ECON 100 Week 4, Disc 1

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Economics

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"Monopoly and Market Entry and Monopolistic Competition" Please respond to the following:

  • Identify a company in your local area that you would classify as a monopoly. Explain why you classified the company as a monopoly, and state how the company relates to at least two characteristics of that particular market.
  • From the e-Activity article http://for.tn/1tqLvTF, explain your position on whether or not Apple is stifling competition and monopolizing the tablet market. Examine the type of market structure within which Apple operates. Support your answer by relating to each of the characteristics described in Chapter 8 of your textbook.Chapter 8

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Chapter 8 Market Entry, Monopolistic Competition, and Oligopoly During the recession that started in 2008, some industries actually experienced increases in demand that caused market entry – new firms entered the markets. Prepared By Brock Williams Learning Objectives 1. Describe and explain the effects of market entry. 2. List the conditions for equilibrium in monopolistic competition. 3. Contrast monopolistic competition and perfect competition. 4. Explain the role of advertising in monopolistic competition. 5. Explain why a price-fixing cartel is difficult to maintain. 6. Explain the effects of a low-price guarantee on the price. 7. Explain the behavior of an insecure monopolist. 8. Define a natural monopoly and explain the average-cost pricing policy. 9. List three features of antitrust policy. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-2 Market Entry, Monopolistic Competition, and Oligopoly ●monopolistic competition A market served by many firms that sell slightly different products. The term, monopolistic competition, actually conveys the two key features of the market: • Each firm in the market produces a good that is slightly different from the goods of other firms, so each firm has a narrowly defined monopoly. • The products sold by different firms in the market are close substitutes for one another, so there is intense competition between firms for consumers. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-3 8.1 THE EFFECTS OF MARKET ENTRY MARGINAL PRINCIPLE Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-4 8.1 THE EFFECTS OF MARKET ENTRY (cont.) FIGURE 8.1 Market Entry Decreases Price and Squeezes Profit (A) A monopolist maximizes profit at point a, where marginal revenue equals marginal cost. 300 toothbrushes at a price of $2.00 (point b) and an average cost of $0.90 (point c). Profit of $330 is shown by the shaded rectangle. (B) Entry of a second firm shifts the firm-specific demand curve for the original firm to the left. The firm produces only 200 toothbrushes (point d) at a lower price ($1.80, shown by point e) and a higher average cost ($1.00, shown by point f). Profit, shown by the shaded rectangle, shrinks to $160. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-5 8.1 THE EFFECTS OF MARKET ENTRY (cont.) Entry Squeezes Profits from Three Sides Entry shrinks the firm’s profit rectangle because it is squeezed from three directions. The top of the rectangle drops because the price decreases. The bottom of the rectangle rises because the average cost increases. The right side of the rectangle moves to the left because the quantity decreases. Examples of Entry: Stereo Stores, Trucking, and Tires Empirical studies of other markets provide ample evidence that entry decreases market prices and firms’ profits. In other words, consumers pay less for goods and services, and firms earn lower profits. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-6 APPLICATION 1 SATELLITE VS. CABLE APPLYING THE CONCEPTS #1: How does market entry affect prices? Consider the market for television signals provided to residential consumers. How will an existing cable-TV provider respond to the entry of a firm that provides TV signals via satellite? In most cases, the entry of a satellite firm causes the cable firm to improve the quality of service and decrease its price, so consumer surplus increases. In some cases, the cable company improves the quality of service and increases price. Because the service improvement is typically large relative to the price hike, consumer surplus increases in this case too. On average, the entry of a satellite firm increases the monthly consumer surplus per consumer from $3.96 to $5.22, an increase of 32 percent. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-7 8.2 MONOPOLISTIC COMPETITION Under a market structure called monopolistic competition, firms will continue to enter the market until economic profit is zero. Here are the features of monopolistic competition: • Many firms. • A differentiated product. ●product differentiation The process used by firms to distinguish their products from the products of competing firms. • No artificial barriers to entry. