Questions for Classroom Discussion on Monopoly

The purpose of this real-world application from 2008 is to not only provide an example of a monopoly created by a common barrier to entry, but to also show how the wireless industry wasn’t necessarily always monopolized. (It might also be considered a social commentary on the dominance of Apple?) Consider the following:

• What does this article argue is the reason for the dominance of one firm in the wireless industry?
• What would life be like without monopolies?

Our classroom discussion will take place on Thursday, April 5 after we talk a bit about Monopolistic Competition.  

Posted by Prof. C-S

 

Monopoly

Discussion on “iSurrender: Apple’s new iPhone augurs the inevitable return of the Bell telephone monopoly” by Tim Wu (Slate Magazine, June 2008)

Summary

In “iSurrender: Apple’s new iPhone augurs the inevitable return of the Bell telephone monopoly,” Tim Wu argues that the previously broken up Bell telephone monopoly may be reforming with the help of Apple’s revolutionary phone.  

Wu begins by citing a personal experience: his impending purchase of the, at that time, new iPhone 3G. In order to connect the phone to the network, he must sign a two-year contract with AT&T. No other provider offers or has the ability to offer the plan for the new phone. He uses this example to make the point that the wireless industry, once thought of as the “poster child for competition,” is becoming more and more monopolistic, just like the days when Bell Telephone had a monopoly on the phone industry. Since the contract between Apple and AT&T ended a couple years ago, Verizon has become another big player in the iPhone sector. Wu argues that these two companies’ takeover of providing wireless for iPhones puts all the power back in the two halves of the old Bell company. Many of the small providers are being bought up, and others like T-Mobile just aren’t big enough to play with the bigger providers. Wu cites the high costs of being a player in this market as the main reason for its monopolistic characteristics. There is the possibility of change if Google and Android can make a run at Apple’s chokehold on the industry (Android’s coverage is provided by the Open Handset Alliance- Intel, Sprint, and T-Mobile). Wu finishes with an ironic fact that Apple, which used to be the victim of larger firms like IBM and Microsoft, is now a symbol of industry consolidation.

This is relevant to our discussion of monopolies since AT&T’s contract with Apple gives them the right to provide the network for the fastest growing phone on the market. Consequently, AT&T has a monopoly on wireless plans for iPhones. With no competition for the duration of the contract with Apple, they could charge a higher price than if the market was competitive.

Commentary

The justification behind the argument that monopolies are unethical is that it gives one firm the power to set a higher price than is necessary, or a higher price than would be set in a competitive market. This can be especially problematic in markets that contain necessities, or goods that everyone needs. Setting a higher than equilibrium price will cause people to devote more of their income to that item, and therefore make them worse off than they would be if the price was at market equilibrium. They are allowed to exist when economies of scale can be achieved at high levels of production only. For example, in the wireless industry a large amount of infrastructure is necessary to operate, making it hard for companies to enter the market.

Real-World Example

The utilities industry is a real world application of a monopoly market. There are very few providers that are all very big and often span large areas across the country.  This industry is similar to the wireless industry in that it also requires a large investment in infrastructure. Because of its monopolistic tendencies, this industry is highly regulated by the government.

Posted by Ian, Monica and Gunnar (Section 4)

Monopoly

Discussion on “iSurrender: Apple’s new iPhone augurs the inevitable return of the Bell telephone monopoly” by Tim Wu (Slate Magazine, June 2008)

Summary

This article highlights the effects of a potential monopoly in the wireless industry. Today, more so than when the article was even written in 2008, AT&T and Verizon dominate the wireless industry. Both companies are the two offshoots of the Bell telephone empire. All other companies who try and compete in the market are either dying (Sprint Nextel), bought out (Altell) or significantly smaller (T-mobile). The old Bell empire, then, still holds a monopoly over the wireless industry since it is essentially a duopoly today. Sales of the iPhone, only serviced by Verizon and AT&T, have driven the market further into this monopolistic model. Apple continuously comes out with new models of the iPhone that are always in high demand and dominating the wireless phone market. What is key about the iPhone though, is that it requires a plan from only AT&T or Verizon. Thus as demand for the phone rises, the structure of monopoly is advanced.

The article points out that the main reasons for the wireless industry tending towards being a monopoly is because the costs of competing in the industry are so high. Auctioning for rights to transmit signals across the electromagnetic spectrum costs firms billions; so only firms that are strong enough can compete in the market. This leads to the success of either a single firm or only a couple of firms, like AT&T and Verizon. While the article recognizes that Google and the Open Handset Alliance could pose a challenge to the structure, but the chances, especially with the existence of the iPhone are slim.

