16 Real-World Competition and

This is not an industry.

I'm going to kill them before they kill me.

The monitoring problem has implications for economics.

Competition should be seen as a process, not a state.

Discuss how firms protect monopoly.

We've seen some nice models, but they don't fit reality.

Real-world markets aren't perfect.
The monopolistic competition and oligopoly models in previ ous chapters come closer to reality and provide some important insights into the "in-between" markets, but they fail to capture aspects of the actual nature of competition.

I give you a sense of what firms, markets, and competition are like in this chapter.

This chapter shows how economists' modern models differ from traditional textbook models and discusses an issue that is very much in the news.

Competition is for winners.

Business is not the opposite.

A monopoly is earned by solving a unique problem.

The goal of all businesses should be to create a monopoly for themselves, and that successful businesses are constantly working towards that end, according to Thiel.

Other companies are simultaneously building up their own monopolies, some directly affecting you, and others affecting you in a roundabout way.
You die if you don't continually improve and integrate new technology.
In your business strategy, you are constantly thinking about how to fight off competition and strengthen your monopoly.

This view of competition is different from the view students get from introductory economics books.

Competition on one end and monopoly on the other form the basis of the textbook view.
monopolistic competition is turned inside out by Thiel's view of the world.
Dynamic monopoly is the only market structure.

The process view of competition is not unique to Thiel.

All types of economists, including me, view competition as a process, and discussions of the competitive pro cess have a long history in economics.
The introductory economics course is built around neat simple models that don't fit into neat simple discussions of the competitive process.

The process view of competition in which the market is seen as composed of dynamic monopolies can't be captured in such models.

In this chapter, we get out of the formal modeling mode and think about competition as a dynamic process, and then relate that thinking back to our models.

Talking about the driving force of most businesses is needed to introduce the concept of dynamic monopoly.

Most people start businesses because they want to solve problems and achieve goals.
Businesses that solve problems for their customers at a lower cost than their competitors benefit society.
Customers are paying for their product.
Benefiting society makes you feel good.
The profits are nice, but for most entrepreneurs, it's not a profit at all, it's a freedom to make their own decisions and feel good about themselves.
For dynamic monopolies, even those run by a single individual, profit maximization is not an especially good assumption to capture their goals.
The profit goal is not highlighted by the standard model.

Short-run profit is not the focus in a dynamic context.

Why isn't profit maximization an profit is.
Even if firms are profit maximizers, their primary concern is not short- especially good assumption to make run profit, but rather long-run profit.

200 corporations in the United States are essentially con or given to individuals when a corporation is formed.

If you own stock, you can troll by managers and have little effective stockholder vote in the election of directors.

The goal of business control is assumed by economic theory.

Most stockholders want to maximize profits and have little input into the decisions that corporations make.
Most corpora holders made the decisions.
Managers don't have the same incentives as owners who run them for their own benefit.
There's also for the owners.
Pressure on managers to maximize the owners' control of management profits can be limited.

A large percentage ofcorpora firms deal with this problem and they don't have control over tions' stock.

Financial institutions that invest indi price encourage them to worry about the price of viduals' money for them and by the way, many companies give owners; instead, it is controlled by financial institutions their managers stock options--rights to buy stock at a low such as mutual funds.
The institutions that hold people's money for them until it is to value of company ownership, decrease profits per share, be paid out to them upon their retirement, are diminished by these stock options.
The owner and can give managers an incentive to overstate profits is another step removed from individ through accounting tricks.
In the early 2000s, 80 percent of the largest Xerox was shown in studies.

Firms spend millions of dollars to improve their reputations.

Firms want to be known as good citizens.
Even if short-run profit is reduced, reputation and goodwill expenditures can increase long-run profit.
In its first decade, Amazon didn't make a profit.

The difficulties with the profit-maximizing assumption are increased when firms are no longer run by a single individual.

It doesn't take place in owner-operated businesses, but in large corporations.

The decisions about what the firm does are not made by those who get the profit.

Signing a proxy statement is the same as directing the company they own to maximize profit.

