Fourth Edition - pearsoncmg.com

Fourth Edition - pearsoncmg.com

R. GLENN HUBBARD OBRIEN ANTHONY PATRICK Economics FOURTH EDITION CHAPTER 1 5 Monopoly and Antitrust Policy Chapter Outline and Learning Objectives 15.1 Is Any Firm Ever Really a Monopoly? 15.2 Where Do Monopolies Come From? 15.3 How Does a Monopoly Choose Price and Output? 15.4 Does Monopoly Reduce

Economic Efficiency? 15.5 Government Policy toward Monopoly 2013 Pearson Education, Inc. Publishing as Prentice Hall 2 of 44 Is Cable Television a Monopoly? The first cable systems were established in the 1940s offering just a few channels, and by 1970, only about 7 percent of households had cable television. In the late 1970s, Congress loosened regulations on rebroadcasting distant stations and charging for premium channels, but the city government requires a firm to obtain a license to enter a local cable television market. Although few firms in the United States are monopolies, Time Warner Cable had a monopoly until 2008 because it was the only provider of cable TV in the Manhattan borough of New York City. Its very difficult for a firm to remain the only provider of a good or service because usually in a market system, whenever a firm earns economic profits, other firms will enter its market. AN INSIDE LOOK AT POLICY on page 510 discusses the entry of Verizon into the market for cable TV in upstate New York to compete with Time Warner Cable. 2013 Pearson Education, Inc. Publishing as Prentice Hall

3 of 44 Economics in Your Life Why Cant I Watch the NFL Network? Are you a fan of the National Football League? Would you like to see more NFL-related programming on television? If so, youre not alone. The NFL concluded that there was so much demand for more football programming that it began its own football network, the NFL Network. Unfortunately for many football fans, the NFL Network is not available to many households that have cable television, including, as of August 2011, Time Warner Cable that serves the majority of cable customers in New York, the largest television market in the United States. See if you can answer these questions by the end of the chapter: Why are some of the largest cable TV systems unwilling to include the NFL Network in their channel lineups? Why are some systems requiring customers who want the NFL Network to upgrade to more expensive channel packages? 2013 Pearson Education, Inc. Publishing as Prentice Hall 4 of 44 The economic model of monopoly provides a benchmark for the extreme where a firm is the only one in its market and, therefore, faces no competition from other firms supplying its product.

The monopoly model is also useful in analyzing situations in which firms agree to collude, or not compete, and act together as if they were a monopoly. 2013 Pearson Education, Inc. Publishing as Prentice Hall 5 of 44 Is Any Firm Ever Really a Monopoly? 15.1 LEARNING OBJECTIVE Define monopoly. Monopoly A firm that is the only seller of a good or service that does not have a close substitute. 2013 Pearson Education, Inc. Publishing as Prentice Hall 6 of 44 Making Is Google a Monopoly? the

Connection The federal government can take legal action against a firm under the antitrust laws if it believes that the firm has created a monopoly. In 2011, Microsoft filed a complaint with the European Commission that Google was using its dominant position as an Internet search engine to create an effective monopoly by excluding competitors, and the U.S. Federal Trade Commission (FTC) indicated that it was investigating whether Google had violated the antitrust laws. Google argues that its dominant market share is due to the higher quality of its search engine, not any attempts the company has made to reduce the access of other search engines to online content. While Google is not the only Internet search option available, many economists consider a firm to have a monopoly if other firms are unable to compete away its profits in the long run. MyEconLab Your Turn: Test your understanding by doing related problems 1.7 and 1.8 at the end of this chapter. 2013 Pearson Education, Inc. Publishing as Prentice Hall 7 of 44

