4.2 — Consequences and Causes of Market Power

# 4.2 — Consequences & Sources of Power

## ECON 306 • Microeconomic Analysis • Fall 2022

### Ryan Safner Associate Professor of Economics <a href="mailto:safner@hood.edu">safner@hood.edu</a> <a href="https://github.com/ryansafner/microF22">ryansafner/microF22</a> <a href="https://microF22.classes.ryansafner.com"> microF22.classes.ryansafner.com</a>

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# Outline

### [The Social Harm of Market Power](#4)

### [What *Is* a Monopoly?](#)

### [The Dynamic Benefits of Markets (with Market Power)](#19)

### [What If You’re Just *Better*?](#34)

### [Barriers to Entry](#44)

### [The *Ugly* of Market Power: Rent-Seeking](#59)

### [Antitrust](#75)

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# Market Power: The Good, the Bad, and the Ugly

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.smaller[
- No market is perfectly competitive, but **that does not .ul[necessarily] imply market failure**
  - Static vs. dynamic benefits of markets

- Market power is *interesting*
  - Most firms clearly have *some* market power
  - Market power `$\neq$` bad, necessarily!

- Today, we’ll examine what I call .hi-purple[“the good, the bad, and the ugly” of market power]
  - (but not necessarily in that order)
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# The Social Harm of Market Power

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# Perfectly Competitive Market

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.smallest[
- In a .hi[competitive market] in .hi[long run equilibrium]:
  - .hi-purple[Economic profit] is driven to $0; resources (factors of production) optimally allocated
  - .hi-purple[Allocatively efficient]: `$\color{blue}{p}=\color{red}{MC(q)}$`, maximized .blue[CS] `$+$` .red[PS]
  - .hi-purple[Productively efficient]: `$\color{blue}{p}=\color{orange}{AC(q)_{min}}$` (otherwise firms would enter/exit)
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# The Bad of Monopoly: DWL I

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- Consider an industry with some simplified cost assumptions:

`$$C(q)=cq$$`
 - No fixed cost; `$\color{red}{MC(q)}=\color{orange}{AC(q)} = c$`.magenta[†]

- If this industry were **competitive**, firms would set `$\color{blue}{p_c}=\color{red}{MC(q)}$` and (collectively), industry would produce `$q_c$`
  - Max .blue[consumer surplus], `$\color{green}{\pi=0}$`

.footnote[.magenta[†] Why? [See here](/resources/appendices/2.5-appendix/#common-cost-assumptions) for a reminder.]
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# The Bad of Monopoly: DWL II

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- A **monopolist** would face *entire* industry demand and set `$(q_m,p_m)$`:
  - Set .purple[`\$MR(q)\$`] `$=$` .red[`\$MC(q)\$`]: `$q_m$`
  - Raise `$p$` to .blue[max. WTP (Demand)]: `$p_m$`

- .hi-purple[Restricts output and raises price], compared to competitive market

- Earns .hi-green[monopoly profits (`\$p>AC\$`)]

- Loss of .hi-blue[consumer surplus]

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# The Bad of Monopoly: DWL III

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- **Deadweight loss** of surplus destroyed from lost gains from trade
  - Consumers willing to buy more than `$q_m$`, if the monopolist would lower prices!
  - Monopolist *would* benefit by accepting lower prices to sell more than `$q_m$`, but this would yield *less* than _maximum_ profits
      - main problem is that monopolist must lower price on all units sold

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# The Bad of Monopoly II

- **Deadweight loss** of surplus destroyed from lost gains from trade
  - Consumers willing to buy more than `$q_m$`, if the monopolist would lower prices!
  - Monopolist *would* benefit by accepting lower prices to sell more than `$q_m$`, **but this would yield _less_ than _maximum_ profits**
      - main problem is that monopolist must lower price on all units sold

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# In General

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# What Is a Monopoly?

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# What Is a Monopoly?

- Everyone (economists & the public alike) generally agree that monopoly is bad

- .hi-turquoise[But what *is* a monopoly?]

- A surprisingly difficult question to answer!
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# In Ye Olde Days

Lord Edward Coke

1552—1634

Chief Justice (King's Bench)

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> “A monopoly is an institution or allowance by the king, by his grant, commission, or otherwise...to any person or persons, bodies politic or corporate, for the sole buying, selling, making, working, or using of anything, whereby any person or persons, bodies politic or corporate, are sought to be restrained of any freedom or liberty that they had before, or hindered in their lawful trade,” (181).

