[Music]
The Fisherman's Friend restaurant is the only
restaurant in Stonington, Maine, so even though
lobster prices reached a 40-year low in 2012,
diners at the restaurant did not pay lower
prices for their lobster meals.
The Fisherman's Friend restaurant had a monopoly
on selling seafood dinners in Stonington.
They are Price Setters and all consumers there,
are Price Takers.
Barriers high enough to create monopoly can
be due to: (1) government blocking the entry
of more than one firm into a market; (2) one
firm having control over a necessary resource;
(3) the existence of network externalities
in supplying the good or service; (4) economies
of scale so large that one firm has a natural
monopoly.
We have considered how markets form in response
to many factors, but really it comes down
to companies selling products that people
want and need to buy.
If the product is carrots and just about anyone
can grow them and loads of people want to
buy them, then you have a perfectly competitive
market like we saw in the farmer's markets.
When loads of people want to buy the product,
but there is some differentiation of product
quality and price for the goods vendors sell,
we have the Monopolistically Competitive market
like we see with Starbucks Coffee or a State College.
The Monopoly market structure comes in many
flavors including the power creation and distribution
network of the country, land-line telephone
services, US Postal Service, and even computer
operating systems.
We will look into these different flavors
to understand how they influence our consumption
habits.
But first, we will sit in on a discussion
with Economist Milton Friedman in a lecture
from the 1960s as he talked of monopolies.
[Music]
Mr. Friedman how much government
intervention do you think is necessary
to prevent the rise of monopolies and
oligopoly under the free enterprise
system or would it take care of itself
well I believe if you examine that if
you examine the sources of Monopoly and
oligopoly you will find that almost all
those sources are government
intervention I think the situation is
almost precisely the reverse let me put
it in a very simple way so far as I were
to ask this audience my favorite
question along these lines you have one
law you can pass it's only purpose is to
reduce the extent of monopoly that's
it's only purpose you have one law what
law would be most effective in achieving
that end what law would you pass
I don't mean any gimmicks you know it's
not going to be something in which you
can have a law with 4,000 different
parts I'm not asking you very
complicated question what would you do
limit the size of the market that they
could well that's one proposal the limit
is proposal but you will agree with me
i'm sure immediately that mine is a much
better one and that's free trade
eliminate all tariffs and all
restrictions on foreign trade and you
enable the world to come in as
competition to prevent domestic monopoly
wouldn't that do a great deal more good
in preventing monopoly than would a
limit on the size of enterprises with
much less restriction and human freedom
now if you ask yourself ask yourself
where to monopolize come from in the
united states the most important and the
strongest monopolies are unquestionably
those are derived from governmental
privilege the monopoly of a TV license
granted by the government at a zero
price that's a source of monopoly
privilege it also has been a source of
wealth for some notable Americans the
grant of a the grant of a tariff
protection with the steel industry in
the United States have any kind of
monopoly or oligopoly position if we
weren't able to get government to impose
impose restrictions on imports of
foreign items and so on the trade union
monopolies they get their strength in
their support from Davis-Bacon Act Walsh
Healy Act other governmental measures
that interfere with competition by
others it's very hard in fact I have
tried to I have tried to consider and
George Stigler is a greater authority on
this tonight so we maybe we ought to get
him in there add to this what private
monopolies there are that have been able
to maintain themselves over any long
period of time without government
assistance and I have myself only been
able to construct two one is an
international one the De Beers diamond
monopoly it really isn't it I don't
understand it maybe George can tell us
the answer
has been successful over a very long
period and the second was a New York
stock exchange not more recently because
since 1934 it's had the
help of the FCC but before 1934 from
about the Civil War to 1934 so far as I
know it had no government support and
yet it did maintain an effective
monopoly but almost every other case you
have temporary monopolies developed and
if the government doesn't come in to
shore them up they fall to pieces the
railroads became a monopoly only because
they were able to get the Interstate
Commerce Commission established trucking
is the monopoly because the ICC keeps
out competitors and you can go down the
line and find then one hypothetical
monopoly case after another derives from
governmental assistance and support so I
think the answer to your question and
you and I have the same objective here
is less government intervention, not more.
[Music]
[Music]
A monopoly is a firm that is the only seller
of a good or service that does not have a
close substitute.
A narrow definition of monopoly is that a
firm is a monopoly if it can ignore the actions
of other firms.
