WEBVTT NOTE 10.05. The Theory of Monopolistic or Imperfect Competition 1 00:00:00.000 --> 00:00:07.000 5. THE THEORY OF MONOPOLISTIC OR IMPERFECT COMPETITION 2 00:00:07.000 --> 00:00:12.000 a. MONOPOLISTIC COMPETITIVE PRICE 3 00:00:12.000 --> 00:00:22.000 The theory of monopoly price has been generally superseded in the literature by the theories of monopolistic or imperfect competition. 4 00:00:22.000 --> 00:00:36.000 As against the older theory, the latter have the advantage of setting up identifiable criteria for their categories, such as a perfectly elastic demand for pure competition. 5 00:00:36.000 --> 00:00:41.000 Unfortunately, these criteria turn out to be completely fallacious. 6 00:00:41.000 --> 00:00:47.680 Essentially, the chief characteristic of the imperfect competition theories is that they 7 00:00:47.680 --> 00:00:56.180 uphold as their pure competition, rather than competition or free competition. 8 00:00:56.180 --> 00:01:02.600 Pure competition is defined as that state in which the demand presented to each firm 9 00:01:02.600 --> 00:01:06.760 in the economy is perfectly elastic. 10 00:01:06.760 --> 00:01:14.320 In this supposedly pristine state of affairs, no one firm can, through its actions, possibly 11 00:01:14.320 --> 00:01:18.480 have any influence over the price of its product. 12 00:01:18.480 --> 00:01:22.700 Its price is then set for it by the market. 13 00:01:22.700 --> 00:01:28.800 Any amount it produces can and will be sold at this ruling price. 14 00:01:28.800 --> 00:01:35.600 In general, it is this state of affairs, or else this state without uncertainty, perfect 15 00:01:35.600 --> 00:01:41.800 Competition, that has received most of the elaborate analysis in recent years. 16 00:01:41.800 --> 00:01:47.300 This is true both for those who believe that pure competition fairly well represents the 17 00:01:47.300 --> 00:01:54.560 real economy and for their opponents who consider it only an ideal with which to contrast the 18 00:01:54.560 --> 00:01:58.260 actual monopolistic state of affairs. 19 00:01:58.260 --> 00:02:05.120 Both camps, however, join in upholding pure competition as the ideal system for the general 20 00:02:05.120 --> 00:02:12.560 Welfare, in contrast to various vague, monopoloid states that occur when there is departure 21 00:02:12.560 --> 00:02:16.640 from the purely competitive world. 22 00:02:16.640 --> 00:02:21.480 The pure competition theory, however, is an utterly fallacious one. 23 00:02:21.480 --> 00:02:28.360 It envisages an absurd state of affairs, never realisable in practice and far from idyllic 24 00:02:28.360 --> 00:02:29.760 if it were. 25 00:02:29.760 --> 00:02:36.560 In the first place, there can be no such thing as a firm without influence on its price. 26 00:02:36.560 --> 00:02:43.280 The monopolistic competition theorist contrasts this ideal firm with those firms that have 27 00:02:43.280 --> 00:02:51.240 some influence on the determination of price and are therefore in some degree monopolistic. 28 00:02:51.240 --> 00:02:59.380 Yet it is obvious that the demand presented to a firm cannot be perfectly elastic throughout. 29 00:02:59.380 --> 00:03:05.180 At some points, increase in supply will tend to lower market price. 30 00:03:05.180 --> 00:03:11.340 In aggregating market demand, we saw that for each hypothetical price, the consumers 31 00:03:11.340 --> 00:03:14.900 will decide to purchase a certain amount. 32 00:03:14.900 --> 00:03:20.400 If the producers attempt to sell a larger amount, they will have to conclude their sale 33 00:03:20.400 --> 00:03:25.940 at a lower price in order to attract an increased demand. 34 00:03:25.940 --> 00:03:33.480 Even a very small increase in supply will lead to a perhaps very small lowering of price. 35 00:03:33.480 --> 00:03:40.380 The individual firm, no matter how small, always has a perceptible influence on the 36 00:03:40.380 --> 00:03:42.300 total supply. 37 00:03:42.300 --> 00:03:49.900 In an industry of small wheat farms, the implicit model for pure competition, each small farm 38 00:03:49.900 --> 00:03:57.900 The term contributes a part of the total supply, and there can be no total without a contribution from each farm. 39 00:03:57.900 --> 00:04:04.900 Therefore, each farm has a perceptible, even if very small, influence. 