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Perfect Competition _ Monopoly Definitions

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Perfect Competition _ Monopoly Definitions Powered By Docstoc
					Profit, Total Revenue, Total Cost
•   Profit = Total Revenue - Total Cost
•   Accounting Profit = Total Revenue - Explicit Costs
•   Economic Profit = Total Revenue - (explicit and implicit cost)
•   Normal Profit - A level of profit that is just sufficient to maintain
    ownership.
•   Total Cost = Explicit + Implicit Costs
•   Total Cost - explicit payments to the factors of production plus the
    opportunity cost of the factors provided by the owner of the firm.
•   Remember, total cost includes the owner’s wage, or a normal rate of
    return to the owner.
   Perfect Competition & Monopoly
                Definitions

• Perfect Competition – A market
  structure characterized by a large
  number of buyers and sellers of an
  identical product.
• Monopoly – A market structure
  characterized by a single seller of a
  highly differentiated (unique) product.
  Price Taker vs. Price Maker
• Market Power – the ability to influence the
  price of a good in the market.
• Price Taker – Buyers and sellers whose
  individual transactions are so small that they
  do not affect market prices.
• Price Maker – Buyers and sellers whose large
  transactions affect market prices. i.e. a firm
  with market power.
• NOTE: Being a price maker does not mean you
  can charge any price you like.
            Perfect Competition
              Characteristics
1.    The number of firms is large.
2.    Free entry and exit - there are no barriers to entry
      Barriers to entry - social, political, or economic impediments
      that prevent other firms from entering a market.
3.    The product is homogenous (i.e. no product differentiation).
4.    There is complete information: buyers and sellers know about
      prices, product quality, and seller location. No seller has an
      advantage over another firm.
5.    Selling firms are profit maximizing firms.
As a result:      A perfectly competitive firm is a price taker.
          Perfect Competition
            Market vs. Firm
• At the market level, the demand curve is
  downward sloping. If prices rise, quantity
  demand will fall. If prices fall, quantity
  demand will rise.
• At the firm level, the demand curve is
  horizontal. Because the firm is too small
  relative to the market, increases in the amount
  the firm produces does not impact the price the
  firm receives in the market.
       Perfect Competition
     Short Run vs. Long Run
• In the short-run economic profit (or loss)
  is possible.
• In the long-run, competitive pressures
  will cause the typical firm to earn zero
  economic profits.
                Monopoly
              Characteristics
1. There is one seller
   –   [as opposed to many small sellers]
2. Product is unique
   –   [as opposed to a homogenous good]
3. Blockaded entry and exit
   –   [as opposed to free entry and exit]
4. Imperfect information
   –   [as opposed to perfect information]
5. Firm is a profit maximizer
As a result, the firm is a price maker
            Monopoly Myths
• Myth one:      Monopolies can charge
  whatever price they wish.
  – A monopoly is constrained by its level of demand.
• Myth Two:      A monopoly always makes an
  economic profit.
  – If demand is insufficient, P < ATC, and the firm will
    not make an economic profit.
  – If all monopolies made an economic profit, each
    small town would have the same assortment of
    goods and services offered in a larger city.
      Social Costs of Monopoly
• Deadweight Loss
   – Consumer surplus - the difference between the
     maximum price a buyer is willing and able to pay
     for a good or service and the price actually paid.
   – CS = Maximum buying price - price paid
• Rent-seeking - actions of individuals and
  groups who spend resources to influence public
  policy in the hope of redistributing income to
  themselves from others.
• X-inefficiency
• Price discrimination - to charge different prices
  to different individuals or groups of individuals
               Price Discrimination
•   Price discrimination - to charge different prices to different individuals or groups
    of individuals.
•   First Degree Price Discrimination - the process of charging each consumer the
    maximum she or he is willing to pay.
     – Transfers all dead weight loss to the firm
     – Only possible if the firm knows the maximum price each person will pay.
•   Second Degree of Price Discrimination - charging consumers different prices based
    upon the quantity the consumer consumes.
     – Occurs when a firm charges different prices depending upon how many tickets
         the consumer buys.
     – Takes advantage of the fact demand curve is downward sloping, which