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-8 8.2 MONOPOLISTIC COMPETITION (cont.) When Entry Stops: Long-Run Equilibrium FIGURE 8.2 Long-Run Equilibrium with Monopolistic Competition Under monopolistic competition, firms continue to enter the market until economic profit is zero. Entry shifts the firm specific demand curve to the left. The typical firm maximizes profit at point a, where marginal revenue equals marginal cost. At a quantity of 80 toothbrushes, price equals average cost (shown by point b), so economic profit is zero. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-9 8.2 MONOPOLISTIC COMPETITION (cont.) Differentiation by Location FIGURE 8.3 Long-Run Equilibrium with Spatial Competition Book stores and other retailers differentiate their products by selling at different locations. The typical book store chooses the quantity of books at which its marginal revenue equals its marginal cost (point a). Economic profit is zero because the price equals average cost (point b). Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-10 APPLICATION 2 OPENING A DUNKIN’ DONUTS SHOP APPLYING THE CONCEPTS #2: Are monopolistically competitive firms profitable? One way to get into a monopolistically competitive market is to get a franchise for a nationally advertised product. How much money are you likely to make in your donut shop? You will compete for donut consumers with other donut shops, bakeries, grocery stores, and coffee shops. Given the small barriers to entering the donut business, you should expect keen competition. You should expect to make zero economic profit, with total revenue equal to total cost. Your total cost includes the franchise fee and royalties, as well as the opportunity cost of your time and the opportunity cost of any funds you invest in the business. Table 8.1 shows the franchise fees and royalty rates for several franchising opportunities. The fees indicate how much entrepreneurs are willing to pay for the right to sell a brand-name product.  TABLE 8.1 Franchising Fees and Royalties Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-11 8.3 TRADE-OFFS WITH ENTRY AND MONOPOLISTIC COMPETITION Average Cost and Variety There are some trade-offs associated with monopolistic competition. Although the average cost of production is higher than the minimum, there is also more product variety. When firms sell the same product at different locations, the larger the number of firms, the higher the average cost of production. But when firms are numerous, consumers travel shorter distances to get the product. Therefore, higher production costs are at least partly offset by lower travel costs. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-12 8.3 TRADE-OFFS WITH ENTRY AND MONOPOLISTIC COMPETITION (cont.) Monopolistic Competition versus Perfect Competition  FIGURE 8.4 Monopolistic Competition versus Perfect Competition (A) In a perfectly competitive market, the firm-specific demand curve is horizontal at the market price, and marginal revenue equals price. In equilibrium, price = marginal cost = average cost. Equilibrium occurs at the minimum of the average-cost curve. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-13 8.3 TRADE-OFFS WITH ENTRY AND MONOPOLISTIC COMPETITION (cont.) Monopolistic Competition versus Perfect Competition  FIGURE 8.4 (cont’d.) Monopolistic Competition versus Perfect Competition (B) In a monopolistically competitive market, the firm- specific demand curve is negatively sloped and marginal revenue is less than price. In equilibrium, marginal revenue equals marginal cost (point b) and price equals average cost (point c). Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-14 APPLICATION 3 HAPPY HOUR PRICING APPLYING THE CONCEPTS #3: How does monopolistic competition compare with perfect competition? Consider the phenomenon of “happy hour.” Many bars and restaurants near workplaces face an increase in demand for food and drink around 5:00 p.m., and many cut their prices for an hour or two. According to the model of perfect competition, an increase in demand will lead to higher, not lower prices. What explains the happy hour combination of higher demand and lower prices? Bars are subject to monopolistic competition. Each bar has a local monopoly within its neighborhood, but faces competition from other bars outside its neighborhood. For an individual consumer, the higher the demand for food and drink, the greater the incentive to consider alternatives to the nearest bar. If you expect to purchase large quantities of bar food and drink, the savings achieved by finding a lower price at an alternative bar will be relatively large. In other words, when individual demand increases, each bar faces a more elastic demand for its products. In a market subject to monopolistic competition, the bar’s rational response to more elastic demand (more sensitive consumers) is to decrease its price. In graphical terms, the demand curve facing each bar becomes flatter, and the demand curve will be tangent to the average-cost curve at a larger quantity and a lower price and average cost. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-15 8.4 ADVERTISING FOR PRODUCT DIFFERENTIATION Celebrity Endorsements and Signaling An advertisement that doesn’t provide any product information may actually help consumers make decisions.  TABLE 8.2 Advertising Profitability and Signaling Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-16 APPLICATION 4 PICTURE OF MAN VERSUS PICTURE OF WOMAN APPLYING THE CONCEPTS #4: How does advertising affect consumer choices? A South African consumer lender decided to use a mass mailing of 53,000 loan offers to test the sensitivity of consumers to variations in interest rates and other features of loan offers. The interest rates in the offer letters ranged from 3.75% to 11.75% per month. As expected, the uptake rate (the number of consumers who accepted a particular Loan offer) was higher for offer letters with low interest rates. The elasticity of the uptake rate with respect to the interest rate was –0.34: a 10% decrease in the interest rate (from say an interest rate of 7.0% to 6.3%) increased the uptake rate by 3.4%. More surprising was the finding that the uptake rate among men was much higher when the offer letter included a picture of a woman rather than a picture of a man. Replacing a male model with a female model was equivalent to cutting the interest rate by 25 percent, for example, from 7.0 percent to 5.25 percent. In contrast, the uptake rate for women consumers was unaffected by the gender of the model. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-17 8.5 OLIGOPOLY AND PRICING? ● Oligopoly A market served by a few firms ● concentration ratio The percentage of the market output produced by the largest firms. An oligopoly occurs for three reasons: 1 Government barriers to entry. 2 Economies of scale in production. 3 Advertising campaigns. An alternative measure of market concentration is the Herfindahl-Hirschman Index (HHI). It is calculated by squaring the market share of each firm in the market and then summing the resulting numbers. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-18 8.5 OLIGOPOLY AND PRICING? (cont.)  TABLE 8.3 Concentration Ratios in Selected Manufacturing Industries Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-19 8.5 OLIGOPOLY AND PRICING? (cont.) Cartel Pricing and the Duopolists’ Dilemma ●duopoly A market with two firms. ● cartel A group of firms that act in unison, coordinating their price and quantity decisions. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-20 8.5 OLIGOPOLY AND PRICING? (cont.) profit = (price − average cost) × quantity per firm FIGURE 8.5 A Cartel Picks the Monopoly Quantity and Price The monopoly outcome is shown by point a, where marginal revenue equals marginal cost. The monopoly quantity is 60 passengers and the price is $400. If the firms form a cartel, the price is $400 and each firm has 30 passengers (half the monopoly quantity). The profit per passenger is $300 (equal to the $400 price minus the $100 average cost), so the profit per firm is $9,000. ●price-fixing An arrangement in which firms conspire to fix prices. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-21 8.5 OLIGOPOLY AND PRICING? (cont.)  FIGURE 8.6 Competing Duopolists Pick a Lower Price (A) The typical firm maximizes profit at point a, where marginal revenue equals marginal cost. The firm has 40 passengers. (B) At the market level, the duopoly outcome is shown by point d, with a price of $300 and 80 passengers. The cartel outcome, shown by point c, has a higher price and a smaller total quantity. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-22 8.5 OLIGOPOLY AND PRICING? (cont.) Price-Fixing and the Game Tree ●game tree A graphical representation of the consequences of different actions in a strategic setting.  FIGURE 8.7 Game Tree for the Price-Fixing Game The equilibrium path of the game is square A to square C to rectangle 4: Each firm picks the low price and earns a profit of $8,000. The duopolists’ dilemma is that each firm would make more profit if both picked the high price, but both firms pick the low price. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-23 8.5 OLIGOPOLY AND PRICING? (cont.)  