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Tuesday, September 11, 2012


Now that we have established that the costs of production (in the sense already used and for the reasons we have indicated) constitutes in the long run the lower limit to which prices can fall, the question suggests itself whether and to what degree they can rise above this lower limit. That they can so rise is undeniable. It is, however, also clear that there is a powerful force which again pushes prices down to the level of costs, namely, the increased supply which results from the competition among the producers to sell at the higher price. The more ineffective this force becomes, the closer we approach monopoly. The resulting peculiarities we must now describe.
The characteristic feature of a monopoly, be it a single enterprise or a monopolistic combination of enterprises (cartel, syndicate, trust) is that it (or they) can freely determine the amount of supply; and where supply is sufficiently curtailed, prices can be held above the level of costs. If we proceed on what is probably the not unreal assumption that the monopolist seeks to maximize his profits, the question then is what price should he select to attain his goal? Should he choose a high price, his profit per unit will be high but his total sales small (“small turnover, large per unit profit”). Should he choose a low price, the profit per unit declines, while total sales increase (“large turnover, small profit per unit”). Confronted with these alternatives, the monopolist will select that price which, multiplied by the number of units sold, will yield the maximum net profit. He will seek by a series of experiments to establish the location of this maximum point. This will vary, of course, from firm to firm, and from plant to plant. The decisive factor here is the elasticity of demand; upon it will depend whether an increase in price will induce a sharp decrease in sales or whether a decrease in price will stimulate a sizable increase in sales. If the telephone company can count on a high elasticity of demand for telephone service, it will find that a reduction in its rates will result in an addition to its revenues which exceeds the total of the amounts lost on the bills of the individual subscribers. Thus, the greater is the elasticity of demand the lower is the monopoly price, and vice versa. From this it follows that a monopoly of foodstuffs may have extremely dangerous consequences for the community, especially a monopoly of grains.
Because of the importance of the elasticity of demand in the determination of monopoly price, the managements of monopolistic enterprises—railroads, electric power companies, the post office, state tobacco monopolies—must base their price policies primarily on this factor and have a fairly clear notion of what the coefficient of the elasticity of demand is in the given case. The monopolist must also take into account the fact that the elasticity of demand is decisively affected by possibilities available to consumers to turn to a substitute product (from the railroad to the automobile, from the gas stove to a coal or electric stove, etc.). On the other hand, there are cases where the elasticity of demand is low, e.g., matches or sewing thread, objects which though they possess slight value in themselves nevertheless have great practical importance. Expenditures for such items are imperceptible in contrast to expenditures with which they are associated (for heating and smoking, and for suiting material and tailoring, respectively), while their mass consumption assures to the manufacturers a large profit.
The position of the monopoly price point is further influenced by the structure of costs at different levels of supply. If costs are of the increasing type (i.e., if they increase as output increases), then a higher price is more advantageous for the monopolist; if costs are of the decreasing type, it would be wise to establish a lower price. Mining monopolies (where increasing costs are encountered) may incline to a policy of restricting supply and keeping prices high, while the publisher of a copyrighted book such as this one will find it to his advantage to fix its price as low as possible; the resultant broadening of the market enables him to benefit from the dominant tendency in book production, which is one of decreasing costs.
This last example suggests a further complication in the formation of monopoly price. If, for instance, the present book were a novel or a play, the publisher would have at his disposal still other means of increasing his profit. To begin with, he could publish a deluxe edition of several hundred copies, on imperial Japan paper and bound in vellum, “numbered and signed by the author.” These he could sell to collectors at a high price. Next, he could bring out an ordinary edition at a medium price, and finally, a “popular” edition for the masses at a sensationally low price. For our publisher to have brought out the popular edition first would not only have entailed extra risks but a further obvious disadvantage in that those who might have been willing to pay a higher price for the ordinary edition, and even for the deluxe edition, would have profited from the lower price of the popular edition. By beginning with the more expensive type, our publisher puts to use his knowledge of the fact that a uniform price for the entire market establishes itself in accordance with the willingness to buy of the marginal buyers, i.e., those whose desire to buy is the weakest. Thus, the establishment of a single uniform price for a given commodity yields to all the buyers who otherwise would have paid a higher price for it a saving which they owe to the greater reluctance to buy of the marginal buyers. This saving, the counterpart of producers’ profits, is designated as consumers’ surplus, an expression to which, naturally, many will object since it refers not to a positive gain but only to a saving. It is understandable that the producers would cast a covetous eye on consumers’ surplus; they are compelled, nonetheless, to cede this much to the buyers so long as a uniform price obtains for all the quantities of a good sold within a given time period. A prime function of competition, we may note, is to ensure, through an easily understood process, such price uniformity.
