Monopoly - Chapter 13 - Microeconomics PDF

13 Monopoly CHAPTER OUTLINE Market Power How a Firm Uses Market Power...

13 Monopoly CHAPTER OUTLINE Market Power How a Firm Uses Market Power to O ­Maximize Profit n June 5, 1981, the Centers for Disease Control and The Costs of Monopoly: Deadweight Prevention reported that a strange outbreak of pneumo- Loss nia was killing young, healthy, homosexual men in Los The Costs of Monopoly: Corruption Angeles. Alarm spread as similar reports streamed in from San ­ and Inefficiency Francisco, New York, and Boston. What had at first looked like a The Benefits of Monopoly: Incentives disease peculiar to homosexual men turned out to be a worldwide for Research and Development killer caused by HIV (the human immunodeficiency virus). Since Economies of Scale and the Regulation 1981, AIDS (acquired immune deficiency syndrome) has killed of Monopoly more than 36 million people. Other Sources of Market Power There is no known cure for AIDS, but progress has been made Takeaway in treating the disease. In the United States, deaths from AIDS dropped by approximately 50% between 1995 and 1997.The m ­ ajor cause of the falling death rate was the development of new drugs called combination antiretrovirals, such as Combivir.1 The drugs work, however, only if one can afford to take them, and they are expensive. A single pill of Combivir costs about $12.50—at two per day, every day, that’s nearly $10,000 INGRAM PUBLISHING/VETTA/GETTY IMAGES per year.2 If you have the money, $10,000 a year is a small price to pay for life, but there are 35 million people worldwide living with HIV and most of them don’t have $10,000.3 If HIV drugs were expensive because production costs were high, economists would have little to say about drug pricing. But it costs about 50 cents to produce a pill of Combivir—thus, the price of one pill is about 25 times higher than the cost.4 In earlier chapters, we emphasized how competitive markets drive the price of a good down to marginal cost.Why hasn’t that process worked here? There are three reasons why HIV drugs are priced well above cost. 1. Market power The cause of AIDS, the human 2. The “you can’t take it with you” effect immunodeficiency virus (HIV) 3. The “other people’s money” effect 235 236 PA R T 3 Firms and Factor Markets The primary reason that AIDS drugs are priced well above costs is monopoly or market power, the subject of this chapter. The “you can’t take it with you” and “other people’s money” effects, which we will also dis- cuss in this chapter, make market power especially strong in the pricing of pharmaceuticals. Market Power GlaxoSmithKline (GSK), the world’s largest producer of AIDS drugs, owns the patent on Combivir. A patent is a government grant that gives the owner the exclusive rights to make, use, or sell the patented product. GlaxoSmithKline, for example, is the only legal seller of Combivir. Even though the formula to manufacture it is well-known and easily duplicated, competitors who try to make Combivir or its equivalent will be jailed, at least in the United States and other countries where the patent is enforced. Market power is the power to GSK’s patent on Combivir gives GSK market power, the power to raise raise price above marginal cost price above marginal cost without fear that other competitors will enter the without fear that other firms market. A monopoly is simply a firm with market power. will enter the market. India does not recognize the Combivir patent, so in that country competition A monopoly is a firm with ­ prevails and an equivalent drug sells for just 50 cents per pill.5 Thus, econom- market power. ics correctly predicts that competition will drive price down to marginal cost; it’s just that GSK’s patent prevents competition from operating. Patents are not the only source of market power. Government regulations other than patents, as well as economies of scale, exclusive access to an impor- tant input, and technological innovation can all create firms with market power. We discuss the sources of market power and appropriate responses at greater length later on in this chapter. For now, we want to ask how a firm will use its market power to maximize profit. How a Firm Uses Market Power to Maximize Profit We know that a firm with market power will price above cost—but how much above cost? Even a firm with no competitors faces a demand curve, so as it raises its price, it will sell fewer units. Higher prices, therefore, are not always better for a seller—raise the price too much and profits will fall. Lower the price and profits can increase. What is the profit-maximizing price? To maximize profit, a firm should produce until the revenue from an additional sale is equal to the cost of an additional sale. This is the same Marginal revenue, MR, is the condition that we discovered in Chapter 11: Produce until marginal rev- change in total revenue from enue equals ­marginal cost (MR = MC). In Chapter 11, however, calculat- ­selling an additional unit. ing marginal revenue was easy because even if a small oil well increases Marginal cost, MC, is the change production significantly, the effect on the world price of oil is so small it in total cost from p­ roducing an can be ignored. For a small firm, therefore, the revenue from the sale of an additional unit. additional unit is the market price (MR = Price). But when a firm’s output To maximize profit, a firm of a product is large relative to the entire market’s output of that product (or increases output ­until MR = MC. very close substitutes), a significant increase in the firm’s output will cause the market price of that product to fall. When GSK produces and sells more Combivir, for example, it pushes the price of Combivir down. Thus, for a  Monopoly C H A P T E R 1 3 237 firm that produces a large share of the market’s total output of a product, the revenue from the sale of an additional unit is less than the current market price (MR < Price). To understand how a firm with market power will price its product, we need to calculate marginal revenue for a firm that is large enough to influence the price of its product. We show how to calculate marginal revenue in the table in the left panel of Figure 13.1. Suppose that at a price of $16 the quantity demanded is 2 units, so that total revenue is $32 (2 × $16). If the monopolist reduces the price to $14, it can sell 3 units for a total revenue of $42 (3 × $14). Marginal r­evenue, the change in revenue from selling an additional unit, is therefore $10 ($42 − $32). Thus, we can always calculate MR by looking at the change in total revenue when production changes by one unit. The right panel of Figure 13.1 shows another way of thinking about marginal revenue. When the monopolist lowers its price from $16 to $14, it makes one additional sale, which increases revenues by the price of one unit, $14—the green area. But to make that additional sale, the monopolist had to lower its price by $2, so it loses $2 on each of the two units that it was selling at the higher price for a revenue loss of $4—the red area. Marginal revenue FIGURE 13.1 Price $20 19 Revenue 18 loss = $4 17 TR MR 16 P Q (P · Q) (Change in TR ) 15 −$4 Revenue 14 gain = $14 18 1 18 13 12 $4 Marginal revenue 16 2 32 14 11 = ($14 − $4) = $10 10 14 3 42 10 9 8 Demand 12 4 48 6 7 6 $10 10 5 50 2 5 4 8 6 48 −2 3 2 1 1 2 3 4 5 6 7 Quantity Marginal revenue Marginal Revenue The table on the left shows that marginal revenue is the change in total revenue when quantity sold increases by 1 unit. When the quantity sold increases from 2 units to 3 units, for ­example, ­total revenue increases from $32 to $42 so marginal revenue, the change in total revenue, is $10. The figure on the right shows how we can break down the change in total revenue into two parts. When the firm lowers the price from $16 to $14, it sells one more unit and so there is a gain in revenue of $14, the price of that unit, but since to sell that additional unit the firm had to lower the price, it loses $2 on each of its two previous sales so there is a revenue loss of $4. Thus, marginal revenue is the revenue gain on new sales plus the revenue loss on previous sales. 