Where Do Monopolies Come From? 15.2 LEARNING OBJECTIVE Explain the four main reasons monopolies arise. 2013 Pearson Education, Inc. Publishing as Prentice Hall 8 of 44 Barriers to entry may be high enough to keep out competing firms for four main reasons: 1. A government blocks the entry of more than one firm into a market. 2. One firm has control of a key resource necessary to produce a good. 3. There are important network externalities in supplying the good or service. 4. Economies of scale are so large that one firm has a natural monopoly. Government Action Blocks Entry In the United States, governments block entry in two main ways: 1. By granting a patent or copyright to an individual or a firm, giving it the exclusive right to produce a product 2. By granting a firm a public franchise, making it the exclusive legal provider of a good or service 2013 Pearson Education, Inc. Publishing as Prentice Hall 9 of 44

Patents, Copyrights, and Public Franchises Patent The exclusive right to a product for a period of 20 years from the date the patent is filed with the government. Pharmaceutical firms apply for patents about 10 years before they begin to sell a new prescription drug, after which most earn economic profits for 20 years. After the patent has expired, other firms are free to legally produce chemically identical drugs called generic drugs, whose competition will eliminate the increasing profits the original firm had been earning during the time remaining on the patent, which is usually about 10 years. Copyright A government-granted exclusive right to produce and sell a creation. After a creators death, his or her heirs retain this exclusive right for 70 years. Public franchise A government designation that a firm is the only legal provider of a good or service. Public enterprises, through which governments may decide to provide certain services directly to consumers rather than rely on private firms, are more common in Europe than in the United States. 2013 Pearson Education, Inc. Publishing as Prentice Hall 10 of 44 Making the The End of the Christmas Plant Monopoly

Connection For many years, the Paul Ecke Ranch in Encinitas, California had a monopoly on poinsettias, whose striking red and green colors that blossom in the winter make them ideal for Christmas decorating. After discovering a new technique for growing the wildflower that was kept secret for decades, the Ecke family was able to maintain a monopoly on its commercial production without acquiring a patent, until a university researcher discovered the technique and published it in an academic journal. As a result, many new firms quickly entered the industry and the price of poinsettias plummeted. MyEconLab Your Turn: Test your understanding by doing related problem 2.10 at the end of this chapter. 2013 Pearson Education, Inc. Publishing as Prentice Hall 11 of 44 Control of a Key Resource Most resources, including raw materials such as oil or iron ore, are widely available from a variety of suppliers, but before World War II, the Aluminum Company of America (Alcoa) and the International Nickel Company of Canada

were two monopolies based on control of a key resource. Network Externalities Network externalities A situation in which the usefulness of a product increases with the number of consumers who use it. From a firms point of view, network externalities can set off a virtuous cycle: If a firm can attract enough customers initially, it can attract additional customers because the value of its product has been increased by more people using it, which attracts even more customers, and so on. 2013 Pearson Education, Inc. Publishing as Prentice Hall 12 of 44 Making the Are Diamond Profits Forever? The De Beers Diamond Monopoly Connection The most famous monopoly based on control of a raw material is the De Beers diamond mining and marketing company of South Africa,

which became one of the most profitable and longestlived monopolies in history by carefully controlling the supply of diamonds to keep prices high. As competition in the diamond business gradually increased over the years, De Beers abandoned its strategy of attempting to control the worldwide supply of diamonds, concentrating instead on differentiating its diamonds by marking each one with a microscopic branda Forevermark. Other firms have followed suit by branding their diamonds. Whether consumers will pay attention to brands on diamonds remains to be seen, although through 2011, the branding strategy had helped De Beers to maintain a 35 to 40 percent share of the diamond market. MyEconLab Your Turn: Test your understanding by doing related problem 2.11 at the end of this chapter. 2013 Pearson Education, Inc. Publishing as Prentice Hall 13 of 44 Natural monopoly A situation in which economies of scale are so large that one firm can supply the entire market at a lower average total cost than can two or more firms. Figure 15.1 Average Total Cost Curve for a Natural Monopoly With a natural monopoly,

the average total cost curve is still falling when it crosses the demand curve (point A). If only one firm is producing electric power in the market, and it produces where the average cost curve intersects the demand curve, average total cost will equal $0.04 per kilowatt-hour of electricity produced. If the market is divided between two firms, each producing 15 billion kilowatt-hours, the average cost of producing electricity rises to $0.06 per kilowatt-hour (point B). In this case, if one firm expands production, it can move down the average total cost curve, lower its price, and drive the other firm out of business. 2013 Pearson Education, Inc. Publishing as Prentice Hall 14 of 44 Solved Problem 15.2 Is the OpenTable Web Site a Natural Monopoly? OpenTable is a Web site and smartphone application that allows people to make restaurant reservations online, charging participating restaurants a fee for each reservation.