But the monopolist has the possibility, thanks to price differentiation, of increasing his profit at the cost of the consumers. This is accomplished in such a way that the whole of demand is ranged in different classes, according to the different degrees of surcharge possible. Next, prices are adapted to the several classes on the basis of what the traffic will bear in each case, as shown in our example of the different editions of the same book. In this example, price differentiation was rendered possible by artificially dividing the good in question into different qualities, the markets for each of these quality classifications being then successively exploited. The practice of selling a good first at a high price and then, following a progressive saturation of the higher strata of demand, at a low price, is usual even in the case of patented manufactured articles. Consider the example of the so-called zip fastener. When it first appeared on the market, it was regarded as an amazing innovation and commanded a high price. Today, the zipper is so cheap that it has been adapted to thousands of different uses. Similarly, most of the price phenomena connected with the production and sale of articles of fashion are explainable in terms of this principle.
There is an abundant assortment of examples that could be cited to illustrate the process by which a good is divided, artificially, into different subclasses. The transport industries afford a prime instance of such class divisions. The establishment, by the railroads, of a hierarchy of rates for passenger traffic enables the managements of such enterprises to leave to the passengers themselves the business of finding their appropriate classification according to the rates they can afford to pay. Customers in the upper classifications are drawn thereto by the greater comfort, but more especially by concern for their social position and by the less crowded condition of the compartments, things which are precisely the result of higher rates. In this and in analogous cases, (e.g., at the theatre), price classification becomes the equivalent of quality classification; this is true in every instance where the payment of a higher price carries with it a visible social distinction and procures the advantages which result from less crowding in the higher price classes. We shall find this tendency to be the more marked the more crowded are the lower priced accommodations. Otherwise, it would be necessary to install more amenities in the higher price classes. Hence, in the case of a railroad whose coaches are normally filled to capacity, there will be no need for the management to spend much on better equipment for the higher priced accommodations. Quite other considerations, again, must be taken into account to explain the differences in postal rates for letters and for printed matter and, similarly, in electricity rates for the home and for the factory.4
The formation of prices on a purely competitive market or on a purely monopolistic one are, in reality, rare occurrences, for these “marginal cases” suppose the existence of conditions which are practically never completely fulfilled. Pure competition occurs only where the number of independent sellers is very great and where there is a perfect market, that is, a market where all the sellers and buyers are simultaneously and always aware of each other’s offers and among whom, accordingly, a process of continual adjustment is going on. These conditions are most nearly realized, however, only on organized markets, in particular, on the most advanced type of an organized market, the stock market. If free or perfect competition exists anywhere, there is where it must be sought. Rather different is the situation on the unorganized markets of which we select retail trade as the best known example. When I enter a store to buy myself a hat, I enter, indeed, the “hat market” in the broad sense that I assert my demand for a hat, simultaneously with the rest of the hat demanders, against the total supply of hats available. But since total supply and total demand in this case coincide neither in time nor in place, a quick over-all view of the market situation is lacking. I must have sought out many shops before being in a position to fairly judge hat prices; many customers must have left hat shops shrugging their shoulders before shop owners bring their prices down and in turn influence the hat manufacturers to do the same. It is to be noticed, then, that the entire mechanism of price formation functions in this instance slowly and hesitantly, a characteristic which explains the many monopoly-like peculiarities of price formation in retail trade.5
But the fact that free competition does not really exist in the chemically pure state, and that many prices contain a certain monopolistic element, must not lead us to conclude that our economic system rests, at bottom, no longer on competition but on monopoly. Such a conclusion would be quite wrong. It is to be observed, first, that pure monopoly is an even rarer phenomenon than pure competition. The most important instances in which the monopoly element prevails over the competitive element are: (1) natural monopoly where the few existing deposits of certain resources are owned by a single individual or group (e.g., the South African diamond syndicate); (2) juridical monopoly based on a grant by the state of an exclusive right to produce or sell a particular commodity (patents, copyrights, etc.), though such a right is usually valid only for a specified period; (2) transportation monopoly where the monopolist is protected within his production