Breaking Up Monopolies

1. 15 Breaking UpMonopolies

2. Solutions to Monopoly • Preventing monopolies by preventing anti-competitive mergers • Sherman Act (1890) – FCC, FTC and SEC • AT&T and T-Mobile (2016) • AT&T and Time Warner • Breaking up existing monopolies • “Divestiture” • Breaking up “Ma Bell” 0r Standard Oil

3. Solutions to Monopoly • “Divestiture” (Sherman Act (1890) • Breaking one big company into a smaller number of “competing” companies • AT&T (1982), Standard Oil (1911) • Telecomm Act (1996) • Allows competitors to access/rent current Telecomm companies network at “forward-looking” costs (best, most efficient technology) • Ignored that: (1) local phone company’s costs based on historical costs to be recovered over 20 years • (2) Residential rates subsidized (below costs)for universal service – higher costs business rates

4. AT&T – A Short History • Alexander Graham Bell patented the telephone in 1876, • formed Bell Telephone which licensed local telephone exchanges in major US cities. AT&T was formed in 1885 • In 1913 AT&T became a regulated monopoly. • had to connect competing local companies • And let the Federal Communication Commission (FCC) approve their prices and policies.

5. AT&T – A Short History • On January 1, 1984, a court forced AT&T to give up its 22 local Bell companies (Divestiture) • This established seven Regional Bell Operating Companies (RBOC). • Since that time, mergers have reduced the number of RBOCs to four: Verizon (originally Bell Atlantic, Nynex and GTE), Qwest (Qwest Communications International took over US West), BellSouth and SBC (originally Southwestern Bell and Pacific Telesys).

6. How Do We “Fix” Monopolies • Lower Barriers to Entry • Goal is to increase competition by allowing more firms to enter the market and compete against each other • AT&T Divestiture (1980) • DOJ and FCC sought to introduce competition into the local phone markets (dominated by 7 RBOCs, “baby bells”) • Required AT&T/RBOCs to lease local wirelines, switching networks, transmission satellites and local household connections at “forward” looking economic costs (which were below historical costs)

7. AT&T Before and After the Break-up

8. How Do We “Fix” Monopolies

9. After the Break Up

10. Colbert on the AT&T Break-Up http://www.ebaumsworld.com/video/watch/955486/

11. 6 Average Total Cost Natural Monopoly – Avg Cost Decrease with Increasing Size/Scale of the Firm – Divestiture Raises Avg Cost ATC in short run with medium factory ATC in long run ATC in short run with large factory ATC in short run with small factory $12,000 Constant returns to scale 10,000 Diseconomies of scale Economies of scale 0 Quantity of Cars per Day 1,000 1,200 Because fixed costs are variable in the long run, the average-total-cost curve in the short run differs from the average-total-cost curve in the long run.

12. Why Monopolies Arise • The production process • A single firm can produce output at a lower cost than can a larger number of producers • Natural monopoly • Arises because a single firm can supply a good or service to an entire market • At a smaller cost than could two or more firms • Economies of scale over the relevant range of output

13. Solutions to Monopoly • For Natural Monopolies • Price regulation • Often, we don’t want to break up firms due to large economies of scale • Don’t need to have redundant water pipes, power lines • In this case, a monopoly may be desirable, but we may still need to regulate the firm to prevent market power abuse

14. 1 Economies of scale as a cause of monopoly Costs Average total cost 0 Quantity of output When a firm’s average-total-cost curve continually declines, the firm has what is called a natural monopoly. In this case, when production is divided among more firms, each firm produces less, and average total cost rises. As a result, a single firm can produce any given amount at the smallest cost

15. Regulatory Solution for Natural Monopoly

16. Marginal Cost Pricing • At P = MC • The monopolist experiences a loss • MC < ATC, so P < ATC (results in losses) • Solutions? • Government subsidies given to the firm • Set P = ATC at the P = MC output level • Government ownership of the firm • French approach • Set P=MC => subsidize ∆ (ATC-MC) from taxes

17. Government Failure • Government intervention • Can eliminate the profit motive and the necessity to innovate and improve efficiency • Free market • Firms under MC pricing have no incentive to lower costs. • Price Caps: • Set maximum price to recover costs (P+ATC) • Adjust price over time for efficiency • P(next year) = P(today) – Average Industry Productivity • Often better than government intervention and changing incentives for a firm

18. Conclusion • While competitive markets generally bring about welfare-enhancing outcomes for society, monopolies often do the opposite • Government seeks to limit monopoly outcomes and promote competitive markets • Perfectly competitive markets and monopoly are market structures at opposite extremes • Most economic activity takes place between these two alternatives

19. Natural Barriers to Entry • Economies of scale • “Bigger is better” (more cost-efficient) • This is due to the ATC being downward-sloping over a large range of output • Lower costs  lower prices • Car production, electricity production,mail delivery • Natural monopoly • A monopoly exists because a single large firm has lower costs than any potential competitor • In addition, breaking up the firm into multiple competitors may increase costs as well

20. Summary • Monopolies • Market structure characterized by a single seller who produces a well-defined product with few good substitutes • Operate in a market with high barriers to entry, the chief source of market power. • May earn long run profits • Perfectly competitive firms are price takers. Monopolists are price makers.

21. Summary • Like perfectly competitive firms, a monopoly tries to maximize its profits. • Same profit maximizing rule of MR = MC is used. • From an efficiency standpoint, the monopolist charges too much and produces too little. • Since the output of the monopolist is smaller than would exist in a competitive market, the outcome also results in deadweight loss.

22. Summary • Government grants of monopoly power encourage rent seeking • There are four potential solutions to the problem of monopoly • First, the government may break up firms to restore a competitive market • Second, government can promote open markets by reducing trade barriers • Third, the government can regulate a monopolist’s ability to charge excessive prices • Finally, there are circumstances in which it is better to leave the monopolist alone

23. Practice What You Know Which of the following firms will most likely be a natural monopoly? A grocery store A cable TV company A gas station A barbershop

24. Practice What You Know Which of the following most accurately describes a patent? An incentive to innovate A profit-sharing mechanism A redistribution of wealth An original invention

25. Practice What You Know What is true for a profit-maximizing monopoly? P = MR = MC P = MR > MC P > MR = MC P > MR > MC

26. Practice What You Know What is the reason for monopoly deadweight loss (relative to perfect competition)? The monopolist faces a downward sloping demand curve People boycott monopolies more often The monopolist sells less output at a higher price The monopolist has no competitors

27. Practice What You Know A monopolist will have negative profits and exit the industry in the long run if: A new competitor enters the industry Demand becomes more elastic Price < ATC A monopolist never has negative profits