238 PA R T 3 Firms and Factor Markets FIGURE 13.2 Price Price Price a a a Demand: P = a – b  Q Demand Demand Marginal 2b revenue = a – 2 b  Q Marginal 1 b revenue 1 Marginal a/2b a /b revenue Quantity 250 500 Quantity 4 8 Quantity The MR Shortcut When the demand curve is a straight line, the marginal revenue curve begins at the same point on the vertical axis as the demand curve and has twice the slope. is the revenue gain (green, $14) plus the revenue loss (red, −$4) or $10 (green striped area). Notice that MR ($10) is less than price ($14)—once again, this is because to sell more units, the mono­polist must lower the price so there is a loss of revenue on previous sales. Now that you understand the idea of marginal revenue, here’s a shortcut for finding marginal revenue. If the demand curve is a straight line, then the marginal revenue curve is a straight line that begins at the same point on the vertical axis as the demand curve but with twice the slope.6 Figure 13.2 shows three demand curves and their associated marginal revenue curves. Notice that if the demand curve cuts the horizontal axis at, say, Z, then the marginal ­revenue curve will ­always cut the horizontal axis at half that amount, Z/2. Figure 13.3 sketches the demand, marginal revenue, marginal cost, and average cost curve for a firm with market power, like GlaxoSmithKline. GSK maximizes profit by producing the quantity where MR = MC. In Figure 13.3, this is at point a, a quantity of 80 million units. What is the maximum price at which the monopolist can sell 80 million units? To find the maximum that consumers will pay for 80 million units, remember that we read up from the quantity supplied of 80 million units to the demand curve at point b. ­Consumers are willing to pay as much as $12.50 per pill when the quantity supplied is 80 million pills, so the profit-maximizing price is $12.50. We can also use Figure 13.3 to illustrate the monopolist’s profit. Remember from Chapter 11 that profit can be calculated as (P − AC ) × Q. At a quantity of 80 million units, the price is $12.50 (point b), the average cost (AC ) is $2.50 (point c), and thus profit is ($12.50 − $2.50) × 80 million units or $800 ­million, as illustrated by the green rectangle. (By the way, the fixed costs of producing a new pharmaceutical are very large so the minimum point of the AC curve ­occurs far to the right of the diagram.) Recall that a competitive firm earns zero or normal profits but a monopolist uses its market power to earn positive or above-normal profits.  Monopoly C H A P T E R 1 3 239 FIGURE 13.3 How a Monopolist Price per pill Maximizes Profit To maximize profit, the monopolist produces until MR = MC (point a). Reading Demand down from point a, we find the profit-maximizing Profit- quantity, 80 million pills. maximizing price Reading upward from point a, we find the profit- maximizing price on the $12.50 b ­demand curve, $12.50. Profit is (P − AC ) × Q and is given by the green rectangle. Profit c 2.50 Average cost a 0.50 Marginal cost 80 Marginal Quantity in millions Profit- revenue of pills maximizing quantity The Elasticity of Demand and the Monopoly Markup Market power for pharmaceuticals can be especially powerful because of the two other effects we mentioned earlier: the “you can’t take it with you” effect and the “other people’s money” effect. If you are dying of disease, what better use of your money do you have than spending it on medicine that might pro- long your life? If you can’t take it with you, then you may as well spend your money trying to stick around a bit longer. Consumers with serious diseases, therefore, are relatively insensitive to the price of life-saving p­ harmaceuticals. Moreover, if you are willing to spend your money on pharmaceuticals, how do you feel about spending other people’s money? Most patients in the United States have access to public or private health insurance, so pharmaceuticals and other medical treatments are often paid by someone other than the patient. Thus, both the “you can’t take it with you” and the “other people’s money” effects make consumers with serious diseases relatively insensitive to the price of life-saving pharmaceuticals— that is, they will continue to buy in large quantities even when the price increases. If GlaxoSmithKline knows that consumers will continue to buy C ­ ombivir even when it increases the price, how do you think it will respond? Yes, it will increase the price! When consumers are relatively insensitive to the price, what sort of demand curve do we say consumers have? An inelastic demand curve. The “you can’t take it with you” effect and the “other people’s money” effect make the demand curve more inelastic. Thus, we say that the more inelastic the demand curve, the more a monopolist will raise its price above marginal cost. 240 PA R T 3 Firms and Factor Markets Is it ethically wrong for GSK to raise its price above marginal cost? Perhaps, but keep in mind that in the United States, it costs nearly a billion dollars to research and develop the average new drug. Once we better understand how monopolies price, we will return to the question of what, if anything, should be done about market power. Figure 13.4 illustrates that the more inelastic the demand curve, the more a monopolist will raise its price above marginal cost. On the left side of the figure, the monopolist faces a relatively elastic demand curve, and on the right side a relatively inelastic demand curve. As usual, the monopolist maximizes profit by choosing the quantity at which MR = MC and the highest price that ­consumers will pay for that quantity. Notice that even though the marginal cost curve is identical in the two panels, the markup of price over marginal cost is much higher when the demand curve is relatively inelastic. Remember from Chapter 5 that the fewer substitutes that exist for a good, the more inelastic the demand curve. With that in mind, consider the follow- ing puzzle. In February of 2014, American Airlines was selling a flight from Washington, D.C., to Dallas for $772. On the same day, it was selling a flight from Washington to San Francisco for $322. That’s a little puzzling. You would expect the shorter flight to have lower costs, and ­Washington is much closer to Dallas than to San Francisco. The ­puzzle, however, is even deeper. The flight from Washington to San Francisco stopped in D ­ allas. In fact, the Washington- to-Dallas leg of the journey was on exactly the same flight!7 Thus, a traveler going from Washington to Dallas was being charged nearly $450 more than a traveler going from Washington to Dallas and then on to San Francisco even though both were flying to Dallas on the same plane. Why? Here’s a hint. Each of the major airlines flies most of its cross-country traf- fic into a hub, an airport that serves as a busy “node” in an airline’s network of flights, and most hubs are located near the center