MONOPOLY AND COMPETITION
1. The Concept of Consumers’ Sovereignty
A. Consumers’ Sovereignty versus Individual Sovereignty
We have seen that in the free market economy people will tend to produce those goods most demanded by the consumers. Some economists have termed this system “consumers’ sovereignty.” Yet there is no compulsion about this. The choice is purely an independent one by the producer; his dependence on the consumer is purely voluntary, the result of his own choice for the “maximization” of utility, and it is a choice that he is free to revoke at any time. We have stressed many times that the pursuit of monetary return (the consequence of consumer demand) is engaged in by each individual only to the extent that other things are equal. These other things are the individual producer’s psychic valuations, and they may counteract monetary influences. An example is a laborer or other factor-owner engaged in a certain line of work at less monetary return than elsewhere. He does this because of his enjoyment of the particular line of work and product and/or his distaste for other alternatives. Rather than “consumers’ sovereignty,” it would be more accurate to state that in the free market there is sovereignty of the individual: the individual is sovereign over his own person and actions and over his own property. This may be termed individual self-sovereignty. To earn a monetary return, the individual producer must satisfy consumer demand, but the extent to which he obeys this expected monetary return, and the extent to which he pursues other, nonmonetary factors, is entirely a matter of his own free choice.
The term “consumers’ sovereignty” is a typical example of the abuse, in economics, of a term (“sovereignty”) appropriate only to the political realm and is thus an illustration of the dangers of the application of metaphors taken from other disciplines. “Sovereignty” is the quality of ultimate political power; it is the power resting on the use of violence. In a purely free society, each individual is sovereign over his own person and property, and it is therefore this self-sovereignty which obtains on the free market. No one is “sovereign” over anyone else’s actions or exchanges. Since the consumers do not have the power to coerce producers into various occupations and work, the former are not “sovereign” over the latter.
The metaphorical shibboleth of “consumers’ sovereignty” has misled even the best economists. Many writers have used it as an ideal with which to contrast the allegedly imperfect free- market system. An example is Professor W.H. Hutt of the University of Cape Town, who has made the most careful defense of the concept of consumers’ sovereignty. Since he is the originator of this concept and his use of the term is widespread in the literature, his article is worth particular attention. It will be used as the basis for a critique of the concept of consumers’ sovereignty and its implications for the problems of competition and monopoly.
In the first part of his article, Hutt defends his concept of consumers’ sovereignty against the criticism that he has neglected the desires of producers. He does this by asserting that if a producer desires a means as an end in itself, then he is “consuming.” In this formal sense, as we have seen, consumers’ sovereignty, by definition, always obtains. Formally, there is nothing wrong with such a definition, for we have stressed throughout this book that an individual evaluates ends (consumption) on his value scale and that his valuation of means (for production) is dependent upon the former. In this sense, then, consumption always rules production.
But this formal sense is not very useful for analyzing the situation on the market. And it is precisely the latter sense that Hutt and others employ. Thus, suppose producer A withholds his labor or land or capital service from the market. For whatever reason, he is exercising his sovereignty over his person and property. On the other hand, if he supplies them to the market, he is, to the extent that he aims at monetary return, submitting himself to the demands of the consumers. In the aforementioned general sense, “consumption” rules in any case. But the critical question is: which “consumer”? The market consumer of exchangeable goods who buys these goods with money, or the market producer of exchangeable goods who sells these goods for money? To answer this question, it is necessary to distinguish between the “producer of exchangeable goods” and the “consumer of exchangeable goods,” since the market, by definition, can deal only in such goods. In short, we can designate people as “producers” and as “consumers,” even though every man must act as a consumer, and every man must also act, in another context, as a producer (or as the receiver of a gift from a producer).
Making this distinction, we find that, contrary to Hutt, each individual has self-sovereignty over his person and property on the free market. The producer, and the producer alone, decides whether or not he will keep his property (including his own person) idle or sell it on the market for money, the results of his production then going to the consumers in exchange for their money. This decision—concerning how much to allocate to the market and how much to withhold—is the decision of the individual producer and of him alone.