40 00:04:04.900 --> 00:04:11.900 No perfectly elastic demand can then be postulated, even in such a case. 41 00:04:11.900 --> 00:04:26.900 The error in believing in perfect elasticity stems from the use of such mathematical concepts as second order of smalls, by which infinite negligibility of steps can be assumed. 42 00:04:26.900 --> 00:04:41.900 But economics analyzes real human action, and such real action must always be concerned with discrete, perceptible steps, and never with infinitely small steps. 43 00:04:41.900 --> 00:04:51.900 Of course, the demand for each small wheat farm is likely to be very highly, almost perfectly elastic. 44 00:04:51.900 --> 00:05:09.900 And yet, the fact that it is not perfect destroys the entire concept of pure competition, for how does this situation differ from, say, the Hershey Chocolate Company, if the demand for the latter firm's products is also elastic? 45 00:05:09.900 --> 00:05:30.900 According to the monopolistic competition theorists, the two influences sabotaging the possible existence of pure competition are differentiation of product and oligopoly, or fewness of firms, where one firm influences the actions of others. 46 00:05:30.900 --> 00:05:40.900 As to the former, the producers are accused of creating an artificial differentiation among products in the mind of the public, 47 00:05:40.900 --> 00:05:44.900 thus carving out for themselves a portion of monopoly. 48 00:05:44.900 --> 00:05:53.900 And E.H. Chamberlain originally attempted to distinguish groups of producers selling slightly differentiated products 49 00:05:53.900 --> 00:05:59.900 from old-fashioned industries of firms making identical products. 50 00:05:59.900 --> 00:06:02.900 Neither of these attempts has any validity. 51 00:06:02.900 --> 00:06:10.900 If a producer is making a product different from that of another producer, then he is a unique industry. 52 00:06:10.900 --> 00:06:18.900 There is no rational basis for any grouping of varied producers, particularly in aggregating their demand. 53 00:06:18.900 --> 00:06:26.900 Furthermore, the consuming public decides on the differentiation of products on its value scales. 54 00:06:26.900 --> 00:06:38.900 There is nothing artificial about the differentiation and, indeed, this differentiation serves to cater more closely to the multifarious wants of the consumers. 55 00:06:38.900 --> 00:06:53.900 Recently, Professor E. H. Chamberlain has conceded this point and has, in a series of remarkable articles, astounded his followers by repudiating the concept of pure competition as a welfare ideal. 56 00:06:53.900 --> 00:07:01.260 ideal, Chamberlain now declares, the welfare ideal itself is correctly described as one 57 00:07:01.260 --> 00:07:04.100 of monopolistic competition. 58 00:07:04.100 --> 00:07:10.460 This seems to follow very directly from the recognition that human beings are individual, 59 00:07:10.460 --> 00:07:17.980 diverse in their tastes and desires, and moreover, widely dispersed spatially. 60 00:07:17.980 --> 00:07:23.940 It is clear, of course, that Ford has a monopoly on the sale of Ford cars. 61 00:07:23.940 --> 00:07:29.260 But this is a full monopoly, rather than a monopolistic tendency. 62 00:07:29.260 --> 00:07:34.900 Also, it is difficult to see what difference can come from the number of firms that are 63 00:07:34.900 --> 00:07:42.060 producing the same product, particularly once we discard the myth of pure competition and 64 00:07:42.060 --> 00:07:44.260 perfect elasticity. 65 00:07:44.260 --> 00:07:51.860 Such a do indeed has been made about strategies, warfare, etc. between oligopolists, but there 66 00:07:51.860 --> 00:07:54.380 is little point to such discussions. 67 00:07:54.380 --> 00:08:00.540 Either the firms are independent and therefore competing, or they are acting jointly and 68 00:08:00.540 --> 00:08:02.780 therefore cartelizing. 69 00:08:02.780 --> 00:08:05.980 There is no third alternative. 