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The Fragility of Monopoly Power

24 April, 2015 - 15:42

An important factor in thinking about public policy toward monopoly is to recognize that monopoly power can be a fleeting thing. Firms constantly seek out the market power that monopoly offers. When conditions are right to achieve this power, firms that succeed in carving out monopoly positions enjoy substantial profits. But the potential for high profits invites continuing attempts to break down the barriers to entry that insulate monopolies from competition.

Technological change and the pursuit of profits chip away constantly at the entrenched power of monopolies. Breathtaking technological change has occurred in the telecommunications industry. Catalog companies are challenging the monopoly positions of some retailers; internet booksellers and online textbook companies such as Flatworldknowledge.com are challenging the monopoly power of your university’s bookstore; and Federal Express, UPS, and other companies are taking on the U.S. Postal Service. The assaults on monopoly power are continuous. Thus, even the monopoly firm must be on the lookout for potential competitors.

Potential rivals are always beating at the door and thereby making the monopoly’s fragile market contestable—that is, open to entry, at least in the sense of rival firms producing “close enough,” if not perfect, substitutes—close enough that they might eliminate the firm’s monopoly power.

KEY TAKEAWAYS

  • A monopoly firm produces an output that is less than the efficient level. The result is a deadweight loss to society, given by the area between the demand and marginal cost curves over the range of output between the output chosen by the monopoly firm and the efficient output.
  • The higher price charged by the monopoly firm compared to the perfectly competitive firm reduces consumer surplus, part of which is transferred to the monopolist. This transfer generates an equity issue.
  • The monopoly firm’s market power reduces consumers’ choices and may result in higher prices, but there may be advantages to monopoly as well, such as economies of scale and technological innovations encouraged by the patent system.
  • Public policy toward monopoly consists of antitrust laws and regulation of natural monopolies.
  • Forces that limit the power of monopoly firms are the constant effort by other firms to capture some of the monopoly firm’s profits and technological change that erodes monopoly power.

TRY IT !

Does the statement below better describe a firm operating in a perfectly competitive market or a firm that is a monopoly?

  • The demand curve faced by the firm is downward-sloping.
  • The demand curve and the marginal revenue curves are the same.
  • Entry and exit are relatively difficult.
  • The firm is likely to be concerned about antitrust laws.
  • Consumer surplus would be increased if the firm produced more output.

Case in Point: Technological Change, Public Policy, and Competition in Telecommunications

Back in the olden days—before 1984—to use a telephone in the United States almost certainly meant being a customer of AT&T. Ma Bell, as the company was known, provided local and long-distance service to virtually every U.S. household. AT&T was clearly a monopoly.

The Justice Department began its battle with AT&T in the 1970s, charging it with monopolizing the industry. The case culminated in a landmark 1984 ruling that broke the company up into seven so-called “Baby Bells” that would provide local telephone service. AT&T would continue to provide long-distance service.

In effect, the ruling replaced a single national monopoly with seven regional monopolies in local telephone service. AT&T maintained its monopoly position in long-distance service—for a while. The turmoil that has followed illustrates the fragility of monopoly power.

Technological developments in the industry have brought dramatic changes. Companies like MCI found ways to challenge AT&T’s monopoly position in long-distance telephone service. Cable operators sprang up, typically developing monopoly power over the provision of cable television in their regional markets. But, technological change has eroded the monopoly power of local telephone companies and of cable operators. Cable companies have begun providing telephone service in competition with local telephone companies, telephone companies have begun providing cable services as well as Internet access, and the introduction of wireless communications has further blurred the distinction between different types of companies. Now, the ready availability of video services on the Internet threatens to make cable providers outmoded middlemen.

The Diffusion Group, a firm that provides analysis of the telecommunications industry, predicts that by 2010 more than 300 million households worldwide will have high-speed Internet access and will thus be able to take advantage of increasing availability of video services on the Internet.

“When you go back to the early 1980s, we were talking about a single product,” Duane Ackerman, CEO of BellSouth told The Wall Street Journal. “Since then, there has been a tremendous explosion of technology. It has changed everything.”

Cable companies once had two-thirds of the market for television services. Today, telephone companies are making inroads into that market. In 2005, telephone companies picked up more television customers than cable companies did. The fierce competition has been reflected in the falling stock prices of cable companies. Comcast Corp., the largest cable company in the United States with 22 million subscribers, suffered a 22% reduction in its stock price in 2005. Mediacom, the seventh largest cable company, had a 33% reduction in its stock price between 2004 and 2006. By 2008, their stock prices have still not recovered.

Already, Time Warner, a cable company that charges its customers $39.95 per month, is offering customers that call to cancel their service to switch to another provider a discount to $29.95. “It’s a save tactic,” admits company spokesperson Mark Harrad. It may be that, but it surely appears to be a harbinger of what is coming to

Sources: Peter Grant and Amy, Schatz, “For Cable Giants, AT&T Deal Is One More Reason to Worry,” The Wall Street Journal Online, March 7, 2006, A1. Dionne Searcey, Amy Schatz, Almar LaTour and Dennis K. Berman, “A Reborn AT&T to Buy BellSouth,” The Wall Street Journal Online, March 6, 2006, A1. Sara Silver, Dennis K. Berman, and Leila cs Abroud, “In Lucent Deal, Two Rivals Face Inroads from China,” The Wall Street Journal Online, March 25, 2006, A1;Sara Silver, Dennis K. Berman, and Leila cs Abroud, “In Lucent Deal, Two Rivals Face China,” The Wall Street Journal Online, March 25, 2006, A1.

ANSWERS TO TRY IT ! PROBLEMS

  1. monopoly
  2. perfect competition
  3. monopoly
  4. monopoly
  5. monopoly