Hutt implicitly recognizes this, however, since he soon shifts his argument and begins inconsistently to hold up “consumers’ sovereignty” as an ethical ideal against which the activities of the free market are to be judged. Consumers’ sovereignty becomes almost an Absolute Good, and any action by producers to thwart this ideal is considered as little less than moral treason. Wavering between consumers’ sovereignty as a necessary fact and the contradictory concept of consumers’ sovereignty as an ideal that can be violated, Hutt attempts to establish various criteria to determine when this sovereignty is being violated. For example, he asserts that when a producer withholds his person or property out of a desire to use it for enjoyment as a consumers’ good, then this is a legitimate act, in keeping with rule by the consumer. On the other hand, when the producer acts to withhold his property in order to attain more monetary income than otherwise (presumably, although Hutt does not state this, by taking advantage of an inelastic demand curve for his product), then he is engaging in a vicious infringement on the consumers’ will. He may do so by acting to restrict production of his own personal product, or, if he makes the same product as other producers, by acting in concert with them to restrict production in order to raise the price. This is the doctrine of monopoly price, and it is this monopoly price that is allegedly the instrument by which producers pervert their rightful function.
Hutt recognizes the enormous difficulty of distinguishing among the producer’s motives in any concrete case. The individual who withholds his own labor may be doing so in order to obtain leisure; and even the owner of land or capital may be withholding it in order to derive, say, an aesthetic enjoyment from the contemplation of his unused property. Suppose, indeed, that there is a mixture of motives in both cases. Hutt is definitely inclined to solve these difficulties by not giving the producer the benefit of the doubt, particularly in the case of property.
But the difficulty is far greater than Hutt imagines. Every individual producer is always engaged in an attempt to maximize his “psychic income,” to arrive at the highest place on his value scale. To do so, he balances on this scale monetary income and various nonmonetary factors, in accordance with his particular valuations. Let us take the producer first as a seller of labor. In judging how much of his labor to sell and at what price, the producer will take into consideration the monetary income to be gained, the psychic return from the type of work and the “working conditions,” and the leisure forgone, balancing them in accordance with the operation of his various marginal utilities. Certainly, if he can earn a higher income by working less, he will do so, since he also gains leisure thereby. And the question arises: Why is this immoral?
Moreover, (1) it is impossible, not simply impracticable, to separate the leisure from monetary considerations here, since both elements are involved, and only the person himself will know the intricate balancing of his own valuations. (2) More important, this act does not contravene the truth that the producer can earn money only by serving the consumers. Why has he been able to extract a “monopoly price” through restricting his production? Only because the demand for his services (either directly by consumers or indirectly from them through lower-order producers) is inelastic, so that a decreased production of the good and a higher price will lead to increased expenditure on his product and therefore increased income for him. Yet this inelastic demand schedule is purely the result of the voluntary demands of the consumers. If the consumers were really angry at this “monopolistic action,” they could easily make their demand curves elastic by boycotting the producer and/or by increasing their demands at the “competitive” production level. The fact that they do not do so signifies their satisfaction with the existing state of affairs and demonstrates that they, as well as the producer, benefit from the resulting voluntary exchanges.
What about the producer in his capacity as a seller of property—the main target of the “anti-monopoly-price” school? The principle, first of all, is virtually the same. Individual producers may restrict the production and sale of their land or capital goods, either individually or in concert (by means of a “cartel”) in order to increase their expected monetary incomes from the sale. Once again, there is nothing distinctively immoral about such action. The producers, other things being equal, are attempting to maximize the monetary income from their factors of production. This is no more immoral than any other attempt to maximize monetary income. Furthermore, they can do so only by serving the consumers, since, once again, the sale is voluntary on the part of both producers and consumers. Again, such a “monopoly price,” to be established either by one individual or by individuals co-operating together in a cartel, is possible only if the demand curve (directly or indirectly of the consumers) is inelastic, and this inelasticity is the resultant of the purely voluntary choices of consumers in their maximization of satisfaction. For this “inelasticity” is simply a label for a situation in which consumers spend more money on a good at a higher than at a lower price. If the consumers were really opposed to the cartel action, and if the resulting exchanges really hurt them, they would boycott the “monopolistic” firm or firms, they would lower their purchasing so that the demand curve became elastic, and the firm would be forced to increase its production and reduce its price again. If the “monopolistic price” action had been taken by a cartel of firms, and the cartel had no other advantages for rendering production more efficient, it would then have to disband, because of the now demonstrated elasticity of the demand schedule.