Business writer James Stewart argued that the site is a natural monopoly because users are attracted to the site with the largest number of listings, and restaurants are attracted to the site with the largest number of users. a. Assuming that Stewart is correct, draw a graph showing the market for online restaurant reservation sites. Be sure that the graph contains the demand for online restaurant reservations and OpenTables average total cost curve. Explain why OpenTable would have lower average costs than would a new site that enters the market to compete against it. b. Does the number of years OpenTable has been operating affect how you evaluate Stewarts claim that the business is a natural monopoly? Briefly explain. Solving the Problem Step 1: Review the chapter material. 2013 Pearson Education, Inc. Publishing as Prentice Hall 15 of 44 Solved Problem 15.2 Is the OpenTable Web Site a Natural Monopoly? Step 2: Answer part a. by drawing a natural monopoly graph and explaining why OpenTable would have lower average costs than new entrants to the market. If Stewart is correct that OpenTable is actually a natural monopoly, the relationship between market demand and its average total costs should look like Figure 15.1.

Make sure your average total cost curve is still declining when it crosses the demand curve. The market for online reservations is a natural monopoly because if one firm can supply Q1 online reservations at an average total cost of ATC1, then dividing the business equally between two firms each supplying Q2 online reservations would raise average total cost to ATC2. OpenTables fixed costs for servers, software programming, and marketing are very large relative to its variable costs, but its marginal cost of accommodating one more visitor to its site will be extremely small. Therefore, economies of scale in this market are likely to be so large that a firm that enters and attracts a small number of visitors to its site will have much higher average costs than OpenTable. 2013 Pearson Education, Inc. Publishing as Prentice Hall 16 of 44 Solved Problem 15.2 Is the OpenTable Web Site a Natural Monopoly? Step 3: Answer part b. by discussing whether how long OpenTable has been in business is relevant to assessing whether it is a natural monopoly.

If a firm is a natural monopoly, it is unlikely that firms will be able to successfully enter its market. A firm that is the first to enter a new market may not initially attract potential competitors because it can take time for them to decide whether it would be profitable to enter the industry, particularly one that might require a substantial initial investment. The longer OpenTable continues to operate without significant competition, the more likely the firm actually is a natural monopoly and that other restaurant owners will see it as such. Keep in mind that competition is good when it leads to lower costs, lower prices, and better products, but when cost conditions in certain markets are such that competition is likely to lead to higher costs and higher prices, these markets are natural monopolies that are best served by one firm. Advances in technology or innovative marketing may make it possible for other firms to successfully compete with OpenTable. MyEconLab Your Turn: For more practice, do related problem 2.12 at the end of this chapter. 2013 Pearson Education, Inc. Publishing as Prentice Hall 17 of 44 How Does a Monopoly Choose Price and Output? 15.3 LEARNING OBJECTIVE

Explain how a monopoly chooses price and output. 2013 Pearson Education, Inc. Publishing as Prentice Hall 18 of 44 A monopoly differs from other firms in that a monopolys demand curve is the same as the demand curve for the product. Marginal Revenue Once Again Recall that firms in perfectly competitive markets are price takers because they face horizontal demand curves. All other firms, including monopolies, are price makers because they face a downward-sloping demand curve as well as a downward-sloping marginal revenue curve. Remember that when a firm cuts the price of a product, one good thing happens, and one bad thing happens: The good thing. It sells more units of the product. The bad thing. It receives less revenue from each unit than it would have received at the higher price.

