: Explain the four main reasons monopolies arise.

A monopoly requires that barriers to entry into the market must be so high that no other firms can enter.There are four reasons entry barriers may be high enough to keep out competing firms:

1. Government can block the entry of more than one firm into a market by granting a patent orcopyright or by granting a firm a public franchise. A patentis the exclusive right to a product fora period of twenty years from the date the patent is filed with the government. U.S. laws grantcopyright protection to creators of books, films, and music. State and local governments in theUnited States have granted public franchisesthe legal right to be the sole provider of a good orserviceto providers of electricity, natural gas, cable television, and water.

2. A firm can become a monopoly by controlling a key resource. Examples of this entry barrier

include the Aluminum Company of America (until the 1940s), the International Nickel Companyof Canada, and major professional sports teams.

3. Network externalities exist in the consumption of a product if the usefulness of the productincreases with the number of consumers who are using it. Some economists argue that networkexternalities are a barrier to entry, but other economists believe dominant positions by firmsreflect their efficiency in satisfying consumer preferences.

15.2

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4. Economies of scale are so large that one firm has a natural monopoly. A natural monopoly is asituation in which one firm can supply the entire market at a lower average total cost than can twoor more firms.

How Does a Monopoly Choose Price and Output? (pages 496499)Learning Objective: Explain how a monopoly chooses price and output.

A monopoly maximizes profit by producing where marginal revenue equals marginal cost. Themonopolys demand curve is the same as the market demand curve for the product. The monopolist is aprice maker and has a downward-sloping demand curve. The monopolys marginal revenue curve liesbelow its demand curve, so at any level of output its marginal revenue is less than its price. If themonopolist earns an economic profit, then new firms will not be able to enter the market. Therefore, long-run economic profits can be earned.

Study HintIt is a common misconception that monopolies can charge any price they want. Remember that a

monopoly can only charge prices that consumers are willing to pay. In other words, monopolies areconstrained by consumer demand. It is true that a monopoly will charge a price that is above marginalcost, but if a monopoly attempts to charge a price that is higher than consumers willingness to pay, themonopoly will be unable to sell that output.

Does Monopoly Reduce Economic Efficiency? (pages 500503)Learning Objective: Use a graph to illustrate how a monopoly affects economicefficiency.

Compared to equilibrium in a perfectly competitive market, which results in the maximum amount ofeconomic surplus, a monopoly will produce less output and charge a higher price. This results in a

reduction of economic surplus and a deadweight loss. Many firms that are not monopolies have somemarket power. Market poweris the ability of a firm to charge a price greater than marginal cost. The lossof economic efficiency due to market power in the United States is small, probably less than 1 percent oftotal production. Some economists claim that the economy may benefit from firms having market power.

Firms with market power are more likely than competitive firms to earn profits that can be used toconduct research and develop new products. The argument that economic progress depends ontechnological change in the form of new products and that new technology pushes out old technology isclosely associated with Joseph Schumpeter. For example, the computer you use replaced the typewriteryour parents and grandparents used. However, many economists disagree with Schumpeter and argue thatfirms that started small, such as Apple and Google, have produced many new products.

15.3

15.4

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Study HintReview Figures 15.4 and 15.5, which compare economic efficiency under conditions of monopoly andperfect competition. Although small firms are one source of invention and innovation, firms with marketpower are better able to afford product development. Product development involves taking a new productor process, perhaps one developed by a small firm, and making it commercially successful. The failurerate for product development can be very high, over 50 percent in some industries, and it may take severalyears for new products to become profitable.

Extra Solved Problem15.4Comcast CableSupports Learning Objective 15.4: Use a graph to illustrate how a monopoly affects economicefficiency.

The following table is reproduced from Solved Problem 15.3in the textbook and represents the demandand costs that Comcast faces in the provision of cable television.

Price Quantity

Total

Revenue

Marginal

Revenue Total Cost

Marginal

Cost

$27 3 $ 81 $ 56

26 4 104 $23 73 $17

25 5 125 21 91 18

24 6 144 19 110 19

23 7 161 17 130 20

22 8 176 15 151 21

a. Use a graph to show the profit-maximizing quantity and price that Comcast will produce andcharge.

b. Use this graph to calculate the deadweight loss associated with this cable monopoly.


This problem is an extension of Solved Problem 15.3, so you may want to review thisproblem beginning on page 498 in the textbook. This problem also requires an understandingof the section Does Monopoly Reduce Economic Efficiency? which begins on page 500 inthe textbook.

