Our subject for this afternoon is competition and monopoly and this is a particularly important
subject for applied economic analysis because the notions of competition and monopoly or
competitive and monopolistic, monopolized have been widely abused not only in the academic
literature but certainly in the popular literature as well.
So you often hear policy makers and pundits discourse on one market being more competitive
than another and what the government needs to do to assure that markets are competitive.
About the worst thing that you can say about a firm these days is that it has monopoly
power or market power.
To accuse an entrepreneur of possessing or exploiting market power is about the worst
thing that you can say.
And as we'll get into later, there's a vast apparatus of antitrust law and other forms
of competition policy within countries and across countries designed to remedy alleged
defects in the competitiveness of markets.
And these policies can have very serious and harmful effects on economic performance, as
we'll see in just a few moments.
What I want to do is start, where I always like to start, with the basics, the fundamentals,
some of the most simplest cases that we can use to illustrate sort of principles of pricing
as they relate to characteristics of markets, characteristics of buyers and sellers, numbers
of buyers and sellers and so on.
You know, what do we mean by competition?
What is a competitive or less competitive situation?
The common sense notion of competitive or competition implies some kind of rivalrous
behavior.
A competition is a rivalry.
We talk about the intense competition between the Auburn University football team and the
University of Alabama football team.
We say that Roger Federer and, what's Nadal's first name, Raphael Nadal, who played in the French Open last week, earlier this week, this weekend, I guess, are fierce competitors, and they've been going at it, these two have been battling each other as numbers one and two in the rankings for a very, very long time.
We might talk about Ford and General Motors or Toyota and Honda as competing fiercely in the markets for automobiles, right?
So we have a sense of some very active and dynamic and rivalrous behavior.
You also might think of sort of illegal or political economy notion of competition, meaning simply freedom.
that competition exists when people are free to compete with each other, free to try to compete with each other, right?
So there's American Idol is holding a competition to determine the best performers and anyone can try out and get smashed by Simon and all the rest of it, right?
Right, but there's no law that says that Italian Americans from New Jersey can't compete in American Idol, although maybe there should be.
So Joseph Salerno could give it a shot if he wanted to.
There's no law that says I can't try to write computer programs if I want to and offer them for sale.
Okay, we'll get into some subtleties of forms of legal barriers such as patent intellectual property and so on.
and so on. Right? But we might think of a situation being competitive as one in which anybody who wants to can try, can give it a shot.
Okay? It's not competitive if there are rules or restrictions on who may enter or who may not enter.
Right? Now, of course, it's not saying that defining competition as freedom to compete does not mean freedom to be successful in competition, of course.
There's no law that says I can't try to be an opera singer, but if you've ever heard me sing, you know that I'm very unlikely to be successful in the market for opera, operatic performances because of rampant discrimination against people with dark hair. It's completely unfair.
Consumers decide, right? Consumers decide which producers they wish to patronize and thus which producers are successful in the marketplace.
So complaining that no one wanted to buy your product does not constitute a legitimate complaint about a lack of competition.
Well, if competition is simply the freedom to compete in the marketplace, what is monopoly, the absence of such competition?
Well, historically, the common law notion of monopoly is simply an artificial grant of privilege by the monarch, by the state.
Okay, so Monopoly typically referred to the British East India Company. So the British Crown said only this particular organization, the East India Tea Company, may legally export tea from the Far East to the British Isles. If anyone else tries to do so, they would be illegal, they would be fined or imprisoned.
Okay, the cable company here in Auburn is Charter Communications, been helping Professor Salerno set up his new high definition television and he had to go and exchange his cable receiver box with some difficulty and as you know if you've ever dealt with the cable company in your town or a regulated public utility, you know they do not typically excel in customer service
Right? So it isn't the case that Charter Communications won a process of rivalrous competition for Joseph Salerno's cable dollars, TV dollars here in Auburn, rather the city of Auburn has granted Charter a monopoly.
They're the only firm that can legally provide wired cable service in the city, so they have a monopoly because the state gave it to them.
That's conventionally what has been meant by monopoly.
Now in the 20th century, as we'll see in just a moment, the term monopoly, the concept of monopoly has been transformed from meaning an exclusive privilege granted by the state to any situation in which one firm or a small set of firms is large in the market.
So, monopoly has come to mean, in contemporary economic discourse, any seller who has a large share of the market.
So, Walmart has monopoly power, it is said. Now, there is no law that restricts me from trying to offer discount goods and services.
Walmart doesn't have a legal monopoly privilege, but many people say, well, it's big and it can charge whatever prices it wants
It's a completely different notion of monopoly.
We'll get into this notion just a bit later.
Mainstream economic discourse today is dominated by attention to particular imaginary constructs or imaginary constructs, hypothetical constructs related to market characteristics.
In particular, the model of so-called perfect competition, as opposed to models of non-perfect or imperfect competition, such as monopoly.
I want to spend a little bit of time this afternoon talking about the model of perfect competition, the other models of imperfect competition, including monopoly,
and explain some of the problems with those models.
Remember that in causal, realist analysis, we do not oppose the use of imaginary constructions per se.
Indeed, some imaginary constructions are vital for understanding key parts of the real economy.
The so-called evenly rotating economy, for instance, is a vital mental tool for allowing us to understand conceptually the distinction between profit and interest.
However, these particular imaginary constructions are not only not useful but completely misleading
and harmful in setting up a hypothetical state of affairs that does not illuminate any aspects
of actual market transactions. In fact, it misleads us and deceives us as to how market
Well, let's start out with a very simple notion of, call it monopoly pricing, quote-unquote.
In other words, how do the prices of goods and services that are exchanged in real markets
differ depending on various characteristics of those markets?
For example, suppose for some reason, we won't say what the reason is, there's only one seller
in a particular market.
Remember when I was talking the other day
about the car radios?
Suppose there's only one car radio in existence
that I could possibly use to replace my broken one,
and maybe there are other people who also seek car radios
to replace their broken ones.
So for whatever reason,
I suppose there's only one seller.
How does that affect the equilibrium price and quantity
as opposed to a condition where there are many sellers,
sellers with different characteristics, okay?
Well, Carl Menger devotes some attention in his 1871 book, Principles of Economics, to
this very kind of question. And it turns out that Menger and his followers in the early
generations of the Austrian School, also in the UK and in the US, in the late 19th and
early 20th centuries, developed a pretty coherent account of how equilibrium prices and quantity
in the 1930s vary with market conditions.
Unfortunately what happened is there were two extremely important books published in
the 1930s by John Chamberlain and, not John, William Henry, William Henry, I've forgotten
which Chamberlain, by Mr. Chamberlain, Professor Chamberlain, and Joan Robinson, I do remember
Edward Chamberlain published books on the theory of competition in the 1930s and they advocated a radically new approach which has been described as the imperfect competition or monopolistic competition approach.
People sometimes speak of the imperfect competition revolution, the monopolistic competition revolution brought about by their thinking, which has for the most part, though not exclusively, come to be incorporated in sort of the 20th century mainstream neoclassical consensus.
And so the theory of Menger and his followers was completely forgotten.
