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CHAPTER 12 Game Theory and Oligopolistic Behavior 413

preemptive investment strategy, Wal-Mart has continued to expand at breathtaking speed
and to beat the competition most of the time. Sales at Wal-Mart increased from $80 bil­
lion in 1994 to $220 billion in 2001 (thus heading the list of the Fortune 500 companies)
and are projected to continue its rise rapidly in the future. Pricier than Wal-Mart and
dowdier than Target, Kmart, instead, filed for bankruptcy in January 2002.

Since 1992, Wal-Mart has also expanded abroad, first in Canada and Mexico
(where it is already the largest retailer), then in Argentina, Brazil, China, Korea and
Puerto Rico, and more recently in Germany, England and Japan. In 2001, Wal-Mart had
1,091 stores abroad, which generated 17% of its total revenue. Regarded as one of the
most successful and aggressive retailers in the United States. Wal-Mart is now also
shaking up the industry abroad in the nations in which it is operating by its winning low-
price strategy, long store hours, friendly service, private-label brands, and a super­
efficient distribution system. During the next few years, Europe is likely to be the fiercest
battleground as Wal-Mart tries to expand across the continent and attempts to duplicate
its American success. For example, Wal-Mart has yet to turn a profit in Germany.
European retailers are responding by also consolidating. For example, in fall 1999,
French retailer Carrefour and Promedes merged, creating Europe’s biggest and the
world's second largest retailer with annual sales of $60 billion and operating more than
9,000 stores in 31 countries.

Sources: “Big Discounters Duel Over Hot market,” Wall Street Journal, August 23, 1995, p. A8; “Wal-
Mart Casts Eye Northward,” New York Times, February 16, 1999, p. C l; “French Retailers Create New
Wall-Mart Rival,” Wall Street Journal, August 31, 1999, p. A 14; “How Well Does Wal-Mart Travel?” Busi­
ness Week, September 3, 2001, pp. 82-84; “Wal-Mart Around the World,” The Economist, December 8,
2001, pp. 55-57; “Kmart to File for Chapter 11 Bankruptcy," Wall Street Journal, January 23, 2002, p. A3;
and “Wal-Mart Heads List o f Fortune 500," New York Times, April 1, 2002, p. C3.

12.6 S trategic M o ves a n d In te r n a tio n a l C o m p e tit iv e n e s s

Game theory can also be used to analyze the strategic trade and industrial policies that a na­
tion could use to gain a competitive advantage over other nations, particularly in the field
of high technology. This is best shown through an example.

Suppose that Boeing (the American commercial aircraft company) and Airbus Indus­
trie (a consortium of German, French, English, and Spanish companies) are both deciding
whether to produce a new aircraft. Suppose also that because of the huge cost of develop­
ing the new aircraft, a single producer would have to have the entire world market for itself
to earn a profit, say of $100 million. If both firms produce the aircraft, each loses $10 mil­
lion. This information is shown in Table 12.8. The case in which both firms produce the air­
craft and each incurs a loss of $10 million is shown in the top left cell of the table. If only
Boeing produces the aircraft, Boeing makes a profit of $100 million while Airbus makes a
zero profit (the top right cell of the table). On the other hand, if Boeing does not produce
the aircraft while Airbus does, Boeing makes zero profit while Airbus makes a profit of
$100 million (the bottom left cell). Finally, if neither firm produces the aircraft, each makes
a zero profit (the bottom right cell).