A broader definition of monopoly is that a
firm is a monopoly if it can retain economic
profits in the long run.
Success is not the mother of monopoly.
When a company creates something unique, valuable,
and it becomes a component of another businesses'
creativity and product development we call
that product a success.
Google did it with their search engine, then
they built on the service to make Gmail, OneDrive,
YouTube, and other services like Google translate.
They did this without government assistance
and they own the market.
Strictly, Google is not a monopoly but because
of their market power they can perform as
if they are.
It is not so dissimilar to Microsoft in its
market position for software.
[Music]
A monopoly requires that barriers to entry
into the market must be so high that no other
firms can enter.
There are four barriers high enough to keep
out competing firms: (1) A government blocks
the entry of more than one firm into a market;
(2) one firm has control over a key resource
necessary to produce a good; (3) there are
important network externalities in supplying
the good or service; and (4) economies of
scale are so large
that one firm has a natural monopoly.
Although governments ordinarily try to promote
competition, sometimes they take action to
block entry into a market.
The U.S.
government blocks entry by granting a patent
or copyright that gives an individual or firm
the exclusive right to produce a product,
and by granting a firm a public franchise,
making it the exclusive legal provider of
a good or service.
A patent is the exclusive right to a product
for a period of 20 years from the date the
patent is filed with the government.
Patents encourage firms to spend money on
research and development necessary to produce
new products.
Books, films, and software can receive copyright
protection.
A copyright is a government-granted exclusive
right to produce and sell a creation.
The right is granted for the creator's lifetime,
and his or her heirs retain this exclusive
right for 70 years after the creator's death.
A public franchise is a government designation
that a firm is the only legal provider of
a good or service.
You cannot hope to become the monopolist of
all board games.
But, you can claim trademark to a unique name,
like the game Monopoly.
Other firms can make board games with their
own rules, but they cannot use the name Monopoly
because of the registered trademark, or the
matching emblems and rules.
Did the US government create a board-game
Monopoly?
Sure it did: the same way it does this for
all intellectual property protection enabled
through our enforcement of property rights.
Controlling a key resource happens infrequently;
examples include the Aluminum Company of America,
which until the 1940s had long-term contracts
to buy nearly all available bauxite.
Another example is the International Nickel
Company of Canada.
Unique access to key resources makes monopolies
possible.
Exclusive access can come in the form of collective
bargaining granted by shrewd negotiations
by organizations like the NFL.
Laws are not in place to make them the only
"authorized" league - in fact the AFL made
a run as a competitor but could not compete
for players - that was their barrier to entry.
Earth minerals and river water are in the
ownership of the government and they enable
extraction under their terms of use.
But what about the sun?
No authority to license it?
Is that why we have not deployed solar panels
to every home in the country?
De Beers of South Africa acted on a national
endowment of diamond mines possessing extremely
high quality and large size diamonds.
They negotiated exclusive rights to mine and
market the gems and built a global market
strategy.
Then diamond mining was expanded in other
countries and competitors eroded De Beers
market dominance.
With 40% of the world diamond market remaining,
De Beers initiated a Forevermark brand on
their stones.
Think about that one for a minute.
Is your purchase of a diamond based on the
name of the jeweler?
I would even take it another step to ask if
the size of the stone is as important as the
intent of the jewelry.
Of course, I am thinking about this in terms
of the biggest market in North America for
diamonds: wedding rings, ear rings, broaches
and necklaces.
Would the wearer want to disassemble the arrangement
to verify its origin?
On the other hand, if the buyer treats the
diamond as an investment, the brand may serve
that purpose.
At least as long as counterfeiters do not
figure out how to replicate the brand.
Network externalities refer to a situation
in which the usefulness of a product increases
with the number of consumers who use it.
Some economists argue that network externalities
can serve as barriers to entry, but there
is considerable debate about the extent to
which they serve as barriers.
This comes to play in terms of Microsoft making
and selling software like Office.
They hold dominant market share for this software
in the Windows and Macintosh operating systems.
We know Microsoft gives MS Office software
for free to college students and that companies
around the world purchase the software from
the corporation to make it a $407 billion
dollar company as of 2016.
But there are software competitors making
MS Office - like products.
Open-Office.org makes a GNU licensed software
solution of Office-like bundle operating much
like MS Office software from about five years
ago.