70 00:08:05.980 --> 00:08:12.220 Once the perfect elasticity myth has been discarded, it becomes clear that all the tedious 71 00:08:12.220 --> 00:08:19.420 This discussion about the number and size of firms and groups and differentiation, etc., 72 00:08:19.420 --> 00:08:20.820 becomes irrelevant. 73 00:08:20.820 --> 00:08:28.100 It becomes relevant only for economic history, and not for economic analysis. 74 00:08:28.100 --> 00:08:34.680 It might be objected that there is a substantial problem of oligopoly, that under oligopoly 75 00:08:34.680 --> 00:08:42.180 each firm has to take into account the reactions of competing firms, whereas under pure competition, 76 00:08:42.180 --> 00:08:56.180 In competition, or differentiated products without oligopoly, each firm can operate in the blissful awareness that no competitor will take account of its actions, or change its actions accordingly. 77 00:08:56.180 --> 00:09:07.180 Hiram Jones, the small wheat farmer, can set his production policy without wondering what Ezra Smith will do when he discovers what Jones' policy is. 78 00:09:37.180 --> 00:10:06.180 These alleged difficulties are non-existent, however, there is no reason why the demand presented to a firm cannot include expected reactions by other firms. 79 00:10:06.180 --> 00:10:20.180 The demand presented to a firm is the set of a firm's expectations at any time of how many units of its product consumers will buy at an alternative series of prices. 80 00:10:20.180 --> 00:10:27.180 What interests the producer is the hypothetical set of consumer demands at each price. 81 00:10:27.180 --> 00:10:34.180 He is not interested in what consumer demand will be in various sets of non-existent situations. 82 00:10:34.180 --> 00:10:43.680 His expectations will be based on his judgment of what would actually happen should he charge various alternative prices. 83 00:10:43.680 --> 00:10:50.180 If his rivals will react in a certain way to his charging a higher or a lower price, 84 00:10:50.180 --> 00:10:56.180 then it is each firm's business to forecast and take account of this reaction, 85 00:10:56.180 --> 00:11:01.680 in so far as it will affect buyer's demand for its particular product. 86 00:11:01.680 --> 00:11:11.680 There would be little sense in ignoring such reactions if they were relevant to the demand for its product or in including them if they were not. 87 00:11:11.680 --> 00:11:20.680 A firm's estimated demand, therefore, already includes any expected reactions of rivals. 88 00:11:20.680 --> 00:11:30.680 The relevant consideration is not the fewness of the firms or the state of hostility or friendship existing among firms. 89 00:11:30.680 --> 00:11:40.680 Those writers who discuss oligopoly in terms applicable to games of poker or to military warfare are entirely in error. 90 00:11:40.680 --> 00:11:54.680 The fundamental business of production is service to the consumers for monetary gain and not some sort of game or warfare or any other sort of struggle between producers. 91 00:11:54.680 --> 00:12:15.020 In oligopoly, where several firms are producing an identical product, there cannot persist any situation in which one firm charges a higher price than another, since there is always a tendency toward the formation of a uniform price for each uniform product. 92 00:12:15.020 --> 00:12:34.020 Whenever Firm A attempts to sell its product higher or lower than the previously ruling market price, it is attempting to discover the market, to find out what the equilibrium market price is, in accordance with the present state of consumer demand. 93 00:12:34.020 --> 00:12:41.300 If, at a certain price for the product, consumer demand is in excess of supply, the firms will 94 00:12:41.300 --> 00:12:48.100 tend to raise the price, and vice versa if the produced stock is not being sold. 95 00:12:48.100 --> 00:12:54.880 In this familiar pathway to equilibrium, all the stock that the firms wish to sell clears 96 00:12:54.880 --> 00:12:59.520 the market at the highest price that can be obtained. 97 00:12:59.520 --> 00:13:06.640 The jockeying and raising and lowering of prices that takes place in oligopolistic industries 98 00:13:06.640 --> 00:13:13.400 is not some mysterious form of warfare, but the visible process of attempting to find 99 00:13:13.400 --> 00:13:20.240 market equilibrium, that price at which the quantity supplied and the quantity demanded 100 00:13:20.240 --> 00:13:21.920 will be equal. 