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4 1 4 PART FOUR Im perfectly Com petitive Markets

1TABLE 12.81 Two-Firm Competition and Strategic Trade Policy

Produce Airbus
Don't Produce

Boeing Produce -10. -1 0 1 0 0 .0
Don't Produce 0. 100 0 .0

Suppose that for whatever reason, Boeing enters the market first and earns a profit of
$100 million (we might call this the first-mover advantage). Airbus is now locked out of the
market because it could not earn a profit. This is the case shown in the top right cell of
the table. If Airbus entered the market, both firms would incur a loss (and we would have
the case shown in the top left column of the table). Suppose now that European govern­
ments give a subsidy of $15 million per year to Airbus. Airbus would then produce the air­
craft even though Boeing is already producing the aircraft, because with the $15 million
subsidy, Airbus would turn a loss of $10 million into a profit of $5 million. Without a sub­
sidy, however, Boeing will go from making a profit of $100 million (without Airbus in the
market) to incurring a loss of $10 million afterwards (we are still in the top left com er of
the table, but with the Airbus entry changed from —10 without the subsidy to + 5 with the
subsidy). Because of its unsubsidized loss, Boeing will stop producing the aircraft, thereby
leaving the entire market to Airbus, which will then make a profit of $100 million without
any further subsidy (the bottom left cell of the table).9

The U.S. government could, of course, retaliate with a subsidy of its own to keep
Boeing producing the aircraft. Except in cases of national defense, however, the U.S. gov­
ernment is much less disposed to grant subsidies to firms than European governments.
Although the real world is certainly much more complex than this example, we can see
how a nation could overcome a market disadvantage and acquire a strategic comparative
advantage in a high-tech field by means of an industrial and strategic trade policy.

One serious shortcoming of the above analysis is that it is usually very difficult to ac­
curately forecast the outcome of government industrial and trade policies (i.e., get the data
to fill a table such as Table 12.8). Even a small change in the table could completely change
the results. For example, suppose that if both Airbus and Boeing produce the aircraft. Air­
bus incurs a loss of $10 million (as before) but Boeing makes a profit of $10 million (with­
out any subsidy), say, because of superior technology. Then, even if Airbus produces the
aircraft with the subsidy, Boeing will remain in the market because it is able to earn a profit
without any subsidy. Then. Airbus would require a subsidy indefinitely, year after >ear. in
order to continue to produce the aircraft. In this case, giving a subsidy to Airbus does not
seem to be such a good idea.10Thus, it is extremely difficult to carry out this type of analy­
sis in the real world. Getting the analysis wrong, however, can be very harmful and may

4 This type o f analysis was first introduced into international trade by J. Brander and B. Spencer. See 'heir
"International R & D Rivalry and Industrial Strategy." Review o f Economic Studies, October 198?. pp 707-722-
See also M. Porter. The Com petitive Advantage o f Nations (New York: The Free Press. 19901.
10 See "A Paper Dart Against Boeing." The Economist. June 11. 1994. pp. 6 1 -6 2 .

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CHAPTER 12 Game Theory and Oligopolistic Behavior 415

even result in the firm’s failure (see Example 12-5). This is the reason that most U.S. econ­
omists today are against industrial policy and still regard free trade as the best policy for the
United States.11

Airbus did decide in 2000 to build its super-jumbo A380 capable of transporting
550 passengers and to be ready by 2006 at a cost of over $ 10 billion, and thus compete head-
on with the Boeing 747 (which has been in service since 1969 and can carry up to 475 pas­
sengers). Boeing greeted Airbus'decisions to build its A 380by announcing in 2001 plans to
build a new “sonic cruiser" jet that can transport, non-stop, up to 300 passengers to any point
on earth at close to the speed of sound. Boeing believes that passengers prefer arriving at their
destinations sooner and avoid congested hubs and the hassle and delays of intermediate
stops. It remains to be seen as to which strategy turns out to be the winning or best one.12

EXAMPLE 1 2 - 5 ___________________________________________________________

Companies' Strategic Mistakes and Failures

Nearly 100,000 businesses failed in the United States during 1992 (a recession year) as
compared with only about 35,000 in 2000 (the last year of the boom of the 1990s) and
nearly 40,000 in 2001 (a recession year). Although the reasons businesses fail are many
and the details differ from case to case, several general underlying causes can be identi­
fied. First, many business failures arise because senior executives do not fully under­
stand the fundamentals of their business or core expertise and business of the firm. Then
the company drifts (often through mergers and acquisitions) into lines of business about
which it knows little. This, for example, happened to Kodak when it diversified from its
core camera and film business into pharmaceuticals and consumer health products dur­
ing the 1990s.