Economic theory says that self interested decision makers have little incentive to hold down their pay if someone sees it.

The cost of the firm is their pay.
The firm's profit will be lower if their pay isn't held down.
Managers are expected to make at least a predesignated level of profit.

To explain why CEOs are paid more today than they were 30 years ago.

They argue that the demand for top 250 times that of what an average worker receives is higher today than it was 30 years ago.
It has been suggested that CEOs are greedy and that they make small differences in CEO.
That's performance matters a lot.
It's probably true that CEO talent is in short supply, but it doesn't explain why the supply curve for before is highly inelastic because CEOs are paid so much more today.
We have to look at who gets very high pay.
Replacing another place for an answer.

Workers' pay is being held down by competition and out of $60 million.

This means that today is large.
The number of ing, the amount of money CEOs are paid, is not restrained by outsourc CEOs.
Back in the 1980s, large firms increased, which caused labor unrest, and today it demands for CEOs more than ever.

If true, this explanation offers a policy suggestion for those who feel that the CEOs aren't deserving of their York University degree: make the income tax more progressive.

If one makes the income tax more mine pay of CEOs, it will have little effect on the quantity, because unconstrained supply and demand forces deter supplied significantly.

There is a problem in applying the model to the real world.

The text book economic model assumes that people are motivated by self-interest.
In the textbook model of the firm, the assumption is made that firms composed of self-interest-seeking individuals are profit-seeking firms, without explaining how self-interest-seeking individuals who manage real world corporations will find it in their interest to maximize profit for the firm.

The problem was introduced in an earlier chapter.

It's costly to see that an employee does the owner's bidding because the employee's incentives are different.

If it's too costly to monitor the managers to make sure they do what's in the structure of the firm, owners will only maximize firm profit.

If the structure of the firm requires them to do so, self-interested managers are interested in maximizing the firm's profit.

High-level managers can make a lot of money if appropriate monitoring doesn't happen.

The CEO of Charter Communications was paid $98 million.
That is a difficult question.

One way to arrive at an answer is to compare U.S. managers' salaries with those in Japan.

Banks in Japan have a lot of control over firms' operations.

This suggests that high managerial pay in the U.S. is due to a monitoring problem inherent in the structure of corporations.

There are other perspectives.

It depends.

Real-world firms often have complicated goals that reflect the structure of the system.

One of their goals is profit.

Incentives are designed to get managers to focus on profit.

Firms tend to focus on intermediate goals.

Many firms focus on other intermediate world firms for growth in sales, at other times they institute cost reduction goals such as cost and sales.

Many, but not all, real-world corporations are described in this term.

Firms faced mostly domestic competition when Robinson came up with the term.
Firms are a bit less lazy now that they are facing more and more global competi tion.

The lazy monopolists don't push as hard as they could to hold down their costs because they see to it that they make enough profit.

They are consistent with keeping their jobs.
Firms with monopoly positions don't make large profits.
If X-inefficiency becomes bad enough, their costs may rise because of ineffi ciency, or they may simply make a normal level of profit.

The standard model assumes that the owner of the firm makes all the decisions.

The owners of firms who receive the Q-4 would like to see the costs held down because they only want the profit.

Most real-world firms don't operate that way.

Managers are hired to make those decisions.

Managers don't have the same incentive to hold down costs.
It isn't surprising to many economists that managers' pay is usually high and that high level managers see to it that they have "perks" such as chauffeurs, jet planes, ritzy offices, and assistants to do as much of their work as possible.

Until the firm reached a minimally accept able level of profit, the lazy monopolist would allow costs to increase.

The cost inefficiencies eat up the rest of the potential profit.

The degree of competitive pressures a firm faces limits its laziness.

All economic institutions need to make enough money to cover their costs.

They can translate the monopoly profit into X-inefficiency, which will benefit the managers and workers in the firm, but they can't be more efficient once they've done so.

They would close their business.

If all individuals in the industry are lazy, then competitive pressures won't affect their profits.