101 00:13:21.920 --> 00:13:28.400 The same process indeed takes place in any market, such as the non-oligopolistic wheat 102 00:13:28.400 --> 00:13:30.540 or Strawberry Markets. 103 00:13:30.540 --> 00:13:36.920 In the latter markets, the process seems to the viewer more impersonal, because the actions 104 00:13:36.920 --> 00:13:45.520 of any one individual or firm are not as important or as strikingly visible as in the more oligopolistic 105 00:13:45.520 --> 00:13:46.680 industries. 106 00:13:46.680 --> 00:13:52.360 But the process is essentially the same, and we must not be led to think differently by 107 00:13:52.360 --> 00:14:00.540 by such often inapt metaphors as the automatic mechanisms of the market or the soulless impersonal 108 00:14:00.540 --> 00:14:03.140 forces on the market. 109 00:14:03.140 --> 00:14:08.180 All action on the market is necessarily personal. 110 00:14:08.180 --> 00:14:12.300 Machines may move, but they do not purposefully act. 111 00:14:12.300 --> 00:14:19.380 And in oligopoly situations, the rivalries, the feelings of one producer toward his competitors 112 00:14:19.380 --> 00:14:26.160 may be historically dramatic, but they are unimportant for economic analysis. 113 00:14:26.160 --> 00:14:31.620 To those who are still tempted to make the number of producers in any field the test 114 00:14:31.620 --> 00:14:38.580 of competitive merit, we might ask, setting aside the problem of proving homogeneity, 115 00:14:38.580 --> 00:14:42.500 how can the market create sufficient numbers? 116 00:14:42.500 --> 00:14:49.300 If Crusoe exchanges fish for Friday's lumber on their desert island, are they both benefiting? 117 00:14:49.300 --> 00:14:56.800 or are they bilateral monopolists exploiting each other and charging each other monopoly prices? 118 00:14:56.800 --> 00:15:03.500 But if the state is not justified in marching in to arrest Crusoe and or Friday, 119 00:15:03.500 --> 00:15:11.100 how can it be justified in coercing a market where there are obviously many more competitors? 120 00:15:11.100 --> 00:15:22.100 Economic analysis, in conclusion, fails to establish any criterion for separating any elements of the free market price for a product. 121 00:15:22.100 --> 00:15:30.600 Such questions as the number of firms in an industry, the sizes of the firms, the type of product each firm makes, 122 00:15:30.600 --> 00:15:37.100 the personalities or motives of the entrepreneurs, the location of plants, etc., 123 00:15:37.100 --> 00:15:44.100 are entirely determined by the concrete conditions and data of the particular case. 124 00:15:44.100 --> 00:15:49.100 Economic analysis can have nothing to say about them. 125 00:15:54.100 --> 00:16:01.100 Perhaps the most important conclusion of the theory of monopolistic or imperfect competition 126 00:16:01.100 --> 00:16:13.100 is that the real world of monopolistic competition is inferior to the ideal world of pure competition, where no firm can affect its price. 127 00:16:13.100 --> 00:16:21.100 The only assumption we need to understand this is that for any plant and any branch of production, 128 00:16:21.100 --> 00:16:28.020 Production, there will be some optimum point of production, that is, some level of output 129 00:16:28.020 --> 00:16:32.180 at which average unit cost is at a minimum. 130 00:16:32.180 --> 00:16:39.440 All levels of production lower or higher than the optimum have a higher average cost. 131 00:16:39.440 --> 00:16:46.660 In pure competition, where the demand presented to any firm is perfectly elastic, each firm 132 00:16:46.660 --> 00:16:55.300 will eventually adjust so that its total costs equal total revenues and profits are zero. 133 00:16:55.300 --> 00:17:00.920 Now contrast this picture with that of monopolistic competition. 134 00:17:00.920 --> 00:17:07.320 Monopolistic competition yields higher prices and less production, that is, a lower standard 135 00:17:07.320 --> 00:17:14.140 of living, than pure competition, for output will not take place at the point of minimum 136 00:17:14.140 --> 00:17:32.380 by a process of revision in recent years, some of it by the originators of the doctrine 137 00:17:32.380 --> 00:17:37.760 themselves, this theory has been effectively riddled beyond repair. 