The second basic reason for business failures is lack of vision or the inability of top
management to anticipate or foresee serious problems that the business may face down
the road. For example, U.S. automakers (General Motors, Ford, and Chrysler) failed to
understand early enough the seriousness of the competitive challenge coming from
Japan and almost willingly ceded the small-car market to Japan (because o f the low
profits per car earned in that market) during the 1970s in the erroneous belief that Japan
would never be able to compete effectively in the medium-range segment of the market
(where profit per automobile was much higher and American automakers were
stronger). This resulted in huge losses for American automakers during the second half
of the 1980s and early 1990s and almost drove Chrysler out of business (this is exam­
ined in Example 13-6). Another example is provided by Sears, which was unable or

11 "Remember Clinton's Industrial Policy? O.K. Now Forget It." Business Week, December 12. 1994. p. 53;
and P. Knjgman. "Is Free Trade Passé" The Journal o f Economic Perspectives, Fall 1987. pp. 131-144.
12 “The Birth o f Giant," Business Week, July 10. 2000. pp. 1 7 0 -176 and “Boeing Opts to Build New' Class
o f "Sonic Cruiser" Jet." Financial Times, March 30. 2001. p. 1.

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4 1 6 PART FOUR Im perfectly Com petitive Markets

unwilling to understand the kind of change going on in consumer preferences, and this
eventually propelled Wal-Mart to replace it as (he nation’s top marketeer. Most danger­
ous are latent or stealthy competitors, who as a result of some major and quick techno­
logical or market change can devastate the firm in its very core business. A clear exam ­
ple of this is IBM 's inability to recognize early enough the importance and dramatic
growth of the PC market in the mid-1980s and subsequent signing of M icrosoft to de­
velop the software and Intel to supply the chips for its PCs.

A third reason for business failures is the loading of the firm with a heavy debt bur­
den (usually to carry out a program of merger and acquisitions, often at overpriced
terms) which then robs the firm of its strength in a market downturn. This is precisely
what happened (together with greed, deceit, and financial chicanery) to Enron (one of
the world's largest energy traders), which filed the largest U.S. claim for bankruptcy in
December 2001 (exceeded by WorldCom bankruptcy in July 2002).

Fourth, business failures arise when firms vainly try to recapture their past glories
and become stuck on an obsolete strategies and are unable to respond to a new and
major competitive challenges. This is, to some extent, what happened to General
Motors and IBM during the past decade before the brutal forces of the market shook
them out of their complacency. It is often more difficult to keep a business great than to
build it in the first place. Finally, a company may fail as a result of strikes and hostili­
ties from unhappy workers. This may happen to some of the nation’s airlines during the
next few years.

Sources: “Dinosaurs?,” Fortune, May 3, 1994, pp. 36-42; “Why Companies Fail,” Fortune, November 14,
1994, pp. 52-68; “How good Companies Go Bad,” H arvard Business Review, July-August 1999,
pp. 42-52; “Why Enron Went Bust,” Fortune, December 24, 2001, pp. 58-68; “Enron: How Governance
Rules Failed," Business Week, January 21, 2002. pp. 21-22; “WorldCom Files for Bankruptcy: Largest
U.S. Case,” The New York Times, July 22 ,2 0 0 2 , p. 1; and “Why Companies Fail,” Business Week, May 22.
2002, pp. 50 -6 2 .