It is not absolute.
If an industry is opened up to international competition, the lazy monopolists can be squeezed and must undertake massive restructuring to make themselves competitive.
Many U.S. firms have undergone restructur ing in order to be more competitive.

Private equity firms have done many takeovers in recent years.

Most of the private equity firms are investment vehicles with expertise in finance.

They buy firms that have not been performing well and push them to become more efficient.
If the takeover of 346 Microeconomics is successful, the private equity firm will need to make large profits to cover the interest payments on the debt.

The threat of a Managers generally doesn't like takeovers.

Large amounts of debt are required to finance a large payment to stockholders.

Management is put under more pressure to operate efficiently.
Competitive pressure on firms to maximize profits is placed by the threat of a corporate takeover.

I'm not going to talk about management theory in this place except to make you think about the problem.

I wouldn't present this broad outline of the monitoring problem without mentioning that the drive for efficiency isn't the only drive that pushes for efficiency.
Some people derive pleasure from efficient orga nizations.
Individuals like that don't need to be monitored.
If administrators are intentioned, they will hold down costs even if they aren't profit maximizers.
Some libraries and colleges fall into the category of nonprofits that operate as efficiently as they can.
Their success is built on their employees' pride in their jobs.

Some people have a taste for efficiency, and most economists don't deny that.

Economists believe that holding down costs without the profit motive takes stronger willpower than most people have because of their observation of people's actions.

It's not likely that real-world markets would be perfectly competitive.

Perfect competi tion assumes that individuals accept a competitive institutional structure, even though changing that structure could result in significant gains for buyers.
If you understand how the invisible hand, social forces, and political pressures push against each other to create real-world economic institutions, you can understand real-world competition.
Competition is a fight between the forces of monopolization and the forces of competition.

Let's look at some examples.

Competition pushed down prices and wages during the 1930s.
Many laws were passed to prevent unfair competition.
The unions were given monopoly powers so they could resist the pres and push down wages.
The Robinson-Patman Act made it illegal for large retailers to lower prices to the detriment of local mom-and-pop stores.
Wal-mart lost a court case in which it was accused of charging too-low prices in its pharmacy because of laws passed by individual states.

Agricultural markets have many of the conditions for perfect competition.

Not one country in the world allows a competitive agricultural market.
The United States has a lot of laws, regulations, and programs that prevent agricultural markets from working.
U.S. agricultural markets are characterized by price supports.

Markets that are perfectly competitive aren't allowed to exist.

There are many examples that can be found.
Our laws and social values don't allow perfect competition to work because the government emphasizes other goals.
Competition is prevented from operating when it affects the other goals that most people in society hold.

The movement away from perfectly competitive markets could have been predicted.

Figure 16-2.

Competitive markets are only possible if suppliers and ers don't collude.

Economic theory says that if the cost of colluding and preventing entry is less than that amount, these individuals will collude.

The cost of organizing a protest is higher than the cost of colluding, so consumers accept the restrictions.

Suppliers rarely claim that the reason for the restrictions is to increase their incomes.

The net effect of restricting entry into a market is to increase suppliers' income to the detriment of consumers.

Competition doesn't exist, so don't think that because perfect competition doesn't exist.

Competition is fierce in the real world and the invisible hand is not weakling.

It is against other forces in the economy.

It is necessary to prevent other firms from entering the market for a monopoly to last.

It's almost impossible to prevent entry, and it's almost impossible for perfect monopoly to exist.
Some firms want to get some of the profit from Monopoly.

Firms will break down a monopoly if they can get some of the profit.

Potential competitors will lobby to change the law underpinning the monopoly if it is a legal monop oly.
Potential competitors will generally get around the obstacle by developing a slightly different product if the law can't be changed.

Say that you've found a better mousetrap.

Prepare to enjoy the life of a monopolist after patenting it.
To patent your mousetrap, you must submit the technical drawings of how your better mouse trap works.
Potential competitors have a chance to study your idea and see if they can come up with a slightly different way of doing things to avoid being accused of violating your patent.
In some cases firms don't apply for patents on new products because the information in the application spells out what's unique about the product.
Information can help market more than a patent will hurt them.
When trying to get a patent.