138 00:17:37.760 --> 00:17:43.540 As we have seen, Chamberlain and others have shown that this analysis does not apply if 139 00:17:43.540 --> 00:17:50.900 If we are to take consumer desire for diversity as a good to be satisfied, many other effective 140 00:17:50.900 --> 00:17:55.220 and sound attacks have been made from different directions. 141 00:17:55.220 --> 00:18:01.780 One basic argument is that the situations of pure and of monopolistic competition cannot 142 00:18:01.780 --> 00:18:03.820 be compared. 143 00:18:03.820 --> 00:18:09.780 Chamberlain has pursued his revisionism in this realm also, declaring that the comparisons 144 00:18:09.780 --> 00:18:16.740 are wholly illegitimate. That to apply the concept of pure competition to existing firms 145 00:18:16.740 --> 00:18:23.540 would mean, for example, assuming a very large number of similar firms producing the identical 146 00:18:23.540 --> 00:18:30.260 product. If this were done, say, with General Motors, it would mean that either GM must 147 00:18:30.260 --> 00:18:36.660 conceptually be divided up into numerous fragments, or else that it be multiplied. 148 00:18:36.660 --> 00:18:44.260 If divided, then unit costs would undoubtedly be higher, and then the competitive firm would suffer 149 00:18:44.260 --> 00:18:51.460 higher costs and have to subsist on higher prices. This would clearly injure consumers and the 150 00:18:51.460 --> 00:18:57.780 standard of living. Thus, Chamberlain follows Schumpeter's criticism that the monopolistic 151 00:18:57.780 --> 00:19:06.180 firm may well have, and probably will have, lower costs than its purely competitive counterpart. 152 00:19:06.180 --> 00:19:15.580 If, on the other hand, we conceive of the multiplication of a very large number of General Motors corporations at existing size, 153 00:19:15.580 --> 00:19:22.880 we cannot possibly relate it to the present world, and the whole comparison becomes absurd. 154 00:19:22.880 --> 00:19:30.980 In addition, Schumpeter has stressed the superiority of the monopolistic firm for innovation and progress, 155 00:19:30.980 --> 00:19:39.380 and J.M. Clark has shown the inapplicability in various ways of this static theory to the dynamic 156 00:19:39.380 --> 00:19:46.660 real world. He has recently shown its fallacious asymmetry of argument with respect to price and 157 00:19:46.660 --> 00:19:54.260 quality. Hayek and Lockman have also pointed out the distortion of dynamic reality as we have indicated. 158 00:19:54.260 --> 00:20:02.020 A second major line of attack has shown the vital importance of potential competition to 159 00:20:02.020 --> 00:20:09.380 any would-be reaper of monopoly price from firms both within and without the industry, 160 00:20:09.380 --> 00:20:14.980 and also the competition of substitutes between industries. 161 00:20:14.980 --> 00:20:20.760 All these arguments, added to our own analysis, have effectively demolished the theory of 162 00:20:20.760 --> 00:20:25.600 of Monopolistic Competition, and yet more remains to be said. 163 00:20:25.600 --> 00:20:31.880 There is something very peculiar about the entire construction, even on its own terms, 164 00:20:31.880 --> 00:20:37.520 and practically no one has pointed out these other grave defects in the theory. 165 00:20:37.520 --> 00:20:45.840 In an economy that is almost altogether monopolistically competitive, how can every firm produce too 166 00:20:45.840 --> 00:20:48.920 little and charge too much? 167 00:20:48.920 --> 00:20:51.780 What Happens to the Surplus Factors? 168 00:20:51.780 --> 00:20:53.420 What are they doing? 169 00:20:53.420 --> 00:21:00.160 The failure to raise this question stems from the modern neglect of Austrian general analysis, 170 00:21:00.160 --> 00:21:05.160 and from undue concentration on an isolated firm or industry. 171 00:21:05.160 --> 00:21:12.280 The excess factors must go somewhere, and in that case, must they not go to other monopolistically 172 00:21:12.280 --> 00:21:14.140 competitive firms? 