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398

Step 2: Answer question (a) by drawing a graph representing the demand, marginal

revenue, and marginal cost curves of the firm and indicate the profit-maximizing

quantity and price.

Comcast produces where marginal revenue equals marginal cost and charges the price thatconsumers are willing to pay for that quantity. In this case, Comcast sells 6 subscriptions permonth and changes $24 each.

Price Quantity

Total

Revenue

Marginal

Revenue

Total

Cost

Marginal

Cost

$27 3 $ 81 $ 5626 4 104 $23 73 $17

25 5 125 21 91 18

24 6 144 19 110 19

23 7 161 17 130 20

22 8 176 15 151 21

Step 3: Answer question (b) by showing the deadweight loss on your graph and use your

graph to calculate the deadweight loss to society of the cable monopoly.

To calculate the deadweight loss associated with monopoly, we must first find what price and

quantity would be in this market if the industry was perfectly competitive. The perfectlycompetitive quantity will be where price equals marginal cost, which occurs where thedemand curve and the marginal cost curve intersect. Given the numbers in the table in Step 2,this would occur at a quantity of 8.5 where price is $21.50 and marginal cost is $21.50. Shadein the area between the monopolys profit maximizing quantity and the perfectly competitiveequilibrium and between the marginal cost and demand curves. See the graph below. Tocalculate this area, we calculate the area of a triangle:

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base height = ($24/subscription $19) (8.5 subscriptions 6 subscriptions) =$6.25 per month.

Government Policy toward Monopoly (pages 503509)Learning Objective: Discuss government policies toward monopoly.

Because monopolies reduce consumer welfare and efficiency, most governments regulate their behavior.Collusion refers to an agreement among firms to charge the same price or otherwise not to compete.Antitrust laws are laws aimed at eliminating collusion and promoting competition among firms. The

passage of the first antitrust law was spurred by the formation of various trusts in the 1870s and 1880s.Trusts are combinations of firms in several industries that operate independently but are controlled by acommon board of trustees.

The Sherman Act of 1890 was the first important law regulating monopolies in the United States. ThisAct prohibited price fixing, collusion, and monopolization. The Clayton Act of 1914 made a mergerillegal if its effect was to lessen competition or if the merger tended to create a monopoly.

The federal government regulates business mergers because mergers can result in firms gaining marketpower. Horizontal mergers are mergers between firms in the same industry. Vertical mergers aremergers between firms at different stages of production of a good.

It is important to define the appropriate market when evaluating a proposed merger. The newly mergedfirm may be more efficient than the merging firms were individually. Merging firms must substantiateefficiency claims that would result from their proposed merger.

15.5

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400

The Department of Justice and the Federal Trade Commission developed merger guidelines in 1982. Themerger guidelines were modified in 2010 and have three main parts:

1. Market definition. A market consists of all firms making products that consumers view as closesubstitutes.

2. Measure of concentration. A market is concentrated if a relatively small number of firms have alarge share of total sales in the market. The guidelines use theHerfindahl-Hirschman Index (HHI)to measure concentration, which adds the squares of the market shares of each firm in an industry.

3. Merger standards. The HHI calculation for a market is used to evaluate proposed mergers. If thepost-merger HHI is below 1,500, the merger will not be challenged because the market is notconcentrated. If the post-merger HHI is between 1,500 and 2,500, this indicates the market ismoderately concentrated. Depending on how much the HHI will be increased, the merger may bechallenged. If the post-merger HHI is above 2,500, the market is highly concentrated. Mergers inthis market may be challenged based on how much the merger will increase the HHI.

Local or state regulatory commissions usually set prices for natural monopolies. To achieve economic

efficiency, regulators should require that the monopoly charge a price equal to marginal cost. Often,though, a natural monopolys marginal cost will be less than its average total cost. In this case, mostregulators will allow the monopoly to charge a price equal to its average total cost so that the owners ofthe monopoly can earn a normal return on their investment.

Study HintChapter 14 introduced one measure of concentration in a market called the concentration ratio. In calculatingthe four-firm concentration ratio, you simply add together the market shares of the top four firms in theindustry. When calculating the Herfindahl-Hirschman Index (HHI), remember to add together the squaredmarket shares of allfirms in the industry, not just the top four. Also, make sure you square the market sharesfirst and then add them together. Otherwise, youll find an index equal to 10,000 every time; and the HHI willonly truly be 10,000 if there is only one firm in the industry with a market share of 100 percent.