TABLE 8.4 Duopolists’ Profits When They Choose Different Prices Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-24 8.5 OLIGOPOLY AND PRICING? (cont.) Equilibrium of the Price-Fixing Game ●dominant strategy An action that is the best choice for a player, no matter what the other player does. ●duopolists’ dilemma A situation in which both firms in a market would be better off if both chose the high price, but each chooses the low price. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-25 8.5 OLIGOPOLY AND PRICING? (cont.) Nash Equilibrium ●Nash equilibrium An outcome of a game in which each player is doing the best he or she can, given the action of the other players. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-26 APPLICATION 5 FAILURE OF THE SALT CARTEL APPLYING THE CONCEPTS #5: Why do cartels sometimes fail to keep prices high? At the beginning of the nineteenth century, high overland transportation costs protected salt producers from competition with one another, generating local salt monopolies. Over the course of the nineteenth century, decreases in overland transportation Costs increased competition between salt producers and decreased prices. In response to the increased competition, salt producers colluded by forming salt pools, enterprises that set a uniform price and distributed the salt of all participating producers. Some pools established output quotas or paid firms not to produce salt for a year, a practice known as “dead-renting” a salt furnace. Every salt pool eventually broke down, usually within a year or two of its formation. In some cases, individual firms cheated on the cartel by selling salt outside the cartel. In other cases the artificially high price caused new firms to enter the market and underprice the salt pool. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-27 8.6 OVERCOMING THE DUOPOLISTS’ DILEMMA Low-Price Guarantees ●low-price guarantee A promise to match a lower price of a competitor. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-28 8.6 OVERCOMING THE DUOPOLISTS’ DILEMMA (cont.) Low-Price Guarantees  FIGURE 8.8 Low-Price Guarantees Increase Prices When both firms have a low-price guarantee, it is impossible for one firm to underprice the other. The only possible outcomes are a pair of high prices (rectangle 1) or a pair of low prices (rectangles 2 or 4). The equilibrium path of the game is square A to square B to rectangle 1. Each firm picks the high price and earns a profit of $9,000. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-29 8.6 OVERCOMING THE DUOPOLISTS’ DILEMMA (cont.) Repeated Pricing Games with Retaliation for Underpricing Repetition makes price-fixing more likely because firms can punish a firm that cheats on a price-fixing agreement, whether it’s formal or informal: 1 A duopoly pricing strategy. Choosing the lower price for life. 2 A grim-trigger strategy. ●grim-trigger strategy A strategy where a firm responds to underpricing by choosing a price so low that each firm makes zero economic profit. 3 A tit-for-tat strategy. ●tit-for-tat A strategy where one firm chooses whatever price the other firm chose in the preceding period. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-30 8.6 OVERCOMING THE DUOPOLISTS’ DILEMMA (cont.) Repeated Pricing Games with Retaliation for Underpricing  FIGURE 8.9 A Tit-for-Tat Pricing Strategy (cont’d) Under tit-for-tat retaliation, the first firm (Jill, the square) chooses whatever price the second firm (Jack, the circle) chose the preceding month Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-31 8.6 OVERCOMING THE DUOPOLISTS’ DILEMMA (cont.) Price-Fixing and the Law Under the Sherman Antitrust Act of 1890 and subsequent legislation, explicit price-fixing is illegal. It is illegal for firms to discuss pricing strategies or methods of punishing a firm that underprices other firms. Price Leadership A system under which one firm in an oligopoly takes the lead in setting prices. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-32 APPLICATION 6 LOW PRICE GUARANTEE INCREASES TIRE PRICES APPLYING THE CONCEPTS #6: Do low price guarantees generate higher or lower prices? In two successive months (November and December), a Florida tire retailer listed prices for 35 types of tires in newspaper advertisements. In November the average price was $45, and in December the average price was $55. The December advertisement was different in another way: it included a low-price guarantee under which the retailer agreed to match any lower advertised price (and also pay the customer some percentage of the price gap). In fact, for each of the 35 types of tires, the December price was the same or higher than the November price. In this case, a low-price Guarantee generated higher prices. Is the relationship between low-price guarantees and prices apparent or real? A careful study of the retail tire market suggests that prices are generally higher in markets where firms offer low-price guarantees. On average, the presence of a low price guarantee increases prices by $4 per tire, or about 10 percent of the price. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-33 8.7 THE INSECURE MONOPOLIST AND ENTRY DETERRENCE The Passive Approach  FIGURE 8.10 Deterring Entry with Limit Pricing Point c shows a secure monopoly, point d shows a duopoly, and point z shows the zero-profit outcome. The minimum entry quantity is 20 passengers, so the entrydeterring quantity is 100 (equal to 120 – 20), as shown by point e. The limit price is $200. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-34 8.7 THE INSECURE MONOPOLIST AND ENTRY DETERRENCE (cont.) Entry Deterrence and Limit Pricing The quantity required to prevent the entry of the second firm is computed as follows: deterring quantity = zero profit quantity − minimum entry quantity Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-35 8.7 THE INSECURE MONOPOLIST AND ENTRY DETERRENCE (cont.) Entry Deterrence and Limit Pricing  FIGURE 8.11 Game Tree for the EntryDeterrence Game The path of the game is square A to square C to rectangle 4. Mona commits to the entry-deterring quantity of 100, so Doug stays out of the market. Mona’s profit of $10,000 is less than the monopoly profit but more than the duopoly profit of $8,000. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-36 8.7 THE INSECURE MONOPOLIST AND ENTRY DETERRENCE (cont.) Entry Deterrence and Limit Pricing ●limit pricing The strategy of reducing the price to deter entry. ● limit price The price that is just low enough to deter entry Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-37 APPLICATION 7 MICROSOFT AS AN INSECURE MONOPOLIST APPLYING THE CONCEPTS #7: How does a monopolist respond to the threat of entry? Microsoft has a virtual monopoly in the market for personal-computer operating Systems and business software. But there is a constant threat that another firm will launch competing products, so Microsoft engages in limit pricing to deter entry into its key markets. A recent study revealed some of the numbers behind the insecure monopoly. 1 The pure monopoly price for a software bundle of the Windows operating system and the Office Suite of business tools is about $354, but the actual price (the limit price) is about $143. The estimated cost for a second firm to develop, maintain, and market an alternative software bundle is about $38 billion, and Microsoft’s actual price is just low enough to make such an investment unprofitable. 2 The pure monopoly profit would be about $191 billion, while the profit under Microsoft’s limit pricing is about $153 billion. Although the profit under the entry-deterrence strategy is less than the pure monopoly profit, it is greater than the profit Microsoft would earn if it allowed a second firm to enter the market ($148 billion). In other words, entry deterrence is the best strategy. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-38 8.7 THE INSECURE MONOPOLIST AND ENTRY DETERRENCE (cont.) Examples: Microsoft Windows and Campus Bookstores Microsoft picks a lower price to discourage entry and preserve its monopoly. If your campus bookstore suddenly feels insecure about its monopoly position, it could cut its prices to prevent online booksellers from capturing too many of its customers. Entry Deterrence and Contestable Markets ●contestable market A market with low entry and exit costs. When Is the Passive Approach Better? Entry deterrence is not the best strategy for all insecure monopolists. Sharing a duopoly can be more profitable than increasing output and cutting the price to keep the other firm out. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-39 8.8 NATURAL MONOPOLY Picking an Output Level MARGINAL PRINCIPLE Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-40 8.8 NATURAL MONOPOLY (cont.) Picking an Output Level  FIGURE 8.12 A Natural Monopoly Uses the Marginal Principle to Pick Quantity and Price Because of the indivisible input of cable service (the cable system), the long-run average-cost curve is negatively sloped. The monopolist chooses point a, where marginal revenue equals marginal cost. The firm serves 70,000 subscribers at a price of $27 each (point b) and an average cost of $21 (point c). The profit per subscriber is $6 ($27 – $21). Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-41 8.8 NATURAL MONOPOLY (cont.) Will a Second Firm Enter?  FIGURE 8.13 Will a Second Firm Enter the Market? The entry of a second cable firm would shift the demand curve of the typical firm to the left. After entry, the firm’s demand curve lies entirely below the long-run average-cost curve. No matter what price the firm charges, it will lose money. Therefore, a second firm will not enter the market. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-42 8.8 NATURAL MONOPOLY (cont.) Price Controls for a Natural Monopoly  FIGURE 8.14 Regulators Use Average-Cost Pricing to Pick a Monopoly’s Quantity and Price Under an average-cost pricing policy, the government chooses the price at which the demand curve intersects the long-run average-cost curve—$12 per subscriber. Regulation decreases the price and increases the quantity. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-43 APPLICATION 8 PUBLIC VERSUS PRIVATE WATERWORKS APPLYING THE CONCEPTS #8: What is the rationale for regulating a natural monopoly? In the early part of the nineteenth century, public water works could not keep up with rapidly growing demand, so cities allowed private companies to provide water. However, problems with competing private wager providers caused cities to switch back to public systems The British determined that water distribution is a natural monopoly and allowing competition hurts rather than helps public access to water. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-44 8.9 ANTITRUST POLICY ●trust An arrangement under which the owners of several companies transfer their decision-making powers to a small group of trustees. Breaking Up Monopolies One form of antitrust policy is to break up a monopoly into several smaller firms. The label “antitrust” comes from the names of the early conglomerates that the government broke up. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-45 8.9 ANTITRUST POLICY (cont.) Blocking Mergers ●merger A process in which two or more firms combine their operations. A horizontal merger involves two firms producing a similar product, for example, two producers of pet food. A vertical merger involves two firms at different stages of the production process, for example, a sugar refiner and a candy producer.. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-46 8.9 ANTITRUST POLICY (cont.) Blocking Mergers  FIGURE 8.15 Pricing by Staples in Cities with and without Competition Using the marginal principle, Staples picks the quantity at which marginal revenue equals marginal cost. In a city without a competing firm, Staples picks the monopoly price of $14. In a city where Staples competes with Office Depot, the demand facing Staples is lower, so the profitmaximizing price is only $12. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-47 8.9 ANTITRUST POLICY (cont.) Merger Remedy for Wonder Bread In some cases, the government allows a merger to happen but imposes restrictions on the new company.  TABLE 8.5 A Merger Increases Prices Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-48 8.9 ANTITRUST POLICY (cont.) Regulating Business Practices: Price-Fixing, Tying, and Cooperative Agreements ●tie-in sales A business practice under which a business requires a consumer of one product to purchase another product. ●predatory pricing A firm sells a product at a price below its production cost to drive a rival out of business and then increases the price. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-49 8.9 ANTITRUST POLICY (cont.) A Brief History of U.S. Antitrust Policy  TABLE 8.6 Key Antitrust Legislation Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-50 APPLICATION 9 MERGER OF PENNZOIL AND QUAKER STATE APPLYING THE CONCEPTS #9: How does a merger affect prices? In 1998, Pennzoil Motor Oils purchased Quaker State Motor oils in an acquisition valued at $1 billion. The merger brought together two of the five brands of premium motor oil, with a combined market share of 38% (29% for Pennzoil and 9% for Quaker State). The antitrust agencies approved the merger without any modifications. A recent study of the merger concludes that the new company increased the price of the Quaker State products by roughly 5%, but did not change the price of Pennzoil products. The market share of Pennzoil products increased, while the market shares of Quaker State products decreased. The study also examines the price effects of four other mergers. In three of four cases, the merger increased prices, with price hikes between 3 and 7 percent. The Modest price effects might be surprising to (1)people who expect relatively large Positive price effects as firms exploit their greater market power and (2)(2) people who expect negative price effects as the firms become more efficient. Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-51 KEY TERMS cartel limit pricing concentration ratio merger contestable market monopolistic competition dominant strategy Nash equilibrium duopolists’ dilemma oligopoly duopoly predatory pricing game theory price-fixing game tree product differentiation grim-trigger strategy tie-in sales low-price guarantee tit-for-tat limit price trust Copyright ©2014 Pearson Education, Inc. All rights reserved. 8-52
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