Competitors gather information when they go to the patent office.

All industries have variations on reverse engineering.

Consider the industry of clothing.
One firm tells its workers to go to top department stores on their lunch hour to buy the latest fashions.
The garment makers dismantle each garment into its component parts, make a pattern of each part, and sew up the original again after the workers bring the clothes back.

Two weeks after the firm e-mailed the patterns to its Hong Kong office, it received a shipment of garments that were almost identical to the ones the workers bought.

The firm sells this shipment to other stores at a lower price than the original.

Business people will tell you that competition is fierce and that profit opportunities are fleeting, which is a good sign that competition exists in the U.S. economy.

One's view of what government policy should be in relation to natural monopolies is based on the fight between competitive and monopolistic forces.

There have been calls for government regulation of natural monopolies to prevent their exploitation of the consumer due to the fact that they can make large profits.

Policy makers and economists have become less supportive of such regulation over the past decade.

They argue that competi tion works in other ways even in natural monopoly cases.
Sending TV signals through electrical lines is one of the ways that new technologies can compete with phone messages by satellite.
Competition and undermine natural monopolies are provided by new technologies.

When technological competition doesn't work fast enough, people direct their efforts toward government and political pressure is brought to bear either to control the monopoly through regulation or to break up the monopoly.

Natural monopolies are important for the economy because many of the dynamic companies are platform monopolies that have significant natural monopoly elements.

There is a virtual marketplace for trades to take place.
Replacing physical marketplaces with virtual marketplaces increases competi tion in the goods traded within the market enormously, but it also gives the provider of the market a monopoly that it can exploit.
As platform monopolies get bigger, their monopolistic position increases, making them natural monopolies, since the more people that use the market, the more useful it is.

The pressure to regulate natural monopolies has been strong in the past.

They've had to agree to have the price they charge and the services they provide regulated in return for the exclusive right to operate in an industry.
There are regulatory boards in most states.

Firms have little or no incentive to hold down costs when they are allowed to pass on cost increases.

In such cases, cost increases to earn a normal profit on those costs, they have little or no X- inefficiency develops with a passion, and such monopolies look for capital- intensive incentive to hold down costs.

Market structure projects will increase their rate bases.

It is almost impossible for regulatory boards to determine which costs are appropriate and which aren't.
Nuclear power plants were favored by regulated electric companies until they were told that some nuclear power plant construction costs could not be passed on.

Once regulation gets so specific that it's scrutinizing every cost, the regulatory regulations that set prices relative to process becomes extremely bureaucratic, which itself increases the cost.

Often regulatory boards are made up of volunteer lay people who start out with little expertise, and are exhausted or co-opted by the political infighting they have had to endure by the time they develop some of the expertise they need.

There is no easy answer to the problem in economics.

Monopolies believe that a monopoly right should never be granted because regulated monopolies inflate their costs so much and are inefficient and lazy.

The deregulation and competitive supply of both electric power and telephone services took place in the 1980s and 1990s.

Regulators are making these markets competitive by breaking down the layers of the industry into subindustries.
The power generating industry, the power line industry, and the power grid industry are included in the electricity industry.
Regulators can open the remaining parts of the industry to competition by dividing them up.

Let's take a closer look at the industry.

Independent local firms used to provide electricity to their own customers.
Electricity is supplied through a large grid that connects many regions of the country.
With this grid, electricity generated in one area can be sent all over the country, and suppliers can compete for customers in a variety of regions.
Many states have adopted provisions to open their electricity markets to multiple providers because of the grid.

The power line industry is not competitive.

Each company would have to pay for a separate power line into your house.

Natural line industry can be created by economies of scale.

The electrical power industry is not being deregulated as you will likely read in the newspapers.

The portion of the market where there is a chance of a compe tition is being deregulated.

Firms protect their monopolies by being motivated by profits.

It shows how the market economy adjusts to new demands in the real world.
Competition is not static.

Firms don't accept competition if they don't want it.

They spent money on maintaining their monopoly.