The Open-Office.org software is free and operates
on Windows, Mac, and Linux operating systems.
The Network externality kicks in because consumers
are "familiar" with MS Office
and stick with it.
Hmmm, I understand why Microsoft gives it
for free to college students.
A natural monopoly is 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.
In this case, there is room for only one firm.
Natural monopolies are likely to occur in
markets where fixed costs are very large relative
to variable costs.
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,
lowering its price, and drive the other firm
out of business.
We take a look into power production and distribution
in Kenya, where the national government owns
the rights to charge for power, and decides
who receives connections.
Currently, despite high prices paid by consumers,
about 85% of Kenyans are not connected to
the national power grid.
Sasson Matters Energy a Kenyan
legislature has filed a motion seeking
to end the monopoly of the country's
soul and state-owned electricity
distributor and transmission company Kenya
Power on grounds of inefficiency the
legislature David Bowen argues that the
lack of competition in the sector has
contributed to poor services and high
tariffs charged by the company the
country that is set out that has set out
rather to attain middle-income status
over the next 16 years high electricity
charges among fact as a contributor
Kenya's high cost of doing business the
motion also seeks to have Kenya Power
compelled to compensate those who be
negatively affected by erratic power
supply eighty-five percent of Kenyans
are still not connected to the national
grid and liberalizing the sector as a
whole Athena's one way of getting them
connected faster by leveraging private
investments.
[Music]
Like other firms, a monopoly maximizes profit
by producing where marginal revenue equals
marginal cost, but unlike other firms, the
monopolistic industry's demand curve is the
demand curve for the company.
Remember the Monopolistic Competition industry
has profits in the short-run, but the entry
of competitors will vacate profits in the
long-run.
Barriers to entry creating the monopoly prevents
the evacuation of profits in the long-run:
profits remain without competition.
Now it resides on the selectivity of consumers
to participate in the market for that product.
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 at a lower price the subscriptions
that it could have sold at a higher price.
The firm's 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 Warner's marginal
revenue is less than the price for every subscription
sold after the first subscription.
Therefore, Time Warner's marginal revenue
curve will be below its demand curve.
Like other firms, a monopoly maximizes profit
by producing where marginal revenue equals
marginal cost, but unlike other firms, the
monopoly's demand curve is the same as the
demand curve for the product.
BAM!
We are right back to the Monopoly Game Sign
with Mr.
Clifford as we see again the Marginal Revenue
curve is steeper than the Demand curve.
The slope of the Marginal Revenue curve decides
the effect price will have on quantity demanded.
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, both the marginal revenue from
selling the sixth subscription and the marginal
cost are $27.
Time Warner maximizes profit by selling 6
subscriptions per month and charging a price
of $42 (point B).
Putting a wrapper around these topics, start
by considering the Average Total Cost curve
in panel B.
I would consider this firm a low cost provider
of the product they sell.
I call them this way because the ATC curve
is only slightly above the intersection of
Marginal Revenue and Marginal Cost.
The barrier to entry may be in the form of
government restrictions, control over key
resources, or even a natural monopoly situation.
Remember how we determine price to charge
as the intersection at point A to discover
the quantity, drawn up to point B, to the
price at this intersection with the demand
curve.
Total Revenue is bounded by the axes to point
B.
Profits here are bounded by the quantity line
at 6 units, times the price between price
at point B and the intersection of the ATC
curve: green shaded box.
The blue box showing the area above price
and below the demand curve shows Consumer
Surplus enjoyed by buyers of the commodity.
Another interesting interaction here is to
identify the area in Panel A where the Marginal
Revenue price is greater than zero and realize
it shows the elastic range of demand.
Where Marginal Revenue price is below zero,
we have the inelastic range of demand.
You might also call that point of Marginal
Revenue intersection with the X-axis at the
Perfectly Elastic point of production.
Based on this sample monopoly's example, it
operates within the elastic realm of production.
That means increases in price will increase
the total revenue for the manufacturer.
Socially Optimal production levels are entertained
with resources under control of the government,
like river water dammed up for hydroelectric
power, or railroad transportation fees on
lines built and maintained by the government.
The intersection of Marginal Cost with the
Demand curve represents the quantity and price
at this Socially Optimal Quantity and price.