of the country. Delta’s hub, for example, is in Atlanta. So if you fly cross-country on Delta, you will probably FIGURE 13.4 Relatively Elastic Demand Relatively Inelastic Demand Small Markup Big Markup Price Price PI Big markup Demand Small Pe Demand markup MC MC Qe MR Quantity QI Quantity MR The More Inelastic the Demand Curve, the More the Monopolist Raises Price Above Marginal Cost  Monopoly C H A P T E R 1 3 241 travel through Atlanta. United’s hub is in Chicago and American Airlines has its hub in Dallas. Have you solved the puzzle yet? Of the flights into the Dallas-Fort Worth airport, 84% are on American Airlines, so if you want to fly from Washington to Dallas at a convenient time, you have few choices of airline. But if you want to fly from Washington to San ­Francisco, you have many choices. In addition to flying on American Airlines, you can fly Delta, United, or Jet Blue. Since travelers flying from Washington to Dallas have few substitutes, their demand curve is inelastic, like the demand curve in the right panel of Figure 13.4. Since travelers flying from ­Washington to San Francisco have many substitutes, their demand curve is more elastic, like the one in the left panel of Figure 13.4. As a result, travelers flying from ­Washington to ­Dallas (inelastic demand) are charged more than those flying from Washington to San F ­ rancisco (elastic demand). You are probably asking yourself why someone wanting to go from ­Washington to Dallas doesn’t book the cheaper flight to San Francisco and then CHECK YOURSELF exit in Dallas? In fact, clever people try to game the system all the time—but don’t try to do this with a round-trip ticket or the airline will cancel your > As a firm with market power moves down the demand return flight. As a matter of contract, most airlines prohibit this and similar curve to sell more units, what practices—their profit is at stake! happens to the price it can charge on all units? ▲ > What type of demand curve does a firm with market power prefer to face for its The Costs of Monopoly: Deadweight Loss products: relatively elastic What’s wrong with monopoly? The question may seem absurd—isn’t it the or inelastic? Why? high prices? Not so fast. The high price is bad for consumers, but it’s good for the monopolist. And what’s so special about consumers? Monopolists are ­people, too. So if we want to discover whether monopoly is good or bad, we need to count the gains to the monopolist equally with the losses to ­consumers. It turns out, however, that the monopolist gains less from monopoly ­pricing than the consumer loses. So monopolies are bad—they are bad because, com- pared with competition, monopolies reduce total surplus, the total gains from trade (consumer surplus plus producer surplus). In Figure 13.5 on the next page, we compare total surplus under competition with total surplus under monopoly. In the left panel, the competitive equilibrium price and quantity are Pc and Qc. We also label Qc the optimal quantity because it is the quantity that maximizes total surplus (recall from Chapter 4 that a com- petitive market maximizes total surplus). For simplicity, we assume a constant cost industry so the supply curve is flat (MC = AC ) and producer surplus is zero.­Total surplus is thus the same as consumer surplus and is shown by the blue triangle. The right panel shows how a monopolist with the same costs would behave. Setting MR = MC, the monopolist produces Qm, which is much less than Qc, and prices at Pm. Consumer surplus is now the much smaller blue triangle. Now here is the key point: Some of the consumer surplus has been transferred to the monopolist as profit, the green area. But some of the consumer surplus is not transferred; it goes to neither the consumers nor to the monopolist; it goes to no one and is lost. We call the lost consumer surplus deadweight loss. To better understand deadweight loss, remember that the height of the d­ emand curve tells you how much consumers are willing to pay for the good, and the height of the marginal cost curve tells you the cost of producing the good. Now notice that in between the amount that the monopolist produces, Qm, and the amount that would be produced under competition, Qc, the ­demand curve is above the 242 PA R T 3 Firms and Factor Markets FIGURE 13.5 Competition Maximizes Competition Monopoly Total Surplus, Monopolies P P Do Not Maximize Total ­Surplus The left and right Consumers get this panels compare a competitive The monopolist market with a monopolized Consumers get Consumer gets this this surplus ­market with the same Pm demand and cost curves. Consumer No one gets this Under monopoly, the price surplus (deadweight loss) increases from Pc to Pm, Profit DWL ­consumer surplus falls, and Pc Supply Pc MC = AC profit increases. Importantly, consumer surplus falls by more than profit increases—the difference is the deadweight Demand Demand loss from monopoly. Q c = Optimal Q Qm Q c = Optimal Q quantity quantity Marginal revenue marginal cost curve. In other words, consumers value the units between Qm and Qc more than their cost; so if these units were produced, total surplus would increase. But the monopolist does not produce these units. Why not? Because to sell these units, the monopolist would have to lower its price; and if it did so, the increase in revenue would not cover the increase in costs, that is, MR would be less than MC, so the monopolist’s profit would decrease. Let’s look at deadweight loss in practice. GlaxoSmithKline prices ­Combivir at $12.50 a pill, the profit-maximizing price. There are plenty of consumers who can’t pay $12.50 a pill but would gladly pay more than the marginal cost CHECK YOURSELF of 50 cents a pill. Deadweight loss is the value of the ­Combivir sales that do not > Does the monopolist price its occur because the monopoly price is above the competitive price. product above or below the t price of a competitive firm? > Does the monopolist produce more or less than competitive The Costs of Monopoly: Corruption firms? Why? and Inefficiency Sadly, around the world today, many monopolies are government-­created and born of corruption. Indonesian President Suharto (in office from 1967 to 1998), for ­example, gave the lucrative clove monopoly to his playboy son, Tommy ­Suharto. Cloves may sound inconsequential, but they are a key ingredient in Indonesian cigarettes, and the monopoly funneled hundreds of m­ illions of dollars to Tommy. A lot of rich playboys buy Lamborghinis—Tommy bought the entire company. Monopolies are especially harmful when the goods that are monopolized are used to produce other goods. In Algeria, for example, a dozen or so army gener- als each control a key good. Indeed, the public ironically refers to each ­general by the major commodity that they m ­ onopolize—General Steel, ­General Wheat, General Tire, and so forth. Steel is an input into automobiles, so when General Steel tries to take advantage of his market power by raising the price of steel, this increases costs  Monopoly C H A P T E R 1 3 243 for General Auto. General Auto responds by raising the price of automobiles even more than he would if steel were competitively produced. Similarly, General Steel raises the price of steel even more than he would if automobiles were competitively produced. Throw in a General Tire, a General PETER HARHOLDT/SUPERSTOCK Computer, and, let’s say, a General Electric and we have a recipe for economic disaster. Each general tries to grab a larger share of the pie, but the combined result is that the pie gets