area against outside competition by the high costs of transport, a situation which may therefore also be termed area monopoly (for example, Pittsburgh steel manufacturers); (4) lastly, trade name monopoly arising from the susceptibility of consumers to advertisers’ suggestions that a given product is unique of its kind (use of brand names). But even in these cases the monopolies, as a rule, must reckon with a number of contrarieties: the possibility that consumers will shift to a substitute product, the tendency for outsiders to move in as the monopoly operations become increasingly profitable, and finally and above all, foreign competition (insofar as the monopolist does not succeed in warding off the latter either by inducing the state to establish protective tariffs or import quotas, or by organizing an international cartel). Finally, the monopolists have to beware of employing their power in such ruthless fashion as to incite public opinion and the state to retaliate; this, however, is an obstacle which may be effectively overcome by the monopolists’ skillful influencing of public opinion and of official bodies.
One of the particular accomplishments of modern economic science has been its investigation and definition of the several possible intermediary stages (“market forms”) which may lie between pure monopoly and pure competition. But however useful such a procedure, it has had the unfortunate consequence of leading many to conclude that the concepts “monopoly” and “competition” are, for practical purposes, unusable since, in fact, only the intermediate forms exist. Such blurred distinctions serve not only the monopoly interests but also the collectivists who would view only with uneasiness the restoration of a genuinely competitive economy, inasmuch as they need monopoly as a sort of Exhibit A in their arguments for the establishment of a state monopoly as the only remaining solution to the problem. It is certainly possible to define competition and monopoly in such a way that competition can be shown to be unrealizable; consequently, every attempt to take active measures to restore this narrowly defined “competition” to life will be doomed to failure from the start. Such a definition is, however, meaningless. To supply a definition which makes sense, we must begin with what is a decisive question for the ordering of economic life, i.e., how the actual productive forces of the national economy should be allocated as among the several alternative uses. Then monopoly appears as that market form which frees the producer (to the extent to which he controls supply) from the influence of the consumer over the uses of the productive forces. This arbitrary power of the producer attains its maximum extension when production, in accordance with the collectivist program, is concentrated in the hands of the state which then becomes the most dangerous and most powerful of all monopolists. Not the least reason for fearing a state monopoly is the fact that this most powerful of monopolies is simultaneously the one easiest to disguise with slogans.
A criticism which, at the present writing especially, is very widespread is that our economic system is now and will continue to be dominated by monopolies. To this our emphatic reply must be that there is no necessity for such a development. Indeed, it is astonishing how, in every case, competition sooner or later triumphs over monopoly, if only it is given the chance. To say that “competitive capitalism” is necessarily “monopoly capitalism” is simply untrue. The truth is that there is hardly a monopoly worth the name at whose birth, in one way or another, the state has not acted as midwife. Indeed, the history of heavy industry monopolies in Germany has shown that even where the state directly intervened to establish a monopoly, vigorous coercive measures were necessary to force the several producers under one roof. There would probably be few monopolies in the world today if the state, for numerous reasons, had not intervened with all the weight of its authority, its juridical prestige, and its more or less monopoly-favoring economic policy (including the policy of restricting imports) against the natural tendency towards competition. Constant and vigorous assertion of this truth is necessary since an exactly opposite view is generally affirmed, and in a manner such as to suggest the inanity of further discussion of the point. Decades of Marxist propaganda have greatly contributed to the diffusion of this bias. The reigning ideology which enthuses over the “monumental” and the “grandiose,” and which grows positively lyrical on the subject of “organizing” and “commanding” (at the expense of the natural and the spontaneous), is obviously an ideology favorable to monopoly. Neither do the monopolists fail to make the most of the state of mind of those who go about moaning that “capitalism” is dead or dying, that the competitive system is a contemptible and vulgar business which ought at the earliest opportunity to be replaced by a tightly organized economic system, and more of the same. Nothing, however, prevents governments from shaping their economic policies to the end that the natural tendency towards competition will once again be permitted to play its proper role in the economic system. Such action appears, at the moment, to be rather unlikely. This is certainly not the fault of “capitalism,” but a consequence of the dominance of certain ideologies. We have as little reason to suspend the fight against these ideologies as we have to doubt the economic noxiousness of monopolies (in most cases) in their ultimate effects.