Extra Solved Problem15.5Does Microsoft Stifle Innovation?Supports Learning Objective 15.5: Discuss government policies toward monopoly.

In 2004, the European Commission found that Microsoft was using its market power to impedeinnovation and competition in the information technology market. Microsoft was fined 497 million euros,or $675 million U.S. dollars. Microsoft appealed this ruling to the European Unions Court of FirstInstance and lost the appeal, so the original ruling that Microsoft was impeding competition was upheld.

Sources: Alan Burnside and Lars Liebeler, Always Look On the Bright Side of Innovation, Financial Times, September 5,

2007; Maurits Dolmans and Thomas Graf, Protect Innovators from Microsofts Stifling Monopoly, Financial Times,September 13, 2007.

Explain why the European Commission and the European Unions Court of First Instance would beconcerned with Microsofts actions that impeded competition.

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European countries and the European Union have laws to increase and protect competitionlike those in the United States. To help understand why the European Union agents foundMicrosoft guilty of impeding competition, review the section Government Policy towardMonopoly, which begins on page 503 in the textbook.

Step 2: Answer the question by discussing why the European Unions court system was

concerned with Microsofts actions that impeded competition.

As in the United States, European governments have a strong desire to maintain a significantamount of competition in their markets to maximize the economic surplus in these markets.When a firm, in this case Microsoft, has market power, the firm has the ability to determinethe price and quantity of a good that will be sold in the market. It may also mean that the firmhas created artificial barriers to entry to keep other firms from competing against it in themarket. The European Commission and the Court of First Instance are charged withmaintaining competition in European markets. Therefore, if Microsoft has, in fact, beenimpeding competition, the European Commission will be obliged to take action.

Key Terms

Antitrust laws Laws aimed at eliminatingcollusion and promoting competition amongfirms.

Collusion An agreement among firms to chargethe same price or otherwise not to compete.

Copyright A government-granted exclusiveright to produce and sell a creation.

Horizontal merger A merger between firms inthe same industry.

Market power The ability of a firm to charge aprice greater than marginal cost.

Monopoly A firm that is the only seller of agood or service that does not have a closesubstitute.

Natural monopoly A situation in whicheconomies of scale are so large that one firm cansupply the entire market at a lower average totalcost than can two or more firms.

Network externalities A situation in which theusefulness of a product increases with thenumber of consumers who use it.

Patent The exclusive right to a product for aperiod of 20 years from the date the patent isfiled with the government.

Public franchise A government designation thata firm is the only legal provider of a good orservice.

Vertical merger A merger between firms atdifferent stages of production of a good.

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402

Self-Test

(Answers are provided at the end of the Self-Test.)

Multiple-Choice Questions

1. In which of the following situations can a firm be considered a monopoly?a. when a firm is surrounded by other firms that produce close substitutesb. when a firm can ignore the actions of all other firmsc. when a firm uses other firms prices in order to price its productsd. when barriers to entry are eliminated

2. Using the broader definition of monopoly, in which of the following cases could we argue thatMicrosoft has a monopoly in computer operating systems?a. if Macintosh and Linux were not considered close substitutes for Windowsb. if Microsoft charged prices similar to those that Macintosh and Linux charge for their operating

systems in order to competec. if Macintosh and Linux started to produce operating systems similar to Windowsd. if there are no barriers to entry in the market for computer operating systems

3. A monopoly is a market structure that is characterized bya. many sellers selling differentiated products.b. a single seller of a good or service that does not have a close substitute.c. a single seller of a good or service that has many close substitutes.d. none of the above.

4. Which of the following rights is given to the holder of a patent?a. the exclusive right to a new product

b. control over a key resource used in production of a good or servicec. the right to earn profits from creation of the product indefinitelyd. a public franchise

5. The more cell phones in use, the more valuable they become to consumers. This is an example ofa. what happens when a firm is granted a patent.b. network externalities.c. what happens when a firm has control of a key resource.d. natural monopoly.

6. Natural monopoly happens whena. average total cost curve is decreasing.

b. average total cost curve is increasing.c. average total cost curve is horizontal.d. None of the above is true.

7. The government can block the entry to a market througha. granting a patent or copyright.b. granting a public franchise.c. both (a) and (b).d. none of the above.