This theory was revived in Mises' book Human Action in 1949 and revived and further developed by Rothbard in Man Economy and State in 1962.
Rothbard took a slightly different approach, placing particular emphasis on the role of legal restrictions in the determinants of market structure.
But even among contemporary Austrian economists, this Mungarian tradition has not received as much attention as perhaps it should.
So let's go back to the very beginning, go back to the simple kinds of pricing examples that we studied the other day,
because it turns out we've already looked at some examples of so-called monopoly pricing.
Here's one of the examples from the other day.
Excuse me. Where there's one seller possessing one unit of the good or service in question, this is my car radio example, and assume that the seller has a minimum selling price of $150. He would not sell that good for anything less than $150. Suppose there are five buyers, each of whom has a maximum buying price or reservation price as given in this demand schedule. Well, we said the other day that the good or service
The good will end up going to the most capable buyer, or the buyer with the highest reservation price, highest willingness to pay, at a price below his reservation price, but above that of the next most capable buyer.
Assuming that those prices are above the seller's reservation price.
We know trade cannot take place at a price below 150, because then the seller would rather hold on to it.
The trade can't take place at a price below $275 because then you'd have two buyers bidding against each other.
So the B1 will bid the price up above B2's reservation price so that B2 will drop out of the market.
Equilibrium price will be somewhere between B1's maximum of $300 and B2's maximum of $275.
This is exactly the same copy and paste job from the other day.
Let's try a few slightly different variations.
Suppose you have one seller
who possesses multiple units of the good,
all valued at the same price for the seller.
So the seller has three radios,
each of which he would be willing to sell for a hundred fifty bucks a pop.
What would happen here? Well,
because there are three buyers,
potential buyers, all of whom are willing to pay more than 150.
Right, so B1, B2, and B3 can all get a radio.
Okay, they can all get a radio, and the price, the equilibrium price, again, must lie,
it can't be above 250,
okay, because then B3 would drop out.
Right, it can't be below 225, otherwise B4 would want to come in,
and the other three buyers would have to bid it away from before.
Okay, so the equilibrium price will be somewhere between $250 and $225, okay?
Well, so we've already seen now that we still have only one seller in the market.
We still have a monopoly seller, quote-unquote.
But now the monopoly seller has three units available for sale rather than two, okay?
And because the seller wishes, would like to unload all three units as possible,
competition among buyers, the price will be lower than it would if there were only one unit for sale.
Because the seller has to attract more than just B1, he has to be able to make a deal with B2 and B3 as well.
Another case, suppose you have five sellers, all of whom have the same reservation price, 150 bucks.
What happens here? Well, because the least capable buyer, B5, is willing to pay more than the reservation price of these sellers, 150, all five units of the good can be exchanged.
So we have five sellers, each of whom has one unit. All five units can be transacted, so all five buyers will be satisfied, will end up purchasing a unit of the good.
The equilibrium price will lie somewhere between the least capable buyers' willingness to buy $200 and this reservation price of the sellers $150.
How about this case?
Again, assume we have five units of the good.
We have five sellers, each of whom has a single unit available for sale.
But they have very high reservation prices, say $240.
What's going to happen here? Well, you can see by looking at the buyer's willingness to pay
that not all five units can be purchased.
Because neither B4 nor B5 is willing to pay a price high enough to attract a unit away
to induce one of these sellers to give up a unit of the good.
Okay, so what happens in this case? Well, only three transactions will take place.
Right? So the first three, the three most capable buyers will end up with a radio.
The two least capable buyers will not. And the equilibrium price will lie somewhere below
the last of the capable buyers' reservation price, 250, and the reservation price of the sellers, 240.
So the price can't go below $2.40 here, even though B4's valuation is only $2.25, the price can't go below $2.40, otherwise the sellers will drop out.
What if you have multiple sellers, each of whom has a good or service for sale, but they have different reservation prices?
Reservation Prices.
Now we're back to the analysis of the marginal pairs that we studied two days ago.
So this is the same example that we looked at originally.
We have bilateral competition, competition among buyers, competition among sellers.
So this is the case that we looked at before where there will be four transactions and
The equilibrium price lies below the reservation price of the first excluded buyer, B5, and
above the reservation price of the first excluded buyer, B5, and below the reservation price
of the first excluded seller, S5.
What's the moral of the story here?
What's the point of these examples?
Well, that equilibrium prices and quantities do depend on characteristics of the buyers
and sellers in the markets, no doubt about it.
But it's not simply the numbers of buyers and sellers that matter, it's not the numbers
of buyers and sellers in the market that affect these equilibrium prices and quantities, it's
the entire schedule of valuations on both the buyer and seller sides, it's the reservation
Reservation Prices of the Buyers and the Sellers that Matter.
We've looked at a set of examples here where we kept the buyer's reservation prices the
same and we varied the number of sellers and the levels of reservation prices and the variation
in reservation prices among sellers.
We saw, for example, that if all sellers have the same reservation price and that's below
below at least some buyer's reservation prices, then equilibrium prices are decreasing in
the number of sellers, other things equal, holding constant the characteristics of the
demand side and so on.
But notice, you could flip that around and do a completely symmetric analysis, what economists
sometimes call monopsony rather than monopoly, meaning a reduced competition among buyers.
So if you had a single buyer but a lot of sellers, right, so if we assume that all these buyers have the same reservation prices, and those are above the reservation prices of at least some sellers, then equilibrium prices are increasing in the number of buyers of the things equal.
So it isn't the case that having fewer participants in the market necessarily means that prices will be higher.
Having fewer participants in the market could make prices lower.
It depends on whether we're talking about variations in the supply side or on the demand side.
Okay, the more general point is that we cannot simply count, we can't do a head count and say, well, gosh, having five firms in the market is better than having four firms in the market.
And having six firms in the market is better than having five firms in the market.
Okay, it's a much more complicated story depending on the characteristics of buyers and sellers' subjective valuations.
And it's interesting that a lot of antitrust policy is based on incredibly simple, naively simple models in which you have large numbers of perfectly identical sellers or numbers of perfectly identical buyers and so on.
Also note that there's nothing in this analysis that suggests any, we haven't given any basis for some kind of normative evaluation of those different cases that I put up, different examples, right?
Well, they're ones in which buyers and sellers have different subjective valuations.
Is one of those cases better than another case?
Is social welfare higher in one of those cases than in another case?
Well, we have no scientific basis for saying so.
Remember, as we discussed before, all that we can say in cases like these
is that as long as buyers and sellers are free to transact voluntarily
and no transactions are coerced, meaning someone is forced to buy something
If you buy something at a price higher than his reservation price or someone is forced to sell something at a price lower than his reservation price, then any arrangement of transactions is welfare maximizing in the only scientifically meaningful sense of welfare maximization.
Because we don't have any grounds whatsoever for some sort of competition policy or antitrust policy based on the analysis that we've just walked through, and that's very important.
What about so-called perfect competition?
Are any of the examples that I've just gone through
examples of perfect competition?
If not, what's imperfect about them?
Does it matter what should be done about it?