By making products that are hard to duplicate.

It means charging a low price that discourages entry if they don't take full advantage of their monopoly position.
Firms can make higher short-run profits by charging a higher price, but they forgo the short-run profits in order to strengthen their long-run position in the industry.

Q-9 What decision rule is expensive to create.

They will buy monopoly power until the marginal cost is equal to the marginal benefit.

Here is the probability that a lobbyist will be effective, here is the marginal cost, and here is the marginal benefit.

We are likely to get a lot of business if we do.

Here is the marginal cost and marginal benefit.

Here are the marginal benefits and marginal costs.

Firms spending money to protect or create monopolies are in the news a lot.

Quotas and farm support programs are fought for by the farm lobby.
Drug companies spend a lot of money to find new drugs.
A vivid example of how long firms go to create a monopoly position is Owens Corning's fight to trademark its hue of pink Fiberglas.
Owens Corning spent more than $200 million to promote and protect its right to sole use of the pink color in its insulation products.

The costs and benefits were weighed by the company and they believed that the pink provided enough brand recognition to warrant spending millions to protect it.

Robert Frank at Cornell University has argued that the economy is becoming more and more like a monopoly economy.

He believes that modern competition is a winner-take-all competition.
In winner-take-all markets, the initial lished because of brand loyalty, patent protection, or simply consumer laziness, competition is focused on establishing a monopoly and can charge significantly higher prices than its costs without market position.

The initial competition is intense.

To see how important establishing a market position is in today's economy, con sider the initial public offering of new Internet firms that are often highly valued by Wall Street.

Many of these firms have no profits and no likelihood of profits for a long time, but they sell their stock at high prices.
The companies are spending money on brand names.
As their names become better known, they will establish a monopoly position, and eventually their monopoly positions will be so strong that they can't help but make a profit.

If you haven't been influenced by Miss Chiquita, U.S. firms will spend more.

The Chiquita banana jingle was played on radio stations across the United States in order to create brand names for their products.

The majority of steaks are sold under food related brand names.

Steaks are trying to change the perception of firms such as Omaha.
Don't buy a steak just because you want to form a brand.

When you think of coffee, think of Starbucks and use filters to sell the image of extravagance.

You can create a name like Dasani, Vermont Pure if you can afford a Lexus.
It's better to pay for a cup of coffee from Starbucks.

Pork does a lot of Braaten, photographer pigs and does not carry a "good-for-you" advertising, but it brands the chick image.

When you think of pork producers, you think of Perdue.

It was true for a few firms that established their brands.

Most people don't have a way of deciding which firms are successful.

Many of the most important modern monopolies are platform monopolies that exhibit network externalities.

Network Economies becomes a winner-take-all industry.

The market might not gravitate towards the most efficient technology.
Network externalities lead to market individuals and processes and technological standards are important for platform monopolies.

The United States and Europe have different television broadcast standards, which is why U.S. TVs can't be used in Europe.

Early in the development of new products, there may be two or three competing techno standards that reduce competition in logical standards, any one of which could be a significant improvement over what a market with network externalities has to offer.

The need for a single standard becomes more important as network externalities broaden the use of a product.

The firm will be in charge of the market.

The standard can be used to get your product accepted by the search engine.
Another example is Facebook.
It undermines the development of alternative social networks if people accept Facebook as their social network.

Even if other firms try to enter with a better technologi cal standard, they will have a hard time competing because everyone is already com mitted to the existing industry standard.

Reducing the benefits of the network externality will be achieved by deviating from that standard.

Firms in an industry developing a standard will have a strong incentive to be the first to market with the product; they will be willing to incur large losses initially in their attempt to set the industry standard.

The first-mover advantage helps explain the high stock prices of start-up companies even though they are having large losses.
Technology companies have large losses.

The demand for the product will rise if the firm is successful in getting its product accepted as the standard.

The degree to which standards can be inefficient is debated by economists.

