Summary 341- A natural monopoly occurs when the average cost of production declines
throughout the relevant range of product demand. Regulation via
average-cost pricing is the most common response to natural monopoly. - In monopolistic competition, a large number of firms sell differentiated
products, and there are no barriers to entry by new suppliers. Because
each firm faces a slightly downward-sloping demand curve, price exceeds
minimum average cost.
Questions and Problems
- In 1989, the Detroit Free Pressand Detroit Daily News(the only daily
newspapers in the city) obtained permission to merge under a special
exemption from the antitrust laws. The merged firm continued to
publish the two newspapers but was operated as a single entity.
a. Before the merger, each of the separate newspapers was losing about
$10 million per year. What forecast would you make for the merged
firms’ profits? Explain.
b. Before the merger, each newspaper cut advertising rates substantially.
What explanation might there be for such a strategy? After the
merger, what prediction would you make about advertising rates? - A pharmaceutical company has a monopoly on a new medicine.
Under pressure by regulators and consumers, the company is
considering lowering the price of the medicine by 10 percent. The
company has hired you to analyze the effect of such a cut on its profits.
How would you carry out the analysis? What information would you
need? - The ready-to-eat breakfast cereal industry is dominated by General Mills,
Kellogg, Kraft Foods, and Quaker Oats that together account for 90
percent of sales. Each firm produces a bewildering proliferation of
different brands (General Mills alone has over 75 cereal offerings),
appealing to every conceivable market niche. Yet, the lowest brands on
each company’s long pecking list generate meager or no profits for the
corporate bottom line.
What strategic reasons might the dominant companies have for pur-
suing extreme brand proliferation? Explain. - Formerly, the market for air travel within Europe was highly regulated.
Entry of new airlines was severely restricted, and air fares were set by
regulation. Partly as a result, European air fares were higher than U.S.
fares for routes of comparable distance. Suppose that, for a given
European air route (say, London to Rome), annual air travel demand is
estimated to be Q 1,500 3P (or, equivalently, P 500 Q/3),
where Q is the number of trips in thousands and P is the one-way fare in
dollars. (For example, 600 thousand annual trips are taken when the
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