much, much smaller. Compare a competitive market economy with a monop- olized economy: Competitive producers of steel work to reduce prices so they can sell more. Reduced prices of steel result in reduced prices of automobiles. Cost savings in one Monopoly profit sector are spread throughout the economy, resulting in eco- nomic growth. In a monopolized economy, in contrast, the entire process is thrown into reverse. Each firm wants to raise its prices, and the resulting cost increases are spread throughout the economy, resulting in poverty and stagnation. One of the great lessons of economics is to show that good institutions chan- nel self-interest toward social prosperity, whereas poor institutions channel self- interest toward social destruction. Business leaders in the United States are no less self-interested than generals in Algeria. So why are the former a mostly positive force, while the latter are a mostly negative force? It’s because competitive markets channel the self-interest of business leaders toward social prosperity, whereas the political structure of Algeria channels self-interest toward social destruction. The Benefits of Monopoly: Incentives for Research and Development GlaxoSmithKline prices its AIDS drugs above marginal cost. If GSK didn’t have a monopoly, competition would push prices down, more people could afford to buy Combivir, and total surplus would increase (i.e., deadweight loss would decline). So isn’t the solution to the monopoly problem obvious? Open up the RANDY M. URY/FLIRT/CORBIS industry to competition by refusing to enforce the firm’s patent or force Glaxo­­ SmithKline to lower its price. In fact, many countries pursue one or the other of these policies. India, for example, has traditionally not offered strong patent protection, and Canada con- trols pharmaceutical prices. India’s and Canada’s policies have successfully kept pharmaceutical prices low in those countries. Many people argue that the United States should also control pharmaceutical prices. Unfortunately, the story is not so Thomas Edison spent years ­experimenting with thousands of simple. We need to revisit our question, what’s wrong with m ­ onopoly? materials before he discovered In the United States, researching, developing, and successfully testing the that carbonized bamboo filament average new drug cost nearly $1 billion.8 Firms must be compensated for these would make a long-lasting expenses if people expect them to invest in the discovery process. But if compe- lightbulb. If anyone could have tition pushes the price of a pill down to the marginal cost, nothing will be left capitalized on his idea, Edison would not have been able to over for the cost of invention. And he who has no hope of reaping will not sow. profit from his laborious research Patents are one way of rewarding research and development. Look again at and ­development and perhaps he Figure 13.3, which shows the green rectangle of monopoly profit. It’s precisely would not have done the necessary the expectation (and hope) of enjoying that monopoly profit that encourages ­research in the first place. firms to research and develop new drugs. Profit fuels the fire of invention.  244 PA R T 3 Firms and Factor Markets If pharmaceutical patents are not enforced, the number of new drugs will decrease. India is poor and Canada is small, so neither contributes much to the global profit of pharmaceutical firms. But if the United States were to limit pharmaceutical patents significantly or to control pharma- ceutical prices, the number of new drugs would decrease significantly.9 But new drugs save lives. As noted in the introduction, antiretrovirals like Combivir were the major cause of the 50% decrease in AIDS deaths in the United GETTY IMAGES States in the mid-1990s. We should be careful that in push- ing prices closer to marginal cost, we do not lose the new drug entirely. Eyes on the prize Prizes are another way of In evaluating pharmaceutical patents, you should keep in rewarding research and development without creating mind that patents don’t last forever. A patent lasts for at most monopolies. SpaceShipOne, pictured here, won the 20 years, and by the time a new drug is FDA-approved, its $10 million Ansari X Prize for being the first privately effective life is typically only 12–14 years. Once the drug developed manned rocket capable of reaching space and returning in a short time. Netflix, the DVD goes off patent, generic equivalents appear quickly and the distribution firm, offered and paid a $1 million prize for deadweight loss is eliminated as price falls. improvements to its movie r­ecommendation system. Pharmaceuticals are not the only goods with high The Department of Defense has sponsored prizes for development costs and low marginal costs. Information ­driverless ­vehicles and Congress established the L-Prize for advances in lightbulb technology. goods of all kinds often have the same cost structure. Video games like Halo, Madden NFL, and The Sims have typical development costs of $7 million to $10 million; Grand Theft Auto IV cost more than $100 million to develop. Once the code has been written, however, the marginal cost of distributing on the Internet is close to zero. Prices, typically $40–$60, are therefore well above marginal costs. Since prices exceed marginal costs, there is a deadweight loss, which in theory could be reduced by a price control. Reducing prices, however, would reduce the incentive to research and develop new games. What would you rather have: Pong at $2, or, for $50 a game, a constant stream of new and better games? Video games may seem trivial, but the trade-off between lower prices today at the expense of fewer new ideas in the future is a central one in ­modern economies. In fact, modern theories of economic growth emphasize that ­monopoly—when it increases innovation—may increase economic growth. Nobel prize–winning economic historian Douglass North argues that eco- nomic growth was slow and sporadic until laws, including patent laws, were created to protect innovation: [T]hroughout man’s past he has continually developed new techniques, but the pace has been slow and intermittent. The primary reason has been that the incentives for developing new techniques have occurred only sporadically. Typically, innovations could be copied at no cost by others and without any reward to the inventor or innovator. The failure to develop systematic property rights in innovation up until fairly modern times was a major source of the slow pace of technological change.10 Patent Buyouts—A Potential Solution? Is there a way to eliminate the deadweight loss without reducing the incen- tive to innovate? Economist Michael Kremer has offered one speculative idea.11 Take a look again at Figure 13.3. The green profit rectangle is the  Monopoly C H A P T E R 1 3 245 value of the patent to the patent owner, $800 million. Suppose that the gov- ernment were to offer to buy the rights to the patent at, say, $850 million? The monopolist would be eager to sell at this price. What would the govern- ment do with the patent? Rip it up! If the government ripped up the patent, competitors would enter the field, drive the price down to the marginal cost of production, and eliminate the deadweight loss. In other words, Combivir would fall from $12.50 a pill to 50 cents a pill, and more of the world’s poor could afford to be treated for AIDS. The great virtue of Kremer’s proposal is that it reduces the price of new drugs without reducing the incentive to develop more new