AT THE FRONTIER

The Virtual Corporation

T oday's joint ventures and strategic alliances provide a glimpse of the virtual
corporation— the firm of the future. A virtu al co rp o ra tio n is a temporary net­
work of independent companies (suppliers, customers, and even rivals) coming
together with each contributing its core competence to quickly take advantage of
fast-changing opportunities. In today's world of fierce global competition, this
window of opportunity is often so frustratingly brief that it is impossible for a sin­
gle firm to have all the in-house expertise to quickly launch complex products in
diverse markets. By acting strategically and temporarily banding together to take
advantage of a specific market opportunity, and with each company bringing its

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CHAPTER 12 Gam e Theory and Oligopolistic Behavior 417

speciality, the virtual firm is a “best-of-everything organization.” Informational
networks and electronic contracts will permit unusual partners to work together on
a particular project and then disband when the opportunity has been fully exploited.

In a virtual firm, one of the partners may have the idea for a new product,
another may design the product, another may produce it, and still another mar­
ket it. For example, IBM, Apple Computer, and Motorola have come together
to develop a new operating system and com puter chip for a new generation of
computers. MCI Communications has entered into partnerships with as many
as 100 com panies to provide a one-stop package of telecom m unications hard­
ware and services based on MCI com petencies in network integration and soft­
ware development, with the strength of other com panies making all kinds of
telecommunications equipment.

Although power, flexibility, and quickness are crucial advantages, the virtual
corporation model does face two real risks. First, a company joining such a network
may lose control of its core technology. Second, by abandoning manufacturing, the
company may become “hollow" and become unable to resume the manufacturing
of its traditional product in the future when the network dissolves. Some observers
point out that IBM’s desire to quickly enter the personal computer (PC) market in
1981 by relying on Intel for computer chips and Microsoft for the operating soft­
ware left IBM without control of the market and encouraged hundreds of clone
makers to eventually enter the market with lower prices and better products.

Thus, not everyone is sold on the virtual firm model. In order to work, the
virtual firm (1) will have to be formed by partners that are dependable and are
the best in their field, (2) the network must serve the interests of all partners in
a win-win situation, (3) each company must put its best and brightest people in
the network to show its partners that its link with them is important to the com ­
pany, (4) the objective of the network must be clearly defined as well as what
each partner is expected to gain, and (5) the network must build a common
telecommunications network and other infrastructures so that each partner can
be in constant touch with the other partners to anticipate problems and review
progress. Creating and successfully operating a virtual firm is not easy but it
may very well be the strategic way of the future.

Sources: "The Virtual Firm,” Business Week, February 8. 1993. pp. 98-102: and "The Art o f Managing
Virtual Teams: Eight Key Lessons." Harx'ard M anagem ent Review, November 1998. pp. 4 -5 .

SUMMARY_________________________________________________

I . Game theory is concerned with the choice of an optimal strategy in conflict situations.
Every game theory model includes players, strategies, and payoffs. The players are the
decision makers (here, the managers of oligopolist firms) whose behavior we are trying
to explain and predict. The strategies are the potential choices that can be made by the
players (firms). The payoff is the outcome or consequence of each combination of strategies

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418 PART FOUR Im perfectly Com petitive Markets

by the tw o players. The payoff matrix refers to all the outcom es o f the players’ strategies.
A zero-sum gam e is one in w hich the gains or losses o f one player equal the lo sses or
gains o f the other.
2. The dominant strategy is the optim al choice for a player, no matter what the opponent does.
The Nash equilibrium occurs w hen each player has chosen his or her optim al strategy, given
the strategy chosen by the other player. The Cournot solution is an exam ple o f a Nash
equilibrium. Not all gam es have a Nash equilibrium and som e gam es have m ore than one.

3. O ligopolistic firms often face a problem called the prisoners' dilem m a. T his refers to a
situation in w hich each firm adopts its dom inant strategy but could do better (i.e.. earn larger
profit) by cooperating. O ligop olistic firms d ecid ing on their pricing or advertising strateg> or
on whether to cheat on a cartel face the prisoners' dilem m a.

