Lecture Economics (9/e): Chapter 16 - David C. Colander

Chapter 16 - Real-world competition and technology. After reading this chapter, you should be able to: Define the monitoring problem and state its implications for economics; discuss why competition should be seen as a process, not a state; summarize how firms protect monopoly; explain why oligopoly is the best market structure for technological change.

Real-World Competition and Technology

It is ridiculous to call this an  industry. This is rat eat rat; dog  eat dog. I’ll kill ’em, and I’m  going to kill ’em before they kill 

me. You’re talking about the  American way of survival of the  fittest.

— Ray Kroc (founder of 

McDonald’s)

Ø Define the monitoring problem and state its

implications for economics

Ø Summarize how firms protect monopoly

Ø Discuss why competition should be seen as a process,

not a state

Ø Explain why oligopoly is the best market structure for

technological change

Ø Firms care about both short-run and long-run profit

Ø Firms may not take full advantage of a potential

monopolistic situation in the short run to strengthen

their position in the long run

Ø Any expenditures on building a brand and a good

reputation can reduce short-run profits but increase

long-run profits

Ø Managers have an incentive to keep costs down, but their

salaries are included in costs

Ø 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 possible

• This creates a monitoring problem which is the

need to oversee employees to ensure that their actions are in the best interest of the firm

• Employees’ incentives differ from the owner’s

incentives

Ø Firms have complicated goals that reflect the

organizational structure and incentives built into the

system

Ø Although profit is one goal of a firm, often firms focus on

other intermediate goals such as cost and sales

Ø Some firms do not push for cost efficiency and become

lazy monopolists

• Lazy monopolists are firms that do not push for

efficiency, but merely enjoy the position they are already in

Competitive and Monopolistic Forces

Ø Competition is a process – a fight between the forces

of monopolization and the forces of competition

Ø Self-interest-seeking individuals don’t like competition

for themselves and may use political and social means

to fight competition

Ø It is important to understand how the invisible hand,

social forces, and political pressures work in order to

understand competition

Affect Perfect Competition

Ø Laws, social values, and customs in the United

States do not allow perfect competition to work

because our government emphasizes other social

goals besides efficiency

Ø The Robinson-Patman Act and several state laws

prevent firms from charging a price that is too low

Ø The U.S has laws, regulations, and programs that

prevent agricultural markets from working competitively

Ø Natural monopolies are industries whose average

total cost decreases as output increases and

because of this they can make large profits

Ø Economies of scale can create a natural monopoly

Ø New technologies can compete with and undermine

natural monopolies

Ø To prevent abuse of their market power, many natural

monopolies are regulated

Ø Regulated natural monopolies have been given the

exclusive right to operate in the industry

Ø In return, they are allowed to charge a fair price,

which includes all costs plus a normal return on

capital investment

Ø Regulation to allow regulated monopolies to earn a

normal profit

Ø When firms are allowed to pass on all cost increases,

they have little or no incentive to hold down costs and

Ø Many formerly regulated natural monopolies are

being deregulated

Ø In 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 monopoly

Ø Only portions of industries that are likely to be

competitive are being deregulated

Monopolies spend money to maintain their monopoly by:

• Advertising

• Lobbying

• Producing goods that are difficult to copy

• Not taking advantage of their monopoly position

and charging a lower price

Ø Firms will buy monopoly power until the marginal cost of maintaining the monopoly equals the marginal benefit

Ø Technological development is the discovery of new or

improved products or methods of production

Ø Because the global market is significantly larger than a

domestic one, globalization provides an incentive to

develop new technology

Ø Dynamic efficiency refers to a market’s ability to promote cost-reducing or product-enhancing technological change

Ø Market structures that best promote technological change

are dynamically efficient

• There is no incentive to develop new technologies

because they earn no profits to fund research

• Even if they did innovate, competitors would gain from

the new technology without having to pay for it

Perfect competition

• Because of market power, monopolistic competition is

more conducive to technological change

• Due to ease of entry, they lack long-run profits, so their

Monopolistic competition

Standards, and Technological Lock–In

Ø Network externalities occur when greater use of a product

increases the benefit of that product to everyone

Ø Network externalities lead to market standards and affect

market structure

Ø Standards are created when a firm’s standard is accepted and dominates the market

Ø Technological lock-in is when prior use of a technology

makes the adoption of subsequent technology difficult

Ø First-mover advantage helps explain the high stock

prices of start-up technology companies

Ø Profit is an important goal of firms, but actual goals

depend on the incentive structure of the firm

Ø The monitoring problem arises because managers’

incentives are not always to maximize the firm’s profit

Ø Monopolists facing no competition can become subject

to X-inefficiency – operating less efficiently than is

technically possible

Ø The competitive process involves a continual fight

between monopolization and competition

Ø Firms will spend money on monopolization until the

marginal cost equals the marginal benefit

Ø Firms protect their monopolies by advertising, lobbying,

and producing products that are difficult to copy

Ø Oligopoly provides the best market structure for

technological advance

Ø The 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