But, it may be asked, is it not true that the consumers would prefer a lower price and that therefore achievement of a “monopoly price” constitutes a “frustration of consumers’ sovereignty”? The answer is: Of course, consumers would prefer lower prices; they always would. In fact, the lower the price, the more they would like it. Does this mean that the ideal price is zero, or close to zero, for all goods, because this would represent the greatest degree of producers’ sacrifice to consumers’ wishes?
In their role as consumers, men would always like lower prices for their purchases; in their capacity as producers, men always like higher prices for their wares. If Nature had originally provided a material Utopia, then all exchangeable goods would be free for the taking, and there would be no need for any labor to earn a money return. This Utopia would also be “preferred,” but it too is a purely imaginary condition. Man must necessarily work within a given real environment of inherited land and durable capital.
In this world, there are two, and only two, ways to settle what the prices of goods will be. One is the way of the free market, where prices are set voluntarily by each of the participating individuals. In this situation, exchanges are made on terms benefiting all the exchangers. The other way is by violent intervention in the market, the way of hegemony as against contract. Such hegemonic establishment of prices means the outlawing of free exchanges and the institution of exploitation of man by man—for exploitation occurs whenever a coerced exchange is made. If the free-market route—the route of mutual benefit—is adopted, then there can be no other criterion of justice than the free-market price, and this includes alleged “competitive” and “monopoly” prices, as well as the actions of cartels. In the free market, consumers and producers adjust their actions in voluntary cooperation.
In the case of barter, this conclusion is evident; the various producer-consumers either determine their mutual exchange rates voluntarily in the free market, or else the ratios are set by violence. There seems to be no reason why it should be more or less “moral,” on any grounds, for the horse-price of fish to be higher or lower than it is on the free market, or, in other words, why the fish-price of horses should be lower or higher. Yet it is no more evident why any money price should be lower or higher than it is on the market.
A. Cartels and “Monopoly Price”
But is not monopolizing action a restriction of production, and is not this restriction a demonstrably antisocial act? Let us first take what would seem to be the worst possible case of such action: the actual destruction of part of a product by a cartel. This is done to take advantage of an inelastic demand curve and to raise the price to gain a greater monetary income for the whole group. We can visualize, for example, the case of a coffee cartel burning great quantities of coffee.
In the first place, such actions will surely occur very seldom. Actual destruction of its product is clearly a highly wasteful act, even for the cartel; it is obvious that the factors of production which the growers had expended in producing the coffee have been spent in vain. Clearly, the production of the total quantity of coffee itself has proved to be an error, and the burning of coffee is only the aftermath and reflection of the error. Yet, because of the uncertainty of the future, errors are often made. Man could labor and invest for years in the production of a good which, it may turn out, consumers hardly want at all. If, for example, consumers’ tastes had changed so that coffee would not be demanded by anyone, regardless of price, it would again have to be destroyed, with or without a cartel.
Error is certainly unfortunate, but it cannot be considered immoral or antisocial; nobody aims deliberately at error. If coffee were a durable good, it is obvious that the cartel would not destroy it, but would store it for gradual future sale to consumers, thus earning income on the “surplus” coffee. In an evenly rotating economy, where errors are barred by definition, there would be no destruction, since optimum stocks for the attainment of money income would be produced in advance. Less coffee would be produced from the beginning. The waste lies in the excessive production of coffee at the expense of other goods that could have been produced. The waste does not lie in the actual burning of the coffee. After the production of coffee is lowered, the other factors which would have gone into coffee production will not be wasted; the other land, labor, etc., will go into other and more profitable uses. It is true that excess specific factors will remain idle; but this is always the fate of specific factors when the realities of consumer demand do not sustain their use in production. For example, if there is a sudden dwindling of consumer demand for a good, so that it becomes unremunerative for labor to work with certain specialized machines, this “idle capacity” is not a social waste, but is rather socially useful. It is proved an error to have produced the machines; and now that the machines are produced, working on them turns out to be less profitable than working with other lands and machines to produce some other result. Therefore, the economical step is to leave them idle or perhaps to transform their material stuff into other uses. Of course, in an errorless economy, no excessive specific capital goods will be produced.
