Microsoft: Is the company too big?

The U.S. Justice Department is presenting an Antitrust case against Microsoft. They argue that Microsoft is using its near monopoly position in the operating system market to gain an unfair advantage in the brower market. The Justice Department claims this is bad for consumers and firms in the software industry. Microsoft claims that the software industry is extremely competitive and that, while it's a large company, it does not posses unchallenged market power. They also claim that their specific software solutions are the natural result of bringing better products to customers.

Here, we will review monopolies and ask why they are hurt consumers. Then we provide links about the Microsoft case.

Monopoly

Most people have as sense that monopolies are "bad." They often argue that concentration of power is dangerous, or that monopolies make excessive profits. In this section, we'll look at how monopolies behave and why they might be bad for the economy.

What makes monopolies different?

A Monopoly is the only firm in a particular market. At the other end of the spectrum is a perfectly competitive firm. Most industries are somewhere in between pure monopoly and perfect competition. The essential different between the two is the degree to which a firm can control prices.

In any industry, the market price is determined my the intersection of supply and demand for the product. Supply is the sum of all firms' supply curves. If market supply decreases, the price of the product rises.

No matter if the industry is a monopoly or if there are lots of firms, the market cannot be forced to pay a higher price for less goods. The demand curve must always be obeyed. If the price is raised, some will continue to buy, but some will no longer buy the product.

For the perfectly competitive firm (perhaps a small farmer growing corn) they can sell as much (or as little) corn at the given market price. Their decision about how much to produce has no noticeable affect on market quantity and prices. Thus, a firm with no market power takes prices as given. In such an industry, the market price is determined by the intersection of supply and demand.

A monopolist, because it's the only firm in the industry, faces a downward sloping demand curve. That is, the monopolist's decision about how much to produce affects the price. The monopolist is able to pick a point along the market demand curve. What point do they pick? If a monopolist decides to raise prices, it gets more profit because it earns more from selling each good. However, it also loses profit because it sells fewer goods at the higher price. These two effects work against each other. It turns out that the monopolist will charge a higher price than it's marginal cost (the cost of producing one extra unit). If the supply curve shows the monopoly's marginal costs, then the only way that a monopoly can charge a price higher than it's marginal costs is by producing a quantity less than at the intersection of supply and demand. (Remember that a monopolist must charge a price along the Demand curve).

Remember that in an industry with lots of firms, the equilibrium price and quantity are determined by the intersection of supply and demand. Thus, relative to an perfectly competitive industry, a monopoly will charge a higher price and supply fewer goods.

What is Bad about monopoly behavior?

The following graph shows the competitive and monopoly solutions for an industry. If there were many firms, the price would be P_pc (price perfect competition) and quantity would be q_pc. If one firm buys them out, it would charge P_m and product qm.

Since both points are along the market demand curve, why is the competitive solution preferred? After all, the market demand curve shows that prices that consumers are willing to pay for different amounts of goods. Why is one point preferred?

From society's point of view, we need to evoke marginal analysis. Our basic decision rule is to produce a good until the marginal social benefit is equal to the marginal social cost. This will give us the largest "pie" and insure that we are efficient. The Marginal social benefit (if we assume no spillovers) goes to consumers of the product, so the demand curve shows marginal social benefit at each quantity. The supply curve (again assuming no spillovers) shows the marginal social cost at each quantity. Only at the perfectly competitive solution are they equal. At the monopolists' solution, MSB>MSC, so it would benefit society by producing more of the good.

What is the cost associated with this? Economists call the area of the red triangle above the Dead Weight Loss of monopoly. The more the monopolist raises prices and lowers output, the greater the size of the triangle, the greater the DWL, and the smaller the "pie" for everyone.

Microsoft

The Justice Department is claiming that if Microsoft gains a monopoly in the browser market, this will be bad for consumers. But the arguments against Microsoft are more subtle than simply considering Dead Weight Loss. In particular, Microsoft has not acted as a traditional monopolist--it did not raise prices of its internet browswer. In fact, it actually gives Internet Explorer away for free.

The Justice Department argues that innovation will be reduced if Microsoft is a monopoly. The claim is that Microsoft will have less desire to innovate (an perhaps an incentive to stop innovation elsewhere) if it becomes the dominant web browser. On the other side, one can argue that the internet browser market naturally leads to one or two large companies (see Krugman). One can also argue that Microsoft (or any company) will not pay the extremely large costs of developing software unless it can make a profit by selling at a "high" price latter. We talked about these arguments in class. These further readings should be helpful in looking at the case:

The case explained in simple terms by the BBC.

Yahoo's Microsoft Coverage
Policy.com's Microsoft Coverage.
Microsoft's (MSNBC) FAQ

On Innovation (Lehrer News Hour)

The Economics of Antitrust, Why Bill Gates Should Worry, and Bill Gate's Reply from the Economist

Soft Microeconomics by Paul Krugman