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8. Fill in the blank. A patent gives its holder the exclusive right to a product for a period of _________from the date the patent is filed with the government.a. 10 years.b. 20 years.c. 30 years.d. None of the above are true.

9. A natural monopoly occurs whena. average variable cost curve is increasing.b. diseconomies of scale are large enough so that one firm can supply the entire market at a lower

average total cost than can two or more firms.c. economies of scale are large enough so that one firm can supply the entire market at a lower

average total cost than can two or more firms.d. None of the above is true.

10. Refer to the graph below. Which point corresponds to a natural monopoly serving this market andbreaking even?

a. pointAb. pointBc. Both pointAand pointBare associated with a natural monopoly breaking even.d. Neither pointAnor pointBis associated with a natural monopoly breaking even.

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16. Which firms face a downward-sloping demand curve and a downward-sloping marginal revenuecurve?a. all price takersb. all price makersc. monopolies onlyd. monopolistically competitive firms only

17. When a firms demand curve slopes downward and the firm decides to cut price, which of thefollowing happens?a. It sells more units and receives higher revenue per unit.b. It sells more units but receives lower revenue per unit.c. It sells fewer units and receives lower revenue per unit.d. It sells fewer units but receives higher revenue per unit.

18. Fill in the blanks. The demand curve facing a monopolist is _________ and the marginal revenuecurve facing the monopolist is _________.a. horizontal; horizontalb. horizontal; downward sloping

c. downward sloping; horizontald. downward sloping; downward sloping

19. In the long run, the monopolist can earna. only zero economic profit.b. zero or positive economic profit.c. only negative economic profit.d. none of the above.

20. Fill in the blank. The monopolists marginal revenue curve is _________ its demand curve.a. aboveb. below

c. either above or belowd. None of the above is true.

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406

21. Refer to the table below. How much is the average revenue associated with serving five subscribersper month?

a. $33b. $45

c. $5d. none of the above

22. Refer to the table below. How much is the marginal revenue associated with serving sevensubscribers per month?

a. $39b. $45c. $21

d. none of the above

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23. Refer to the graph below. In this graph, which curve is conceptually the same as average revenue?

a. the demand curveb. the marginal revenue curvec. both curvesd. neither curve

24. Refer to the graph of monopoly below. What is profit when the firm sells six subscriptions permonth?

a. $90

b. $42c. $27d. None of the above; there is insufficient information to answer the question.

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408

25. Refer to the graph below. What is the firms profit when it sells six subscriptions per month?

a. $90b. $72c. $42d. $18

26. Refer to the graph of a monopoly below. What point represents the price and output level that amonopoly will choose?

a. point Ab. point Bc. point Cd. none of the above

27. Assume that an industry that began as a perfectly competitive industry becomes a monopoly. Whichof the following describes a change in the market as a result of becoming a monopoly? Compared towhen the industry was perfectly competitive, the monopolist willa. charge a higher price and produce less output.b. charge a higher price and increase consumer surplus.c. produce less output and decrease producer surplus.d. produce more output and increase producer surplus.

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28. Refer to the graph below. What point represents the price and quantity that will prevail when theindustry is perfectly competitive?

a. point Ab. point Bc. point Cd. none of the above

29. Refer to the graph below. Which area shows the reduction in consumer surplus that results from thisindustry being a monopoly rather than perfectly competitive?

a. areaAb. areaB+ area Cc. areaA+ areaBd. none of the areas indicated on the graph

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410

30. Refer to the graph below. Which area shows a reduction in consumer surplus that is transferred toproducers as a result of this industry being a monopoly rather than being perfectly competitive?

a. areaAb. areaB + area Cc. areaA + areaBd. none of the areas indicated on the graph

31. Refer to the graph below. Which area is considered a reduction in economic surplus as a result of thisindustry being a monopoly rather than being perfectly competitive?

a. areaAb. areaBc. area Cd. areaB + area C

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32. Refer to the graph below. If the industry changes from being perfectly competitive to being amonopoly, what happens to producer surplus?

a. It increases by areaAand decreases by areaB.b. It increases by areaAand decreases by area C.c. It increases by areaB + C.d. It increases by areaAand decreases by areaB + C.

33. Which of the following are effects of monopoly?a. Monopoly causes a reduction in consumer surplus.b. Monopoly causes an increase in producer surplus.c. Monopoly causes a reduction in economic efficiency.d. All of the above are effects of monopoly.

