Chapter 16 - Real-world competition and technology. After reading this chapter, you should be able to: Define the monitoring problem and state its implications for economics; discuss why competition should be seen as a process, not a state; summarize how firms protect monopoly; explain why oligopoly is the best market structure for technological change.
Introduction: Thinking Like an Economist CHAPTER 2 CHAPTER 16 12 Real-World Competition and Technology It is ridiculous to call this an industry. This is rat eat rat; dog eat dog. I’ll kill ’em, and I’m going to kill ’em before they kill me. You’re talking about the American way of survival of the fittest — Ray Kroc (founder of McDonald’s) McGrawHill/Irwin Copyright © 2013 by The McGrawHill Companies, Inc. All rights reserved RealWorld Competition and Technology 16 Chapter Goals Ø Ø Ø Ø Define the monitoring problem and state its implications for economics Discuss why competition should be seen as a process, not a state Summarize how firms protect monopoly Explain why oligopoly is the best market structure for technological change 162 RealWorld Competition and Technology 16 Short-Run vs Long-Run Profit Ø Ø Ø Firms care about both short-run and long-run profit Firms may not take full advantage of a potential monopolistic situation in the short run to strengthen their position in the long run Any expenditures on building a brand and a good reputation can reduce short-run profits but increase long-run profits 163 RealWorld Competition and Technology 16 Managers’ Incentives and the Need for Monitoring Ø Managers have an incentive to keep costs down, but their salaries are included in costs • This creates a monitoring problem which is the need to oversee employees to ensure that their actions are in the best interest of the firm • Ø Employees’ incentives differ from the owner’s incentives To address this problem, firms sometimes give managers incentive-compatible contracts in which the incentives of each of the two parties to the contract are made to correspond as closely as possible 164 RealWorld Competition and Technology 16 What Do Real-World Firms Maximize? Ø Ø Ø Firms have complicated goals that reflect the organizational structure and incentives built into the systemprofit is one goal of a firm, often firms focus on Although other intermediate goals such as cost and sales Some firms not push for cost efficiency and become lazy monopolists • Lazy monopolists are firms that not push for efficiency, but merely enjoy the position they are already in 165 RealWorld Competition and Technology 16 The Fight between Competitive and Monopolistic Forces Ø Ø Ø Competition is a process – a fight between the forces of monopolization and the forces of competition Self-interest-seeking individuals don’t like competition for themselves and may use political and social means to fight competition It is important to understand how the invisible hand, social forces, and political pressures work in order to understand competition 166 RealWorld Competition and Technology 16 How Monopolistic Forces Affect Perfect Competition Ø Ø Ø Laws, social values, and customs in the United States not allow perfect competition to work because our government emphasizes other social goals besides efficiency The Robinson-Patman Act and several state laws prevent firms from charging a price that is too low The U.S has laws, regulations, and programs that prevent agricultural markets from working competitively 167 RealWorld Competition and Technology 16 Competition and Natural Monopolies Ø Ø Ø Ø Natural monopolies are industries whose average total cost decreases as output increases and because of this they can make large profits Economies of scale can create a natural monopoly To prevent abuse of their market power, many natural monopolies are regulated New technologies can compete with and undermine natural monopolies 168 RealWorld Competition and Technology 16 Regulating Natural Monopolies Ø Ø Ø Ø Regulated natural monopolies have been given the exclusive right to operate in the industry In return, they are allowed to charge a fair price, which includes all costs plus a normal return on capital investment Regulation to allow regulated monopolies to earn a normal profit When firms are allowed to pass on all cost increases, they have little or no incentive to hold down costs and X–inefficiency develops 169 RealWorld Competition and Technology 16 Deregulating Natural Monopolies Ø Ø Ø Many formerly regulated natural monopolies are being deregulated In the electricity industry, power supply has been deregulated, but because of the existence of economies of scale, the power line industry has remained a regulated monopoly Only portions of industries that are likely to be competitive are being deregulated 1610 RealWorld Competition and Technology 16 How Firms Protect Their Monopolies Monopolies spend money to maintain their monopoly by: • Advertising • Lobbying • Producing goods that are difficult to copy • Ø Not taking advantage of their monopoly position and charging a lower price Firms will buy monopoly power until the marginal cost of maintaining the monopoly equals the marginal benefit 1611 RealWorld Competition and Technology 16 Technology, Efficiency, and Market Structure Ø Ø Ø Ø Technological development is the discovery of new or improved products or methods of production Because the global market is significantly larger than a domestic one, globalization provides an incentive to develop new technology Market structures that best promote technological change are dynamically efficient Dynamic efficiency refers to a market’s ability to promote cost-reducing or product-enhancing technological change 1612 RealWorld Competition and Technology 16 Market Structure and Technology Perfect competition • • There is no incentive to develop new technologies because they earn no profits to fund research Even if they did innovate, competitors would gain from the new technology without having to pay for it Monopolistic competition • • Because of market power, monopolistic competition is more conducive to technological change Due to ease of entry, they lack long-run profits, so their ability to recoup their investment is limited 1613 RealWorld Competition and Technology 16 Network Externalities, Standards, and Technological Lock–In Ø Ø Ø Ø Ø Network externalities occur when greater use of a product increases the benefit of that product to everyone Network externalities lead to market standards and affect market structure Standards are created when a firm’s standard is accepted and dominates the market First-mover advantage helps explain the high stock prices of start-up technology companies Technological lock-in is when prior use of a technology makes the adoption of subsequent technology difficult 1614 RealWorld Competition and Technology 16 Chapter Summary Ø Ø Ø Ø Profit is an important goal of firms, but actual goals depend on the incentive structure of the firm The monitoring problem arises because managers’ incentives are not always to maximize the firm’s profit Monopolists facing no competition can become subject to X-inefficiency – operating less efficiently than is technically possible The competitive process involves a continual fight between monopolization and competition 1615 RealWorld Competition and Technology 16 Chapter Summary Ø Ø Ø Ø The U.S government is deregulating natural monopolies by dividing the firms into various subindustries, carving out those parts that exhibit the characteristics of a natural monopoly, and opening the remaining parts to competition Firms will spend money on monopolization until the marginal cost equals the marginal benefit Firms protect their monopolies by advertising, lobbying, and producing products that are difficult to copy Oligopoly provides the best market structure for technological advance 1616 ... structure for technological change 16 2 RealWorld Competition and Technology 16 Short-Run vs Long-Run Profit Ø Ø Ø Firms care about both short-run and long-run profit Firms may not take full... building a brand and a good reputation can reduce short-run profits but increase long-run profits 16 3 RealWorld Competition and Technology 16 Managers’ Incentives and the Need for Monitoring... efficiency refers to a market’s ability to promote cost-reducing or product-enhancing technological change 16 12 RealWorld Competition and Technology 16 Market Structure and Technology Perfect competition