4. The best strategy for repeated or m ultiple-m ove prisoners’ dilem m a gam es is tit-for-tat. This
strategy postulates that each firm should start by co o p era tin g and continu e to d o so as long as
the rival cooperates, but stop cooperating once the rival stops cooperating.

5. O ligopolists often make strategic m oves. A strategic m ove is one in w hich a player constrains
its own behavior in order to m ake a threat credible so as to gain a com petitive advantage over a
rival. The firm m aking the threat m ust be com m itted to carrying it out for the threat to be
credible. This m ay involve accepting low er profits or building ex cess capacity.

6. Just like firms, nations can make strategic m oves, such as subsidizing and providing export
subsidies to a high-tech industry or adopting an industrial policy for the entire nation, to gain
a com petitive advantage over other nations. Industrial p olicies lead to w aste if industries that
are subsidized or otherw ise supported do not becom e internationally com petitive. Sim ilarly,
not know ing the exact payoff or outcom e o f the strategic m oves open to it greatly com p licates
the develop m ent and conduct o f business strategy by the firm. The virtual corporation is a
temporary network o f independent com panies com ing together with each contributing its
core technology to quickly take advantage o f fast-changing opportunities.

KEY TERMS Zero-sum game Repeated gam es
Nonzero-sum game Tit-for-tat
Game theory Dom inant strategy Strategic m ove
Players N ash equilibrium Virtual corporation
Strategies Prisoners' dilem m a
Payoff
Payoff matrix

| REVIEW QUESTIONS i

1. In what w ay d o e s gam e theory exten d the a n a ly sis 4. a. W hy is the Cournot equilibrium a Nash
o f o ligop olistic behavior presented in Chapter 11? equilibrium ?

2. a. Can gam e theory be used only for oligopolistic b. In w hat w a y d o e s the C ournot equilibriu m differ
interdependence? from the N ash equilibriu m g iv en in Table 12.2?

b. In what w a y is gam e theory' sim ilar to p la y in g 5. In w h at w ay is the prison ers' d ile m m a related
chess? to the ch oice o f dom inant strategies by the

3. D o w e have a N ash equilibriu m w h en ea ch firm players in a gam e and to the concept o f N ash
chooses its dom inant strategy? equilibrium ?

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CHAPTER 12 Gam e Theory and Oligopolistic Behavior 419

6. H ow can the concept o f the prisoners’ dilem m a be 10. H ow did the 1971 law banning cigarette
used to analyze price com petition? advertising on television solve the prisoners'
dilem m a for cigarette producers?
7. How can introducing yearly style changes lead to a
prisoners’ dilem m a for automakers? 11. a. W hat is the m ean ing o f “tit-for-tat” in gam e
theory?
8. a. W hat is the incentive for the m em bers o f a cartel
to cheat on the cartel? b. W hat co n d itio n s are u sually required for
tit-for-tat strategy to be the best strategy ?
b. W hat can the cartel d o to prevent cheating?
c. Under what conditions is a cartel more likely 12. a. H ow is a strategic m ove differentiated from a
Nash equilibrium?
to collapse?
b. W hat is a cred ible threat? W hen is a threat not
9. D o the duopolists in a Cournot equilibrium face a credible?
prisoners’ dilem m a? Explain.

P R O B L E M S _______________

1. From the fo llo w in g p a y o ff m atrix, where the payoffs *3. From the follow in g payoff matrix, w here the
are the profits or losses o f the tw o firms, determ ine payoffs are the profits or losses o f the tw o firms,
a. w hether firm A has a dom inant strategy. d eterm in e
b. w h ether firm B has a d om in ant strategy. a. whether firm A has a dom inant strategy.
c. the optim al strategy for each firm. b. w h ether firm B has a d om in ant strategy.
c. the optim al strategy fo r ea ch firm.
Firm B d. the N ash equilibrium .

Low High e. Under what conditions is the situation
Price Price indicated in the p a y o ff m atrix lik ely to
occur?