34. What is the definition of market power?

a. Market power is the same as inefficiency as measured by the amount of deadweight loss from amonopoly.b. Market power is the ability of a firm to eliminate competition.c. Market power is the ability of one firm to control other firms in the market.d. Market power is the ability of a firm to charge a price greater than marginal cost.

35. The monopolist produces an output that is _________ the perfectly competitive industry wouldproduce.a. less thanb. more thanc. same asd. None of the above is true.

36. The monopolist charges a price that is _________ the perfectly competitive industry.a. less thanb. higher thanc. same asd. None of the above is true.

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412

37. In the United States, the loss in economic efficiency due to market power isa. small.b. large.c. zero.d. none of the above.

38. Because the monopolist faces a downward-sloping demand curve,a. there will be no deadweight loss.b. there will be deadweight loss.c. there is no inefficiency.d. None of the above is true.

39. Refer to the graph below. How can the loss of economic efficiency resulting from this market being amonopoly rather than being perfectly competitive be estimated?

a. by estimating the size of the triangleB + Cb. by estimating the size of the rectangleAc. by estimating the size of the areaA + B + Cd. None of the above; the loss of economic efficiency cannot be estimated using this graph.

40. According to Joseph Schumpeter, what does economic progress depend on?a. competition, especially price competitionb. technological change in the form of new productsc. government protection of competitiond. the initial endowment of economic resources, such as the amount of labor and capital available

41. What does the term collusion refer to?a. Collusion refers to an agreement among firms to charge the same price or otherwise not to

compete.b. Collusion refers to an agreement among existing firms to prevent potential competitors from

entering an industry.c. Collusion refers to laws aimed at promoting competition among firms.d. Collusion refers to a price war among competing firms.

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42. What are laws aimed at promoting competition among firms called?a. collusionb. antitrust lawsc. laws of comparative advantaged. merger legislation

43. Which of the following laws outlawed monopolization?a. the Sherman Actb. the Clayton Actc. the Robinson-Patman Actd. the Cellar-Kefauver Act

44. Which of the following laws prohibited charging buyers different prices if the result would reducecompetition?a. the Sherman Actb. the Clayton Actc. the Robinson-Patman Actd. the Cellar-Kefauver Act

45. What is a merger between firms in the same industry called?a. a horizontal mergerb. a vertical mergerc. a conglomerated. a divestiture

46. Which of the following is most likely to increase market power?a. horizontal mergersb. vertical mergersc. stricter enforcement of antitrust lawsd. divestitures

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414

47. Refer to the graph below. Suppose that two firms each produce with a marginal cost of MC1and thatwhen the two firms merge, marginal cost falls toMC2. As a result of the merger, the price consumerspay ________, and the quantity produced _________.

a. decreases fromP1toP2; equals Q4b. decreases fromP2toP3; equals Q3c. decreases fromP3toP4; equals Q4d. increases fromP2toP1; equals Q1

48. What is the value of the Herfindahl-Hirschman Index (HHI) when there are four firms in an industrywith each firm having an equal market share?a. 4b. 625c. 2,500

d. 4,000

49. Refer to the graph of natural monopoly below. If regulators want to achieve economic efficiency,what price would regulators require?

a. P1b. P2c. P3d. none of the above

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50. Refer to the graph of natural monopoly below. What price will ensure that the owners of themonopoly are able to earn a normal rate of return on their investment?

a. P1b. P2

c. P3d. none of the above

Short Answer Questions

1. There are four firms in Industry A with the following market shares: 75 percent, 12 percent,10 percent, and 3 percent. Industry B also has four firms, but each firm has a 25 percent marketshare. Compare the four-firm concentration ratio and the Herfindahl-Hirschman Index (HHI) ofconcentration for both of these industries.

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

2. In the United States, regulatory commissions usually set prices for natural monopolies, such asfirms selling natural gas. To achieve economic efficiency, commissions should require the firmsthey regulate to charge a price equal to marginal cost. Explain why regulators do not generallyrequire that price be equal to marginal cost.

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

______________________________________________________________________________

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3. Some economists argue that small, competitive firms have developed new products andtechnologies. Competition spurs firms to continually develop new products in order to stay aheadof competing firms. As a result, smaller firms are more effective at developing new products thanlarger firms. How might Joseph Schumpeter counter that argument?