 Relevance to Classroom Theory

This article is relevant to classroom theory because it gives a close to real world example of a monopoly market. Government regulation today has prevented most firms from forming monopolies, however, this article highlights how the wireless industry operates in a virtual monopoly where only the offshoots of the Bell empire dominate and survive. Further, the theory in class assumes that entry and exit from the market is difficult. This article shows that this is the case for the wireless industry because of the extreme costs of spectrum auctions forming strong barriers to entry. Finally, the theory assumes that the firm is unique or without close substitutes. Because AT&T and Verizon have acquired the most rights to transmit signals across the electromagnetic spectrum there are no substitutes that can offer nearly the same quality of wireless service.

 Discussion

 

Monopolies are considered unethical because of the detriment they cause to society as a whole. Although one could make the argument that monopolies are beneficial because they occur naturally in a capitalistic economy and they provide jobs, the negatives outweigh these positives. Monopolies are caused by barriers to entries in an industry. Barriers to entry can include a high cost of starting a business, as in the wireless phone industry, to an established customer base, as in the National Football League. These barriers to entry lead to a lack of innovation from potential competitors. Another detriment of monopolies is the high cost charged to the consumer because of little competition. This elevated cost causes a deadweight loss because the supplier is making a larger profit and thus is able to produce less. Monopolies are allowed to exist because the products that monopolies produce are usually the best in the industry. Monopolies also tend to have the support of a loyal customer base, which makes it hard for the government to disband them in a legal battle. Another possible reason why monopolies may exist is with government intervention. In industries such as the oil industry and the postal service, it is crucial that the products these producers provide arrive on time and at an appropriate price. Government intervention assures that these companies are run smoothly and in the best interest of the country.

 Real World Application

Another real world application of the monopoly market is the credit card industry. Until 2004, Visa and MasterCard operated in a virtual monopoly with the banks. Banks would generally only issue credit and debit cards through either Visa or MasterCard associations. Visa and MasterCard were able to standardize procedures with the records to reduce fraud and misuse of the cards and both worked to establish international systems so the cards could be used globally. However, in 2004, Visa and MasterCard have been slapped with an antitrust court ruling that was originally brought up by smaller competitors. From then on, banks have been issuing Discover cards and American Express cards through banks in addition to Visa and MasterCard. This market provides a good example of what could happen to virtual monopolies should government intervention come into play.

Posted by Derek, Maria and Robert (Section 3)

Monopoly

Discussion on “iSurrender: Apple’s new iPhone augurs the inevitable return of the Bell telephone monopoly” by Tim Wu (Slate Magazine, June 2008)

In this article, Tim Wu discusses the potential for a monopoly to form in the wireless phone industry, using Apple’s iPhone 3G to show how AT&T and Verizon are gaining power over competitors. The author discusses how the launch of the then latest iPhone 3G, with its groundbreaking features, will force him to leave T-Mobile and sign a two year contract with AT&T (at the time, AT&T was the only provider that Apple had partnered with). He goes on to argue that the huge demand that Steve Jobs and Apple created for the new iPhone is just another force that is propelling the industry into a state of monopoly where AT&T and Verizon are by far the strongest competitors, while Sprint recorded a huge loss in a single quarter of 2007, and T-Mobile didn’t have the market share to compete strongly with AT&T and Verizon at the time. This is significant because AT&T and Verizon were both part of the Bell Telephone monopoly that was broken after an anti-trust lawsuit in the 1980’s. The fact that these two firms seem to be monopolizing the industry leads Wu to argue that some industries, particularly the utility industries with high costs and high barriers to entry, leading to opportunities for economic profit in the long run, are prone to monopolies forming over time.

Many people argue that monopolies are unethical, justified by the fact that, when they control an industry, they become price makers rather than price takers (as in perfect competition), and can charge as high of prices as they want giving the consumer little to no power at all. This can be seen in the iPhone example, where AT&T can charge high prices for iPhone contracts because they are the only provider that has partnered with Apple. In other words, Apple’s choice in partnership has made it so that, if a consumer wants an iPhone they must pay whatever price AT&T wants to charge for service, since the iPhone is a unique good with almost no close substitutes, one of the main characteristics of a monopoly. It’s important to note that there will be an upper limit to what AT&T can charge since demand for the iPhone is not perfectly inelastic, and still has a downward sloping demand curve, but AT&T and Apple can still both make billions from this partnership by excluding the other wireless providers from this deal.