Well, as I said before, the model of so-called
perfect competition, like the other models,
like the contrasting models of imperfect competition,
are imaginary constructs or constructions,
But they're not particularly useful ones, they're bad ones, it turns out, okay?
Well, what are in these imaginary constructions?
Well, the kind of standard textbook approach to market structure
is to say, well, you can take any hypothetical market and characterize it according to four dimensions, okay?
First would be characteristics of the product.
Are the products offered by different sellers perfect substitutes?
Each seller is selling a product that's identical to that of every other seller.
Or are the products slightly different?
Or does a seller have a completely unique product?
Okay, so sacks of wheat are more or less homogeneous.
So you could say, well, the wheat market is one in which you have lots of sellers selling wheat
and buyers don't distinguish between Farmer Jones' wheat and Farmer Smith's wheat. It's just all wheat.
Of course, that isn't technically true because there are lots of different grades and categories of wheat.
That's even less so today because you have
genetically modified wheat and non-genetically modified wheat. So there actually is a lot of variety.
But assume that there is some category of wheat
within which all products are homogeneous.
You can imagine a market for slightly differentiated products like soft drinks.
Coke and Pepsi aren't identical, but to most people they're pretty similar.
I just gave you a hint as to something that makes this kind of analysis very tricky.
In the southern United States, particularly in Georgia where I used to live,
we have very, very strong opinions about Coke and Pepsi.
Let's say Pepsi is not even remotely a close substitute for Coke, whereas there are people in other parts of the world who would think Coke and Pepsi are pretty much the same, and if you don't drink soft drinks at all, you would have no reason to differentiate among them.
What that tells us right away is that, I'm planting a little seed that we'll nourish a little bit later, is that it's not the objective characteristics of the product, some kind of scientific or technical attributes that make a pair of products substitutes or complements or homogenous or differentiated, right?
So whether a product is homogeneous or not depends on how it's perceived by consumers, not the chemical composition of the product.
You can also think of a market in which there's a completely unique product.
The iPhone, if you guys are planning to get the new iPhone from Apple, it looks extremely cool.
I mean, it's a phone, right? But to some people, it's a completely unique phone. I mean, it can do all those. Have you seen the ads, all the different things it can do? It's extremely cool. If anyone listening out there would like to send me one.
But some people say, oh, that's a unique product. So Apple has a monopoly on the iPhone. No one else makes the iPhone. Well, I mean, there's a sense in which that's true, right? Okay.
Okay, but so already we've seen, there's not really a scientific distinction here.
Also notice that when we studied pricing and exchange before, right, we defined a market,
we defined a market as being one in which goods and services, units of goods and services
that are perceived as perfect substitutes are being exchanged, right?
Okay, so the market for sacks of wheat or for bottles of water or for car radios.
We're assuming that consumers, that B1 doesn't care if he gets S1's radio or S2's radio or S3's radio, he just wants a radio.
Okay, if he thinks that S1's radio is different from S2's radio, well then S1 and S2 are not selling in the same market.
It doesn't make sense to talk about an equilibrium price in that market because the market, there's no unified market, okay.
So a market is defined as one in which homogeneous units of good and service are being exchanged
in the analysis that we presented in the last few days.
Okay, but in the standard sort of textbook analysis, you can have a market with slightly
differentiated products.
How many buyers and sellers in the market and how big are they?
Are there lots of buyers and sellers?
The model of perfect competition requires that products being exchanged are perceived as homogeneous, and there's not only a lot of buyers and sellers, there's really a lot of buyers and sellers.
There's an infinite number of buyers and sellers. Infinity. Literally an infinite number of buyers and sellers.
Technically speaking, the model says what happens to price and quantity as the number of buyers and sellers approaches infinity.
It's a calculus notion of what happens in the limit.
But so for a market to be perfectly competitive, there would have to be an infinite number of buyers and sellers.
I haven't seen many of those around here. Maybe you have.
Conditions on entry and exit.
So, is this a market in which anyone can freely enter and exit, or are there barriers to entry?
Now, in this kind of textbook analysis, what's meant by a barrier to entry is not necessarily a law.
A law saying you can't be in this market, that could constitute a barrier to entry.
But anything that limits you from sort of magically, instantaneously being in the market is considered a barrier.
Right? So, I mean, it is objectively true that while there's no legal reason that I couldn't set up a discount store today to compete with Wal-Mart, I'm practically constrained because I do not at present have the capital resources necessary to purchase a huge storefront.
I could try to borrow the money but I actually can't get to the bank before it closes today
because I have to lecture here until 3.30 and the bank closes at 4 and I don't even have a bank account
with a bank in this state.
In the sort of mainstream approach, that would constitute an entry barrier.
I can't compete with Walmart because I don't literally have the funds in my pocket right now to set up a store.
or Walmart has a brand advantage.
People already know the name Walmart.
When you buy something from Walmart, you assume that it is going to be of reasonable quality
because if they sold you faulty products or food products that were filled with poison or whatever,
people wouldn't want to shop at Walmart again.
That would hurt Walmart's long-run profitability.
So established sellers who have a brand, consumers have some confidence in that brand. Well, nobody knows what Peter's discount store sells. I haven't established a reputation with consumers. They might be reluctant to buy my products. So I can't compete with Walmart, the argument goes. They have a brand name advantage that I don't have.
Notice we're getting away from the realm of legal restrictions and into one in which anything that prevents me from doing sort of whatever I want to do constitutes a barrier to entry.
It's a little bit fanciful, right?
There's also conditions on information. The perfectly competitive model assumes that everyone has perfect information.
I know exactly who all the other market participants are, where they are.
I know all the relevant characteristics of the good or service in question and so on, perfect information.
In the textbooks, you typically find four different market structures described.
Perfect competition, monopolistic competition, described by these English economists in the 1930s, we mentioned before, oligopoly and perfect monopoly or pure monopoly.
Ironically, while the imperfect competition theories, the monopolistic competition theories of the 1930s were the ones that sort of led to the demise of the Mengerian approach, the imperfect competition or monopolistic competition models now are almost themselves forgotten.
So most of the textbooks have dropped the section on monopolistic competition, which was there when I was an undergraduate.
And now they just discussed perfect competition, oligopoly and monopoly, and oligopoly has become a much more popular model because they're typically analyzed using concepts from game theory, which is a very trendy and fashionable approach to mathematical economic analysis, okay?
So a market is perfectly competitive if it satisfies particular requirements on these four conditions.
Homogeneous product, infinite numbers of buyers and sellers, free entry and exit, in the sense that we just discussed, and perfect information.
If any of those is lacking, the market is not perfectly competitive, and it's one of these three alternatives.
What does the firm do in this hypothetical perfectly competitive market?
What's the situation facing the firm?
Well, assume that the firm seeks to maximize its money profit,
where profit is defined as the difference between total revenues and total costs.
So the firm, if the firm faces a marginal cost curve that is upward sloping, in other words if the cost of producing an additional unit of output by increasing one or more variable factors is increasing in the quantity of output, okay, and that itself can be derived from the principle of diminishing returns, which we discussed the other day, right, to produce
Remember, if I add, I have my flower pot with the corn, right, if I add, each time I add an ounce of fertilizer, I don't get a proportional increase, a consistent and even increase in corn.