173 00:21:14.140 --> 00:21:18.740 In which case, the thesis breaks down as self-contradictory. 174 00:21:18.740 --> 00:21:21.780 But the proponents have prepared a way out. 175 00:21:21.780 --> 00:21:26.020 They take first the case of pure competition. 176 00:21:26.020 --> 00:21:31.660 Then they assume a sudden shift to conditions of monopolistic competition. 177 00:21:31.660 --> 00:21:38.660 Then the firm restricts production and raises its price accordingly, reaps profits, attracts 178 00:21:38.660 --> 00:21:45.040 new firms entering the industry, and the new competition reduces the output saleable by 179 00:21:45.040 --> 00:21:46.540 each firm. 180 00:21:46.540 --> 00:21:53.300 Hence, say the monopolistic competition theorists, not only does monopolistic competition suffer 181 00:21:53.300 --> 00:22:00.980 from too little production in each firm, and excessive costs and prices, it also suffers 182 00:22:00.980 --> 00:22:05.060 from too many firms in each industry. 183 00:22:05.060 --> 00:22:08.380 Here is what has happened to the excess factors. 184 00:22:08.380 --> 00:22:13.080 They are trapped in too many uneconomic firms. 185 00:22:13.080 --> 00:22:18.480 This seems plausible, until we realize that the whole example has been constructed as 186 00:22:18.480 --> 00:22:19.760 a trick. 187 00:22:19.760 --> 00:22:26.400 If we isolate a firm or an industry as does the example, we may just as well start from 188 00:22:26.400 --> 00:22:32.640 a position of monopolistic competition, and then suddenly shift to conditions of pure 189 00:22:32.640 --> 00:22:33.740 competition. 190 00:22:33.740 --> 00:22:40.100 This is certainly just as legitimate, or rather illegitimate, a base for comparison. 191 00:22:40.100 --> 00:22:41.180 What then? 192 00:22:41.180 --> 00:22:48.040 It will now be profitable for each firm to expand its output, and it will then make profits. 193 00:22:48.040 --> 00:22:51.860 New firms will then be attracted into the industry. 194 00:22:51.860 --> 00:22:58.480 Are we now proving that there are more firms in an industry under pure than under monopolistic 195 00:22:58.480 --> 00:23:00.080 competition? 196 00:23:00.080 --> 00:23:04.960 The author first learned this particular piece of analysis from the classroom lectures of 197 00:23:04.960 --> 00:23:11.100 Professor Arthur F. Burns, and to our knowledge, it has never seen print. 198 00:23:11.100 --> 00:23:17.220 The fundamental error here is failure to see that under the conditions established by the 199 00:23:17.220 --> 00:23:24.780 assumptions, any change opening up profits will bring new firms into an industry. 200 00:23:24.780 --> 00:23:31.840 Yet the theorists are supposed to be comparing two different static equilibria of pure and 201 00:23:31.840 --> 00:23:37.820 of monopolistic competition and not discussing paths from one to the other. 202 00:23:37.820 --> 00:23:45.820 Thus, the monopolistic competition theorists have by no means solved their problem of surplus factors. 203 00:23:45.820 --> 00:23:53.820 But aside from this point, there are more difficulties in the theory, and Sir Roy Herod, himself one of its originators, 204 00:23:53.820 --> 00:23:59.820 is the only one to have seized the essence of the remaining central difficulty. 205 00:23:59.820 --> 00:24:04.820 As Herod says, if the entrepreneur foresees the trend of events, 206 00:24:04.820 --> 00:24:12.820 Which will, in due course, limit his profitable output to x-y units, why not plan to have 207 00:24:12.820 --> 00:24:21.820 a plant that will produce x-y units most cheaply, rather than encumber himself with excess capacity? 208 00:24:21.820 --> 00:24:28.900 To plan a plant for producing x units, while knowing that it will only be possible to maintain 209 00:24:28.900 --> 00:24:42.180 And yet, asserts Herod puzzledly, the accepted doctrine apparently deems it impossible to 210 00:24:42.180 --> 00:24:47.380 be an entrepreneur and not suffer from schizophrenia. 211 00:24:47.380 --> 00:24:51.280 Clearly here is a patent contradiction with reality. 212 00:24:51.280 --> 00:24:52.280 What is wrong? 