As Wu touched on in the article, some industries are more prone to the formation of monopolies than others, the cell phone industry being just one example. Therefore, one reason that the government may allow, or even create monopolies, is so that it can have more control over the industry and the supply of that particular good or service. Although this may seem unethical, many argue that it is necessary in certain industries that aren’t naturally capable of perfect, or even any, competition.

The cartoon that will be displayed in class (memory peg) is among the most famous political cartoons in U.S. history.  This depicts the infamous Standard Oil monopoly as a giant octopus, with each tentacle representing the company’s influence in various different spheres.  They include the Capitol, the White House, lobbyists, etc.  It was truly one of the most powerful forces in America at the time.  By 1890, Standard Oil controlled 88% of refined oil in the United States. This allowed them to control the price of oil. Also, since oil refining has such high barriers to entry, they had no serious competitors, making them basically the only company in the industry.  In 1911, the Supreme Court declared the company anti-competitive and broke it up into 34 independent companies under the Sherman Antitrust Act of 1890.

Posted by Brenna and David (Section 2)

Monopoly Blog Entry

Discussion on “iSurrender: Apple’s new iPhone augurs the inevitable return of the Bell telephone monopoly” by Tim Wu (Slate Magazine, June 2008)

 Summary

In his article “iSurrender,” Tim Wu argues that the wireless telephone industry has returned back to a monopoly. With the iPhone being continuously upgraded and improved, Apple is dominating the wireless industry leaving competitors far behind.

Wu notes the blame companies have placed on the iPhone for their severe losses and fall to acquisitions. Well known telephone companies have recently plummeted, with Sprint Nextel losing $29.5 billion in only one quarter last year and Alltel being bought by Verizon. The recent failure of these formerly successful companies is due to the lack of competition present in the wireless telephone industry. The article points out that the wireless market is no longer the “poster for competition,” but now includes only few producers with Apple as its single powerhouse.

One reason the iPhone appears to be a monopoly is barriers to entry, with costs of entering the market being sky high. Wu notes the soaring prices of fair spectrum and specifically how it serves as a barrier to entry in the wireless telephone market. In perfectly competitive markets, firms enter the market with ease when they view economic profits, forcing prices to go down until firms choose to exit. In such markets, profit in the long run is inevitably zero. Without free entry and exit, as in the wireless telephone industry, firms can earn profits in the long run and thus have no incentive to exit the market. The lack of competition in a monopoly allows a firm to be price maker instead of a price taker, thus earning high profits and dominating the market as Apple does.

In Wu’s opinion, the growing popularity of the iPhone is not Apple’s fault. Rather, it is due to the economic nature of monopolies that so many wireless companies have begun to fail. The absolute dominance of the iPhone has surely changed the wireless telephone industry as we have recently known it. Wu notes, however, that the iPhone has actually brought back the telephone monopoly that has lasted for most of our history.

 Commentary

Monopolies have an immense amount of power in the marketplace due to the lack of substitutes and little to no amount of competition. A monopolistic company can sometimes be formed because the barriers of entry to the industry are so high, such as in the oil industry. They can also be created by gradually beating out the smaller competitors and local businesses on price until they can no longer compete which is argued to be unethical. By being the only producer of a good, this also means that the demand curve of the company and the demand curve of the market are equal. In essence, a single business encompasses the entire industry. This allows a monopolistic firm to set their own prices and maintain complete control over the production decisions. Monopolies are able to sell fewer products at higher prices without being effected by any competition in the market place that would normally drive their prices down.  To some, this is viewed as unethical because it allows the company to become inefficient over time and charge unreasonably high prices for a product and high profit margins.

Even though they are sometimes viewed as unethical, some monopolies are allowed to exist. In fact, the government often creates specific monopolies (called government-granted monopolies) through patents and copyrights. These granted monopolies are argued to ensure a degree of organization over a certain industry, without having the industry actually be run by government. The government would also want to create a monopoly over certain goods such as electricity, the postal system or public utilities in order for them to remain carefully controlled.

 Real World Application

Monopolies have a history of forming in the technology and telecommunications sectors of the market.  The former titan of the technology space, Microsoft, was accused of monopolistic practices and taken to court in the famous United States v. Microsoft case.  The Department of Justice claimed that by bundling Internet Explorer with Microsoft Windows the market for alternate web browsers was severely restricted, as they were less convenient to acquire.  Moreover, there were questions over whether Microsoft’s programming interfaces were designed to work better with Internet Explorer, which would further cement the argument.  These claims point to one of the main causes of monopoly power, barriers to entry.  The harder it is for other firms to enter into the space Microsoft occupies, the easier it is for Microsoft to maintain as high a market share as possible.

Posted by Benjamin, Jennifer and Kayla (Section 1)