So if I want to get 10% more corn and then another 10% more corn, then another 10% more corn, right, I have to add more than just 10% more fertilizer.
I've got to add 20% and then 30% and then 40%, so I have to continually increase the degree to which I add my variable factors to get a constant increase in output.
So to produce additional units of output, the marginal cost is increasing, the cost of producing a marginal unit rises as I produce more and more.
Okay, what's supposed to be, what's unique about the perfectly competitive firm is that it is alleged to face a demand curve that is completely flat or in the language that Joe used on Monday, I think it was, or Tuesday, perfectly elastic.
Okay, so it's assumed that the perfectly competitive firm faces a perfectly elastic demand curve.
demand curve. What's a perfectly elastic demand curve? Well, it's one in which for any quantity that the firm wishes to sell, it can sell as many units as it wants at the prevailing price, PPC for perfect competition, without ever driving the price down. In other words, the wheat farmer can bring as many bushels of wheat to market as he wants, and he can sell everyone without ever having to
lower the price below the prevailing market price PC, PPC.
Now, how is that even conceptually possible?
Well, in the story, in the standard story,
remember this perfectly competitive firm,
despite having actual finite costs
and producing an actual specific quantity,
Remember how big this guy is?
How many of these sellers are there?
Many, many.
Yeah, infinity.
So each one is how small?
Each one is infinitely small
relative to the total amount produced.
Okay, so the theory is this guy is so teeny, teeny,
teeny tiny, he's like in, you know,
the Honey I Shrunk the Kids movies.
So he's like this teeny tiny little farmer
who's about this big, right?
And he produces these teeny tiny little bushels of wheat, getting into some pretty fanciful
territory here, and no matter how many he sells, he's so tiny that nobody even notices.
Has literally zero effect on the market price, which is determined as sort of the big grown-up
adult wheat market.
So the theory is, well, what's this producer going to do?
Well, he's going to expand his output, his quantity, up to the point where the revenue
he receives from selling an additional unit of output is equal to what it costs him to
produce an additional unit of output.
So he maximizes his profits by choosing the quantity, producing the quantity at which
marginal revenue is equal to marginal cost.
But because his demand curve is perfectly elastic, the revenue he receives from selling
one more unit, his marginal revenue, is always the same amount, it's a constant number, it's
a constant, simply given by the market price.
If wheat sells for $10 a bushel, then each additional bushel of wheat he brings to market
adds $10 to his revenues.
You might wonder as an aside, well, where does the price come from then?
If every producer sort of takes the price as exogenously given, well, what determines
the price then?
Well, and the standard answer is, it's the interaction of all of these infinitely many
infinitely small buyers and sellers that determines the price.
So individually, each one is too small to affect the price, but collectively their actions
It's a little bit paradoxical. In fact, it's quite like the paradox of voting. Why do people vote? Well, I mean, I can vote for the candidate of my choice, but I know that the probability that my vote will affect the outcome, not only in a national election, even in a state or local election, is effectively zero.
Okay, certainly in a presidential election, right, with the tens of millions of votes that will be cast, the probability that the outcome will hinge on my vote is zero.
Okay, indeed the probability that the outcome will be determined by any one person's vote is effectively zero.
So if no one's vote affects the outcome, then what determines who wins?
Well, it's all the votes.
Right now, sensible people, when they think about this, come to the conclusion that there's no reason to vote.
Okay, or it's perfectly legitimate for me to vote, but I'm doing so only because it makes me feel good.
Okay, I get some subjective utility out of expressing my preference and wearing a little sticker or a button.
It's a fun thing. I enjoy participating in the democratic process. It's perfectly fine, but if I think that my casting a vote is going to determine the winner, then I'm nuts.
Ironically, what we have here in the perfectly competitive model is firms who know that their actions have no effect on the outcome, but yet continue to participate anyway.
Okay, they're not producing because they get utility out of it, they're producing because they want to maximize their profits and so on.
There's a lot of peculiarities about the model.
Okay, now let's talk a little bit more about this concept of marginal revenue.
Okay, marginal revenue is simply the addition to total revenue from producing one more unit of output.
If the firm faces a perfectly elastic demand curve, in other words, a horizontal demand curve, marginal revenue is pretty easy to calculate.
Because if the market price of wheat is $10 a bushel, each time I sell another bushel of wheat, I add $10 to my revenues.
The situation is not so easy for a firm facing a downward sloping demand curve for its product.
And there are a couple of different ways to think about this. When I teach this to my undergraduate students, I say, well, first, let's just make up some numbers and let's use a numerical example and just calculate the marginal revenue from selling various quantities of output and see what happens.
So look, take the simplest demand curve you can imagine, just a straight line with a slope of one, so imagine that at a price of $10 a unit, the quantity demanded by consumers is one, at a price of $9 a unit, the quantity demanded by consumers is two, and so on.
So we're plotting a line that even humanities majors could understand. I'm just kidding.
So we'll just calculate, well, what's the total revenue received by the seller from producing either one unit, two units, three units, four units, and so on.
If I produce one unit, I sell it for $10, so I have $10 of total revenue.
If I produce two units, to sell two units, I have to lower the price to $9 each.
So I get $18 of revenue. To sell three units, I can't charge any more than $8 each, so I get $24 and so on.
So this gives me my sort of total revenue schedule, total revenue as a function of the quantity produced.
What's marginal revenue? Well, it's simply the difference between the total revenue I receive producing N units
and the total revenue I would receive from producing n minus one units.
Well, or minus one, plus one or minus one, yeah.
So, in other words, where do I get these numbers?
Well, if I produce one, my total revenue is ten.
If I produce two, my total revenue is eighteen.
So, producing the second unit added eight dollars to my revenues.
Producing the third unit added $6 to my revenue, 24 minus 18.
Producing the fourth unit added $4 to my revenue,
28 minus 24 and so on.
Right, you see that the marginal revenue is not constant
as it was for the perfectly competitive firm.
Remember the farmer added $10 to his revenue
each time he produced additional unit.
This firm here, facing a downward slipping demand curve,
is adding less to its revenue each time it produces a unit
than it did when it produced the previous unit.
So yeah, marginal revenue is still positive,
greater than zero, at least up to the sixth unit.
So my total revenue is growing
as I increase my output from one to six,
but it's growing at a smaller rate.
It's increasing at a decreasing rate by a decreasing amount each time.
In fact, I even get to a point where when I produce six units, I can charge $5 each for them, I get $30 of revenue.
If I produce a seventh unit, I have to lower the price to $4 a unit, and I only earn $28 in revenue.
My total revenue actually went down when I increased output from six to seven.
7, lowering price from 5 to 4. Does anyone remember, what does that tell me about my
demand curve beyond a quantity equal to 6? Economics majors, you can't answer. Right,
Joe talked about the relationship between, he told us something about pricing and total
Total Revenue, if I cut the price from 5 to 4, I increase my output from 6 to 7, but
my total revenues go down.