         indicates that people will be willing to pay less per ticket as the quantity
         purchased increases.
•   Third Degree of Price Discrimination - occurs when a firm charges different prices
    for the same good in different segments of the market.
     – Occurs when a firm charges different prices to students and/or senior citizens.
     – Higher prices are charged to the least responsive demand. Lower prices are
         charged to those with the most responsive demand.
              In Defense of Monopoly
• Are professional sports a monopoly? Depends upon
  how one defines the market.
• Are professional sports a natural monopoly?
   – A team has high fixed costs and low variable costs. Hence
     expansion in output will lower average total cost.
   – An entrant, with less output, will be unable to produce at a
     lower per-unit cost.
   – Review the work of Walter Neale (1964)
• As a monopoly, professional teams can invest in player
  development, much more so than competitive firms.
      Basic Anti-Trust History
•    Origins of Anti-Trust Laws
1.   Firms increase in size
2.   Increase in the number of mergers
3.   Political issues
       Sherman Anti-Trust Law
• Sherman Anti-trust Act (1890)
• Section I: Every contract, combination in the form of
  trust or otherwise, or conspiracy, in restraint of trade
  or commerce among the several states or with foreign
  nations is hereby declared to be illegal.
• Section II: Every person who shall monopolize or
  attempt to monopolize, or combine or conspire to
  monopolize any part of the trade or commerce among
  the several States, or with foreign nations, shall be
  deemed guilty...and....punished.
• Section IV: Attorney general is authorized to institute
  lawsuits against offenders
• Section VII: Allows injured parties to bring suit for
  recovery of triple damages against offenders of Section
  I and II.
     Problems with the Sherman
           Anti-Trust Act
• Monopolizing vs. Monopoly
  Is the existence of monopoly a crime? The Act forbids
  monopolizing, not monopoly.
• The ‘Rule of Reason’ Initially the courts only acted
  against monopoly that was created via an
  ‘unreasonable restraint of trade.’ What is considered
  ‘unreasonable’ though, varies from court to court.
          The Federal League Case
•   The Federal League challenged the AL and NL from 1914-1915. The
    league was favored by the players, who saw salaries drop after the AL and
    NL ‘merger’ in 1903.
•   The Federal League sued baseball, in the court of Judge Kenesaw
    Mountain Landis, a noted trustbuster. Unfortunately, Landis was a big
    baseball fan.
•   Landis stalled until MLB reached an agreement with every owner, but
    one, of the Federal League.
•   The lone holdout was Ned Hanlon of the Baltimore franchise whose
    buyout offer was less than other Federal League owners.
•   Baltimore won its case in court, but the decision was over turned in
    appeals on the grounds that major league baseball was not interstate
    commerce. The Supreme Court agreed with this position.
•   The Federal League decision, though, was not allowed as an argument by
    the Supreme Court with respect to any other industry or sport.
               The Toolson Case
• George Toolson was a player in the Yankee system, who refused
  assignment to the minor leagues. He then sued the Yankees,
  claiming the reserve clause violated anti-trust laws.
• As the case went through the courts, the House Subcommittee on
  the Study of Monopoly Power (chaired by Rep. Emmanuel Cellar)
  began reviewing baseball’s anti-trust exemption.
• When it became clear the Toolson case was going to the Supreme
  Court, the Cellar Committee postponed action.
• The Supreme Court ruled that the inaction of the Cellar
  Committee signaled approval from Congress of the exemption.
  Hence the Supreme Court ruled in favor the Yankees.
• The Supreme Court later repeated this action in the Curt Flood
  case, heard in the early 1970s.
     The Anti-Trust Exemption
•    The anti-trust immunity remained in force until July 30, 1999 (Curt
     Flood Act), where it was revoked for labor relations.
•    Why did the courts not reverse their earlier decision? In essence the
     court argued that this was a matter for Congress to determine, not the
     courts.
•    What has been the impact of this immunity?

1.   Ending the reserve clause was a difficult process because of the
     immunity.
2.   Baseball has been able to prevent franchise relocation, a power not held
     by the other major sports leagues.

•    Pete Rozelle was able to get a limited exemption from Congress in order
     to negotiate a broadcast agreement between the NFL and network
     television.
•    What does the Rozelle exemption accomplish? Higher prices for NFL
     broadcast rights, which leads to higher revenues and higher salaries.

				
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