2013 Pearson Education, Inc. Publishing as Prentice Hall 19 of 44 Figure 15.2 Calculating a Monopolys Revenue Time Warner Cable faces a downward-sloping demand curve for subscriptions to basic cable. To sell more subscriptions, it must cut the price. When this happens, it gains revenue from selling more subscriptions but loses revenue from selling them at a lower price than it could have. The firms marginal revenue is the change in revenue from selling another subscription. We can calculate marginal revenue by subtracting the revenue lost as a result of a price cut from the revenue gained. The table shows that Time Warners marginal revenue is less than the price for every subscription sold after the first subscription. Therefore, Time Warners marginal

revenue curve will be below its demand curve. 2013 Pearson Education, Inc. Publishing as Prentice Hall 20 of 44 Figure 15.3 Profit-Maximizing Price and Output for a Monopoly Panel (a) shows that to maximize profit, Time Warner should sell subscriptions up to the point where the marginal revenue from selling the last subscription equals its marginal cost (point A). In this case, the marginal revenue from selling the sixth subscription and the marginal cost are both $27. Time Warner maximizes profit by selling 6 subscriptions per month and charging a price of $42 (point B). In panel (b), the green box represents Time Warners profit. The box has a height equal to $12, which is the price of $42 minus the average total cost of $30, and a base equal to the quantity of 6 cable subscriptions. Time Warners profit therefore equals $12 6 = $72. 2013 Pearson Education, Inc. Publishing as Prentice Hall 21 of 44 Solved Problem 15.3 Finding the Profit-Maximizing Price and Output for a Monopolist Suppose that Comcast has a cable monopoly in Philadelphia. Total Revenue Marginal Revenue

(MR = TR/Q) Price Quantity Total Cost $27 3 $56 26 4 73 25 5 91

24 6 110 23 7 130 22 8 151 Marginal Cost (MC = TC/Q) The table above gives Comcasts demand and costs per month for subscriptions to basic cable (for simplicity, we once again keep the number of subscribers artificially small). a. Fill in the missing values in the table. b. If Comcast wants to maximize profits, what price should it charge, and how many cable subscriptions per month should it sell?

How much profit will Comcast make? Briefly explain. c. Suppose the local government imposes a $25-per-month tax on cable companies. Now what price should Comcast charge, how many subscriptions should it sell, and what will its profits be? 2013 Pearson Education, Inc. Publishing as Prentice Hall 22 of 44 Solved Problem 15.3 Finding the Profit-Maximizing Price and Output for a Monopolist Suppose that Comcast has a cable monopoly in Philadelphia. Total Revenue $81 Marginal Revenue (MR = TR/Q) Total Cost Marginal Cost (MC = TC/Q) Price

Quantity $27 3 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 $56 Solving the Problem Step 1: Review the chapter material. Step 2: Answer part a. by filling in the missing values in the table. To calculate marginal revenue and marginal cost, you must divide the change in total revenue or total cost by the change in quantity. We dont have enough information from the table to fill in the values for marginal revenue and marginal cost in the first row. 2013 Pearson Education, Inc. Publishing as Prentice Hall

23 of 44 Solved Problem 15.3 Finding the Profit-Maximizing Price and Output for a Monopolist Suppose that Comcast has a cable monopoly in Philadelphia. Total Revenue $81 Marginal Revenue (MR = TR/Q) Total Cost Marginal Cost (MC = TC/Q) Price Quantity $27 3

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 $56 Step 3: Answer part b. by determining the profit-maximizing quantity and price. The information in the table tells us that Comcast will maximize profits by selling 6 subscriptions at a price of $24 each, where marginal cost equals marginal revenue. Comcasts profits are equal to the difference between its total revenue and its total cost: Profit = $144 $110 = $34 per month. Step 4: Answer part c. by analyzing the impact of the tax. The $25 tax is a fixed cost that doesnt affect Comcasts marginal revenue, marginal cost, or profit-maximizing level of output. So, Comcast will still sell 6 subscriptions per month at a price of $24, but its profits will fall by the amount of the tax, from $34 per month to $9. MyEconLab Your Turn: For more practice, do related problems 3.4 and 3.5 at the end of this chapter. 2013 Pearson Education, Inc. Publishing as Prentice Hall