Some economists think that inefficiency can be large, while others think it is small.
The debate has focused on the keyboard on computers.
The arrangement of the keys in the keyboard was designed to slow down typing so that the keys wouldn't stick on the early mechanical typewriters, according to research by Paul David.
The need to slow down typing ended as the technology of typewriters improved, but because the QWERTY keyboard was first introduced, it had become the standard.
The keyboards have been proposed but not adopted.
The built-in inefficien cies of the keyboard have not stopped it from remaining.

There is a larger debate about the competitive process and government involvement in it.

The issues are the same as they were in the earlier discussion of government regulation of natural monopolies.
Government involvement is necessary to protect the economy and consumer.
Brian Arthur, an economist, calls it a nudging hand approach in which the government keeps the competition fair.

Modern debates about policy regarding monopoly will be eliminated as competitive forces act against it.

Competition takes dynamic issues into account and they will be temporary.
If the standards are inefficient, there will be a debate about what the role of government should be, or if a new product will make the old standard obsolete.

Natural monopoly and technological lock-in are not reasons for government interference.

Government interference would slow or stop the competitive process and make society worse off.

The stories of competition and monopoly are not over.

Both are continuous processes.

Competition is created by monopolies.

Other monopolies emerge, but are beaten down by competition.
That strug gle is made up of technology.
People and firms try to use technology to their advantage.
They change both the nature of the economy and the direction of technological change.

The phrase "competition is for losers" refers to the belief that businesses should be monopolists if they want to survive.

Firms that are successful pay an amount equal to the cost of products to strengthen their monopoly positions.

Consumers face a higher cost of organizing their efforts than real-world firms.

In order to alleviate the carving out of the parts that exhibit the characteristics monitoring problem, economists have helped design lies by dividing the firms into various subindustries.

Firms will spend money on monopolization until they are able to.

Firms that operate less the marginal cost are called X-inefficiency.

Change in management is often caused by corporate takeovers.

There are two implications of network externalities for the economic process, one is that they increase the likelihood and the other is that the competitive process involves a continual fight of a winner-take-all industry.

The monopolist depicted in the United States will maximize profit.

Competition will eliminate X-inefficiency from firms according to some analysts.

Show the net deadweight loss to society.

Competition should be improved by breaking up platform monopolies.

Patents are bad because they give firms monopoly.

Firms that are technically competent will succeed.

Questions from alternative perspectives.

Managers are compared to politicians.

Some assets can provide b.

How does uncertainty affect firms?

Corporations spend a lot of money to influence public policy.

There are many frequent flyers in airlines and hotels.

You can find a prescription drug that someone in your family or frequent-visitor program takes.

Managers and high-level company officials are paid high salaries because they are worth it to the firm.

How much would you spend on this drug if it cost $5 to $10 per prescription?

A prescription for 100 tablets of fluoxetine would force existing colleges out of business.

$54 was sold at DrugStore.com.

Charles Murray has argued that museums are actually other pharmacies.
The appreciation of art would be hampered by what you conclude.

Why would a company want to make less money?

Monsanto lost its U.S. patent protection because it was essentially the same as the brand-name items.

Soft-drink companies pay universities for exclusive rights to sell their products on campus.

Rather than award patents, UCLA signed a contract with Pepsi for drugs.

On-campus soft-drink sales are limited.

Answers to Margin Questions 1.

Firms are trying to create and maintain mo 6.
Most agricultural markets are not perfect.
The winners are those producers who have a monopoly and face little competition, because they are better than the other firms.

Firms aren't interested in short-run profits.

They are con sumers who are kept out.
This is also interested in long-run profits.
The accompanying graph might be sacrified by a firm.

Those who make the decisions for the firm are not always the ones who own the firm.

They are getting value for their money.

The manager has less motivation to hold down costs than the owner.

It's almost impossible for a monopoly to exist.

If the additional benefits of creating or maintaining a profits are a signal to potential entrants to get the barriers monopoly exceed the cost of doing so, do it.

It is difficult for new firms to challenge and establish costs because a new standard will not benefit hold down costs and can lead to X-inefficiency.

Regulators could scrutinize every cost from the network externalities established in the standard.