Deadweight Loss is seen from the intersection
of marginal cost and demand diagonally to
points A and B when the monopoly price is
set to the level for point B.
This is the loss to the economy for the transaction
that never takes place - the deadweight loss.
On the other hand, if the Socially Optimal
Quantity and price are set, the consumer surplus
will eclipse the area above price and below
the Demand curve.
Some products in the monopolistic market structure
arrangement face a situation of a price ceiling.
In this case, the monopoly producer will face
a not to exceed order based on the ceiling
created by Marginal Cost Intersecting Demand.
Another point of significance for this graph
is where Average Total Cost curve intersects
the Demand curve.
This identifies the point of no economic profit
for the manufacturing company.
This also identifies the level of profits
this firm will experience even with the socially
optimal quantity and price.
Circling back one more time, consider the
monopolist identifying point A to determine
point B and the price to charge.
Now, what happens when marginal costs increase?
Maybe it is a tax imposed by the government
with authority and these costs must be transferred
to consumers.
The new intersection of marginal revenue and
marginal cost increases price and reduces
quantity.
Note that Demand does not change and Marginal
Revenue does not change, it is only the Marginal
Cost structure that is modified.
Though a monopolist can earn economic profits,
new firms will not enter the monopolist's
market.
The firm can earn economic profits even in
the long run.
In some cases, this has the unintended consequence
of a reduction in innovation for the firm.
The incentive to invent and create is reduced
because there are no competitors pushing the
envelope for competition.
[Music]
A monopoly will produce less and charge a
higher price than would a perfectly competitive
industry producing the same good.
Make a mental journey to consider Monopolistically
Competitive markets and Monopolies and think
about artificially created monopolies for
a good you use - like a smart phone.
What would happen to price and quantity, the
quality of the product you buy and the evolution
of your phone's service?
In panel (a), the market for smartphones is
perfectly competitive, and price and quantity
are determined by the intersection of the
demand and supply curves.
In panel (b), the perfectly competitive smartphone
market becomes a monopoly.
As a result:
1. The industry supply curve becomes the monopolist's
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.
This is the serious comparison of these two
market structures for the same product.
In Perfect Competition we had no Marginal
Revenue curve to set price and quantity with,
we use only Supply intersection with Demand.
Monopoly gives the Marginal Revenue curve
to consider and that changes the game.
Because a monopoly raises the market price,
it reduces consumer surplus.
The increase in price due to monopoly increases
producer surplus compared with perfect competition.
By increasing price and reducing the quantity
produced, the monopolist reduces economic
surplus.
The reduction in economic surplus is a deadweight
loss and represents a loss of economic efficiency
due to monopoly.
In contrast to perfect competition, the monopolist
charges a price that is
greater than its marginal cost.
A monopoly charges a higher price, Price Market
or PM, and produces a smaller quantity, Quantity
Market or 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. The area
above Price PC and below the Demand curve
is part of the Perfectly Competitive market's
Consumer Surplus.
In the Monopoly this is transferred partially
to the Producer, rectangle A. The migration
of this surplus still retains the surplus
for the economy, but tringles B and C are
the deadweight loss for the transactions that
never take place - that is an economic loss
brought on by the monopoly.
Because there are few monopolies, the loss
of economic efficiency from monopoly is small.
But many firms have market power, the ability
of a firm to charge a price greater than marginal
cost.
The only firms that have no market power are
firms in perfectly competitive markets.
Because few markets are perfectly competitive,
some loss of economic efficiency occurs in
the market for nearly every good or service.
Arnold Harberger and other economists have
confirmed that the total loss of economic
efficiency in the U.S.
economy from market power is small.
According to Harberger, if every industry
in the United States were perfectly competitive,
the gain in economic efficiency would equal
less than 1% of the value of total production.
Joseph Schumpeter is closely associated with
the argument that the economy may benefit
from firms that have market power.
Schumpeter argued that economic progress is
dependent on technological change in the form
of new products.
Those who support Schumpeter's view argue
that the introduction of new products requires
expenditures on research and development,
and firms with market power that can fund
research are more likely to earn economic
profits than perfectly competitive firms.
Others disagree with Schumpeter's views and
point out that small firms develop many new
products.