24 of 44 If other factors remain unchanged, monopolists can continue to earn economic profits, even in the long run, without facing competition; new firms will not enter the market. Dont Let This Happen to You Dont Assume That Charging a Higher Price Is Always More Profitable for a Monopolist In addition to marginal revenue and marginal cost, a monopolist must pay attention to consumer demand to determine whether the price is maximizing profit. MyEconLab Your Turn: Test your understanding by doing related problem 3.8 at the end of this chapter. 2013 Pearson Education, Inc. Publishing as Prentice Hall 25 of 44 Does Monopoly Reduce Economic Efficiency? 15.4 LEARNING OBJECTIVE Use a graph to illustrate how a monopoly affects economic efficiency. 2013 Pearson Education, Inc. Publishing as Prentice Hall

26 of 44 Equilibrium in a perfectly competitive market results in the greatest amount of economic surplus, or total benefit to society, from the production of a good or service. Comparing Monopoly and Perfect Competition A monopoly will produce less and charge a higher price than would a perfectly competitive industry producing the same good. 2013 Pearson Education, Inc. Publishing as Prentice Hall 27 of 44 Figure 15.4 What Happens If a Perfectly Competitive Industry Becomes a Monopoly? In panel (a), the market for tablet computers is perfectly competitive, and price and quantity are determined by the intersection of the demand and supply curves. In panel (b), the perfectly competitive tablet computer industry becomes a monopoly. As a result: 1. The industry supply curve becomes the monopolists marginal cost curve. 2. The monopolist reduces output to where marginal revenue equals marginal cost, QM. 3. The monopolist raises the price from PC to PM. 2013 Pearson Education, Inc. Publishing as Prentice Hall

28 of 44 Measuring the Efficiency Losses from Monopoly Recall that consumer surplus measures the net benefit received by consumers from purchasing a good or service, and that producer surplus measures the net benefit to producers from selling a good or service. The sum of consumer surplus plus producer surplus equals economic surplus, a reduction in which is called deadweight loss and represents the loss of economic efficiency. 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 deadweight loss, which represents a reduction in economic efficiency. 2013 Pearson Education, Inc. Publishing as Prentice Hall 29 of 44 Figure 15.5 The Inefficiency of Monopoly A monopoly charges a higher price, PM, and produces a smaller quantity, QM, than a perfectly competitive industry,

which charges price PC and produces QC. The higher price reduces consumer surplus by the area equal to the rectangle A and the triangle B. Some of the reduction in consumer surplus is captured by the monopoly as producer surplus, and some becomes deadweight loss, which is the area equal to triangles B and C. 2013 Pearson Education, Inc. Publishing as Prentice Hall 30 of 44 How Large Are the Efficiency Losses Due to Monopoly? Market power The ability of a firm to charge a price greater than marginal cost. The only firms that do not have market power are firms in perfectly competitive markets, which must charge a price equal to marginal cost. Because few markets are perfectly competitive, some loss of economic efficiency occurs in the market for nearly every good or service, yet this loss is small since

true monopolies are rare. Competition keeps price much closer to marginal cost in most industries. The closer price is to marginal cost, the smaller the size of the deadweight loss. Market Power and Technological Change Firms are often forced to rely on their profits to finance the research and development needed for new products, but smaller firms develop a number of new products themselves as well. Government policymakers continue to struggle with the issue of whether, on balance, large firms with market power are good or bad for the economy. 2013 Pearson Education, Inc. Publishing as Prentice Hall 31 of 44 Government Policy toward Monopoly 15.5 LEARNING OBJECTIVE Discuss government policies toward monopoly. 2013 Pearson Education, Inc. Publishing as Prentice Hall 32 of 44 Collusion An agreement among firms to charge the same price or otherwise not to compete.