drugs. Indeed, by offering more than the potential profit, the government could even increase the incentive to innovate! As usual, however, there is no such thing as a free lunch. To buy the patent, the government must raise taxes, and we know from ­Chapter 6 that taxes, just like monopolies, create deadweight losses. Also deter- CHECK YOURSELF mining the right price to buy the patent is not easy and some people worry > Name some firms with market that corruption could be a problem. power that plausibly encour- Kremer’s idea has never been tried on a widespread basis, but despite these age innovation. Name some problems, economists are becoming increasingly interested in patent buyouts firms with market power that do not seem to encourage and the closely related idea of prizes as a way to encourage innovation without innovation. creating too much deadweight loss. > If we rewarded innovation with prizes instead of patents, ▲ how large do you think the prize should be for a new Economies of Scale and the Regulation ­cancer drug? of Monopoly Governments are not the only source of market power. Monopolies can arise naturally when economies of scale create circumstances where one large firm Economies of scale are the (or a handful of large firms) can produce at lower cost than many small firms. a­ dvantages of large-scale When a single firm can supply the entire market at lower cost than two or more ­production that reduce average cost as quantity increases. firms, we say that the industry is a natural monopoly. A subway is a natural monopoly because it would cost twice as much to A natural monopoly is said to exist when a single firm can supply the build two parallel subway tunnels than to build one, but even though costs entire market at a lower cost than would be twice as high, output (the number of subway trips) would be the two or more firms. same. Utilities such as water, natural gas, and cable television are typically natural monopolies because in each case it’s much cheaper to run one pipe or cable than to run multiple pipes or cables to the same set of homes. In Figure 13.5, we compared competitive firms with an equal cost monopoly and showed that total surplus was higher under competition. The compari- son between competitive firms and natural monopoly is more difficult. Even though natural monopolies produce less than the optimal quantity, competitive firms would also produce less than the optimal quantity because they could not take advantage of economies of scale. If the economies of scale are large enough, it’s even possible for price to be lower under natural monopoly than it would be under competition. ­Figure 13.6 on the next page shows just such a situation. Notice that the ­average cost curve for the monopoly is so far below the average cost curves of the competitive firms, that the mono­poly price is below the competitive price. It’s possible, for example, for every home to produce its own electric power with a small generator or solar panel, but the costs of producing elec- tricity in this way would be higher than buying electricity produced from a dam even if the dam was a natural m ­ onopoly. 246 PA R T 3 Firms and Factor Markets FIGURE 13.6 A Monopoly with Large Price Economies of Scale Can Average Have a Lower Price than costs for ­Competitive Firms Economies small firms of scale mean that a monopoly producer can have lower costs Competitive price of production than competitive Monopoly firms. It’s cheaper to produce price ­electricity for 100,000 homes with one large dam, for example, than with a solar panel for each home. If economies of scale are large enough, the monopoly price can be lower than the AC of monopoly ­competitive price and the MC of monopoly monopoly output can be higher than the ­competitive output. Demand 0 Monopoly Optimal Quantity Competitive quantity quantity quantity Marginal revenue Is there any way to have our cake and eat it too? That is, is there a way to have prices equal to marginal cost and to take advantage of economies of scale? In theory the answer is yes, but it’s not easy. In Chapter 8, we showed that a price control set below the market price would create a shortage. But surpris- ingly, when the market price is set by a monopolist, a price control can increase output. Let’s see how. Suppose that the government imposes a price control on the monopolist at level PR, as in Figure 13.7. Imagine that the monopolist sells two units and ­suppose it wants to sell a third. What is the marginal revenue on the third unit? It’s just PR. In fact, when the price is set at PR, the monopolist can sell up to QR units without having to lower the price. Since the monopolist doesn’t have to lower the price to sell more units, the marginal revenue for each unit up to QR is PR. Notice that we have drawn the new marginal revenue curve in Figure 13.7 equal to PR in between 0 and QR (after that point, to sell an addi- tional unit, the mono­polist has to lower the price on all previous units so the MR curve jumps down to the level of the old MR curve and becomes negative). Now the problem is simple because, as always, the monopolist wants to produce until MR = MC, so QR is the profit-maximizing quantity. Notice that the monopolist produces more as the government-regulated price of its output falls. So what price should the government set? Since the optimal quantity is found where P = MC, the natural answer is that the government should set PR = MC. Unfortunately, that won’t work when economies of scale are large because if the price is set equal to marginal cost, the monopolist will be taking a loss. Remember that Profit = (P − AC ) × Q so setting PR equal to marginal cost creates a loss illustrated by the red area in Figure 13.7. The government could subsidize the monopolist to make up for the loss when PR = MC but, once again, taxation has its own deadweight losses. If the  Monopoly C H A P T E R 1 3 247 FIGURE 13.7 A Price Control on a Price Monopoly Can Increase Output Without regulation, Old marginal the ­monopoly maximizes profit revenue curve by choosing Pm, Qm. If the government imposes a price control at PR, the monopolist New marginal chooses QR, a larger quantity. Pm revenue curve The optimal price is at P = MC, A but at this price the monopolist lower price... is making a loss and will exit the PR industry. The lowest price that will keep the monopolist in the a industry is P = AC at point a. AC of monopoly Loss if P = MC At that price, the monopolist P = MC Marginal cost makes a zero (normal) profit. Demand Qm QR Optimal Quantity quantity... leads to higher output. g­ overnment set PR = AC at point a, where the AC curve intersects the demand curve, the monopolist would just break even; output would then be larger than the monopoly quantity but less than the optimal quantity. This seems like a fairly good solution, but there are other problems with regulating a monopolist. When the monopolist’s profits are regulated, it doesn’t have much incentive to increase quality with innovative new products or to lower costs. The strange history of cable TV regulation and California’s ill-fated ­efforts at electricity deregulation ­illustrate some of the real problems with regulating and deregulating monopolies. I Want My MTV Regulation of retail subscription rates for cable TV seemed to keep prices low in the early years of television, when there were basically only three channels, ABC, CBS, and NBC. In the 1970s, however, new technology made it possible KEITH BERNSTEIN/©HBO/COURTESY EVERETT COLLECTION for cable operators to offer 10, 20, or even 30 channels. But if subscription rates were fixed at the low levels, thereby limiting profit rates, the cable operators would have little incentive to add channels. Recognizing this, Congress lifted caps on pay TV rates in 1979 and on all cable television in 1984. Deregulation of cable TV rates led to higher prices, just as the theory of natural monopoly predicts, but something else happened—the number of ­television channels and the quality of programming increased dramatically. And, contrary to natural monopoly theory, consumers seemed to ­appreciate the new channels more than they disliked the higher prices.This is evident because even as prices rose, more people signed up for cable television.12 Congress re-regulated “basic cable” rates in 1992 but left ­“premium channels” unregulated. Wayne’s World was the result. Let’s explain: Cable operators were typically required to carry a certain number of channels in the basic package, but they had some choice over which channels were included in the package. Quality comes at a price.  