© 2010 Pearson Education CanadaChapter 9 - 1 Chapter 9 Monopoly Rules © 2010 Pearson Education...

© 2010 Pearson Education CanadaChapter 9 - 1

Chapter 9

Monopoly Rules

© 2010 Pearson Education Canada


Monopoly Rules

Government Regulation,

Competition, and the Law


LEARNING OBJECTIVES

9.1 Describe natural monopolies and explain

the challenge they create for policymakers

9.2 Explain how strategic interaction between

competitors complicates business

decisions, creating two smart choices

9.3 Explain why cartels form and why they are

unstable and illegal

continued…


9.4 Explain arguments for and against

government regulation, and describe three

of its forms

9.5 Differentiate between the public-interest

view and the capture view of government

regulation


SIZE MATTERS NATURAL MONOPOLY & REGULATION

Natural monopolies create a challenge for policymakers — gain the low-cost efficiencies

of economies of scale, but avoid the inefficiencies of monopoly’s restricted output

and higher price.


NATURAL MONOPOLY & REGULATION

• Economies of scale

average total costs fall as quantity of output

increases

• Natural monopoly

technology allows only single seller to achieve

lowest average total cost

• Policies governments use for natural monopoly

– public ownership

– regulation

continued…


• Crown corporations

publicly owned businesses in Canada

– BC Hydro

– Canada Post

– Canadian Broadcasting Corporation (CBC)

– GO Transit

– Hydro-Québec

– Saskatchewan Liquor and Gaming Authority

– Via Rail

continued…


• Regulated private monopoly

– banks

– air transportation, including airports

– railway and road transportation across borders

– telephone, telegraph and cable systems

– grain elevators, feed and seed mills

– uranium mining and processing

– fisheries as a natural resource

continued…


• Public ownership and regulation achieve

economies of scale, but lack of competition

weakens incentives to reduce costs or

innovate

• Rate of return regulation

set price allowing regulated monopoly to just

cover average total costs and normal profits


COOPERATE OR CHEAT?PRISONERS’ DILEMMA AND CARTELS

Strategic interaction among competitors complicates business decisions, creating two

smart choices — one based on trust and the other based on

non-trust.


PRISONERS’ DILEMMA AND CARTELS

• Game theorymathematical tool for understanding how players make decisions, taking into account what they expect rivals to do

• Prisoners’ dilemmagame with two players who must each make a strategic choice, where results depend on other player’s choice

• Nash equilibriumoutcome of game where each player makes own best choice given the choice of the other player

continued…


• Two smart choices exist in prisoners’ dilemma

game: one based on nontrust and one based on

trust

continued…


Figure 9.1 THE PRISONERS’ DILEMMA OF BONNIE & CLYDE


• If other player cannot be trusted, smart choice

is cheat/confess

– all players driven to Nash equilibrium outcome where everyone cheats/confesses

• If other player can be trusted, smart choice is

cooperate/deny

– all players driven to equilibrium outcome where everyone cooperates/denies

continued…


• Prisoners’ “dilemma” is

– each player (prisoner) is motivated to cheat (confess)

– yet each would be better off if they could trust each other to cooperate (deny)

continued…


C-WORDS EVERYWHERE CARTELS, COLLUSION,

CHEATING,COMPETITION (LAW)

Cartels collude to raise prices and restrict output to increase economic profits.

Cartels are unstable because members can increase individual profits by cheating on

others.


CARTELS, COLLUSION, CHEATING, COMPETITION (LAW)

• Collusion

conspiracy to cheat or deceive others

• Cartel

association of suppliers formed to maintain

high prices and restrict competition

– OPEC (Organization of Petroleum Exporting Countries)

continued…


“People of the same trade seldom meet

together, even for merriment and

diversion, but the conversation ends in a

conspiracy against the public, or in some

contrivance

to raise prices.”