Suppose, for example, that before the coffee cartel went into operation, X amount of labor and Y amount of land co-operated to produce 100 million pounds of coffee a year. The coffee cartel determined, however, that the most remunerative production was 60 million pounds and therefore reduced annual output to this level. It would have been absurd, of course, to continue wasteful production of 100 million pounds and then to burn 40 millions. But what of the now surplus labor and land? These shift to the production, say, of 10 million pounds of rubber, 50,000 hours of service as jungle guides, etc. Who is to say that the second structure of production, the second allocation of factors, is less “just” than the first? In fact, we may say it is more just, since the new allocation of factors will be more profitable, and hence more value-productive, to consumers. In the value sense, then, overall production has now expanded, not contracted. It is clear we cannot say that production, overall, has been restricted, since output of goods other than coffee has increased, and the only comparison between the decline of one good and the increase in another must be made in these broad valuational terms. Indeed, the shifting of factors to rubber and jungle guidance no more restricts coffee production than a previous shift of factors to coffee restricted the production of the former goods.
The whole concept of “restricting production,” then, is a fallacy when applied to the free market. In the real world of scarce resources in relation to possible ends, all production involves choice and the allocation of factors to serve the most highly valued ends. In short, the production of any product is necessarily always “restricted.” Such “restriction” follows simply from the universal scarcity of factors and the diminishing marginal utility of any one product. But then it is absurd to speak of “restriction” at all.
We cannot, then, say that the cartel has “restricted production.” After the final allocation has eliminated the producer’s error, the cartel’s action will effect a maximization of producers’ incomes in the service of the consumers, as do all other free-market allocations. This is the result that people on the market tend to attain, in consonance with their skill as forecasting entrepreneurs, and this is the only situation in which man as consumer harmonizes with man as producer.
It follows from our analysis that the producers’ original production of 100 million pounds was an unfortunate error, later corrected by them. Instead of being a vicious restriction of production to the detriment of the consumers, the cutback in coffee production was, on the contrary, a correction of the previous error. Since only the free market can allocate resources to serve the consumer, in accordance with monetary profitability, it follows that in the previous situation, “too much” coffee and “too little” rubber, jungle guide service, etc., were being produced. The cartel’s action, in reducing the production of coffee and causing an increase in the production of rubber, jungle guiding, etc., led to an increase in the power of the productive resources to satisfy consumer desires.
If there are anticartelists who disagree with this verdict and believe that the previous structure of production served the consumers better, they are always at perfect liberty to bid the land, labor, and capital factors away from the jungle-guide agencies and rubber producers, and themselves embark on the production of the allegedly “deficient” 40 million pounds of coffee. Since they are not doing so, they are hardly in a position to attack the existing coffee producers for not doing so. As Mises succinctly stated:
Certainly those engaged in the production of steel are not responsible for the fact that other people did not likewise enter this field of production. . . . If somebody is to blame for the fact that the number of people who joined the voluntary civil defense organization is not larger, then it is not those who have already joined but those who have not.
The position of the anticartelists implies that someone else is producing too much of some other product; yet they offer no standards except their own arbitrary decrees to determine which production is excessive.
Criticism of steel owners for not producing “enough” steel or of coffee growers for not producing “enough” coffee also implies the existence of a caste system, whereby a certain caste is permanently designated to produce steel, another caste to grow coffee, etc. Only in such a caste society would such criticism make sense. Yet the free market is the reverse of the caste system; indeed, choice between alternatives implies mobility between alternatives, and this mobility obviously holds for entrepreneurs or lenders with money to invest in production.
Furthermore, as we have stated above, an inelastic demand curve is purely the result of consumers’ choice. Thus, suppose that 100 million pounds of coffee have been produced and lie in stock, and a group of growers jointly decide that a burning of 40 million pounds of coffee will, say, double the price from one gold grain per pound to two gold grains per pound, thus giving them a higher total income acting jointly. This would be impossible if the growers knew that they would be confronted with an effective consumer boycott at the higher price. Further, consumers have another way, if they so desire, to prevent destruction of the good. Various consumers, acting either individually or jointly, could offer to purchase the existing coffee at higher than present prices. They could do this either because of their desire for coffee or because of their philanthropic dismay at the destruction of a useful good, or from a combination of both motives. At any rate, if they did so, they would prevent the producers’ cartel from decreasing the supply sold on the market. The boycott at a higher price and/or increased offers at the lower price would change the demand curve and render it elastic at the present stock level, thereby removing any incentive or need for the formation of a cartel.