248 PA R T 3 Firms and Factor Markets So when basic cable was re-regulated, the cable operators moved some of the best channels to their unregulated premium package. To fill the gaps in the basic package, they added whatever programs were cheap, including television shows created by amateurs on a shoestring budget. Wayne’s World, a Saturday Night Live comedy sketch, mocked the proliferation of these amateur cable shows. Rates were mostly deregulated again in 1996. Not entirely coincidentally, this was the first year that HBO won an Emmy. Today, “basic tier cable” is regulated by local governments, but anything beyond the most basic service is predominantly free of regulation and cable companies can charge a market rate. As before, prices have risen since deregulation, but so have the number of television channels and the quality of programming. If you like Game of Thrones, Pretty Little Liars, and The Walking Dead, then cable deregulation has worked well. Deregulation of electricity, however, has proven shocking. Electric Shock Government ownership is another potential solution to the natural monop- oly problem. In the United States, there are some 3,000 electric utilities, and ­two-thirds of them are government-owned (the remainder are heavily ­regulated). ­Government ownership of utilities began early in the twentieth century with ­municipalities owning local distribution companies. In the 1930s, the federal ­government became a major generator of electricity with the c­ onstruction of the then largest manmade struc- tures ever built, the Hoover Dam in 1936 and the even larger Grand Coulee Dam in 1941. Government ownership and regulation worked reasonably well for several decades in providing the United States with cheap power. Without the discipline of competition or a profit motive, however, there is a tendency for a government-run or regulated monopoly to become inefficient. Why reduce costs when costs can be passed on to customers? In the 1960s and 1970s, multi­billion-dollar cost over- runs for the construction of nuclear power plants drew attention to industry inefficiencies as the price of power i­ncreased. Historically, a single firm handled the generation, long-distance transmission, and local distribution of electricity. In the 1970s, ANDREW ZARIVNY/SHUTTERSTOCK however, new technologies reduced the ­average cost of generating electricity at small scales (in Figure 13.6 you can think of the curves labeled “Average costs for small firms” as moving down). Although the transmission and d­istribution of electricity r­emained ­ natural monopolies, the new ­ technologies meant that the ­ generation of electricity was no longer a ­natural monopoly. Economists began to ­argue that unbundling generation from transmission and distribution The Hoover Dam The natural monopoly that could open up ­electricity generation to competitive forces, thereby lights Las Vegas. reducing costs. California’s Perfect Storm Hoping to benefit from lower costs and greater innovation, California deregulated wholesale electricity prices in 1998. In the first two years after deregulation, all appeared well. In fact, as the new century was born, California was booming. In Silicon Valley, college students in computer  Monopoly C H A P T E R 1 3 249 science were being turned into overnight millionaires and billionaires. In 2000, personal income in California rose by a whopping 9.5%. Higher incomes and an unusually hot summer increased the demand for elec- tricity. But California’s generating c­ apacity, which was old and in need of repair, began to strain. To meet the demand, California had to import power from other states, but other states had little to spare. Hot weather was pushing up demand throughout the West and the supply of hydro- electric power had fallen by approximately 20% because of low snowfall the previous winter. All of these forces and more smashed together in the summer of 2000 to double, triple, quadruple, and finally quintuple the wholesale price of ­electricity from an average in April of $26 per megawatt hour (MWh) to an August high of $141 per MWh. Prices declined modestly in the fall but jumped again in the winter, reaching for one short period a price of $3,900 per MWh and peak- ing in December at an average monthly price of $317 per MWh—about 10 times higher than the previous December’s rate.13 Worse yet, when not enough power was available to meet the demand, blackouts threw more than 1 million Californians off the grid and into the dark. The new century wasn’t looking so bright after all. Mother Nature was not the only one to blame for California’s troubles. The combination of increased demand, reduced supply, and a poorly designed deregulation plan had created the perfect opportunity for generators of elec- tricity to exploit market power. When the demand for electricity is well below capacity, each generator has very little market power. If a few generators had shut down in 1999, for ­example, the effect on the price would have been minimal because the power from those generators could easily have been replaced with imports or power from other generators. Thus, in 1999, each genera- tor faced an elastic demand for its product. In 2000, however, every generator was critical because nearly every generator needed to be up and running just to FIGURE 13.8 keep up with demand. Electricity is an unusual com- Relatively Elastic Relatively Inelastic modity because it is expensive to store, and if demand Demand, Demand, and supply are ever out of equilibrium, the result can Small Markup Big Markup be catastrophic blackouts. Thus, when demand is near P P capacity, a small decline in supply leads to much higher prices as utilities desperately try to buy enough power Small PI markup Big to keep the electric grid up and running. Thus, in 2000, Demand markup Demand the demand curve facing each ­g enerator was becoming Pe MC MC very inelastic. And what happens to the incentive to increase price when demand becomes i­ nelastic? Do you Qe MR Q Q I MR Q remember the lesson of Figure 13.4, also ­pictured on the right in F ­ igure 13.8? In the summer and winter of 2000, demand was near capacity and every gen- erator was facing an ­inelastic demand curve. A firm that owned only one gen- erating plant couldn’t do much to exploit its market power: If it shut down its plant, the price of ­electricity would rise but the firm wouldn’t have any power to sell! Many firms, however, owned more than one generator, and