Firm A L ow Price 1,1 3 ,-1 Firm B
H igh Price -1 ,3 2 ,2

2. From the fo llo w in g payoff matrix, w here the Sm all Large
p ayoffs are the profits or losses o f the tw o firms, Cars Cars
d eterm in e
a. w hether firm A has a dom inant strategy. Firm A Sm all Cars 4 ,4 - 2 ,-2
b. w h ether firm B has a dom in ant strategy. Large Cars —2 , —2 4 ,4
c. the optim al strategy for ea ch firm.
d. the Nash equilibrium , if there is one. *4. Provide a hypothetical payoff matrix for
exam ple 12.2 in this chapter.
Firm B
5. From the follow in g payoff m atrix, w here the
Low High payoffs (the negative values) are the years o f
Price Price possible imprisonment for individuals A and B.
d eterm in e
Low Price 1,1 3 ,-1 a. w hether individual A has a dom inant strategy.
High Price -1 ,3 4 ,2 b. w h ether individual B has a dom in ant strategy.

Firm A

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4 2 0 PART FOUR Imperfectly Competitive Markets

c. the optim al strategy for each individual. *9. Starting w ith the p a y o ff m atrix o f Problem 1. sh ow
d. D o individuals A and B face a prisoners” w hat the tit-for-tat strategy w o u ld be for the first
five o f an infinite num ber o f gam es it firm A starts
dilem m a? by cooperating but firm B d o e s not c o o p era te in
the next period.
Individual B
10. G iven the follow in g payoff matrix
Don't a. indicate the best strategy for ea ch firm.
Confess Confess b. W hy is the entry-deterrent threat by firm A to
low er price not cred ible to firm B ?
Individual A ^ -5 .-5 -1 ,-1 0
Don t Confess -1 0 .-1 c. W hat could firm A do to m ake its threat
-2 .-2 credible without building excess capacity?

6. E xplain w h y the p a y o ff matrix in Problem 1 Firm B
indicates that firms A and B face the prisoners'
dilem m a. Enter Don't
Enter
7. D o firms A and B in Problem 2 face the prisoners'
dilem ma? W hy? Firm A Low Price 3, -1 3,1
High Price 4 ,5 6 ,3
*8. From the follow ing payoff matrix, where the payoffs
refer to the profits that firms A and B earn by 11. Show how the payoff m atrix in the table o f
cheating and not cheating in a cartel, Problem 10 m ight change for firm A to make
a. determ ine w hether firms A and B face the acredible threat to lower price by building excess
prisoners’ dilem m a. capacity to deter firm B from entering the market.
b. W hat w ou ld happen if w e changed the p a y o ff
in the bottom left c ell to (5 , 5)? 12. W hat strategic industrial or trade policy w ou ld be
required (if any) in the U nited States and in Europe
Firm B if the entries in the top left cell o f the p ayoff matrix
in Table 12.8 w ere changed to
Cheat Don’t
Cheat a. 10, 10?

b. 5 ,0 ?

c. 5 .- 1 0 ?

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IBM: http://w ww .ibm .com
Dell: http://w w w .dell.com

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/

f 1(

CHAPTER 1 3
% /J

Market Structure, Efficiency,
and Regulation

eople of the same trade seldom meet together, even for merriment and diversion, but

I J the conversation ends in a conspiracy against the public, or in some contrivance to

raise prices.” 1This is one of the most famous quotations in economics, and it is as
relevant today as two-and-a-quarter centuries ago when it was written. It explains in a nut­
shell why we are so interested in market structure, efficiency, antitrust, and regulation. In
this chapter, we examine the relationship between these elements. We begin by reviewing
why inefficiency and social costs arise in imperfect markets. We then consider how to mea­
sure market imperfections and ways to minimize, prevent, or overcome (through antitrust
and regulation) the most serious social costs that arise from these market imperfections.
The examples and applications in the chapter show the importance of the theory and its
uses, while the “At the Frontier” section examines the relatively new field of experimental
economics.