In the United States, antitrust laws are designed to prevent monopolies and collusion. Antitrust Laws and Antitrust Enforcement Congress passed the Sherman Act in 1890 to promote competition and prevent the formation of monopolies. The act targeted firms in several industries that had combined together to form trusts, the most notorious of which was the Standard Oil Trust, organized by John D. Rockefeller. In a trust, the firms were operated independently but gave voting control to a board of trustees, which enforced collusive agreements for the firms to charge the same price and not to compete for each others customers. Antitrust laws Laws aimed at eliminating collusion and promoting competition among firms. 2013 Pearson Education, Inc. Publishing as Prentice Hall 33 of 44 To address several loopholes in the Sherman Act, Congress passed the Clayton Act, under which a merger was illegal if its effect was substantially to lessen competition, or to tend to create a monopoly, and the Federal Trade Commission Act, which set up the Federal Trade Commission (FTC) to police unfair business practices. Currently, both the Antitrust Division of the U.S. Department of Justice and the FTC are responsible for merger policy. Table 15.1 Important U.S. Antitrust Laws

Law Date Enacted Sherman Act 1890 Prohibited restraint of trade, including price fixing and collusion. Also outlawed monopolization. Clayton Act 1914 Prohibited firms from buying stock in competitors and from having directors serve on the boards of competing firms. Federal Trade Commission Act 1914 Established the Federal Trade Commission (FTC)

to help administer antitrust laws. Robinson-Patman Act 1936 Prohibited firms from charging buyers different prices if the result would reduce competition. Cellar-Kefauver Act 1950 Toughened restrictions on mergers by prohibiting any mergers that would reduce competition. 2013 Pearson Education, Inc. Publishing as Prentice Hall Purpose 34 of 44 Mergers: The Trade-off between Market Power and Efficiency Horizontal merger A merger between firms in the same industry. Vertical merger A merger between firms at different stages of production

of a good. Two factors can complicate regulating horizontal mergers: 1. The market that firms are in is not always clear. 2. There is the possibility that the newly merged firm might be more efficient than the merging firms were individually. In practice, the government defines the relevant market on the basis of whether there are close substitutes for the products being made by the merging firms. Even if a merged firm is more efficient and has lower costs, that may not offset the increased market power of the firm enough to increase consumer surplus and economic efficiency. 2013 Pearson Education, Inc. Publishing as Prentice Hall 35 of 44 Figure 15.6 A Merger That Makes Consumers Better Off The figure shows the result of all the firms in a perfectly competitive industry merging to form a monopoly. If costs are unaffected by the merger, the result is the same as in Figure 15.5: Price rises from PC to PM, quantity falls from QC to QM, consumer surplus declines, and a loss of economic efficiency results. If, however, the monopoly has lower costs than the perfectly competitive

firms, as shown by the marginal cost curve shifting to MC after the merger, it is possible that the price will actually decline from PC to PMerge and that output will increase from QC to QMerge following the merger. Although the newly merged firm has a great deal of market power, because it is more efficient, consumers are better off and economic efficiency is improved. 2013 Pearson Education, Inc. Publishing as Prentice Hall 36 of 44 The Department of Justice and FTC Merger Guidelines Economic analysis shaped antitrust policy after Donald Turner became the first Ph.D. economist to head the Antitrust Division of the Department of Justice in 1965 and the Economics Section of the Antitrust Division was established in 1973. By 1982, economists played a major role in the development of merger guidelines by the Department of Justice and the FTC. Modified in 2010, the guidelines have three main parts: 1. Market definition 2. Measure of concentration 3. Merger standards 2013 Pearson Education, Inc. Publishing as Prentice Hall

37 of 44 Market Definition A market consists of all firms making products that consumers view as close substitutes, which can be identified by looking at the effect of a price increase. Beginning with a narrow definition of the industry, we identify the relevant market involved in a proposed merger if profits increase after a price increase. If profits decrease, we consider a broader definition, continuing the process until a market has been identified. Measure of Concentration A market is concentrated if a relatively small number of firms have a large share of total sales in the market. The higher a markets concentration, the likelier a merger between firms in the industry will increase market power. The Herfindahl-Hirschman Index (HHI) of concentration squares the market shares of each firm in the industry and adds up their values. 2013 Pearson Education, Inc. Publishing as Prentice Hall 38 of 44 The following are some examples of calculating HHI: 1 firm, with 100 percent market share (a monopoly): HHI = 1002 = 10,000 2 firms, each with a 50 percent market share: HHI = 502 + 502 = 5,000