To regard a cartel as immoral or as hampering some sort of consumers’ sovereignty is therefore completely unwarranted. And this is true even in the seemingly “worst” case of a cartel that we may assume is founded solely for “restrictive” purposes, and where, as a result of previous error and the perishability of product, actual destruction will occur. If consumers really wish to prevent this action, they need only change their demand schedules for the product, either by an actual change in their taste for coffee or by a combination of boycott and philanthropy. The fact that such a development does not take place in any given circumstance signifies that the producers are still maximizing their monetary income in the service of the consumers—by a cartel action, as well as by any other action. Some readers might object that, in offering higher demands for existing stock, the consumers would be bribing the producers, and that this constitutes an unwarranted extortion on the part of the producers. But this charge is untenable. Producers are guided by the goal of maximizing monetary income; they are not extorting, but simply producing where their gains are at a maximum, through exchanges concluded voluntarily by producers and consumers alike. This is no more nor less a case of “extortion” than when a laborer shifts from a lower-paying to a higher-paying job or when an entrepreneur invests in what he thinks will be a more rather than a less profitable project.
It must be recognized that once an error has been committed, as it had been in the aforementioned situation, the rational course is not to bewail the past, nor to attempt to “recover” historical costs, but to make the best (ceteris paribus, the most money) of the present situation. We recognize this when previously produced machines or other capital goods face a loss of demand for their product. In the production process, as we have seen, labor energies work on natural and produced factors to arrive at the most urgently demanded consumers’ goods. Since error is inevitable, this process is bound to lead to a considerable amount of “idle” capital goods at any given time. Similarly, much original land area will remain idle because existing labor has more profitable work to do on other lands. In short, the “idle” coffee is the result of an error in forecasting and should be no more shocking or reprehensible than “idle capacity” in any other type of capital good.
Our argument is just as applicable to a single firm producing a unique product with an inelastic demand as it is to a cartel of firms. A single firm, with inelastic demand for its product, could also destroy part of its stock after committing a forecasting error. Our critique of the “anti-monopoly-price” and consumers’-sovereignty doctrines applies equally well to such a case.
A common argument holds that cartel action involves collusion. For one firm may achieve a “monopoly price” as a result of its natural abilities or consumer enthusiasm for its particular product, whereas a cartel of many firms allegedly involves “collusion” and “conspiracy.” These expressions, however, are simply emotive terms designed to induce an unfavorable response. What is actually involved here is co-operation to increase the incomes of the producers. For what is the essence of a cartel action? Individual producers agree to pool their assets into a common lot, this single central organization to make the decisions on production and price policies for all the owners and then to allocate the monetary gain among them. But is this process not the same as any sort of joint partnership or the formation of a single corporation? What happens when a partnership or corporation is formed? Individuals agree to pool their assets into a central management, this central direction to set the policies for the owners and to allocate the monetary gains among them. In both cases, the pooling, lines of authority, and allocation of monetary gain take place according to rules agreed upon by all from the beginning. There is therefore no essential difference between a cartel and an ordinary corporation or partnership. It might be objected that the ordinary corporation or partnership covers only one firm, while the cartel includes an entire “industry” (i.e., all firms producing a certain product). But such a distinction does not necessarily hold. Various firms may refuse to enter a cartel, while, on the other hand, a single firm may well be a “monopolist” in the sale of its particular unique product, and therefore it may also encompass an entire “industry.”
The correspondence between a co-operative partnership or corporation—not generally considered reprehensible—and a cartel is further enhanced when we consider the case of a merger of various firms. Mergers have been denounced as “monopolistic,” but not nearly as vehemently as have cartels. Merging firms pool their capital assets, and the owners of the individual firms now become part owners of the single merged firm. They will agree on rules for the exchange ratios of the shares of the different companies. If the merging firms encompass the entire industry, then a merger is simply a permanent form of cartel. Yet clearly the only difference between a merger and the original forming of a single corporation is that the merger pools existing capital goods assets, while the original birth of a corporation pools money assets. It is clear that, economically, there is little difference between the two. A merger is the action of individuals with a certain quantity of already produced capital goods, adjusting themselves to their present and expected future conditions by cooperative pooling of assets. The formation of a new company is an adjustment to expected future conditions (before any specific investment has been made in capital goods) by cooperative pooling of assets. The essential similarity lies in the voluntary pooling of assets in a more centralized organization for the purpose of increasing monetary income.