The principal charge that can be formulated against monopolies is that they do violence, in the fashion already described in Chapter II, to the “business principle” and thus to one of the most essential principles of our economic system. Simultaneously, they introduce into economic life an element of arbitrary power which, in the extreme case of the complete and all-embracing state monopoly (collectivism), becomes absolute. Not only are monopolies in a position to reap super-profits (since competition alone can compel the rendering of a good or service equal in value to payment received) but they cause still further damage by gravely lessening the suppleness and adaptive power of our economic system.6
The full perniciousness of monopoly price formation becomes apparent when we remember that prices are the better able to fulfill their regulatory function in the economy the more flexible they are and the more faithfully they reflect the costs of production. Every price is a double appeal addressed to buyers and sellers: to the sellers an appeal to increase or restrict their supply; to the buyers an appeal to restrict or to increase their demand. Thus prices regulate simultaneously the use of the productive factors of the economy whose prices constitute, jointly, the production costs of a good. To sum up, prices are nothing other than continuous appeals to the consumers to decide which of the economy’s scarce production goods should or should not be, at any given moment, allocated to the various economic uses which can be made of them. It stands to reason that prices will the better acquit themselves of the function the less they are manipulated by monopoly power or by interventions of the state.
Only in one case is that situation characterized by the word “monopoly” (which in the strict meaning of its Greek root means “single seller”), viz., the exclusive concentration of the supply of a commodity in a single hand, a consciously pursued objective of economic policy. This is the case of the government’s fiscal monopoly by means of which a government (as in the well-known example of the tobacco monopolies of some countries [Austria and Italy]), having forcibly eliminated all competition, openly employs its resulting power to raise prices for the purpose of securing income for which it otherwise would be dependent on excise taxes on the commodity in question.
Precisely this special case makes clear that howevermuch a monopoly position may be desirable from a purely egoistic point of view, it is something which from the standpoint of the general welfare is undesirable, or at least must be regarded with serious misgivings. A consensus may be said to exist on the point that monopoly is basically undesirable because it involves the exercise of a degree of power in the economic and social life of the community which, even where the power is not consciously abused, appears incompatible with the ideals of freedom and justice and in addition creates the danger of disturbances of economic equilibrium and a lessening of productivity. Most people quite correctly associate with the concept of “monopoly” notions of exclusiveness, privilege, arbitrariness, excessive power, and exploitation. These characteristic attributes of monopoly are simultaneously the grounds for one of the most weighty and irrefutable objections to collectivism. As mentioned above, such an economic order, by its extreme concentration of production and distribution in the hands of the state, establishes a complete and all-embracing monopoly against which, in virtue of the apparatus of state coercion on which it rests, there is no appeal. The basic nature of such a system, moreover, is unaffected by possible decentralization of the governmental administration machinery or by the practice of inciting the state-run plants to compete with each other. The idea that in this case the state’s exercise of monopoly power provides a guarantee that such power will be employed in the interest of the general welfare is revealed as a fiction.
In a few important instances, monopoly is to be recognized on technical or organizational grounds as superior or even as essential; such instances are the so-called “public utilities” (gas, electricity, water, telephone) in which it is all but impossible to permit the existence of competing firms. All the more unendurable in such cases would be monopoly left to its own devices, particularly since what is at stake here are services which are indispensable to the public. All the more necessary is it, in cases such as these where monopoly is practically unavoidable, to establish a system of control and supervision of the monopolistic enterprises (see Note 6 following this chapter).
