Profit, Total Revenue, Total Cost • Profit = Total Revenue - Total Cost • Accounting Profit = Total Revenue - Explicit Costs • Economic Profit = Total Revenue - (explicit and implicit cost) • Normal Profit - A level of profit that is just sufficient to maintain ownership. • Total Cost = Explicit + Implicit Costs • Total Cost - explicit payments to the factors of production plus the opportunity cost of the factors provided by the owner of the firm. • Remember, total cost includes the owner’s wage, or a normal rate of return to the owner. Perfect Competition & Monopoly Definitions • Perfect Competition – A market structure characterized by a large number of buyers and sellers of an identical product. • Monopoly – A market structure characterized by a single seller of a highly differentiated (unique) product. Price Taker vs. Price Maker • Market Power – the ability to influence the price of a good in the market. • Price Taker – Buyers and sellers whose individual transactions are so small that they do not affect market prices. • Price Maker – Buyers and sellers whose large transactions affect market prices. i.e. a firm with market power. • NOTE: Being a price maker does not mean you can charge any price you like. Perfect Competition Characteristics 1. The number of firms is large. 2. Free entry and exit - there are no barriers to entry Barriers to entry - social, political, or economic impediments that prevent other firms from entering a market. 3. The product is homogenous (i.e. no product differentiation). 4. There is complete information: buyers and sellers know about prices, product quality, and seller location. No seller has an advantage over another firm. 5. Selling firms are profit maximizing firms. As a result: A perfectly competitive firm is a price taker. Perfect Competition Market vs. Firm • At the market level, the demand curve is downward sloping. If prices rise, quantity demand will fall. If prices fall, quantity demand will rise. • At the firm level, the demand curve is horizontal. Because the firm is too small relative to the market, increases in the amount the firm produces does not impact the price the firm receives in the market. Perfect Competition Short Run vs. Long Run • In the short-run economic profit (or loss) is possible. • In the long-run, competitive pressures will cause the typical firm to earn zero economic profits. Monopoly Characteristics 1. There is one seller – [as opposed to many small sellers] 2. Product is unique – [as opposed to a homogenous good] 3. Blockaded entry and exit – [as opposed to free entry and exit] 4. Imperfect information – [as opposed to perfect information] 5. Firm is a profit maximizer As a result, the firm is a price maker Monopoly Myths • Myth one: Monopolies can charge whatever price they wish. – A monopoly is constrained by its level of demand. • Myth Two: A monopoly always makes an economic profit. – If demand is insufficient, P < ATC, and the firm will not make an economic profit. – If all monopolies made an economic profit, each small town would have the same assortment of goods and services offered in a larger city. Social Costs of Monopoly • Deadweight Loss – Consumer surplus - the difference between the maximum price a buyer is willing and able to pay for a good or service and the price actually paid. – CS = Maximum buying price - price paid • Rent-seeking - actions of individuals and groups who spend resources to influence public policy in the hope of redistributing income to themselves from others. • X-inefficiency • Price discrimination - to charge different prices to different individuals or groups of individuals Price Discrimination • Price discrimination - to charge different prices to different individuals or groups of individuals. • First Degree Price Discrimination - the process of charging each consumer the maximum she or he is willing to pay. – Transfers all dead weight loss to the firm – Only possible if the firm knows the maximum price each person will pay. • Second Degree of Price Discrimination - charging consumers different prices based upon the quantity the consumer consumes. – Occurs when a firm charges different prices depending upon how many tickets the consumer buys. – Takes advantage of the fact demand curve is downward sloping, which indicates that people will be willing to pay less per ticket as the quantity purchased increases. • Third Degree of Price Discrimination - occurs when a firm charges different prices for the same good in different segments of the market. – Occurs when a firm charges different prices to students and/or senior citizens. – Higher prices are charged to the least responsive demand. Lower prices are charged to those with the most responsive demand. In Defense of Monopoly • Are professional sports a monopoly? Depends upon how one defines the market. • Are professional sports a natural monopoly? – A team has high fixed costs and low variable costs. Hence expansion in output will lower average total cost. – An entrant, with less output, will be unable to produce at a lower per-unit cost. – Review the work of Walter Neale (1964) • As a monopoly, professional teams can invest in player development, much more so than competitive firms. Basic Anti-Trust History • Origins of Anti-Trust Laws 1. Firms increase in size 2. Increase in the number of mergers 3. Political issues Sherman Anti-Trust Law • Sherman Anti-trust Act (1890) • Section I: Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states or with foreign nations is hereby declared to be illegal. • Section II: Every person who shall monopolize or attempt to monopolize, or combine or conspire to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty...and....punished. • Section IV: Attorney general is authorized to institute lawsuits against offenders • Section VII: Allows injured parties to bring suit for recovery of triple damages against offenders of Section I and II. Problems with the Sherman Anti-Trust Act • Monopolizing vs. Monopoly Is the existence of monopoly a crime? The Act forbids monopolizing, not monopoly. • The ‘Rule of Reason’ Initially the courts only acted against monopoly that was created via an ‘unreasonable restraint of trade.’ What is considered ‘unreasonable’ though, varies from court to court. The Federal League Case • The Federal League challenged the AL and NL from 1914-1915. The league was favored by the players, who saw salaries drop after the AL and NL ‘merger’ in 1903. • The Federal League sued baseball, in the court of Judge Kenesaw Mountain Landis, a noted trustbuster. Unfortunately, Landis was a big baseball fan. • Landis stalled until MLB reached an agreement with every owner, but one, of the Federal League. • The lone holdout was Ned Hanlon of the Baltimore franchise whose buyout offer was less than other Federal League owners. • Baltimore won its case in court, but the decision was over turned in appeals on the grounds that major league baseball was not interstate commerce. The Supreme Court agreed with this position. • The Federal League decision, though, was not allowed as an argument by the Supreme Court with respect to any other industry or sport. The Toolson Case • George Toolson was a player in the Yankee system, who refused assignment to the minor leagues. He then sued the Yankees, claiming the reserve clause violated anti-trust laws. • As the case went through the courts, the House Subcommittee on the Study of Monopoly Power (chaired by Rep. Emmanuel Cellar) began reviewing baseball’s anti-trust exemption. • When it became clear the Toolson case was going to the Supreme Court, the Cellar Committee postponed action. • The Supreme Court ruled that the inaction of the Cellar Committee signaled approval from Congress of the exemption. Hence the Supreme Court ruled in favor the Yankees. • The Supreme Court later repeated this action in the Curt Flood case, heard in the early 1970s. The Anti-Trust Exemption • The anti-trust immunity remained in force until July 30, 1999 (Curt Flood Act), where it was revoked for labor relations. • Why did the courts not reverse their earlier decision? In essence the court argued that this was a matter for Congress to determine, not the courts. • What has been the impact of this immunity? 1. Ending the reserve clause was a difficult process because of the immunity. 2. Baseball has been able to prevent franchise relocation, a power not held by the other major sports leagues. • Pete Rozelle was able to get a limited exemption from Congress in order to negotiate a broadcast agreement between the NFL and network television. • What does the Rozelle exemption accomplish? Higher prices for NFL broadcast rights, which leads to higher revenues and higher salaries.