I'm selling more units, but I'm getting less for each one that I sell, and below $5 a unit
or beyond six quantity equal to six, the amount I add to my, the effect from selling an extra unit is outweighed by the fact of getting less per unit, so I actually end up making less money in total, okay?
So we know that beyond Q equals six, this demand curve is inelastic, okay? The demand schedule is inelastic, right?
From quantity equal 1 to 6, however, demand is elastic. It's elastic. How do I know? Because as I increase output from 1 to 6, lowering price from 10 to 9, 9 to 8, 8 to 7, as I cut price, my total revenue increases.
How can that be? I'm cutting my price. How can my revenue go up? Because when I cut my price, I sell more units.
Right? And in the elastic part of the demand curve, the effect of selling more units outweighs the fact that I'm getting less per unit.
In the inelastic region of the demand curve, the fact that I'm getting less per unit outweighs the fact that I'm selling more units and my total revenue falls.
Okay? So, we took the simplest demand curve that we could think of, just a straight line with a slope of one, and you see that that demand curve has multiple regions, right? Part of it is elastic, to the left of Q equals six, it's elastic, to the right of Q equals six, it's inelastic, right? There's this sort of crossover point right in the middle where the textbooks, they call that the point of unit elasticity. Yeah, Matthew?
I'm just trying to understand, like, the P stands for price, right? So what I'm confused about is, is this demand of marginal revenue, is it measuring production? And how we price what we produce? Or is it measuring retail relations? And how we price what people are buying? Because, for example, I'm thinking of this as a similar model to a used bookstore I've seen function where people put the date that the book came into the store in the front of the book, and each time three months pass, they cut the price of the book.
Is this simply a model of exchange? Or does it include production and exchange?
I don't think the distinction is relevant here.
All we're saying is that consumer demands are such that
if I wanted to sell five units, I cannot charge more than $6 per unit.
This is not a single good, the price of which is lowered over time.
I've estimated the demand curve to look like this demand curve. I believe that this is what the demand curve looks like.
So I think that if I want to sell five units, I can't charge more than six dollars each.
If I want to sell six units, I can't charge more than five dollars each. Otherwise, people won't buy them.
If I only want to sell three units, I can charge as much as eight dollars apiece.
Okay, so we haven't said anything about the entrepreneurs cost of production, if that's what you're asking.
We're only talking about the revenue side here.
Okay, so this is all sales.
Revenues are just sales or sales receipts.
So they're saying, you know, how much revenue am I going to have in my pocket if I try to sell this many, if I try to sell that many?
We haven't said how much he has to pay for his factors of production.
We're only looking at his receipts or his revenues, okay?
Oh, so going back to our story, why is this relevant to our story?
Well, go back to the previous analysis of the firm seeking to maximize its profits,
but assume that it does not face a perfectly elastic demand curve for its product,
but rather it faces a demand curve that looks something like this.
it faces a downward sloping demand curve for its product.
In other words, it cannot sell as many units as it wants
without lowering the price.
Okay, to sell more units,
you have to lower the price per unit.
Okay, we have a picture that looks something like this.
Okay, once again, we've depicted
an upward sloping marginal cost curve,
but rather than a horizontal
or perfectly elastic demand curve for the firm's product,
we depicted a downward sloping demand curve.
Okay, so this could be like the downward sloping
demand curve from the previous slide.
So if the seller wants to sell an additional unit of output,
he has to lower the per unit price.
Okay, and as we saw in the previous diagram,
previous chart, if the demand curve is downward sloping,
then the marginal revenue curve is also downward sloping
and it's steeper than the demand curve, okay?
The marginal revenue curve lies below the demand curve
and it's steeper than the demand curve.
Why is that?
Again, I said when I introduce this in class,
I ask people just to crank through the numbers like this,
okay, and if you just plot that MR curve,
it's gonna look something like the MR curve I've got there,
right, it bisects the horizontal axis at Q equals six.
So if you just crank through the numbers,
and Plot Points, you realize, well, for that kind of a demand curve, the MR curve is gonna look something like that one.
But sometimes it's hard for people to see intuitively, why is that?
Why does the MR curve lie below the demand curve?
And why is it steeper than the demand curve?
Well, the easiest way to understand is the following.
That remember the seller, we're talking about market clearing or equilibrium prices, right?
So, in the market, the seller has to charge the same price to each buyer.
Nobody would pay more than what some other buyer is paying to clear the market.
Okay, so if I'm currently selling three units and charging $8 a piece for them,
and then I produce a fourth unit at $7 a piece, I don't add $7 to my revenues.
So why not? You're adding a fourth unit and it sells for seven dollars each.
But remember, if I want to sell four units rather than three,
I have to lower the price not only on that fourth unit,
but on all the other units that came before.
Okay? To sell one more unit, I have to lower the price on every unit.
Which is why, as we move down the demand curve,
where I'm selling in larger and larger quantities,
To sell one more, I have to lower the price on these lots and lots of units that came before it,
which is why eventually my total revenue begins to fall as I expand output.
That's the inelastic part of the demand curve, okay?
So that's why the marginal revenue curve lies below the demand curve and has a steeper slope, okay?
What is this firm going to do?
Well, once again, it wants to maximize its profits by producing up to the point
Where Marginal Revenue is Equal to Marginal Cost, okay?
However, so if I go to where the marginal cost curve
and marginal revenue curves intersect,
that gives me this quantity here.
So call this the monopoly quantity, okay?
What price will the firm charge?
Well, it doesn't have to charge the price
where the MR and MC curves intersect,
because what's the highest price I can charge
and still be able to unload this many units.
I can go all the way up to my demand curve.
Okay, so I can charge a price as high as this price, PM,
and still be able to sell this many units.
Right, notice that with the downward-sloping demand curve
in the standard model, in equilibrium,
the firm is charging a price that's higher
than what its actual marginal cost is at that quantity
to produce the QM unit, the marginal cost was this much,
and the price I can charge is this much.
People sometimes talk about a markup
of price over marginal cost.
With the downward-sloping demand curve,
the firm can charge a price that exceeds
the marginal cost of production.
Whereas with the perfectly elastic demand curve,
the price that's charged is equal
to the Marginal Cost of Production.
So what, you might wonder?
Is this good, bad, or indifferent?
Well, the standard analysis is to say,
to put it in a really complicated language,
good, bad.
Okay, that's the essence
of sort of contemporary competition theory.
Perfectly competitive firms with perfectly elastic demand curves are good, and firms facing downward sloping demand curves having market power are bad.
Why? Because the monopoly firm, the firm facing the downward sloping demand curve, because it's in the elastic part of the demand curve,
produces less than it could produce to be able to increase the price over marginal cost.
Instead of producing here where price is equal to marginal cost, the firm deliberately restricts output,
produces less than that to be able to charge a price that exceeds marginal cost.
Okay, and that's the alleged welfare loss or inefficiency associated with downward sloping demand curves.
Okay, what can we say about this? Well, the first and most obvious thing to say is that every firm faces a downward sloping demand curve.
Every actual firm faces a demand curve that is at least downward sloping in some parts.
