Chapter 16: Real-World Competition and Technology

Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinChapter GoalsDefine the monitoring problem and state its implications for economicsSummarize how firms protect monopolyDiscuss why competition should be seen as a process, not a stateExplain why oligopoly is the best market structure for technological changeShort-Run vs. Long-Run ProfitFirms care about both short-run and long-run profitFirms may not take full advantage of a potential monopolistic situation in the short run to strengthen their position in the long runAny expenditures on building a brand and a good reputation can reduce short-run profits but increase long-run profitsManagers’ Incentives and the Need for MonitoringManagers have an incentive to keep costs down, but their salaries are included in costs To address this problem, firms sometimes give managers incentive-compatible contracts in which the incentives of each of the two parties to the contract are made to correspond as closely as possibleThis creates a monitoring problem which is the need to oversee employees to ensure that their actions are in the best interest of the firmEmployees’ incentives differ from the owner’s incentivesWhat Do Real-World Firms Maximize?Firms have complicated goals that reflect the organizational structure and incentives built into the systemAlthough profit is one goal of a firm, often firms focus on other intermediate goals such as cost and salesSome firms do not push for cost efficiency and become lazy monopolistsLazy monopolists are firms that do not push for efficiency, but merely enjoy the position they are already inThe Fight between Competitive and Monopolistic ForcesCompetition is a process – a fight between the forces of monopolization and the forces of competitionSelf-interest-seeking individuals don’t like competition for themselves and may use political and social means to fight competitionIt is important to understand how the invisible hand, social forces, and political pressures work in order to understand competitionHow Monopolistic Forces Affect Perfect CompetitionLaws, social values, and customs in the United States do not allow perfect competition to work because our government emphasizes other social goals besides efficiencyThe Robinson-Patman Act and several state laws prevent firms from charging a price that is too lowThe U.S. has laws, regulations, and programs that prevent agricultural markets from working competitivelyCompetition and Natural MonopoliesNatural monopolies are industries whose average total cost decreases as output increases and because of this they can make large profits Economies of scale can create a natural monopolyNew technologies can compete with and undermine natural monopoliesTo prevent abuse of their market power, many natural monopolies are regulatedRegulating Natural MonopoliesRegulated natural monopolies have been given the exclusive right to operate in the industryIn return, they are allowed to charge a fair price, which includes all costs plus a normal return on capital investmentRegulation to allow regulated monopolies to earn a normal profitWhen firms are allowed to pass on all cost increases, they have little or no incentive to hold down costs and X–inefficiency developsDeregulating Natural MonopoliesMany formerly regulated natural monopolies are being deregulatedIn the electricity industry, power supply has been deregulated, but because of the existence of economies of scale, the power line industry has remained a regulated monopolyOnly portions of industries that are likely to be competitive are being deregulatedHow Firms Protect Their MonopoliesMonopolies spend money to maintain their monopoly by:AdvertisingLobbyingProducing goods that are difficult to copyNot taking advantage of their monopoly position and charging a lower priceFirms will buy monopoly power until the marginal cost of maintaining the monopoly equals the marginal benefitTechnology, Efficiency, and Market Structure Technological development is the discovery of new or improved products or methods of productionBecause the global market is significantly larger than a domestic one, globalization provides an incentive to develop new technologyDynamic efficiency refers to a market’s ability to promote cost-reducing or product-enhancing technological changeMarket structures that best promote technological change are dynamically efficientMarket Structure and TechnologyThere is no incentive to develop new technologies because they earn no profits to fund researchEven if they did innovate, competitors would gain from the new technology without having to pay for itPerfect competitionBecause of market power, monopolistic competition is more conducive to technological changeDue to ease of entry, they lack long-run profits, so their ability to recoup their investment is limitedMonopolistic competitionNetwork Externalities, Standards, and Technological Lock–InNetwork externalities occur when greater use of a product increases the benefit of that product to everyoneNetwork externalities lead to market standards and affect market structureStandards are created when a firm’s standard is accepted and dominates the marketTechnological lock-in is when prior use of a technology makes the adoption of subsequent technology difficultFirst-mover advantage helps explain the high stock prices of start-up technology companiesChapter Summary Profit is an important goal of firms, but actual goals depend on the incentive structure of the firm The monitoring problem arises because managers’ incentives are not always to maximize the firm’s profitMonopolists facing no competition can become subject to X-inefficiency – operating less efficiently than is technically possibleThe competitive process involves a continual fight between monopolization and competitionChapter Summary Firms will spend money on monopolization until the marginal cost equals the marginal benefitFirms protect their monopolies by advertising, lobbying, and producing products that are difficult to copyOligopoly provides the best market structure for technological advanceThe U.S. government is deregulating natural monopolies by dividing the firms into various subindustries, carving out those parts that exhibit the characteristics of a natural monopoly, and opening the remaining parts to competition