5--MONOPOLY G406, Regulation, Eric Rasmusen , erasmuse@indiana.edu February 25, 2014

1. 5--MONOPOLY G406, Regulation, Eric Rasmusen, erasmuse@indiana.edu February 25, 2014

2. An Idea from Last Time If a market has more suppliers, competition will drive the price down more.

3. The Cournot Model

4. Profits As Output Rises

5. One Firm: A Monopoly

6. Asymmetric Cournot Duopoly 6

7. The Reaction Curve 7

8. MR = MC What does this mean?

9. Pricing with Market Power The simplest case is when the seller has zero marginal cost. Then its task is to set MR = 0, which means to maximize revenue. Why not lower all the prices if you aren’t filling up the football stadium? Note the market failure: some seats were wasted.

10. Pricing with Market Power

11. Linear Demand and Marginal Revenue We often use linear (straight line) demand curves in diagrams. When demand is linear, marginal revenue is linear too, with twice as steep a slope. Calculus makes this easy to see. If demand is P = a -bQ , then revenue is R = PQ = (a - bQ)Q = aQ – bQ^2, and marginal revenue is MR=dR/dQ = a - 2bQ, just like demand but with a “2” so it slopes down twice as fast. (I use the notation Q^2 here to mean Q*Q, that is, Q squared.)

12. Drawing Marginal Revenue In drawing, remember that if the demand curve hits the Quantity axis at Q = 10, then the marginal revenue curve hits it at Q = 5. Also, though quantity demanded is 0 for bigger quantities than 10, the marginal revenue curve keeps going negative, because revenue can certainly decline as output increases.

13. Asymmetric Reaction Curves 13

14. Firm 2 14

15. Firm 2’s Reaction Function 15

16. Equilibrium Outputs 16

17. Symmetric Cournot Duopoly 17

18. The Symmetric Reaction Curves 18

19. Three Firms or More 19

20. Output with N Firms

21. N-Firm Outputs

22. The Lerner Rule I Thus, if the quantity demanded falls by 20% when the price rises by 10%, the elasticity of demand is -2.

23. The Lerner Rule II (old slide) (old slide) (new on this slide)

24. The Lerner Rule III MC =100, Elasticity = -2, then P = (-2/(-2+1)(100)) = (2)(100) = 200. and (P – MC)/P = -1/(-2) = ½. Elasticity = -3, then P = (-3/(-3+1)(100)) = (1.5)(100) = 150. and (P – MC)/P = -1/(-3) = 1/3. The Lerner Rule only applies if demand is elastic. What should the firm do if demand is inelastic?

25. Price Fixing The two most common kinds of illegal monopolizing cases involve: industries for homogeneous products that have few sellers, (b) bidders in auctions, whether auctions to sell objects where the high bid wins or auctions for procurement contracts where the low bid wins.

26. Prisoner’s Dilemma

27. Price-Fixer’s Dilemma

28. Cartels

29. Slides after this point probably won’t be used in class

30. Blank 30

31. Reaction Planes—3 Firms

32. HarbergerTriangles I Another source of hope comes from something discovered by Arnold Harberger in 1954: Triangles are smaller than rectangles. Harberger started by assuming that any 1924–28 manufacturing industry with accounting profit rates above average was earning monopoly profits Furniture earned a 14% return on capital, 2% more than average, so Harberger took its price to be 2% over marginal cost.

33. HarbergerTriangles II From last slide: Price is 2% over marginal cost (draw a triangle on the board) He used -1 as the elasticity of demand, and calculated that sales were 2% less than the optimum, so the triangle loss of .5 (2) (2) was 2% of furniture sales. He did this for all manufacturing, and came up with a welfare loss of 1/10 of one percent of GDP.

34. Harberger Triangle Diagram Suppose half of the economy is monopolized so prices rise 20%. Suppose the elasticity of demand for that half of the economy is -1. The triangle is .5(.2)(.2)(.5) of GDP, 1% of GDP, 140 billion dollars.

