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					         Chapter 9: Competition
         and Government Policy
   “Perfect competition” is an imaginary state of
       Very many buyers and sellers
       Everybody knows all the relevant information
       Everybody produces exactly the same product
       Capital can be moved around without cost
       Result: zero economic profits
   While this is helpful for thinking about
    markets, it’s not at all realistic
       Ignores the process by which markets get to
        Competition is a process,
          not a state of affairs
   In the real world, buyers and sellers often
    bargain or haggle about what would be an
    agreeable price.
       There is no way to predict how bargaining will
        turn out.
       Some economists just ignore bargaining
        because they can’t attach numbers to it
       Ignoring bargaining is a major error (p. 207)
               Restricting entry
   Competition is tough, and many business
    people just wish their competition would go
    away. There are basically two ways to make
    this happen:
       Form a cartel – a group of sellers who agree to
        fix prices among themselves
       Get the government to exclude or restrict
   A cartel is a group of sellers who agree to
    maintain their price above the market-
    clearing price.
       This would ordinarily result in surpluses
       In order to clear the market they must agree to
        restrict sales – shift the supply curve left
       Cartels tend to be unstable because of the
        temptation to cheat.
           Example of a cartel
   Five manufacturers each sell 2,000 widgets
    per year (total 10,000) at $5 each, with
    marginal costs of $4 each.
   Each makes a profit of 2,000*(5-4) = $2,000
    per year
   They get together and agree that everyone
    will raise their asking price to $6
   They discover that at $6 the quantity
    demanded is only 8,000
   They agree that each will produce only 1,600
    per year so as to clear the market
              Example of a cartel
   Each now makes a profit of 1600*(6-4) =
   Everyone is happy until one seller decides to
    cheat. He offers 1,800 for sale instead of his
    quota of 1,600.
       If he can get $6 each for the extra 200, his profit
        increases by 200*(6-4)=$1,200 for a total profit
        of $4,400.
       He hopes the others don’t notice
       He hopes the added quantity supplied doesn’t
        pull prices down noticably
   In addition to the possibility of cheating, there
    is always the possibility of competition from
    outside the Cartel
   Cartels are like government-mandated price
    floors except
       They cannot be legally enforced (why not?)
       They cannot legally punish “cheaters”
   Cartels are possible and occasionally happen
    but they are unstable
       OPEC does not work very well as a cartel
            Predatory pricing
   A large firm lowers prices and endures
    temporary losses for the sake of driving a
    competitor out of business.
   Once the competitor is gone, the big firm
    then raises prices and profits, enough to
    recover losses during the predatory period
    Example of predatory pricing
   Bigfirm, Inc. sells 1,000 widgets per year at $10 each with
    $8 cost per unit, no fixed cost. Annual profit $2,000
   Bigfirm, Inc. has $10,000 in the bank
   Lilfirm, Inc. sells 200 widgets per year at $10 each with $8
    cost per unit, no fixed cost. Annual profit $400
   Lilfirm, Inc. has $1,000 in the bank
   Bigfirm lowers price to $7 per unit. Quantity demanded
    increases to 1,200 per year. Bigfirm profit is 1200*(7-8) =
    $1,200 loss per year
   Lilfirm matches the $7 price. Sells 250 per year, loss =
    250*(7-8) = $250 loss per year
   After four years of losses Lilfirm has depleted its bank
    account and goes out of business
   Bigfirm has drawn its bank account down from $10,000 to
    $5,200 (four years of losses at $1,200 per year)
    Example of predatory pricing
   Now that Lilfirm is gone, Bigfirm raises its price to $12,
    quantity demanded drops to 800 per year, profit = 800*(12-
    8) = $3,200 per year
   Bigfirm uses its profits to replenish its bank account and
    reward its management and shareholders
   Why predatory pricing usually fails:
      Bigfirm can’t be sure how long Lilfirm can hang on
      Bigfirm can only guess the demand for its widgets
           Quantity demanded may be higher than expected

            during the loss phase
           Quantity demanded may be lower than expected after

            Lilfirm is gone
      Lilfirm’s assets could be purchased by a new firm which
       could then enter the market
                Restricting entry
   Examples, p. 209 & 210
   Other examples
       Interior decorators in Arizona
       Florists in Louisiana
   State licensing
       Premise: protect consumers from incompetent
       Reality: destroy competition and raise prices
       Civil engineers
       Marriage & family therapists
       Institute for Justice
    Summary of ways to restrict
   Cartels (a free market activity)
       Possible but unstable
   Predatory pricing (a free market activity)
       Possible but difficult to succeed
   Monopoly grants (a government activity)
       Can work well, to the detriment of consumers
   Licensing (a government activity)
       Can work well, to the detriment of consumers
            Selling “below cost”
   Banana example p. 213
   The relevant cost for decision making is the
    marginal cost of the action being considered,
    not sunk cost: looking ahead, not back.
   The fact that the grocer paid 25¢ each is
    irrelevant to the question of what price to ask,
    now that they’re turning brown.
       20¢?
       10¢?
       Free?
       Pay someone to haul them off?
               “Antitrust” policy
   Stated intent:
       Intervene in markets to prevent or reduce harm
        to consumers
   Historical reality:
       Intimidation of productive business firms, huge
        waste of money on lawyers, etc.
       Example: Standard Oil
       Example: Alcoa
       Example: General Motors
       Example: IBM
       Example: Microsoft
               “Antitrust” policy
   Restraint of mergers and takeovers
       Horizontal mergers: two similar firms combine
       Vertical mergers: one firm is a supplier to
        another. The firms combine
   Manufacturer control of retail prices
       Example: Apple forbids retail sales of computers
        below prices it sets
       Possible benefit to consumers: assurance that
        retailers will provide training, service, etc.
        Discounters could undercut these services
       This practice was mandatory at one time
       Then it was made illegal
    What about one gigantic firm
      that owns everything?
   In the 1890’s Standard Oil bought out the
    majority of the small refineries that competed
    with it.
   Without anti-trust laws, what would stop a
    huge firm from buying more and firms until it
    controlled all production?
   Answer:
       Without competition there can be no price
       Without market-determined prices, there would
        be tremendous waste
       With freedom of entry, new firms would re-enter
      Present state of anti-trust
   Very little anti-trust activity since the
    Microsoft case in the 1990’s
   May be more activity under current
    administration (IBM?)
   European regulators claim jurisdiction over
    American firms like Microsoft and Oracle

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