Parts, or in other words, no real firm in a finite world can face a perfectly elastic
demand curve.
The assumption of perfect elasticity assumes infinitely divisible units, so that firms
can be infinitely small, output levels relative to the total can be infinitely small and so
on.
But in fact, all real firms produce discrete units of output.
Not one gazillionth of a bushel of wheat, not one hundredth of a bottle of water, but
discrete units.
So there are no perfectly elastic demand curves in reality.
So any sort of analysis that says, well, if a market is not characterized by firms with
perfectly elastic demand curves, there's something wrong with it and we need to fix
it.
Well, I mean, that's not much of a guide because every market will have something wrong with it and needs to be fixed.
It doesn't tell us what the fix ought to be.
Okay, so no market is adequate according to this standard.
And you sometimes hear people, even well-trained economists, being a little bit sloppy on this point and saying,
well, yeah, of course, perfect competition is an ideal we could never reach, but we should try to get as close to it as we can.
So market A has 50 firms in it, and market B only has 40 firms in it, so therefore market A is closer to perfect competition than market B.
That's actually not, that's completely incorrect.
The model of perfect competition doesn't say that if you start out with a perfectly elastic demand curve, and then as it gets a little bit more elastic,
Sorry, a little bit less elastic than sort of incrementally consumer welfare goes down just a little bit each time.
No, it's a discreet, it's a completely discreet kind of analysis, okay, meaning we don't know according even to these criteria
whether a market with 50 firms is better or worse for consumers than a market with 40 firms.
Okay, it's not a continuous kind of analysis even though it's sometimes sloppily described that way.
Another point, which again we can say in a value-free scientific sense, is that there's something a bit odd about the notion that it's wrong for firms to produce less than some specified quantity.
That firms should be better if they were producing this higher quantity, and it's wrong that they restrict output to QM, they should be forced to increase it somehow.
Well, if the seller is maximizing his profit at quantity QM, then selling any additional units beyond QM means that the seller is being required to exchange units in return for less than his reservation price.
Okay, so some transactions that would not occur as voluntary exchanges that are not mutually beneficial are being coerced by law, as it were.
Okay, well, I mean, why should the seller be required to produce more than QM?
By doing so, we're necessarily requiring the seller to engage in transactions that he or she would not otherwise engage in.
Thus, in a meaningful sense, we've reduced overall welfare.
Okay? In the sense that we're not, we're requiring, we're coercing particular transactions. Okay?
It's easy to see this in, you know, a case of, you know, a movie star.
You know, Brad Pitt or something.
Right? Brad Pitt doesn't appear in every single movie he could possibly appear in.
He only sells some of his labor services. He doesn't work 365 days a year. If he were to appear in every single movie, every single TV show, every single commercial, every single radio spot that he could possibly do, well then you would start seeing Brad Pitt everywhere and the value of having Brad Pitt, seeing him one more time would go down. He'd be less desirable if he were sort of everywhere.
So, I mean, Brad Pitt, he picks and chooses what he wants to do.
He reduces the total quantity of his labor that is made available for sale to increase
the average value of his labor services, so he can increase the price that he charges.
Well, I mean, should we require him to appear in more movies?
I mean, again, imagine a law that says if you're a movie star, you know, with certain characteristics, you must be in 25 movies a year, even if you only want to be in 24.
Well, I mean, that sounds a lot like slavery to me, that society or the state is forcing this guy to be in this movie he doesn't want to be in.
It's hard to see how that would be a socially desirable policy, but yet if we say, well, the Microsoft Corporation should be required to produce more copies of Windows than it willingly is producing, is there any essential difference?
Well, yeah, because Microsoft is a big, bad, evil company and Brad Pitt, well, he's Brad Pitt.
Okay? Analytically, it's the same case, the same kind of case, okay? Another point is, even if you believed that, you know, it's sort of a bad thing that firms face downward sloping demand curves, gee, wouldn't it be nice? Wouldn't it be better if demand curves were perfectly elastic? Well, I mean, where is the elasticity of demand coming from? Where does the position and shape of the demand curve come from?
This doesn't just drop from the heavens. The demand curve for any good or service reflects
consumers' preferences for that good or service. Consumers can willingly change their demands.
They can make a firm's demand curve as elastic or inelastic as they want through their decisions
to purchase or to refrain from purchasing. This touches on a point that we made earlier.
People often say that, well, what it means to have a very steep demand curve, it means that there are a few close substitutes for your product.
The more substitutes are available, the more elastic your demand curve, the demand curve facing that firm will be.
There's lots of different kinds of bottled water out there, and there's lots of close substitutes for bottled water.
There's tap water, there's bottled juice, there's soft drinks and so on.
Okay, so a bottled water producer can't charge too high a price, right?
But, you know, Apple's iPhone,
it's a unique product, so Apple can charge whatever price it wants.
Or it can charge a really, really high price, because there are a few close substitutes.
Well, again, what constitutes a close substitute?
It isn't given by engineers. That's not an engineering term, it's a consumer
is an evaluation term, is this cell phone a substitute for an Apple iPhone or not?
Well, it kind of depends on you, it depends on you and me, it depends whether we think there are substitutes or not.
So the whole notion of the availability of substitutes is a subjectively perceived economic concept, not a technological one.
Give another example. It has to do with so-called potential competition. Imagine a seller. Say you define a particular market, say the iPhone market.
Say you define the market so narrowly that only Apple makes the product. Yeah, there are other cell phones and handheld computers and blackberries and things, but they're not as good.
is good. They're not really substitutes for the iPhone. Even if that were true, even if consumers did not perceive any of the competing products as being good substitutes, does that mean that Apple can charge whatever price it wants? Well, suppose it charged $1,000 per iPhone or $2,000 per iPhone, right? Even if no one else is currently making a product that consumers regard as a close substitute. If Apple charges a price that's high enough, what's that going to do? What incentives does that give to competitors?
Inventors, to try to produce something that's a close substitute, to persuade consumers that
their product is a substitute, to produce new products that are very similar to the
design.
Okay, so Apple has to think not only about what its current rivals are doing, but what
potential rivals might be doing.
We can see that with a really simple numerical example.
Here's a case similar to the ones we looked at before. Suppose there's a unique seller
of the commodity, there's one seller with a single unit of the good, five potential
buyers, and say the seller has a very high reservation price, $290. Well, only one unit
of this good will be exchanged, there's only one unit to exchange, B1 will get it at a
at a price somewhere below $300 and $290. But suppose the seller believes that there's
another potential seller out there. Someone who isn't currently in the market, maybe is
geographically, you know, is in another area, but could come into the market if desired.
And suppose that other seller has a reservation price of $280. Can you see that? Suppose there's
There's a potential S2 out there who would be willing to sell for 280, and S1 knows that.
Well now the equilibrium price for this transaction is going to be between 300 and 280, not 290.
Why?
Because if S1 charges a price anything above 280, then S2 will jump into the market and
take away that sale.
So the incumbent seller, he can't charge a price above what the potential seller, who could enter the market but hasn't yet done so, would accept.
So sellers are constrained by the preferences of potential sellers, not only actual sellers.