Recently, the attempt has been made (in particular, by Joseph A. Schumpeter in Capitalism, Socialism, and Democracy) to prove the advantages of monopoly by reference to the special case of public utilities. It is precisely the economic power and capital reserves of the large organization, so runs this argument, which favor technological innovation and progress. What is valid in this argument is that it cannot be known beforehand what use a monopolist will make of the power over which he disposes, whether he will merely extract profits from his enterprise, allowing it otherwise to stagnate behind the sheltering wall of market power, or whether he will seek to enter upon new paths of discovery and invention. What is true in any case is that the promotion of technological progress by means of monopoly can be expected only under specific, and for the most part only infrequently encountered conditions. The decisive fact remains that monopolists dispose of a degree of power over their markets and over the economy which a well-ordered, purposeful economic system based on a just relationship between performance and reward cannot tolerate. To the extent that technological progress is rooted in monopoly privilege, it is at least questionable whether the economic resources of the nation are being employed in accordance with the wishes of the consumer, such as these wishes would have manifested themselves in a context of effective competition.
At the same time, there is one consideration in this connection to which we must pay due regard if we are to arrive at usable definitions of monopoly and competition. Concepts of “pure” or “perfect” competition based on abstract mathematical models, whose assumptions must necessarily remain unrealized in the dynamic reality of economic life, should be replaced by the concept of “active” or “workable” competition in which the continuous striving of the producers for the favor of the consumers is emphasized as the essential note of competition. Where competition of this kind is maintained, it is probable that now one, now the other producer will advance ahead of others and thus acquire a special position. Such a situation is not to be described as “monopolistic” however, so long as other producers have “free entry” into the market in question and thereby the opportunity of themselves acquiring, in turn, such special positions. In this continuous testing and contesting of the protagonists in a given market, and in the incentives provided by the temporary advantages of market dominance, we see precisely that characteristic feature of competition which makes it such an extremely valuable institution. A position of dominance in the market need not be qualified as “monopoly” providing it is temporary and the leader is closely followed by competitors who are free to overtake him in turn. Hence, it does not follow that such progress as is promoted by the expectation and hope of taking the lead in a given industry should be attributed to monopoly. It is legitimate to speak of monopoly only where this competition for the “lead” is eliminated and the “lead” becomes a permanent position of privilege and power—a situation which is calculated more to hinder than to promote progress. On this reasoning, the state’s legal sanction by a patent of the “lead,” provided by an invention or innovation, constitutes not only just security for intellectual property rights, but also an indispensable economic incentive. Patent rights begin to be problematical, however, to the extent that competition is thereby hindered, and monopoly rights ending in abuses of market power are created.
Where competition is defined as a situation of continuous striving for the favor of the consumers, the concept of monopoly is correspondingly narrowed and limited to those cases in which this striving with its temporary positions of power is eliminated and replaced by a situation of permanently protected positions of power in the market. This makes it possible to set forth all the more unreservedly the evils brought upon the whole community by monopoly. They are found: 1. in the position of dominance of the producer over the consumer achieved in virtue of the elimination of the striving for the favor of consumers who, in turn, lose their appropriate economic role as the “sovereigns” of production; 2. in the resulting possibility of exploitation of consumers and the disruption of the just relationship between performance and reward (business principle), so that the monopoly price lacks the note of the “just price” peculiar to a competitive price; 3. in the weakening of the incentives inherent in competition to provide optimum supply in terms of both price and quality; 4. in the disturbance to the total economic order based on competition and free prices and in the resulting misallocation of resources; 5. in the creation of positions of power which seal off markets from new entrants, thereby depriving them of a fair chance at the economic and social opportunities which otherwise would have been available. Monopoly conditions may exist not only on commodities markets but also on the various individual labor markets in virtue of the power of strong labor unions to establish—by means of techniques such as the closed shop—exclusive control of the supply of labor. The resulting economic evils are analogous to those we have already described.
Applying what we have said thus far to the economic system which predominates in the free world, viz., the market economy, it is clear that such an economy, precisely on account of the central role played in it by competition, suffers a diminution both of its efficiency and its justice (in social terms) where it is plagued by monopoly. If it is desired to reap all those advantages of a market economy lacking in a collectivist economy, if what we wish is a “social market economy” of the type so successfully maintained by the German government since 1948, then the fight against monopoly and the maintenance of effective competition must be recognized as one of the prime conditions thereof.