4 firms, with market shares of 30 percent, 30 percent, 20 percent, and 20 percent: HHI = 302 + 302 + 202 + 202 = 2,600 10 firms, each with market shares of 10 percent: HHI = 10 (102) = 1,000 2013 Pearson Education, Inc. Publishing as Prentice Hall 39 of 44 Merger Standards The Department of Justice and the FTC use the HHI calculation for a market to evaluate proposed horizontal mergers according to these standards: Postmerger HHI below 1,500. These markets are not concentrated, so mergers in them are not challenged. Postmerger HHI between 1,500 and 2,500. These markets are moderately concentrated. Mergers that raise the HHI by less than 100 probably will not be challenged. Mergers that raise the HHI by more than 100 may be challenged. Postmerger HHI above 2,500. These markets are highly concentrated. Mergers that increase the HHI by less than 100 points will not be challenged. Mergers that increase the HHI by 100 to 200 points may be challenged. Mergers that increase the HHI by more than 200 points will likely be challenged. Increases in economic efficiency will be taken into account and can lead to approval of a merger that otherwise would be opposed, but the burden of showing that the efficiencies exist lies with the merging firms. 2013 Pearson Education, Inc. Publishing as Prentice Hall

40 of 44 Making the Should AT&T Have Been Allowed to Merge with T-Mobile? ConnectionThe two main ways that a merger between two large firms can increase the combined firms profits are by (1) increasing market power so as to increase prices, which the federal government may see as violating the antitrust laws, and (2) lowering costs through increased efficiency, which firms typically emphasize. AT&T argued that the combined company, which would become the largest wireless firm in the United States, could operate at lower cost than could the companies operating separately. AT&T was proposing a horizontal merger that would sharply increase both concentration in the wireless industry and HHI points, but because the Antitrust Division didnt believe that cost savings would offset the increased market power the newly merged firm would acquire, it filed a lawsuit to stop the merger. AT&Ts attempt to merge with T-Mobile was shaping up as a classic antitrust case of reduced price competition more than offsetting increased efficiency.

MyEconLab Your Turn: Test your understanding by doing related problem 5.15 at the end of this chapter. 2013 Pearson Education, Inc. Publishing as Prentice Hall 41 of 44 Figure 15.7 Regulating a Natural Monopoly A natural monopoly that is not subject to government regulation will charge a price equal to PM and produce QM. If government regulators want to achieve economic efficiency, they will set the regulated price equal to PE, and the monopoly will produce QE. Unfortunately, PE is below average cost, and the monopoly will suffer a loss, shown by the shaded rectangle.

Because the monopoly will not continue to produce in the long run if it suffers a loss, government regulators set a price equal to average cost, which is PR in the figure. The resulting production, QR, will be below the efficient level. Local or state regulatory commissions usually set the prices for natural monopolies. 2013 Pearson Education, Inc. Publishing as Prentice Hall 42 of 44 Economics in Your Life Why Cant I Watch the NFL Network? At the beginning of the chapter, we asked why some cable systems dont carry the NFL Network. You might think that the cable systems would want to televise one of the most popular sports in the nation. In most cities, a cable system may be the sole source of many programs, preventing its customers from switching to a competing cable system (although some consumers have the option of switching to satellite television). As a result, a cable system can increase its profits by, for example, not offering popular programming such as the NFL Network as part of its normal programming package, requiring instead that consumers upgrade to digital programming at a higher price. 2013 Pearson Education, Inc. Publishing as Prentice Hall

43 of 44 AN INSIDE LOOK AT POLICY The End of the Cable TV Monopoly? Competition lowers the price of cable TV and increases economic efficiency. 2013 Pearson Education, Inc. Publishing as Prentice Hall 44 of 44

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