— Adam Smith, 1776


• Desirable competitive behaviour

– active attempts to increase profits and gain market power of monopoly

– hard to distinguish from undesirable collusive behaviour

continued…


• The Competition Act (1986)

– “to maintain and encourage competition in Canada in order to promote the efficiency and adaptability of the Canadian economy”

– to prevent anti-competitive business behaviour

– raises expected costs to business of price fixing (by prison time, fines, legal prohibition) relative to expected benefits (profits)

continued…


• Criminal offences

– punished by prison time, fines

– price fixing, bid rigging, false/ misleading advertising

• Civil offences

– punished by fines, legal prohibitions

– mergers, abusing dominant market position, lessening competition

continued…


• Competition Tribunal for civil offenses weighs

costs of lessening competition against

benefits

of any increased efficiencies

• If mergers that reduce competition also

provide economies of scale, may be

approved

for promoting “efficiency and adaptability”


MASTER OR SERVANT?REGULATORY AGENCIES IN CANADA

The discipline of market competition eventually eliminates dangerous products, but in the

process people may be harmed. Three major forms of government regulation in Canada address this

problem.


REGULATORY AGENCIES IN CANADA

• Caveat emptor (“let the buyer beware”) — buyer alone responsible for checking quality of products before purchasing

• Certain products — nuclear power, medicines, poisonous insecticides — regulated by government because average consumer not capable of knowing product’s quality

• Major forms of government regulation in Canada– government departments,

government-appointed agencies/boards

– professional self-governing bodies


PICK YOUR POISONMARKET FAILURE OR GOVERNMENT FAILURE?

Two views of government regulation. Public-interest view suggests government actions improve market failure outcomes.

Capture view suggests government actions produce government failure.


MARKET FAILURE & GOVERNMENT FAILURE

• Public-interest view government regulation eliminates waste, achieves efficiency, promotes public interest

• Capture view government regulation benefits regulated businesses, not public interest

• Evidence mixed on government regulation — some supports public-interest view, some supports capture view

• Most economists agree Competition Act serves public interest well continued…


• Government failure

regulation fails to serve public interest,

instead benefits industry being regulated

– market outcome, even with monopoly power, may be better than government regulation outcome if significant government failure

– government outcome, especially with public interest regulation, may be better than market outcome if significant market failure


Chapter 9Refresh Slides


NATURAL MONOPOLY & REGULATION

1. What is a natural monopoly, and how does

it help consumers?

2. If you were to manage a regulated private

monopoly (like New Brunswick Power)

governed by rate of return regulation,

explain the incentives you would personally

face for delivering electricity at the lowest

cost to consumers.

continued…


1. Identify one regulated private monopoly

you

buy services from. Find out from its website

everything you can about its costs and the

regulations under which it operates. Do you

think its services could be improved?

Explain your answer.


PRISONERS’ DILEMMA & CARTELS

1. Describe the scenario for the prisoners’

dilemma.

2. What is a Nash equilibrium?

3. Explain the tension in the key insight of

game theory.


CARTELS, COLLUSION, CHEATING, COMPETITION

1. What is a cartel?

2. Explain the two kinds of anti-competitive

offences in the 1986 Competition Act.

continued…


3. Construct a payoff matrix (similar to Figure 9.1)

for two oil companies forming a cartel, where

the single strategic choice is to collude (stick to

an agreement to restrict output and raise prices)

or to cheat on the agreement. Your payoffs

should be made-up numbers of the expected $

profits of each combination of player choices.

Explain the difference between the Nash

equilibrium of the game and the outcome that

would be best for the two oil companies.



1. What are the three forms of regulation in

Canada?

2. Explain the arguments for and against the

principle of caveat emptor.

continued…



1. Suppose you are a successful dairy farmer

recruited to serve on the Canadian Dairy

Commission. You understand well the

industry from a producer’s perspective, but

your mandate is to regulate the industry in

the public interest, where the public

consists mostly of consumers. What

conflicts might you face in doing your job?


MARKET FAILURE OR GOVERNMENT FAILURE

1. Explain the public-interest and capture views

of government regulation.

2. If a previously regulated industry is

deregulated, and we observe that prices rise

and output falls, which view of government

regulation does that evidence support?

Explain why.

continued…


MARKET FAILURE OR GOVERNMENT FAILURE

1. In Chapter 5, we observed that a conservative

politician on the political right might tend to

value efficiency more than equity, while a left-

leaning politician might value equity more

than efficiency. Which of the two views on

government regulation — public-interest or

capture — do you think a conservative

politician is more likely to hold? Which view is

a left-leaning politician more likely to hold?

Explain your answers.

© 2010 Pearson Education CanadaChapter 9 - 1 Chapter 9 Monopoly Rules © 2010 Pearson Education...

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