CHAPTER 13
Discussion Questions
1. Electric companies and telephone companies usually have declining average costs as more customers are added and more use is made of their services. A large part of the costs are fixed, in the form of the distribution network. It would be wasteful to add a second or third distribution network that covers the same routes as the first. Costs to consumers would have to rise. So a monopoly can serve the public interest, provided that the firm does not use its market power to exploit its customers. Changes in technology can significantly alter the cost structure of an industry and potentially eliminate a natural monopoly. An example is the impact of small satellite TV dishes on cable TV networks.
3. When a regulatory agency imposes a price floor, it may encourage more firms to enter the industry, but it does not really encourage competition. The point of having many firms compete against each other is to force them to be efficient and to keep costs and prices low. In the case of the regulated price floor, the regulatory agency creates the appearance of competition, but at the expense of providing its benefits to the consumer.
4. As the question states, there is great uncertainty and disagreement about this topic. But one aspect of predatory pricing is that it is, and is intended to be, temporary. Its purpose is to drive out (and keep out) rivals, after which time the predatory pricer can raise prices and enjoy higher-than-normal profits. It follows that a court should not find a price predatory and illegal simply because it is lower than other competitors can meet, if the low price can be sustained by the company. In such a case, consumers benefit in the long run. To distinguish between predatory pricing and nonpredatory profit maximization, one should identify potential barriers to entry, determine if the market is contestable, estimate the relevant demand elasticities, estimate the firm’s average and marginal cost curves, and identify the number of potential and actual competitors. It is difficult, but important to distinguish between predatory pricing and pricing decisions based on cost advantages or price discrimination.
5. Students will have their own criteria for fairness. But it is helpful to approach this question by thinking of what the alternative is to having urban telephone users subsidize rural telephone users. One alternative is that rural rates would be higher than urban rates—this could be seen as fairer (because rural average costs are higher than urban) or less fair (because people are being charged different prices for the same service). One consequence of higher rural rates might be that some rural households would choose to go without telephone service, and students may feel this is an undue burden. Another alternative, however, is that rural rates could be kept at the urban level by means of a government subsidy—this would impose the burden of the subsidy upon all taxpayers, in proportion to their capacity to pay income taxes, rather than upon urban phone users, and students may feel that this is more fair.
6. Rational consumers should consider any fall in price to be a good development, because it increases their utility. They are in no way harmed by the increase in the company’s profitability. In fact, it may well have been the incentive of the increased profits that led the firm to figure out how to reduce costs and prices.
7. An agreement between a library and construction firms under which the firms agree to limit their hours of work in the neighborhood would seem to be a reasonable restraint on trade. So would a voluntary agreement among owners of fishing boats to limit the size of their catch in order to preserve the long-run yield of the fishery. But many commercial agreements are deemed by the law to be unreasonable, for example a cartel arrangement in which a small group of large firms agrees to limit their output in order to raise the market price.
13. Nothing in the question indicates that oil companies have monopoly power. If the industry were perfectly competitive, the supply and demand curves might be as shown in Figure 18-1. A price ceiling of PC might cause a shortage, that is to say an excess of quantity demanded, QD, over quantity supplied, QS, and consequently long lines at gas stations. When the ceiling is removed, the price would naturally rise to its market equilibrium level, P1; this would increase the quantity supplied, reduce the quantity demanded and eliminate the shortage and the lines. There is no evidence that the companies have monopoly power to raise prices.
Figure 1
14. Predatory pricing exists when a firm temporarily reduces its price below the profit-maximizing level, in order to force other, weaker firms to reduce their prices, in the expectation that those firms will go out of business, thus allowing the initial firm to have greater power, set a higher price, gain market share and increase profits. The risk is that the predatory firm itself may incur losses and even go out of business, because it has chosen such low prices.
15. This is very similar to question 4 about predatory pricing. To distinguish between an anticompetitive act and a legitimate competitive act one should identify potential barriers to entry, determine if the market is contestable, estimate the relevant demand elasticities, estimate the firm’s average and marginal cost curves, and identify the number of potential and actual competitors. If Firm X is able to profitably sustain the new low price and if new, more efficient firms enter the market this action was a result of legitimate competition that resulted in the elimination of the inefficient Firm Y. If Firm X raises its price after the exit of Firm Y and is able to prevent new firms from entering the market, this price cut was an anti-competitive act.