Case: The Mail Monopoly
The U.S. Postal Service, with increased use of the Internet, has itself established a presence on the World Wide Web. Visit the U.S. Postal Service. Private delivery services are on the Web as well. Visit "FedEx: The World on Time," maintained by the Federal Express Corporation and "United Parcel Service: Moving at the Speed of Business," maintained by the United Parcel Service of America, Inc.
Barriers to entry often last for a relatively short time. In the United States, patents have a legal life of seventeen years. In most European countries, firms must renew patents annually and pay a substantial fee to renew. Studies have found that the average duration of a European patent is closer to seven years than seventeen. That is, firms often do not find it profitable to renew the patent after seven years because the patent has lost its value. A patent loses its value when new discoveries make the patented product or process obsolete or less unique.
Another barrier to entry — control of a key resource — also tends to be weakened over time. Few resources are in such limited supply that one firm can capture all of the supplies. Even when this does occur, other firms are likely to search for alternative sources of the resource or for other resources that can be used as substitutes. For example, over time, discoveries of bauxite reduced Alcoa's control of bauxite. Similarly, at one time U.S. Steel controlled most of the high-quality iron ore reserves in the country. Depletion of those reserves, combined with new discoveries of rich iron ore reserves elsewhere in the world, have broken down this barrier to entry.
In contrast, economies of scale can have long-lasting effects, since they are based on technical considerations and not on economic behavior. Government restrictions can also be long lasting, although the protected firms may have to spend resources (that is, engage in rent seeking) to maintain their privileged position.
Question to Think About: How could a firm that experiences significant economies of scale ever lose its monopoly position?
Price Elasticity and Price Discrimination
We learned from the text that a monopolist that price-discriminates charges a higher price to the group of customers with the less elastic demand. Price elasticity of demand is determined by the number and closeness of substitutes. Hence, the monopolist is charging the group with fewer alternatives a higher price. If the firm tried to charge the higher price to the group with the more elastic demand, people would switch to substitutes.
The relationship between substitutes and price discrimination can be seen by examining prices set by local phone companies and by local electric utilities. Most electric utilities charge a higher rate to residential customers than to industrial customers. To some extent, this difference reflects lower costs of servicing industrial customers. However, it also reflects the fact that industrial customers have more substitutes for the utility's electricity than residential customers have. Residential customers have very few options other than conservation if electricity rates increase; industrial users can often generate their own electricity.
Most phone companies charge business users a higher rate than they charge residential users. Again, the rate differential is due to the availability of substitutes. Residential users can always use pay phones or a neighbor's phone if rates go up — or they can do without a phone. Businesses cannot do without a phone as easily. It's not good for a business's image if prospective customers must call a neighboring establishment to do business! Consequently, business demand for phone service is more inelastic.
Question to Think About: What are other examples of price discrimination? How do elasticities of demand and the availability of substitutes relate to the different prices in such examples?
Topic: The De Beers Diamond Monopoly
The first case study in this chapter, entitled Are Diamonds Forever?,
examines the De Beers diamond monopoly. To succeed, any monopoly must
control the key resource in the industry. In this case the key resource
is raw diamonds. The case study reports the difficulty De Beers is having
controlling the supply of raw diamonds coming out of Russia. After
several unsuccessful negotiations during 1996, De Beers has given Russia
an ultimatum to agree to sell 95% of its diamonds to De Beers, or else De
Beers will buy diamonds more selectively. Most industy observers do not
expect the Russian government to agree to sell most diamonds to De Beers.
During the last three years Russian sales to De Beers averaged about
$1.2 billion versus Russian sales on the open market of about $1 billion.
The lack of an agreement will subject the price of diamonds more to
market forces, which over the long run would tend to lower prices.
Topic: Microsoft Office 97
Microsoft's Office software, a combinations of applications including Word, Excel, and PowerPoint, is used by 25 million customers and outsells all competitors by six to one. In January 1997, Microsoft is scheduled to roll out Office 97, which will allow users to create and view Web pages as easily as they now create and read Word documents. Office will
also automatically create hyper links to any Web page. A "Web Page
Wizard" will walk new users through the process. Another part of Office,
called Outlook, is a personal information manager, combining a calendar
with email. Observers expect Microsoft to sell 20 million copies of
Office 97 in 1997. Such sales would boost Microsoft's market share from
85% in 1996 to 88% in 1997. Despite Microsoft's market dominance, it
still faces potential competition from the likes of Corel Office, which
is more technologically advanced.(Updated 11/22/96)