Okay, there's a great, a very important example of this has to do with so-called predatory pricing, right, which is where a large firm that has a cost advantage over smaller firms because of scale economies and so on, according to the story, you know, price is so low that the smaller firms can't compete at that low price.
So the large firm uses prices really low to drive the small firms out of the market.
Once they're gone, then the large firm has a monopoly position and can jack up the price to whatever it wants.
This is what, for example, Standard Oil was accused of doing in the late 19th and early 20th centuries.
The early antitrust laws were claimed to alleviate problems associated with so-called predatory price cutting.
Well, there's a theoretical problem here, which turns out to be backed up very close by the empirical evidence.
Suppose that a firm tried that strategy. It tried to price lower than other firms could afford to drive them out of the market.
Suppose it's successful in doing so. It's charging these really low prices to force other firms out of the market.
market. If it then tries to raise prices, what are other firms going to do? They're going to jump back in, right? People say, well, Walmart, you know, they build a Walmart on the periphery, they go to some small town, and they build a Walmart on the outskirts, and they price all the mom and pop stores out of business. Then they can charge monopoly prices, except that they never do.
They charge low prices, and indeed a lot of the small mom and pop stores can't compete.
And once the small mom and pop stores are gone, what does Walmart do?
It continues to charge low prices.
Because if it were to raise its price, the mom and pop stores would come back into the market.
In the standard oil case, John D. Rockefeller indeed was trying to drive some of his rivals out of the market by pricing low.
Hello, but if you think about something like an oil refinery, what does it mean to be driven
out of the market, to go bankrupt in the oil industry? Well, there's Rockefeller has his
refinery here, there's some rival who has a refinery here, and so Rockefeller lowers
his price to try to drive this guy to business. He succeeds, and so the owner of the second
refinery goes bankrupt. Well, there's still a refinery sitting there. The physical assets
The Rockefeller could, too. Then he would have owned both refineries.
What Rockefeller found, what actually happened to Rockefeller, is that people quickly realized that he was trying to buy out competitors to do precisely what you describe, so what happened is people started building oil refineries just so Rockefeller would buy them out, and they charged such a high price that Rockefeller complained to his colleagues about being blackmailed.
His strategy of so-called predatory pricing was driving him bankrupt because people were building all these factories just so he would try to under-price or buy them out.
He couldn't afford to do it anymore.
Let me talk a little bit more specifically about the role of government here.
I said at the very beginning of the discussion that an alternative conception of monopoly,
The classical common law notion of monopoly is a special privilege that is granted by the state.
There are lots of obvious examples of this.
A patent.
If you file a patent on a particular product or process,
the state says that no one else can produce a closely similar product or use the same process
for the duration of your patent for 17 years or whatever.
Otherwise, they go to jail.
You can sue them or fine them, they can be imprisoned.
Okay, so a patent is a government-granted monopoly
of finite duration, okay?
Exclusive grants, charters, concessions,
the grant, the exclusive rights given
to the East India Tea Company by the British Crown,
the exclusive rights given to charter communications
by the city of Auburn and so on,
would be obvious examples of government-granted monopoly.
We talked about occupational licensing
and the other day, compulsory licensing of attorneys and physicians and so on is a way of granting monopoly status or quasi monopoly status to those who hold the license and restricting entry by those who do not.
International trade policy can have a monopolizing effect, right?
I think Joe was talking about the automobile industry in the 80s where U.S. automakers persuaded Congress to impose restrictions on Japanese imports.
What does that do to the demand curve facing American automobile producers?
It makes it less elastic, gives them a steeper demand curve than they otherwise would have by eliminating a potential source of competition, potential competing products.
The article on your reading list by Sudha Shanoi does a nice job of pointing out some less obvious sources of monopoly privilege.
Even some sort of tax and regulatory policies that we don't normally associate with competition policy have an anti-competitive effect in the sense of giving special privilege to particular firms.
Programs. Progressive taxation and state taxes and other policies that limit the accumulation
of capital benefits incumbent producers who have already amassed large amounts of capital.
Anything that makes it costlier for a new entrant to accumulate capital to compete with
an incumbent is giving the incumbent an advantage, a competition advantage. Interestingly a lot
A lot of labor and environmental restrictions, by design or not, end up conferring monopoly privilege on particular firms.
One of the classic examples is in the environmental area, the Clean Air Act of 1970, which required factories to reduce emissions of particular kinds of,
they weren't called greenhouse gases back then, but sulfur dioxide, for example,
by requiring factories to install expensive equipment, you know, smoke stack scrubbers
and to use higher cost but more environmentally friendly production technologies.
However, the legislation exempted or grandfathered in under the old rules, incumbent producers.
Okay, so obviously this is a way that incumbents and naturally incumbent energy producers were
very big supporters of the Clean Air Act because it imposed costs on potential competitors.
There's a state mandated entry barrier. The Americans with Disabilities Act is another
example requiring designated parking spaces and ramps and specially outfitted restrooms
and so on for Americans with disabilities. You might think that businesses would have
would have been opposed to these kind of, you know, a very sort of onerous or draconian set of regulations requiring every firm to have certain accommodations for the disabled because it's costly to firms.
However, if you look at the legislative history of the Americans with Disabilities Act, lobby groups representing large firms, the National Association of Manufacturers and so on,
were very strongly in favor of the legislation, whereas lobby groups representing small firms were much more likely to oppose the legislation.
Why? Because complying with the requirements of the ADA is much easier for a large firm that already has a staff of lawyers and so on,
and can install wheelchair ramps and so on at a cost that's a much lower percentage of the firm's overall sales,
or overall capital expenditures than a small firm for whom those restrictions may be very costly
relative to the size of total operations.
So large firms were happy to raise the costs of their smaller rivals through the regulatory process,
thus giving them monopolistic privilege.
Now, we turned out to just say a few words about antitrust policy itself.
are very messy and complicated.
Among economists who would describe themselves
as pro-market or free-market economists,
you find two different views about the role of the state
as it relates to competition and monopoly.
The view that has been expressed here this week
and the view that you find for the most part
in the causal realist tradition
is that the role of government should be simply
to refrain from granting monopoly privilege.
Don't give exclusive licenses and charters
and protections to particular firms
and competition will flourish.
However, there's another view associated with
some other sort of pro-market,
generally pro-market economists,
which is that monopoly does tend to arise naturally
on the market even in the absence of government intervention
and that therefore government intervention is required
to eliminate monopoly or to reduce monopoly.
Or in other words, markets will not be competitive,
quote unquote, unless certain government policies
assure that competition prevails.
So for instance, if a firm gets really large
and has a large percent of sales in an industry,
has a large market share, the government should step in
and break it up into a set of smaller firms.
If a large firm is charging prices that seem quote-unquote too high, the government should step in and force it to lower its prices.
If two or more firms appear to be getting together and setting prices collectively, colluding over price, the government should forbid them from doing so.
This second view is really based on a misuse, as it were, of the model of perfect competition that we looked at earlier.
What has happened is that some economists have made the perfectly competitive model not simply an imaginary construction that could be used to illustrate the effects of this or that,
But rather as a normative benchmark, as a description of the ideal state of affairs to which markets should have to conform.