[Music]
One role we usually associate with
government intervention or government
activity is the regulation of monopolies
and we think of we think of legislation
like the Sherman Antitrust Act as a way
that we control the growth of monopoly
market power and the ability of firms to
come to dominate one industry and the
the history of this kind of regulation
teaches us a lot about the economic
processes that drive innovation and
economic activity and whether or not
regulation in these natural monopoly
situations actually provides value and
makes consumers better off take for
example the electricity industry by the
1890s it's really starting to grow
especially in large cities like New York
and Chicago initially they were very
rival wrists a lot of firms entered the
market to provide electric service in
larger cities and competed against each
other the kinds of innovations that
happened in this industry were a big
scale large generators lots of long
wires connecting large generators in
places like Niagara Falls to cities like
New York and that changed the cost
structure of the industry it changed the
cost structure of the industry in a way
that the electric company that owned
this generator their fixed cost was very
very high for building these big
generators but then their cost for
serving an additional customers really
really really low and so that meant that
their average cost per unit of
electricity they sold and their average
cost per customer really fell and fell
over the course of surveying a large
number of customers and in economics we
call this economies of scale in this
economies of scale in
the big technologies and industries like
electricity really make it challenging
to have rival risk competition so in
Chicago for example in the late 1890s
they were about a dozen different firms
providing electric service in the
Chicago market but as they competed
against each other they competed so much
that they were lowering the prices
lowering the price of lowering their
prices until price would go so low that
they couldn't actually pay all of the
fixed costs that they had incurred to
build the generators in the first place
and not all of the companies could stay
in the market and that process over time
led to the consolidation of the
electricity industry in cities like New
York and Chicago into one large firm and
that firm could as a monopoly in that
market charge a high price to consumers
and that was very much a part of the
Public Interest motivation of regulation
the this Progressive Era suspicion of
large corporate activity suspicion of
large companies and also the Progressive
Era belief in the ability of government
regulation to stand in for competition
and correct the imperfections that they
saw there's also a more kind of public
choice motivation looking at the
incentives and the interests of both
policymakers and the industry they have
an incentive to embrace regulation
because regulation constructs a legal
entry barrier and says in a particular
geographic territory you will be the
only firm allowed to provide retail
electricity service to the people living
in this area and no one else is allowed
to do that in return for government
protection of your monopoly
our we will regulate the profits that
you earn on your assets and in that
process regulate the prices you can
charge to consumers and we're going to
shoot for trying to keep those prices at
around average cost per unit of output
to try to keep prices as low as our
sustainable in the long run but still
consistent with the firm investing in
assets entering a return on their assets
and so that's the regulatory compromise
and that's one reason why industry
actually embraced regulation in
electricity one of the presumptions on
which regulation is built in this
industry is one of a sort of stability
that we have a static environment and so
you know this is the cost structure in
this industry boom this is what kind of
assets firms are going to build boom and
so we can figure all that out and back
out what the right profits are and what
the right prices are the information
required to get that right is I would
argue unknowable you know they just
think okay here's this demand for
electricity and we have to meet this
demand but now especially with air
conditioning we see demand fluctuating
dramatically over the course of the day
and yet we pay the sixth average retail
price that gives us as individual
consumers no incentive to change our
consumption even at five o'clock when
it's 95 degrees out on an August
afternoon I would argue that but today
here you know here we are in early in
the 21st century that now is when we're
really seeing the cost of regulation in
terms of how it stifled innovation I
attribute this to a misunderstanding in
the late nineteenth and early twentieth
century about what competitive process
is actually entail and what drives them
and what they create and that's where we
are now is
trying to deal with the fact that the
regulatory system of the past century
doesn't address you know hasn't adapted
to hasn't evolved along with the ways we
use electricity the new ways we may
generate electricity including
renewables it has evolved to take into
account the growth of digital
technologies that we can use to you know
basically program and monitor our own
electricity use and respond
automatically to price changes and so I
think that's where we are now is on the
brink of recognizing the costs of
regulation we've focused for so long in
the benefits to consumers of having
these low stable fixed prices and
universal service but now these low
stable fixed prices are leading to a lot
of electricity consumption in peak hours
when it's really expensive to provide it
for us and also the environmental
concerns it's generating a lot of
emissions in the process
and so those are the 21st century
challenges
[Music]
Most governments have policies that regulate
the behavior of monopolies.
U.S. antitrust laws make illegal any attempts
to form a monopoly or to collude.
