ECON 262
Notes on Competition and Monopoly
COMPETITION -- Economists don't agree on how we should look at competition in an industry. So we will look at two different theories and you can make up your own mind.
Structuralist View of Competition vs. the Process View of Competition
But first - some definitions (and please -- forget the definitions you have learned elsewhere):
Monopoly:
Oligopoly:
Duopoly:
Monopsony:
THE STRUCTURALIST VIEW OF COMPETITION
Became popular in the 1930s. Competition is defined by the structure of the industry (number and size of firms). The ideal situation (and most competitive) is an industry with many small firms -- known as the model of perfect competition. This model assumes that all firms are small, there are a lot of them, all firms sell the exact same good and it is costless to exit or enter an industry. Each individual firm has no say on what price it charges -- simply has to just take the price that is determined by supply and demand in the market.
Basically: The Structure leads to the Conduct (what price is charged, how much is produced, etc.) which leads to the Performance (are the firms in the industry efficient or not).
By definition a monopoly is anti-competitive under this view. An oligopoly is also considered much less competitive than many small firms.
Efficiency under this view is defined by either productive efficiency or allocative efficiency.
Productive efficiency:
Allocative efficiency:
Barriers to Entry:
If an industry is making economic profit and entry does not occur -- this model assumes there is a barrier to entry. The important barriers to entry (constraint that keeps firms from entering an industry) in this view are:
capital costs,
advertising,
economies of scale,
legal barriers to entry
Policy Implications of this View:
The Anti-trust laws are based upon the structuralist view. The idea is to make firms smaller by breaking them up, or not allowing firms to get larger (keep firms from merging with other firms for example). The law is trying to force industries to look like the "ideal world of perfect competition."
Antitrust Laws - Some Major Ones
1890 - Sherman Act - Special Interest Legislation
Section I: "Every contract, . . . in restraint of trade or commerce . . . is hereby declared to be illegal."
Section II: "Every person who shall monopolize, or attempt to monopolize, or combine or conspire
with any other person or persons, to monopolize any part of the trade or commerce . . . shall be
deemed guilty of a felony."
1914 - Clayton Act
1936 - Robinson-Patman Act
1950 - Celler-Kefauver Act
The idea that Anti-trust laws are "good" follows the "public interest" theory of government regulation (the idea that the reason for the regulation is to seek an efficient use of resources and therefore the public in general benefit from the regulation).
THE PROCESS VIEW OF COMPETITION
Under this view there are two parts to the definition of competition:
(1) rivalry or rivalrous behavior:
(What are the people in the firm doing? Are they trying to improve? Trying to gain customers by creating better quality products at lower prices? - It is the behavior that matters.)
and
(2) discovery procedure or process:
in the act of competing we learn what is competitive and what is not competitive (via F. A. Hayek). But we must compete to find out. No one can ever know what structure any particular industry should have -- the structure will emerge as firms try new ways of competing and see what works and what does not work. Looking at a structure at any given time is not relevant, because OVER TIME the industry will change and the profits and losses of different firms will change. Large profits in an industry for an extended period of time is not necessarily anything to worry about -- those profits will generate competitive behavior through time.
The structure of the industry, therefore, is not important unless it in some way affects rivalry or the behavior of the firms. We then ask, what rules increase rivalry and what rules hamper rivalry?
Barriers to Entry under this View:
The only relevant barriers to entry under this view are legal barriers to entry (government granting of a public franchise, license, patent, copyrights, or regulations such as tariffs and quotas). Under this view a monopolist can be competitive -- but only if there is potential entry. The only barriers to entry that keep firms from entering a profitable industry OVER TIME are legal barriers to entry. Therefore, the only monopolies worth worrying about are those created by legal barriers to entry (for example the taxi situation in NYC or the US Post Office or tariffs).
Efficiencey:
Efficiency under this view is simply what works at any given time.... and we can never know if a firm is being (perfectly) allocatively efficient or productively efficient -- therefore, those are impossible standards to use in deciding government policy. The managers/owners of a firm at any time never really know if they are being the most efficient they could be -- all they can do is try something and see if profit goes up or down (which tells them relative efficiency with respect to the value they are creating for consumers).
In any case each individual manager/owner of a firm is in a better position to ascertain what works and what does not work than some abstract theory that defines efficiency based upon the owners having perfect knowledge.
Structure Does NOT determine Performance:
The Performance of the firms in the industry is based upon what individual owners want (did they make money or did they achieve other goals the owners of the firm might have or not). In other words, is the business owner satisfied with his or her return relative to their opportunity cost? The answer to this then will determine the Conduct (or continuing conduct) of the owners - which then influences the Structure (which changes through time).
Policy Implications of this View:
Under this view the Antitrust laws are actually anti-competitive. Instead of using their resources to try to come up with something that will please consumers more than their more successful competitor(s), firms are using resources to encourage the Justice Dept. or the Federal Trade Commission to prosecute their more successful competitors. Not only is there a waste in the opportunity cost of these resources used in lobbying, but also the consumers are the one's who are ultimately hurt. Instead of getting better products, they get higher tax bills. In other words, less profitable firms are trying to eliminate their more profitable competitors not by producing something better, but by having the government remove the competitor.
This is known as the "capture" theory of government regulation -- the idea that regulation helps producers to "capture" economic profits (often not in the interest of consumers). This follows from the special interest legislation we discussed earlier. Small groups "capture" benefits at the expense of everyone else (especially consumers and taxpayers).
DO ICE