13.1 M a r k e t S t r u c t u r e a n d E ffic ie n c y

The concept and measure of efficiency, as well as the need for antitrust and regulation,
is based on marginal analysis. Specifically, we have seen in previous chapters that the
best level of output for a firm under any form of market organization (be it perfect com­
petition, monopoly, monopolistic competition, or oligopoly) is where marginal revenue
equals marginal cost. If marginal revenue exceeds marginal cost, it pays for the firm
to expand output because by doing so the firm will add more to its total revenue than to

1 A. Smith, The Wealth o f Nations (Toronto: Random House, 1937), p. 128.

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4 2 2 PART FOUR Im perfectly Com petitive Markets

its total costs. On the other hand, if marginal cost exceeds marginal revenue, it pays
for the firm to reduce output because by doing so its total costs will decline more than
its total revenue. Thus, the best level of output is where marginal revenue equals
marginal cost.

Chapter 9 showed that a perfectly competitive firm faces an infinitely elastic demand
curve and so price equals marginal revenue. Thus, at the best level of output. P = MR =
MC. Since price measures the marginal benefit that consumers receive for the last unit of
the commodity consumed at the output where MR = MC. the marginal benefit to con­
sumers equals the marginal cost to producers under perfect competition. If less of the com­
modity is produced. P = MR > MC. so that consumers' satisfaction would increase if firms
produced more of the commodity. On the other hand, if more of the commodity is pro­
duced. P = MR < MC. This means that consumers would benefit if some inputs were
shifted to the production of some other commodity. Thus, application of the P = MR =
M C rule by the firm leads to the highest consumer satisfaction when all markets are per­
fectly competitive. As pointed out in Figure 9.9. in long-run perfectly competitive equili­
brium. consumers can purchase the commodity at the lowest possible price (i.e.. at P =
lowest LAC).

In imperfectly competitive markets (monopoly, monopolistic competition, and oligop­
oly), however, the firm faces a negatively sloped demand curve, and so price exceeds mar­
ginal revenue. Thus, at the best level of output P > M R = MC. This means that the marginal
benefit to consumers from the last unit of the comm odity consumed exceeds the marginal
cost that the firm incurs in producing it. Consumers want more of the commodity than is
available, but producers have no incentive to produce more. As a result, consum ers' satis­
faction is not maximized. Furthermore, imperfect competitors do not usually produce
at the lowest point on their LAC curve when in long-run equilibrium, and (except for
monopolistic competitors) the price that they charge for the commodity may also include
a profit margin. The social cost resulting when a constant-cost perfectly competitive
industry is suddenly monopolized was shown in Figure 10.7. In the real world, we seldom
if ever have (unregulated) monopoly, but firms in various industries have various degrees
of monopoly power. Thus, it becomes important to examine ways to m easure the degree
of monopoly pow er in order to assess the social costs resulting from it. This topic is ex­
plored in Section 13.2. Section 13.3 then compares the social costs with the alleged dynamic
benefits of monopoly power.

In many industries, however, technological conditions require such a large scale of pro­
duction (to take advantage of economies of scale) that only one firm (natural monopoly) or
a handful of firms (oligopoly) arise. For example, it would be inconceivable and highly in­
efficient to have numerous small producers of automobiles, steel, aircraft, and many other
products. In the case of oligopolies, the government usually relies on the enforcement of an­
titrust law s aimed at attaining some degree of workable competition. This is examined in
Section 13.4. In the case of natural monopoly, on the other hand, the single firm is usually
allow ed to operate, but with the government regulating the price and the quality o f se n ice.
This is examined in Section 13.5. The rest of the chapter deals with the deregulation mov e­
ment. the regulation of international competition, and price regulation. Table 13.1 summa­
rizes and compares the various types of market structure that we have examined in previous
chapters, from perfect competition to monopoly.

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