Collusion is an agreement among firms to charge
the same price or otherwise not to compete.
Governments also regulate firms that are natural
monopolies.
The first important law regulating monopolies
in the United States was the Sherman Act in
1890, which was designed to promote competition
and prevent the formation of monopolies.
The Sherman Act targeted firms that had combined
to form trusts.
Trusts enabled firms to collude.
Trusts disappeared after the Sherman Act was
passed, but the term antitrust laws continue
to be used to refer to laws aimed at eliminating
collusion and promoting competition among
firms.
To address loopholes in the Sherman Act, Congress
passed the Clayton Act and the Federal Trade
Commission Act in 1914.
Under the Clayton Act, a merger was illegal
if its effect was "substantially to lessen
competition, or to tend to create a monopoly."
The Federal Trade Commission Act established
the Federal Trade Commission, FTC, which was
given power to police unfair business practices.
Congress divided the authority to police mergers
between the FTC and the Antitrust Division
of the U.S.
Department of Justice.
Apple IPad was a new and innovative product
to sell consumers books on tablet-like devices.
Their pricing strategy was suspiciously like
a price fixing solution involving Apple and
five of the largest book publishers who colluded
to set e-book prices above competitive price
standards.
The Department of Justice won the case against
Apple.
The federal government regulates mergers because
if firms gain market power by merging they
may use this power to raise prices and reduce
output.
The government is most concerned with horizontal
mergers.
A horizontal merger is a merger between firms
in the same industry.
A vertical merger is a merger between firms
at different stages of production of a good.
Two factors complicate regulating horizontal
mergers.
First, the market that firms are in is not
always clear.
Second, there is a possibility that the newly
merged firm might be more efficient than the
merging firms were individually.
This figure shows the result of all the firms
in a perfectly competitive industry merging
to form a monopoly.
If the merger does not affect costs, the result
is 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 of the good will actually decline from
PC to PMerge and that output will increase
from QC to QMerge following the merger.
If they all happened like this, mergers would
be encouraged!
But, this is a best-case scenario.
In 1973, the Economics Section of the Antitrust
Division of the Department of Justice was
established and staffed with economists who
were entrusted with evaluating the economic
consequences of proposed mergers.
In 1982, the Department of Justice and the
FTC developed merger guidelines that made
it easier for firms considering a merger to
understand whether the government would allow
the merger.
The guidelines have three main parts:
(1) Market definition.
A market consists of all firms making products
that consumers view as close substitutes.
This definition of the market is extremely
important.
For this candy example consider if you are
talking about candy, snacks, or all food.
The broader the market, the less of an effect
is the merger.
(2) The measure of market concentration.
A merger between firms in a market that is
already highly concentrated is likely to increase
market power.
The guidelines use the Herfindahl-Hirschman
Index (HHI) of concentration, which squares
the market shares of each firm in the industry
and adds up the values of the squares.
This incorporates the expanse of a market
across areas, states, regions, and the entire
nation.
A merger might represent a significant potential
effect on a city, but if the firms are spread
around the entire nation and their co-location
is not uniform in each community, the market
shares before and after merger may be comparatively
low.
Also consider if the products the companies
make are sold only within the local production
area, or if the product is sold nationally
and internationally.
(3) Merger standards.
The Department of Justice and the FTC use
the HHI calculations to evaluate proposed
horizontal mergers.
The measurement criteria receiving acute attention
pivots on if merger would result in substantial
efficiency gains.
If it does, then both price would decrease,
and quantity supplied would increase.
By now, you know I have a history working
in natural resources, specifically in forestry.
In February 2016, one of the largest vertically
integrated timber products companies in North
America, Weyerhauser, made a move to merge
with Plum Creek Timber, another mega-timber
products firm of North America.
On the face of it, the vertical merger of
these two companies would catch the attention
of both the Department of Justice and the
Federal Trade Commission.
How would the Herfindahl-Hirschman Index calculate
the effects of this merger?