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# In Ye Olde Days

> "[A man lives] in a house built with monopoly bricks, with windows...of monopoly glass; heated by monopoly coal (in Ireland monopoly timber), burning in a grate made of monopoly iron...He washed himself in monopoly soap, his clothes in monopoly starch. He dressed in monopoly lace, monopoly linen, monopoly leather, monopoly gold thread...His clothes were dyed with monopoly dyes. He ate monopoly butter, monopoly currants, monopoly red herrings, monopoly salmon, and monopoly lobsters. His food was seasoned with monopoly salt, monopoly pepper, monopoly vinegar...He wrote with monopoly pens, on monopoly writing paper; read (through monopoly spectacles, by the light of monopoly candles) monopoly printed books," (quoted in Acemoglu and Robinson 2011, pp.187-188).

Acemoglu, Daron and James A Robinson, 2013, *Why Nations Fail*]

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# Isn’t a Single Seller a Monopolist?

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- Isn’t the only seller of something a monopolist?
  - A new inventor?
  - An artist?
  - LeBron James?
  - First-mover?
  - The only hardware store in town?
  - The only seafood restaurant?

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# Maybe...Depends on the Price Elasticity!

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.hi-purple[The more (less) price elastically a good, the less (more) market power]: `$L=\frac{p-MC(q)}{p}=-\frac{1}{\epsilon}$`
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# And Recall What Determines Price Elasticity!

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- A main determinant of price elasticity is the .hi-purple[availability of substitutes]!
  - More substitutes `$\rightarrow$` higher elasticity `$\rightarrow$` less market power
  - Universal substitute: not buying!

- So again, it’s .blue[Consumer Demand] all the way down!

- Aside: courts in .hi[antitrust] cases often also focus on the .hi-purple[cross-price elasticities] between goods!
  - helps determine substitutability of a good, where/whether customers will go in response to price hike 
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![](../images/groceryaisle.jpg)
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# And Cross-Price Elasticity!

> “For every product substitutes exist. But a relevant market cannot meaningfully encompass that infinite a range. The circle must be drawn narrowly to exclude any other product to which, within reasonable variations in price, only a limited number of buyers will turn; in technical terms, products whose 'cross-elasticities of demand' are small,” *Times-Picayune Publishing v. United States*, 345 U.S. 594 at 621 n. 31 (1953)

> “Every manufacturer is the sole producer of the particular commodity it makes but its control in the above sense of the relevant market depends on the availability of alternative commodities for buyers: i.e., whether there is a cross-elasticity of demand between cellophane and the other wrappings,” *U.S. v. E. I. du Pont de Nemours &. Co.*, 351 U.S. 377 (1956)

> “Cross-price elasticity is a more useful tool than own-price elasticity in defining a relevant antitrust market. Cross-price elasticity estimates tell one where the lost sales will go when the price is raised, while own-price elasticity estimates simply tell one that a price increase would cause a decline in volume,” *New York v. Kraft General Foods*, 926 F. Supp. 321 (1995)
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# The Dynamic Benefits of Markets (with Market Power)

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# Markets as an Evolutionary Process

Joseph Schumpeter

1883-1950
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.right-column[
.smallest[
> “Capitalism...is by nature a form of economic change and not only never is but never can be stationary...The essential point to grasp is that in dealing with capitalism we are dealing with an .hi[evolutionary process],” (pp.82).

> “[I]n capitalist reality as distinguished from its textbook picture, it is...that kind of competition...from the new commodity, the new technology, the new source of supply, the new type of organization....hi[competition] which commands a decisive cost or quality advantage .hi[which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives],” (p.132).

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# Creative Destruction

Joseph Schumpeter

1883-1950
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> “Industrial mutation—if I may use that biological term—that .hi[incessantly revolutionizes the economic structure from within], incessantly destroying the old one, incessantly creating a new one.  This .hi[process of Creative Destruction is the essential fact about capitalism].  It is what capitalism consists in and what every capitalist concern has got to live in,” (p.83).

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# Creative Destruction: Examples

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![](../images/horsebuggy.png)
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![](../images/car.png)
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# Creative Destruction: Example II

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# Creative Destruction: Example III

59 years of progress
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