To properly evaluate the possibilities of a successful fight against monopolies, we must note first that the emergence and even more the duration of monopolies (in the realistic sense used here) are confined within much narrower limits than is popularly supposed and is maintained by social theories which aim at putting the nature of the free economy and its prospects in the most unfavorable light possible. Equally erroneous, we may add, is the view that the development of modern economic life and technological progress tend in ever increasing degree to favor monopolism. If there is an immanent tendency in the free economy it is, today as yesterday, a tendency in the direction of competition, not monopoly. This tendency has been in our time strengthened rather than weakened due precisely to the continuous revolutions in technology and improvements in transportation—with their market-enlarging effects—and the economic development of new areas. Everything is in movement as never before and he who is on top today, whether he be the greatest and most powerful, can maintain his place against his closely following rivals only with the most strenuous effort. If, notwithstanding, monopoly remains one of the greatest problems of our age, this is due not alone to the fact that the conditions favorable to competition are realized only with delay and in any event incompletely, but also to the manifold, often unconscious governmental interventions which frustrate competition. Perhaps the most serious of such interventions are those governmental measures aimed at eliminating foreign competition by means of restrictions on imports.
There is no question but that the outmoded old-liberal view that the desirable situation of free competition is self-perpetuating so long as the state refrains from economic interventions of any kind has been shown to be a fateful error. At the same time, there is a kernel of truth in the notion. Maximum international trade has been shown to be a highly effective corrective for monopolistic tendencies. But it would be unrealistic to count on the realization of this ideal, and even in such case it would be an unjustified simplification to regard the problem of modern monopolism as solved. Consequently, the governments of the free nations of the world cannot avoid the obligation of making the restraint and reduction of monopoly the object of a specific antimonopoly policy. The obligation is indeed one of the most urgent confronting those anxious to defend the free economy successfully against a collectivism whose appeal and propaganda are based largely on the alleged monopoly elements in “capitalism.”
Since it happens only rarely that an individual producer can attain and maintain a more than temporary monopoly position (exception being made for the case of natural resources), the existence of monopoly generally supposes that a number of producers have joined together for the express purpose of eliminating competition among themselves (the principal form of such combination is the cartel, though it is to be observed that not all cartels are formed for the purpose of eliminating competition, in particular not such cartels whose interest is the promotion of more rational specialization, scientific research, and the exchange of technological information). In this case, freedom of contract is uniquely and illegitimately misused to restrict contractual freedom and hence economic freedom in general.
At the same time, the inherent difficulties and weaknesses of the cartel ought not be underestimated. As noted above, it is not easy to bring together the firms of a given industry and to keep them together in spite of their persistently divergent interests, and it is still less easy to deal effectively with the omnipresent threat of competition by outsiders who can destroy the cartel by selling below the cartel price. With the intent of overcoming such difficulties the cartels customarily resort to the technique of “compulsory membership,” a procedure which must arouse the deepest misgivings. A further disturbing fact is that the difficulties attendant on the formation of cartels vary in severity in different industries (they are least important in those heavy industries which consist of a few large firms, whose fixed capital investments are large, and which are engaged in the production of homogeneous mass-produced commodities), with the result that the less “cartelizable” industries (finished goods industries such as the textile industry) are at a serious disadvantage.
Antimonopoly policy is consequently essentially identical with the legal control of the cartel form of organization. Such control may take three forms. The mildest—and therefore also the least effective—form is the one under which cartels are admitted in principle and only their “abuse” prohibited (principle of prevention of abuse). The second possibility is the prohibition of cartels as such, enforced by the police power of the state (principle of prohibition on the model of the American antitrust legislation of 1890). The third and most desirable form of control is to make cartels subject not to criminal but civil prosecution and thereby to deprive a cartel agreement as an abuse of freedom of contract of the protection of the law (principle of denial of legal protection), without prejudice to the legal exceptions that might made to such a general rule. There is ground for the expectation that the adoption of this form of control would solve the problem of monopolism satisfactorily and silently.

Economics of the Free Society

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