213 00:24:52.280 --> 00:24:57.560 Herod's own answer is an excellent and novel discussion of the difference between long 214 00:24:57.560 --> 00:25:15.880 The paradox becomes curiouser and curiouser when we fully realize that it all hinges on 215 00:25:15.880 --> 00:25:18.680 a mathematical technicality. 216 00:25:18.680 --> 00:25:25.140 But we must never let reality be falsified in order to fit the niceties of mathematics. 217 00:25:25.140 --> 00:25:33.540 In fact, production is a series of discrete alternatives, as all human action is discrete, 218 00:25:33.540 --> 00:25:41.260 and cannot be smoothly continuous, that is, move in infinitely small steps from one production 219 00:25:41.260 --> 00:25:43.540 level to another. 220 00:25:43.540 --> 00:25:49.340 There is another way for this pseudo-problem to disappear, and that is to call into question 221 00:25:49.340 --> 00:25:56.780 and the entire assumption that total costs and total revenues of the firm will be equal 222 00:25:56.780 --> 00:26:01.080 since profits as well as losses will be zero. 223 00:26:01.080 --> 00:26:06.740 But a key question has been either overlooked or wrongly handled. 224 00:26:06.740 --> 00:26:13.320 Why should the firm produce anything, after all, if it earns nothing from doing so? 225 00:26:13.320 --> 00:26:20.600 But it will earn something in equilibrium, and that will be interest return. 226 00:26:20.600 --> 00:26:26.520 Modern orthodoxy has fallen into this error for one reason, because it does not realize 227 00:26:26.520 --> 00:26:34.520 that entrepreneurs are also capitalists, and that even if in an evenly rotating economy 228 00:26:34.520 --> 00:26:41.080 the strictly entrepreneurial function were no longer to be required, the capital advancing 229 00:26:41.080 --> 00:26:45.840 function would still be emphatically necessary. 230 00:26:45.840 --> 00:26:49.720 Modern theory also tends to view interest return 231 00:26:49.720 --> 00:26:52.440 as a cost to the firm. 232 00:26:52.440 --> 00:26:56.200 Naturally, if this is done, then the presence of interest 233 00:26:56.200 --> 00:26:57.920 does not change matters. 234 00:26:57.920 --> 00:27:01.880 But, and here we refer the reader to foregoing chapters, 235 00:27:01.880 --> 00:27:05.200 interest is not a cost to the firm. 236 00:27:05.200 --> 00:27:08.440 It is an earning by a firm. 237 00:27:08.440 --> 00:27:15.800 The contrary belief rests on a superficial concentration on loan interest and on an unwarranted 238 00:27:15.800 --> 00:27:20.200 separation between entrepreneurs and capitalists. 239 00:27:20.200 --> 00:27:27.280 Actually, loans are unimportant and are only another legal form of entrepreneurial capitalist 240 00:27:27.280 --> 00:27:28.640 investment. 241 00:27:28.640 --> 00:27:36.780 In short, in the evenly rotating economy, the firm earns a natural interest return dictated 242 00:27:36.780 --> 00:27:43.900 by Social Time Preference, and so the paradox of the monopolistic competition theory is 243 00:27:43.900 --> 00:27:47.420 finally and fully interred. 244 00:27:47.420 --> 00:27:52.660 C. Chamberlain and Selling Cost. 245 00:27:52.660 --> 00:27:57.900 One of Professor Chamberlain's most important contributions is alleged to have been his 246 00:27:57.900 --> 00:28:04.120 sharp distinction between selling cost and production cost. 247 00:28:04.120 --> 00:28:10.100 Selling costs are supposed to be the legitimate expenses needed to increase supply in order 248 00:28:10.100 --> 00:28:14.060 to meet given consumer demand schedules. 249 00:28:14.060 --> 00:28:19.860 Selling costs, on the other hand, are supposed to be directed toward influencing consumers 250 00:28:19.860 --> 00:28:25.140 and increasing their demand schedules for the firm's product. 251 00:28:25.140 --> 00:28:28.340 This distinction is completely spurious. 252 00:28:28.340 --> 00:28:33.580 Why does a businessman invest money and incur any costs whatever? 253 00:28:33.580 --> 00:28:37.780 to supply a hoped-for demand for his product. 254 00:28:37.780 --> 00:28:43.760 Every time he improves his product, he is hoping that consumers will respond by increasing 255 00:28:43.760 --> 00:28:45.280 their demands. 256 00:28:45.280 --> 00:28:52.900 In fact, all costs expended on raw materials are incurred in an attempt to increase consumer 257 00:28:52.900 --> 00:28:58.660 demand beyond what it would have been in the absence of these costs. 