in 2000, this created a terrible i­ncentive. A firm with four generators could shut down one, say, for ­“maintenance and repair,” and the price of electricity would rise by so much that the firm could make more money selling the power ­produced by its 250 PA R T 3 Firms and Factor Markets CHECK YOURSELF three o ­ perating ­generators than it could if it ran all four! Suspiciously, far more > Look at Figure 13.7. If r­egulators generators were taken o ­ ff-line for “maintenance and repair” in 2000 and early controlled the price at P = AC, 2001 than in 1999.14 at point a how much would the California was not the only state to restructure its electricity market in the late monopolist produce? Is this better for consumers, the 1990s. Other states such as Texas and Pennsylvania had opened up generation to ­monopolist, or society than the competition and have seen modestly lower electricity prices. R ­ estructuring has unregulated monopoly ­quantity? also occurred in Britain, New Zealand, Canada, and elsewhere, but ­California’s > Telephone service used to be experience has demonstrated that unbundling generation from transmission a natural monopoly. Why? Is it a natural monopoly today? and distribution, which remain natural monopolies, is tricky. Discuss how technology can t change what is and isn‘t a ­natural monopoly. Other Sources of Market Power Table 13.1 summarizes some of the sources of market power. In addition to patents, government regulation and economies of scale, monopolies may be Barriers to entry are factors that created whenever there is a significant barrier to entry, something that raises increase the cost to new firms of the cost to new firms of entering the industry. One firm, for example, might entering an industry. own an input that is difficult to duplicate. Saudi Arabia, for example, has some market power in the market for oil because the demand for oil is inelastic and Saudi Arabia controls a significant fraction of the world’s oil supply.What makes oil special is that oil is found in large quantities in only a few places in the world so a single firm in the right place can monopolize a significant share of the total supply. The market power of Saudi Arabia is enhanced when ­instead of competing with other suppliers, it joins with them to form a cartel, a group of firms that acts in concert to maximize total profits. We analyze cartels at greater length in Chapter 15. Brands and trademarks can also give a firm market power because the prestige of owning the real thing cannot be easily duplicated. Timex watches tell the time as well as a Rolex, but only the Rolex signals wealth and status. Monopolies may also arise when a firm innovates and produces a product that no other firm can immediately duplicate. In 2006, Apple ­ had a 70% share in the market for MP3 players even though Apple’s iPod had many competitors—the iPod was simply better than its rivals.15 As with TABLE 13.1 Some Sources of Market Power Sources of Market Power Example Patents GSK’s patent in Combivir Laws preventing entry of Indonesian clove monopoly, competitors Algerian wheat monopoly, U.S. Postal Service Economies of scale Subways, cable TV, electricity transmission, major highways Hard to duplicate inputs Oil, diamonds, Rolex watches Innovation Apple’s iPod, Wolfram’s Mathematica software, eBay  Monopoly C H A P T E R 1 3 251 p­ atent monopolies, monopolies produced by innovation involve a trade-off: CHECK YOURSELF iPods are priced higher than they would be if Apple had better competitors, > Consider ticket prices at major but Apple would have less incentive to innovate if it didn’t expect to earn league baseball and p ­ rofessional ­monopoly profits. football parks. How does the term “­ barrier to entry” help ▲ explain their p­ ricing? > How permanent are b Takeaway ­ arriers to entry in the following cases: NBA basketball ­franchises, After reading this chapter, you should be able to find marginal revenue given U.S. Postal ­Service delivery ­either a demand curve or a table of prices and quantities (as in Figure 13.1). of first-class mail, U.S. Postal Given a demand and marginal cost curve, you should be able to find and label the ­Service delivery of ­parcels? monopoly price, the monopoly quantity, and deadweight loss. With the addition of an average cost curve, you should be able to find and label monopoly profit. You should also be able to demonstrate why the markup of price over marginal cost is larger the more inelastic the demand—this relationship will also be useful in the next chapter. What makes monopoly theory interesting and a subject of debate among economists is that it’s not always obvious whether monopolies are good or bad. Instead, we are faced with a series of trade-offs. Patent monopolies, such as the one on Combivir, create a trade-off between deadweight loss and innovation. The monopolist prices its product above marginal cost, but without the prospect of monopoly profits, there might be no product at all. Natural monopolies also involve trade-offs, this time between deadweight loss and economies of scale. Deadweight loss means that monopoly is not optimal, but when economies of scale are large, competitive outcomes aren’t optimal either. Regulating monopoly seems to offer an escape from this trade-off, but as we saw in our analysis of cable TV and electricity regulation, the practice of regulation is much more complicated than the theory. Cable TV regulation kept prices low but it kept quality low as well. Overall, deregulation of cable television rates worked surprisingly well, at least according to the consumers who flocked to cable even as rates rose. In contrast, electricity deregulation left California at the mercy of firms wielding market power. Economists don’t always agree on the best way to navigate the trade-offs between deadweight loss, innovation, and economies of scale. Many monopolies, however, perhaps most on a world scale, are “unnatural”—they neither support innovation nor take advantage of economies of scale—instead they are created to transfer wealth to politically powerful elites. For these monopolies, econom- ics does offer guidance—open the field to competition! Alas, economics offers less clear guidance about how to convince the elites to follow the advice of ­economists. CHAPTER REVIEW KEY CONCEPTS economies of scale, p. 245 market power, p. 236 natural monopoly, p. 245 monopoly, p. 236 barriers to entry, p. 250 marginal revenue, MR, p. 236 marginal cost, MC, p. 236 252 PA R T 3 Firms and Factor Markets FACTS AND TOOLS it rise, fall, or be unchanged? Will Rapido’s total revenue rise, fall, or be unchanged? 1. In the following diagram, label the marginal revenue curve, the profit-maximizing price, the d. Apollo, another highly profitable shoe profit-maximizing quantity, the profit, and the ­company, also has market power. It’s s­elling deadweight loss. 15 million shoes per year, and it faces ­marginal costs quite similar to Rapido’s. Apollo’s marketing experts conclude that Price if the company increased prices by 20%, Demand ­profits would rise. For Apollo, is MC > MR, is MC = MR, or is MR > MC? 4. a. When selling e-books, music on iTunes, and downloadable software, the marginal Marginal cost of producing and selling one more unit cost Average cost of output is essentially zero: MC = 0. Let’s think about a monopoly in this kind of market. If the monopolist is doing its best to maximize profits, what will marginal revenue equal at a firm like this? Quantity b. All firms are trying to maximize their ­profits (TR − TC ). The rule from part 2. a. Consider a market like the one illustrated in a tells us that in the special case where Figure 13.5, where all firms have the same marginal cost is zero, “profit maximization” average cost curve. If a competitive firm in is e­ quivalent to which of the following this market tried to set a price above the ­statements? minimum point on its average cost curve, “Maximize total revenue” how many units would it sell? “Minimize total cost” b. If a monopoly did the same thing, raising “Minimize average cost” its price above average cost, what would “Maximize average revenue” happen to the number of units it sells: Does it rise, fall, or remain unchanged? 