Transcript The Economic Effects of the 19th Century Monopoly

The Economic Effects
of the 19th Century
Monopoly
AN ECONOMIC MYSTERY
Mystery
The late nineteenth century was a time when
business leaders used a variety of tactics in their
efforts to establish monopolies in many key
industries. The railroads were prominent among
these concentrated industries. Fear of business
collusion caused the federal government to enact
laws and develop regulations to stop businesses
from colluding. Yet, relatively few businesses
were ever broken up by the actions of the
government. What happened to all the others?
Where did all the monopolies go?
Is bigger better for firms /
consumers?
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Benefits
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Increasing returns to scale (economies of scale)
Standard / reliable products
Costs
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Market power by large firms
Narrowing of consumer choice
Some Nineteen Century Trusts
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Trust: two or more firms in the same industry that
work together to reduce competition
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American Sugar Refining Trust
American Tobacco Trust
Copper Trust
Standard Oil Trust
Steel Beam Trust
United States Steel Corporation
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Railroads in 1860
Railroads: Good or Bad?
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Good:
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Allow transportation of people and goods
Contributed to expanded output
Bad:
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Farmers complain they are charged more by
railroads
Railroads benefit from land grants and lowinterest loans from U.S. government
Business Entities
Type of
Is goal to max Price
Profit Levels
Business Firm profits?
Determination
Pure
Competitor
Yes
Buyers and
Sellers in
Market
Zero
economic
profits
Monopolist
Yes
Determined
Positive
by Monopolist economic
profits
Cartel (Trust)
Yes
Determined
by Cartel
Positive, if
collusion
Economic Concept
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Economic profit – includes all costs including the
opportunity cost of capital, the competitive return on
capital (interest)
Opportunity cost – the value of the next best
alternative
Zero economic profit – means all costs plus a
competitive rate of return on capital are covered. No
profit above the competitive rate is earned – you are
doing as well as everyone else.
Positive economic profit – will attract competitors
since you are making more than a competitive rate
of return.
Discuss: A monopoly can charge
whatever it wants and get away with it.
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Law of demand
Monopoly chooses price to maximize its
profits
If you increase price:
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Earn more per unit (price effect)
Sell fewer units (quantity effect)
Example: Graph of demand and per unit cost
How monopoly / cartel sets price
Monopoly's Choice: $3, $3.50, $4.00, $4.50?
5
4.5
4
3.5
$
3
Price
2.5
Cost
2
1.5
1
0.5
0
0
1
2
3
4
5
6
Quantity
7
8
9
10
11
How Monopolies Raise Price
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Must be willing to restrict output
At higher price, sell less, but make more
profit
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How can a cartel or trust do this?
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How Can Cartels or Trusts
Collude and Raise Prices
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Simulation:
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Get into groups of threes
Distribute index cards; name your railroad cartel
of three people
Write first name and cartel name on your card
Rules
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Members of the Railroad Cartel can assume:
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Members provide identical services
No costs of production (simplified)
Customer must ship 10 items (simplified)
Cartel agreement:
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The Cartel can agree to choose a pricing scheme given
below
Each member is to write the cartel price on the paper
provided. The number written can be changed at any point
prior to the time the transaction between the customer and
railroad begins.
Rewards
Actual Prices Quoted
Total Revenues (PxQ)
$4 - $4 - $4
Each firm makes $13
$4 x 3.33 = $13
$3 - $3 - $3
Each firm makes $10
$3 x 3.33 = $10
$3 - $3 - $4
Two firms charging $3 make $15,
other makes $0
$3 x 5 = $15 and $4 x 0 = 0
$3 - $4 - $4
One firm charging $3 makes $30,
other two make $0.
$3 x 10 = $30, $4 x 0 = 0
Decide!
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In your cartel:
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Discuss prices each person will charge
How you will enforce that price
I will come back to “buy” from each group.
Debriefing the Game
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What is incentive to collude?
What is the incentive to cheat?
Why do we see competition when we might
suspect collusion?
Were Railroads Competitive in
the 1870s?
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Some railroad engaged in anti-competitive practices such as price
fixing.
However, it remained difficult to suppress competition even in the
railroad industry.
Railroads added tens of thousands of miles of track in the 1870s and
1880s.
Additional track provided opportunities for increased competition.
Short hauls in rural areas faced little direct competition. However, long
hauls between cities usually had two or more railroads in competition.
Efforts by railroads to form agreements to fix their rates and find other
means to reduce competition almost always failed. Aggressive
managers or owners (such as Jay Gould) would break the agreements
and begin price cutting.
Price cutting took a variety of forms such as price discrimination and
rebates. The effect to drive down rates, however, was the same.
Laws Enacted to Control
Monopolies
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Sherman Anti-Trust Act of 1890
Clayton Act of 1914
Activity 25.1: Were Robber Barons Really
Robbers?
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Jay Gould, James J. Hill, John D. Rockefeller,
J.P. Morgan, Andrew Carnegie
Price of oil fell / wages increased
Conclusions
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Competition makes collusion difficult to
uphold.
While some trusts last for a while, many
others fail.
What ALTERNATIVES are there for
consumer => competition