258 00:28:58.660 --> 00:29:04.660 Therefore, every production cost is also a selling cost. 259 00:29:04.660 --> 00:29:14.660 Conversely, selling costs are not the sheer waste or even tyranny that monopolistic competition theorists have usually assumed. 260 00:29:14.660 --> 00:29:21.660 The various expenses designated as selling costs perform definite services for the public. 261 00:29:21.660 --> 00:29:26.660 Basically, they furnish information to the public about the goods of the seller. 262 00:29:26.660 --> 00:29:37.660 We live in a world where there can be no perfect knowledge of products by anyone, especially consumers, who are faced with a myriad of available products. 263 00:29:37.660 --> 00:29:45.660 Selling costs are therefore important in providing information about the product as well as about the firm. 264 00:29:45.660 --> 00:29:55.660 In some cases, for example, displays, the selling cost itself directly improves the quality of the product in the mind of the consumer. 265 00:29:55.660 --> 00:30:14.660 It must always be remembered that the consumer is not simply buying a physical product, he may also be buying atmosphere, prestige, service, etc., all of which have tangible reality to him and are valued accordingly. 266 00:30:14.660 --> 00:30:21.940 It is surely highly artificial to call bright ribbons on a packaged good a production cost, 267 00:30:21.940 --> 00:30:28.980 while labeling bright ribbons decorating the store selling the good as a selling cost. 268 00:30:28.980 --> 00:30:35.460 The view that a selling cost is somehow an artifact of monopolistic competition stems 269 00:30:35.460 --> 00:30:40.340 only from the peculiar assumptions of pure competition. 270 00:30:40.340 --> 00:30:47.300 In the ideal world of pure competition, we remember, each firm's demand is given to 271 00:30:47.300 --> 00:30:54.380 it as infinitely elastic so that it can sell whatever it wants at the ruling price. 272 00:30:54.380 --> 00:31:00.540 Naturally, in such a situation, no selling costs are necessary because a market for a 273 00:31:00.540 --> 00:31:03.500 product is automatically assured. 274 00:31:03.500 --> 00:31:09.860 In the real world, however, there is no perfect knowledge, and demand is neither given nor 275 00:31:09.860 --> 00:31:16.580 are infinitely elastic. Therefore, firms have to try to increase demands for their products 276 00:31:16.580 --> 00:31:24.020 and to carve out market areas for themselves. Chamberlain falls into another error in implying 277 00:31:24.020 --> 00:31:31.820 that selling costs, such as advertising, create consumer demands. This is the determinist 278 00:31:31.820 --> 00:31:39.020 fallacy. Every man as a self-owner freely decides his own scale of valuations on the 279 00:31:39.020 --> 00:31:45.340 The free market, no one can force another to choose his product, and no other individual 280 00:31:45.340 --> 00:31:49.340 can ever create someone's values for him. 281 00:31:49.340 --> 00:31:52.700 He must adopt the value himself. 282 00:31:52.700 --> 00:31:59.180 As Mises puts it, the consumer is, according to legend, simply defenseless against high 283 00:31:59.180 --> 00:32:01.460 pressure advertising. 284 00:32:01.460 --> 00:32:08.220 If this were true, success or failure in business would depend on the mode of advertising only. 285 00:32:08.220 --> 00:32:13.900 However, nobody believes that any kind of advertising would have succeeded in making 286 00:32:13.900 --> 00:32:19.780 the candle-makers hold the field against the electric bulb, the horse drivers against 287 00:32:19.780 --> 00:32:27.020 the motor cars, but this implies that the quality of the commodity advertised is instrumental 288 00:32:27.020 --> 00:32:31.180 in bringing about the success of an advertising campaign. 289 00:32:31.180 --> 00:32:37.260 The tricks and artifices of advertising are available to the seller of the better product, 290 00:32:37.260 --> 00:32:43.380 No less than to the seller of the poorer product, but only the former enjoys the advantages 291 00:32:43.380 --> 00:32:47.020 derived from the better quality of his product.