5. a. What’s the rule: Monopolists charge a higher markup when demand is highly elastic or c. What accounts for the difference between when it’s highly inelastic? your answers to parts a and b? b. What’s the rule: Monopolists charge a higher 3. a. In the textbook The Applied Theory of markup when customers have many good Price, D. N. McCloskey refers to the substitutes or when they have few good equation MR = MC as the rule of rational ­substitutes? life. Who follows this rule: monopolies, competitive firms, or both? c. For the following pairs of goods, which ­producer is more likely to charge a bigger b. Rapido, the shoe company, is so popular markup? Why? that it has monopoly power. It’s selling 20 ­million shoes per year, and it’s highly i. S omeone selling new trendy shoes, or profitable. The marginal cost of making extra someone selling ordinary tennis shoes? shoes is quite low, and it doesn’t change ii. A movie theater selling popcorn or a much if the c­ ompany produces more shoes. New York City street vendor selling Rapido’s ­marketing experts tell the CEO of popcorn? Rapido that if it decreased prices by 20%, it iii. A  pharmaceutical company s­elling a would sell so many more shoes that profits new powerful antibiotic or a firm s­elling would rise. If the expert is correct, at its a new powerful cure for ­dandruff? current output, is MC > MR, is MC = MR, or is MR > MC? 6. In 1996, the X Prize Foundation created what became known as the Ansari X c. If Rapido’s CEO follows the expert’s advice, Prize—a $10 million prize for the first what will this do to marginal revenue: Will  Monopoly C H A P T E R 1 3 253 nongovernment group to send a reusable 10. True or False? manned spacecraft into space twice within a. When a monopoly is maximizing its profits, two weeks. In 2004, it was won by the price is greater than marginal cost. Tier One project, financed by Microsoft b. For a monopoly producing a certain cofounder Paul Allen. amount of output, price is less than marginal a. An answer you can find on the Internet: revenue. How high did SpaceShipOne fly when it c. When a monopoly is maximizing its profits, won the Ansari X Prize? marginal revenue equals marginal cost. b. How much did it cost to develop d. Ironically, if a government regulator sets a ­SpaceShipOne? Was the $10 million prize fixed price for a monopoly lower than the enough to cover the costs? Why do you unregulated price, it is typically raising the think Microsoft cofounder Paul Allen marginal revenue of selling more output. ­invested so much money to win the prize? Do ­Allen’s motivations show up in our e. In the United States, government regulation ­monopoly model? of cable TV cut down the price of premium ­channels to average cost. 7. Which of the following is true when a monopoly is producing the profit-maximizing f. When consumers have many options, quantity of output? More than one may be true. ­monopoly markup is lower. Marginal revenue = Average cost g. A patent is a government-created monopoly. Total cost = Total revenue Price = Marginal cost THINKING AND PROBLEM SOLVING Marginal revenue = Marginal cost 1. In addition to the clove monopoly discussed 8. a. Consider a typical monopoly firm like that in this chapter, Tommy Suharto, the son of in Figure 13.3. If a monopolist finds a way Indonesian President Suharto (in office from to cut marginal costs, what will happen: 1967 to 1998), owned a media conglomerate, Will it pass along some of the savings to the Bimantara Citra. In their entertaining book, consumer in the form of lower prices, will it Economic Gangsters (Princeton University paradoxically raise prices to take advantage Press, 2008), economists Raymond Fisman of these fatter profit margins, or will it keep and Edward Miguel compared the stock price the price steady? of Bimantara Citra with that of other firms on Indonesia’s stock exchange around July 4, b. Is this what happens when marginal costs fall 1996, when the government announced that in a competitive industry, or do competitive President Suharto was traveling to Germany markets and monopolies respond differently for a health checkup. What do you think to a fall in costs? happened to the price of Bimantara Citra 9. a. Where will profits be higher: when demand shares relative to other shares on the for a patented drug is highly inelastic or Indonesian stock exchange? Why? What does when demand for a patented drug is highly this tell us about corruption and monopoly elastic? (Figure 13.4 may be helpful.) power in Indonesia? b. Which of those two drugs is more likely to 2. a. Sometimes, our discussion of marginal cost be “important?” Why? and marginal revenue unintentionally hides c. Now, consider the lure of profits: If a the real issue: the entrepreneur’s quest to ­pharmaceutical company is trying to d­ ecide maximize total profits. Here is information what kind of drugs to research, will it be on a firm: lured toward inventing drugs with few good ­substitutes or drugs with many good Demand: P = 50 − Q Fixed cost = 100 substitutes? Marginal cost = 10 d. Is your answer to part c similar to what an all- wise, benevolent government agency would do, Using this information, calculate total profit or is it roughly the opposite of what an all-wise, for each of the values in the following benevolent government agency would do? table, and then plot total profit in the figure. 254 PA R T 3 Firms and Factor Markets Clearly label the amount of maximum a. As long as the sports team is profitable, will a profit and the quantity that produces this mere rise in fixed costs raise the equilibrium level of profit. ticket price, lower the equilibrium ticket price, or have no effect whatsoever on the Total Total Total equilibrium ticket price? Why? Quantity Revenue Cost Profit b. In fact, it seems common in real life for 18 ticket prices to rise after a team raises its fixed costs by building a fancy new s­tadium 19 or hiring a superstar player: In ­recent years, 20 it’s happened in St. Louis’s and San Diego’s baseball stadiums. What’s probably shifting 21 to make this h ­ appen? Name both curves, and 22 state the direction of the shift. c. So, do sports teams spend a lot of money 23 on superstars so that they can pass along the costs to the fans? Why do they spend a lot on superstars, according to monopoly Profit theory? (Note: Books like Moneyball and The Baseball Economist apply economic models to the ­national pastime, and it’s common for sports managers to have solid training in economic methods.) 4. Earlier we mentioned the special case of a monopoly where MC = 0. Let’s find the firm’s best choice when more goods can be produced at no extra cost. Since so much e-commerce is close to this model—where the fixed cost of inventing the product and satisfying government regulators Quantity is the only cost that matters—the MC = 0 case will be more i