So when we look at any real world market, obviously we'll find that it does not meet the requirements of the perfectly competitive model.
But, according to this tradition, the government should try to make it as close to that as it can.
If a market has five firms, we should try to make it have ten firms.
If it has ten firms, we should try to make it have 20 firms.
We should try to force prices down, quantities up, make sure firms don't collude,
try to eliminate naturally occurring barriers to entry, and so on.
There are numerous problems with that approach, as we'll see in just a moment.
What are some of the most important antitrust laws?
The Sherman Act of 1890, which outlawed so-called restraints on trade.
The Clayton Act of 1914 outlawed price discrimination, meaning charging different prices to different consumers,
and so-called tying or bundling, namely attaching the sale of one product to the sale of another.
So if you want to buy product A from me, you also have to buy product B from me.
This is one of the things that Microsoft was accused of doing in the great Microsoft antitrust saga, the mid-1990s, that it was tying its internet browser, its web browser, Internet Explorer, to Windows, the operating system, and requiring people who buy Windows to use Internet Explorer rather than Netscape Navigator or some alternative.
There's a number of fallacies associated with that kind of reasoning, but the basic argument was that Microsoft should be required to sell every product that it makes independently with no restrictions.
I think actually Bill Gates wrote an editorial on the Wall Street Journal, the New York Times,
I think it was the New York Times saying, basically this would be like a law that says the New York Times cannot,
it should allow people to buy just the sports section, or just the editorial page,
and by requiring people to buy the whole paper, this unethical and illegal anti-competitive bundling should be outlawed.
You should be able to buy each word independently for a few pennies each if you want.
The other legislation during the New Deal, such as the Robinson-Patman Act, which outlaws so-called predatory pricing, which we discussed just a few moments ago.
We're almost out of time, so let me just mention some problems.
There are a number of practical problems with the implementation of any kind of antitrust policy.
The first is that any such policy ignores, it assumes that if a firm is large and has a large share of the market,
it must be because there was some imperfection in the structure of that market.
So if a firm is very successful, it must be because there are entry barriers, because it has monopolistic privilege,
Research.
It has a large market share, whereas having a large market share is typically the result
of being a good performer, offering better products and services than your rivals, being
able to produce at a lower cost than your rival.
It isn't just magic or coincidence that Walmart is so big.
It got to be big for a specific reason because it has an incredibly efficient supply chain
and a number of sort of innovations in warehousing and distribution that allowed it to price
lower than its rivals, okay?
We talked earlier about, you know, what is a substitute and what isn't, okay?
So even the very notion of trying to say, well, Walmart has, you know, 50 percent of
the market, it's not totally coherent, I mean, what is the market?
Is the market other large discount retailers like Kmart and Target?
Is it all retail stores, does it include Sears and JCPenney, does it include department stores,
does it include hardware stores, does it include grocery stores?
What kind of stores are included?
As you broaden the set of stores that are included in the market, obviously the share
of the market that Wal-Mart has gets smaller and smaller.
And we're thinking about this a lot
during the days of the Microsoft antitrust case,
where you frequently read newspaper articles
that, well, Microsoft has 90% of the market
for desktop computers.
Well, I mean, is that really true?
I mean, Microsoft may have had 90%
of the operating system market
for IBM PC-compatible desktop computers, right?
So, do you include Macs in that calculation? Well, if so, then Microsoft's market share is a little bit smaller.
Do you include, you know, Unix workstations? Well, then Microsoft's market share gets a little smaller.
Do you include, you know, Blackberries and handheld PDAs, which are computers, in a sense?
Well, literally they're computers. Do you include them? Well, then Microsoft's market share gets even smaller.
Do you include big mainframe computers? Do you include Joseph Salerno's old slide rule?
If you define the market as computing devices,
that's what a slide rule is.
My point is simply that the definition of the market
is arbitrary, right?
There's no scientific test for market definition.
Okay, it's just a value judgment
on the part of the antitrust authority.
There's a sort of interest group explanation
for a problem with antitrust as well,
namely that many if not most antitrust suits, in some industries most antitrust suits are
filed not by regulatory agencies but by competitors, right? So antitrust provides a mechanism for
less efficient firms to complain about their more efficient competitors and try to get
the government to intervene to bail them out. Okay, I'll just close with this classic quote
from a little book called Tom Smith and His Incredible Bread Machine, which is what in
my day would have been called a comic book, but I think now would be called a graphic novel.
Graphic short story.
There's a really funny story on an innovator who runs up against the antitrust authorities,
but there's a great scene where the antitrust regulator, the antitrust official makes this
speech to the young entrepreneur, he says, you're gouging on your prices if you charge
more than the rest. So if you charge more than your competitors, you're price gouging.
But it's unfair competition if you think you can charge less, predatory pricing. Second
point that we would like to make to help avoid confusion, don't try to charge the same amount,
that would be collusion. So there's this sort of, there's kind of a legal problem of, anti-trust
of that, antitrust laws are sort of ex post facto,
meaning there's no way to know ahead of time
whether you violated them or not.
Okay, because there's no sort of statement
about what antitrust, there's no objective criteria
to know whether you are engaged
in monopolistic practices or not.
It's decided ex post by a court.
So you can't avoid the illegal behavior
because it's not defined.
Great article on that aspect of antitrust,
Ironically, it was written by a famous economist named Alan Greenspan back in his younger days before he became a leading government official back when he was sort of a free market economist.
Okay, I've already gone over my time, so let's have some questions and discussion.
Would you agree with Mises that there can be at least some monopoly like resource projects?
There are some differences of opinion about what constitutes monopoly, so Rothbard argues that there can be no monopoly except for an exclusive government grant, exclusive government privilege.
Mises and Israel Kirzner as well have argued that that's mostly right, but there are a few very special cases where monopoly prices could emerge even on the free market.
and there's some disagreement among Austrian economists on this point and it's difficult to explain.
What I'll do is just refer you to some writings on that.
There's a piece, first of all let me say it's a little bit difficult to discern exactly what Mises' position was because he changed it a little bit.
His discussion of monopoly in the first edition of Human Action, the 1949 edition, is different from the discussion, there are subtle changes in the third edition, where his position is a little bit, he takes sort of a stronger, almost more Rothbardian position in the early, in the first edition and a slightly softer position in the later edition, but there's an article by Mises that was published, originally published only in French, isn't that right Joe, the 98 piece?
It was not published at all. It was an unpublished paper, previously unpublished paper, that was only recently discovered, and it's in the quarterly journal of Austrian economics in 1998, right, which explains Mises' own position in more detail.
Joe has also written a paper on the early history of monopoly theory among Austrian economists. Has that been published yet? It is in the QJA?
Yeah, okay. If you just do a Google search for Austrian Monopoly Theory from Menger to Mund, the last person Joe deals with was an economist named Vernon Mund, M-U-N-D, you can Google it, and it explains some of these subtleties in a little bit more detail.
That's a pretty good non-answer, isn't it?
Any other questions you would like me not to answer?
Okay, thank you.