35. Does Macro Matter More?

36. Prof. Taylor’s Comparison

37. The Limits of Monopoly “Caterpillar Inc. closed a 62-year-old locomotive plant in London, Ontario eliminating 450 manufacturing jobs that mostly paid twice US wages. Caterpillar's decision, ending a standoff with locked-out workers huddled around barrels of burning scrap wood outside the London factory gates, may benefit another downtrodden manufacturing city: Muncie, Ind., where Caterpillar last year opened a locomotive plant and where it is trying to fill jobs at about half the pay workers in Ontario received. At a job fair in Muncie Saturday, Caterpillar will be offering jobs at that plant at wages ranging from $12 to $18.50 per hour. Wages for most workers at the Ontario plant are about 35 Canadian dollars an hour (US$35.03).”

38. Everet v. Williams (1725) It recites an oral partnership between the defendant and the plaintiff, who was 'skilled in dealing in several sorts of commodities;' and that the parties had 'proceeded jointly in the said dealings with good success on Hounslow Heath, where they dealt with a gentleman for a gold watch' ... Further recitals show how the parties accordingly 'dealt with several gentlemen for divers watches, rings, swords, canes, hats, cloaks, horses, bridles, saddles, and other things to the value of 200 pounds... and that the defendant would not come to a fair account with the plaintiff touching and concerning the said partnership. http://www.hosteny.com/funcases/highwayman.html

39. “The Highwaymen’s Case” “Whereas, by an order of this Court, made the 29th day of November last, the tipstaff was ordered to take into his custody and bring into this Court William White and William Wreathock the plaintiff's solicitors in this cause --- reflecting upon the honour and dignity of this Court; ... this Court upon consideration had of the premises, doth fyne the said William White 50 pounds, and the said William Wreathock 50 pounds, and commit them to the custody of the Warden of the Fleet until they pay the said fynes.” The defendant was executed 2 years later, and the plaintiff 5 years later.

40. Thomas v. UBS (Posner, J.) “Our plaintiffs ... argue ... that the bank should have prevented them from violating the law. This is like suing one’s parents to recover tax penalties one has paid, on the ground that the parents had failed to bring one up to be an honest person who would not evade taxes and so would not subject himself to penalties.” http://www.leagle.com/xmlresult.aspx?xmldoc=In%20FCO%2020130207166.XML&docbase=CsLwAr3-2007-Curr

41. Thomas II “We needn’t discuss the plaintiffs’ remaining claims — of negligence and malpractice — as they are frivolous squared. This lawsuit, including the appeal, is a travesty. We are surprised that UBS hasn’t asked for the impositionof sanctions on the plaintiffs and class counsel.”

42. Packet II Auction Winner: TommasoSneider: $14.98.

43. Packet Auction Spring 2014

44. End-of-Chapter Readings 1. “Global Cartels Fixed Display Prices for a Decade, EU Finds,” The Wall Street Journal, (December 6, 2012) http://online.wsj.com/article/SB10001424127887324640104578160771350104876.html. 2. “Catching Cartels,” Cento Veljanovski, Case Associates presentation slides, (2008)http://www.casecon.com/data/pdfs/Veljanovski%20Catching%20Cartels%20presentation%20IEA%20London%20March%202008.pdf 3. “Guilty Please in Antitrust Division Municipal Bond Bid Rigging Case,” Forbes (December 30, 2011). http://www.forbes.com/sites/billsinger/2011/12/30/guilty-pleas-in-antitrust-division-municipal-bond-bid-rigging-case-2/ 4. “Ohio Alleges Collusion on Road Salt,” http://online.wsj.com/article/SB10001424052702304724404577295682507253286.html(2012). 5. “The Scam Busters: How Antitrust Economists Are Getting Better at Spotting Cartels,” The Economist, (December 15, 2012) http://www.economist.com/news/finance-and-economics/21568364-how-antitrust-economists-are-getting-better-spotting-cartels-scam-busters

45. An Idea from Last Time If something is taxed, people do less of it.