______________________________________________________________________________

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4. Your friend argues that since the monopolist produces where marginal revenue equals marginalcost, then there is no loss in economic efficiency in the market. Comment on this argument.

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5. What are the main antitrust laws in the United States?______________________________________________________________________________

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True/False Questions

T F 1. Network externalities exist when the usefulness of a product decreases with the number ofconsumers using it.

T F 2. A public franchise is a government designation that a firm is the only legal provider of agood or service.

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T F 3. A merger between two firms in an industry with a Herfindahl-Hirschman Index value below1,500 will not be challenged by the federal government.

T F 4. The Clayton Act (1890) prohibited price fixing and collusion.

T F 5. Joseph Schumpeter argued that small competitive firms are responsible for the developmentof most of the technological change that occurs over time.

T F 6. The monopolist can earn positive economic profits in the short run but not in the long run.T F 7. A monopolist will charge the highest price possible in order to make the most profit.

T F 8. A monopolists demand curve is the same as the market demand curve for the product itsells.

T F 9. A professional sports teams long-term stadium lease is an example of a barrier to entry.

T F 10. A broad definition of monopoly is that a monopolist can ignore the actions of all other firms.

T F 11. The monopolist charges a price that is higher than its marginal cost.

T F 12. A generic drug refers to a drug that is no longer protected by a patent.

T F 13. A merger between two soft drink manufacturers is an example of a vertical merger.

T F 14. Department of Justice and Federal Trade Commission guidelines for evaluating proposed

mergers use the Herfindahl-Hirschman Index to measure market concentration.T F 15. Market power is the ability of the firm to charge a price higher than its average revenue.

Answers to the Self-Test

Multiple-Choice Questions

Question Answer Comment

1. b A narrow definition of monopoly used by some economists is that a firm has amonopoly if it can ignore the actions of all other firms. In other words, otherfirms must not be producing close substitutes if the monopolist can ignore otherfirms prices.

2. a For most computer users, Linux and the Macintosh system are not close substitutesfor Windows. So, using the broader definition, we can say that Microsoft has amonopoly in the market for computer operating systems.

3. b A monopoly market has a single seller of a good or service that does not have aclose substitute.

4. a In the United States, a patent gives a firm the exclusive right to produce a product.

5. b There are network externalities in the consumption of a product if the usefulness of

the product increases with the number of people who are using it. The more cellphones that are in use, the more useful they become to consumers.

6. a A natural monopoly occurs when the ATC curve is decreasing so that one firm cansupply the entire market at a lower ATC than two or more firms.

7. c The government can block the entry to a market by issuing a patent, a copyright, orgiving a firm a public franchise.

8. b The patent gives its holder the exclusive right to a product for twenty years fromthe date the patent is filed with the government.

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9. c A natural monopoly occurs when there is economies of scale large enough so thatone firm can supply the entire market at a lower ATC than two or more firms can

10. a With a natural monopoly, the average total cost curve is still falling when it crossesthe demand curve (point A). If there is only one firm producing electric power in

the market and it produces where average cost intersects the demand curve,average total cost will equal $0.04 per kilowatt-hour of electricity produced.

11. b If the market for electricity is divided between two firms, each producing 15 billionkilowatt-hours, then the average cost of producing electricity rises to $0.06 perkilowatt-hour (pointB).

12. d Natural monopoly occurs when firms must make a substantial investment in fixedcosts (for example, machinery and equipment) in order to produce any output. Asoutput increases, the increase in variable cost (marginal cost) is relatively small andaverage fixed cost falls. The net result is that average total cost falls continuallyuntil the entire market is supplied.

13. d In certain markets, cost conditions are such that competition is likely to lead tohigher costs and higher prices. These markets are natural monopolies that are wellserved by one firm.

14. d Like every other firm, a monopoly maximizes profit by producing where marginalrevenue equals marginal cost.

15. c A monopoly differs from other firms in that a monopolys demand curve is thesame as the demand curve for the product. The textbook emphasizes in Chapter 12that the market demand curve for wheat was very different from the demand curvefor the wheat produced by any one farmer. But if that farmer had a monopoly onwheat production, then the two demand curves would be the same.

16. b Firms in perfectly competitive marketssuch as a farmer in the wheat marketface horizontal demand curves. They are price takers. All other firms, includingmonopolies, areprice makers. If they raise their price, they will lose some, but not

all, of their customers. Therefore, they face a downward-sloping demand curve anda downward-sloping marginal revenue curve as well.