[Music]
I'm Sarah Hashim-Waris for Smart Trend News
one
of the top US forest products companies
Weyerhaeuser operates along several
business lines including wood products
like lumber plywood and other building
materials and cellulose fibers or pulp
products also it's timberlands division
manages some six million acres of
company-owned us timberland and more
than 15 million acres of lease Canadian
Timberland it's real estate unit
develops housing and mastered planned
communities Weyerhaeuser has incorporated
in nineteen hundred and it now operates
offices in 10 countries and serves
customers worldwide I'm Sarah Hashim-Waris
for Smart Trend News for more company
profiles visit our website
Tradethetrend.com or subscribe to our YouTube
channel TradetheTrend
[Music]
I'm Christie Duffy for Smart Trend News
real estate investment trust Plum Creek
Timber is one of the United States
largest timber companies with more than
7 million acres of timberland in 19
states harvesting old and new growth
timber the company sells logs to
sawmills and pulp and paper mills it
also produces lumber plywood and medium
density fiberboard it also has real
estate sales operations and pursues
natural resource opportunities including
mineral extraction and natural gas
production in an effort to promote
environmental conservation Plum Creek
announced plans to sell some 300 10,000
acres of land to environmental groups in
2008.
I'm Christie Duffy for Smart Trend
News for morning from Plum Creek Timber
visit our website TradetheTtrend.com
Shareholders of both companies approved the
merger at separate special meetings of shareholders
held on Feb. 12, 2016.
The combined company retains the Weyerhaeuser
name and continues to be traded under the
WY ticker symbol on the New York Stock Exchange.
The combined company owns more than 13 million
acres of diverse and productive timberlands
and operates 38 wood products manufacturing
facilities across the country.
Both Weyerhaeuser and Plum Creek were vertically
integrated companies who own timberlands,
harvest their own timber and hire logging
contractors, mill their timber products into
lumber, plywood, oriented strand board, particle
board, pulp and paper.
Weyerhaeuser even initiated a sector of their
business as a construction company to build
homes using lumber from their mills.
Doyle Simons, president and CEO of Weyerhaeuser
said, "This is an exciting day for Weyerhaeuser
as we bring together the best assets and talent
in the industry.
In the coming months, we will be relentlessly
focused on creating value for our shareholders
by capturing cost synergies, leveraging our
scale, sharing best practices, delivering
the most value from every acre and driving
operational excellence.
I look forward to being part of this outstanding
team as we work together to be the world's
premier timber, land and forest products company."
Across the nation, Weyerhaeuser and Plum Creek
forestlands and mills were the strongholds
of the industry.
But timber is purchased and milled at regional
locations, like at Clearwater Paper in Lewiston,
Idaho, at Idaho Forest Group in Grangeville,
Idaho, Weyerhaeuser Lumber in Longview, Washington,
and hundreds of other locations around the
forested areas of the country.
Rarely were Weyerhaeuser and Plum Creek mills
co-located in the same communities, so their
merger did not have a direct change to competition
in individual markets for timber.
Where they did, other timber buyers balanced
the competitive influences on individual markets.
Both companies sold lumber on the world market
in a compellation of competitive challengers.
If the merger was considered on the national
scale, the post-merger HHI would potentially
arrive between 1,500 and 2,500.
In this case, the change in the HHI comes
in at less than 100 and the challenge was
not made.
If a firm is a natural monopoly, competition
will not play its role of forcing prices down
to the level where the company earns zero
economic profit.
Local and state regulatory commissions usually
set prices for natural monopolies.
To achieve economic efficiency, regulators
should require that the monopoly charge a
price equal to its marginal cost.
But this strategy has a drawback when the
firm's average total cost curve is still falling
when it crosses the demand curve.
If the firm charges a price equal to marginal
cost, price will be less than average total
cost and the firm will suffer an economic
loss.
Most regulators will set the price equal to
the level of average total cost so that the
firm can at least break even.
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 total cost,
and the monopoly will suffer a loss.
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 total cost, which is PR in this figure.
The resulting production, QR, will be below
the efficient level, but the firm will be
able to produce in the long-run.
Regulatory commissions often recruit their
members from the companies they regulate.
Although these individuals are knowledgeable
about the regulated firm, they may be biased
toward the firm's positions rather than the
consumers
whose interests they are supposed to represent.
Other regulators may be biased against the
firms they regulate.
It is difficult to select commission members
who are both knowledgeable and unbiased.
Another problem is that allowing a firm to
only break even rather than earn an economic
profit may give it less incentive to reduce
its costs than if it were unregulated.
The firm would not earn higher profits from
any cost-cutting actions,
and the commission would be willing to allow a price increase
if higher average total costs could be documented.
[Music]