17. b When a firm cuts the price of a product, one good thing and one bad thing happen.The good thing: It sells more units of the product. The bad thing: It receives lessrevenue from each unit than it would have received at the higher price.

18. d The monopolist faces a downward-sloping demand and marginal revenue curvessince if the monopolist wants to sell more, it has to reduce the price.

19. b In the long run, the monopolist can earn positive or zero economic profit. Becauseof the barriers to entry, new firms cant enter the market in the long run andcompete away the positive economic profit.

20. b Since the demand curve facing the monopolist is downward sloping, the marginal

revenue curve has to be below the demand curve.21. b Average revenue (AR) equals total revenue (TR) divided by output (Q). For five

subscribers,AR= 225/5 =P= $45.

22. c The marginal revenue of the seventh subscription is $273 $252 = $21.

23. a Demand is conceptually the same as average revenue. Total revenue is equal to thenumber of subscriptions sold per month times the price. Average revenueorrevenue per subscription soldis equal to total revenue divided by the number ofsubscriptions sold.

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24. d Profit equals (P ATC) Q. When six units are produced and sold, this amountequals ($42 ATC) 6. The average cost curve must be shown in order to estimatethe amount of profit.

25. b Profit equals (P ATC) Q. When six units are produced and sold, this amount

equals ($42 $30) 6 = $72.26. b A monopoly will produce the quantity that maximizes profitthat is, the quantity

where marginal revenue equals marginal cost. The monopolist will charge the pricethat consumers are willing to pay as represented by the demand curve.

27. a Price will be higher, and there will be less output under monopoly. Because of this,there will be a decrease in consumer surplus and an increase in producer surplus.

28. a If the industry is perfectly competitive, price and quantity are determined by theintersection of the supply (MC) and demand curves.

29. c The higher price reduces consumer surplus by the area equal to the rectangleAplusthe triangleB. AreaAis a transfer of consumer surplus to producers, and area Bispart of the deadweight loss of monopoly.

30. a AreaArepresents a transfer of consumer surplus to the monopoly.31. d Economic surplus is equal to the sum of consumer surplus plus producer surplus.

By increasing price and reducing the quantity produced, the monopolist hasreduced economic surplus by an amount equal to the areas of the triangles Band C(see Figure 15.5 in the textbook). This reduction in economic surplus is calleddeadweight loss and represents the loss of economic efficiency due to monopoly.

32. b We measure producer surplus as the area above the supply curve and below themarket price. The increase in price due to monopoly increases producer surplus byan amount equal to rectangle A, and reduces it by an amount equal to triangle C.Because rectangleAis larger than triangle C, we know that a monopoly increasesproducer surplus.

33. d We can summarize the effects of monopoly as follows:1. Monopoly causes a reduction in consumer surplus.

2. Monopoly causes an increase in producer surplus.

3. Monopoly causes a reduction in economic efficiency, measured by thedeadweight loss.

34. d The only firms that do not have market power are firms in perfectly competitivemarkets who must charge a price equal to marginal cost.

35. a The monopolist produces less output than the perfectively competitive firm would.

36. b The monopolist charges a higher price than the perfectively competitive firmwould.

37. a The loss in economic efficiency due to market power is small. It is less than 1

percent of the value of total production in the United States, or about $480 perperson.

38. b Since the monopolist faces a downward-sloping demand curve, there will be adeadweight loss for the whole economy.

39. a It is possible to put a dollar value on the loss of economic efficiency by estimatingthe size of the deadweight loss triangleas in Figure 15.5 on page 501 in thetextbook.

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40. b Schumpeter argued that economic progress depended on technological change inthe form of new products. Schumpeter was unconcerned that firms with marketpower would charge higher prices than perfectly competitive firms.

41. a Collusion refers to an agreement among firms to charge the same price or

otherwise not to compete.42. b Antitrust laws are laws aimed at eliminating collusion and promoting competition

among firms.

43. a The Sherman Act prohibited restraint of trade, including price fixing andcollusion, and it outlawed monopolization.

44. c The Robinson-Patman Act prohibited charging buyers different prices if the resultwould reduce competition.

45. a Horizontal mergers are mergers between firms in the same industry. Verticalmergers are mergers between firms at different stages of production of a good.

46. a The government is most concerned with horizontal mergers, or mergers betweenfirms in the same industry, because horizontal mergers are more likely than vertical

mergers to increase market power.47. b When the merger realizes efficiency gains, marginal cost shifts toMC2and the

profit-maximizing level of output becomes Q3with a price ofP3.

48. c In this case, the Herfindahl-Hirschman Index (HHI) is calculated as follows: 252+252+ 252+ 252= 2,500.

49. c To achieve economic efficiency, regulators should require that the monopolycharge a price equal to its marginal cost.

50. b The price P2corresponds to the level required to cover average total cost, whichincludes a normal rate of return.

Short Answer Responses

1. The four-firm concentration ratios for both Industry A and Industry B are 100 percent. The HHI forIndustry A = 752+ 122+ 102+ 32= 5,878. The HHI for industry B = 252+ 252+ 252+ 252= 2,500.The HHI index indicates a higher level of concentration in Industry A than in Industry B because itaccounts for the distribution of market shares among the largest firms in the industries. Concentrationratios do not account for the distribution of market shares among firms.

2. Natural monopolies are characterized by economies of scale so that average costs fall as output rises.If the regulated price was equal to marginal cost, it would be less than average total cost, and the firmwould suffer an economic loss. Investors would demand an interest premium for any funds lent to thefirm, and the firms credit rating would suffer. If the firm was publicly owned, stockholders wouldsell their shares and buy shares of firms that offered a higher return. In the long run, the firm would

go out of business. This may well leave consumers worse off than if they had to pay a price higherthan marginal cost.

3. Joseph Schumpeter argued that the positive economic profits monopolies earn can be used to financeresearch and development that lead to the production of new products and new technologies. Largercompanies may also be effective at developing new products then as well.

4. Your friend is wrong in his argument. The monopolist faces a downward-sloping demand curve, soeven when producing whereMR=MC, there will be a deadweight loss associated with this level of

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output. The monopolist produces less than what the perfectly competitive firm would have producedand charges more, which reduces consumer surplus and economic efficiency. Also, the monopolisthas a market power and can charge a price that is greater than the MC and this causes loss ineconomic efficiency. Further, the monopolist does not produce at the minimum point on its ATCcurve.

5. The main antitrust laws in the United States are:

The Sherman Act: Enacted in 1890, its purpose is to prohibit restraint of trade, including pricefixing and collusion. Also, it outlawed monopolization.

The Clayton Act: Enacted in 1914, its purpose is to prohibit firms from buying stock in competitorsand from having directors serve on the boards of competing firms.

The Federal Trade Commission Act: Enacted in 1914, its purpose is to establish the Federal TradeCommission (FTC) to help administer antitrust laws.

The Robinson-Patman Act: Enacted in 1936, its purpose is to prohibit firms from charging buyers

different prices if the result would reduce competition.

The Cellar-Kefauver Act; Enacted in 1950, its purpose is to toughen restrictions on mergers byprohibiting any mergers that would reduce competition.

True/False AnswersQuestion Answer Comment

1. F Network externalities exist when the usefulness of a product increases with thenumber of consumers using it.

2. T A public franchise is a government designation that a firm is the only legal

provider of a good or service, such as electricity and water.3. T See page 506 in the textbook.

4. F The Sherman Act (1890) contained provisions prohibiting price fixing andcollusion.

5. F Joseph Schumpeter argues that large firms are more readily able to have fundsavailable to use for research and development.

6. F The monopolist can earn positive economic profits in the short run and the longrun. The barriers to entry prevent other firms from entering the market and sharethe profit of the monopolist.

7. F Charging the highest price possible means charging the price at the very top ofthe demand curve and (presumably) selling only one unit. That is rarely the profit-

maximizing price.8. T The monopolist faces the entire market demand curve as it is the only firm

providing the good.

9. T The control of a key resource, in this case the stadium, is a barrier to entry.

10. F A broad definition of monopoly is that there is no other firms selling a substituteclose enough that the firms economic profits are competed away in the long run.

11. T The monopolist produces where MRequals to MC. Since the price is higher thanMR,then the monopolist charges a price that is higher than itsMC.

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CHAPTER 15 | Monopoly and Antitrust Policy422


12. T Generic drugs are drugs that are no longer protected by patents and are producedby a number of pharmaceutical companies.

13. F A merger between firms that produce the same product is a horizontal merger.

14. T See the section The Department of Justice and FTC Merger Guidelines

beginning on page 505 in the textbook.15. F Market power is the ability of the firm to charge a price higher than its marginal

cost.

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