The theorists who attack cartels and monopolies do not recognize the identity of the two actions. As a result, a merger is considered less reprehensible than a cartel, and a single corporation far less menacing than a merger. Yet an industry-wide merger is, in effect, a permanent cartel, a permanent combination and fusion. On the other hand, a cartel that maintains by voluntary agreement the separate identity of each firm is by nature a highly transitory and ephemeral arrangement and, as we shall see below, generally tends to break up on the market. In fact, in many cases, a cartel can be considered as simply a tentative step in the direction of permanent merger. And a merger and the original formation of a corporation do not, as we have seen, essentially differ. The former is an adaptation of the size and number of firms in an industry to new conditions or is the correction of a previous error in forecasting. The latter is a de novo attempt to adapt to present and future market conditions.
We do not know, and economics cannot tell us, the optimum size of a firm in any given industry. The optimum size depends on the concrete technological conditions of each situation, as well as on the state of consumer demand in relation to the given supply of various factors in this and in other industries. All these complex questions enter into the decisions of producers, and ultimately of consumers, concerning how large the firms in various lines of production will be. In line with consumer demand and with opportunity costs for the various factors, factor-owners and entrepreneurs will produce in those industries and firms in which they can maximize their monetary income or profit (other psychic factors being equal). Since forecasting is the function of entrepreneurs, successful entrepreneurs will minimize their errors and hence their losses as well. As a result, any existing situation on the free market will tend to be the most desirable for the satisfaction of consumers’ demands (including herein the nonmonetary wishes of the producers).
Neither economists nor engineers can decide the most efficient size of a firm in any situation. Only the entrepreneurs themselves can determine what size of firm will operate most efficiently, and it is presumptuous and unwarranted for economists or for any other outside observers to attempt to dictate otherwise. In this and other matters, the wishes and demands of the consumers are “telegraphed” through the price system, and the resulting drive for maximum monetary income and profits will always tend to bring about the optimum allocation and pricing. There is no need for the external advice of economists.
It is clear that when several thousand individuals decide not to produce and own individual steel plants by themselves, but rather to pool their capital into an organized corporation—which will purchase factors, invest and direct production, and sell the product, later allocating the monetary gains among the owners—they are enormously increasing their efficiency. Compared to production in hundreds of tiny plants, the quantity of production per given factors will be greatly increased. The large firm will be able to purchase heavily capitalized machinery and to finance better organized marketing and distributing outlets. All this is quite clear when thousands of individuals pool their capital into the establishment of a steel firm. But why may it not be equally true when several small steel firms merge into one large company?
It might be replied that in the latter merger, particularly in the case of a cartel, joint action is taken, not to increase efficiency, but solely to increase income by restricting sales. Yet there is no way that an outside observer can distinguish between a “restrictive” and an efficiency-increasing operation. In the first place, we must not think of the plant or factory as being the only productive factors the efficiency of which can increase. Marketing, advertising, etc., are also factors of production; for “production” is not simply the physical transformation of a product, but also consists in transporting it and placing it into the hands of users. The latter implies the expenses of informing the user about the existence and nature of the product and of selling that product to him. Since a cartel always engages in joint marketing, who can deny that the cartel might render marketing more efficient? How, therefore, can this efficiency be separated from the “restrictive” aspect of the operation?
Furthermore, technological factors in production can never be considered in a vacuum. Technological knowledge tells us of a whole host of alternatives that are open to us. But the crucial questions—in what to invest? how much? what production method to choose?—can be answered only by economic, i.e., by financial considerations. They can be answered only on a market actuated by a drive for money incomes and profits. Thus, how is a producer to decide, in digging a subway tunnel, what material to use in its construction? From a purely technological point of view, solid platinum may be the best choice, the most durable, etc. Does this mean that he should choose platinum? He can make a choice among factors, methods, goods to produce, etc., only by comparing the necessary monetary expenses (which are equal to the income the factors could earn elsewhere) with expected monetary income from the production. Only by maximizing monetary gain can factors be allocated in the service of consumers; otherwise, and on purely technological grounds, there would be nothing to prevent the building of platinum-lined subway tunnels the breadth of the continent. The only reason this cannot be done under present conditions is the heavy money “cost” caused by the waste of drawing away factors and resources from uses far more urgently demanded by the consumers. But the fact of this urgent alternative demand—and thus the fact of the waste—can be discovered only through being recorded by a price system actuated by a drive by producers for money incomes. Only empirical observation of the market reveals to us the full absurdity of such a transcontinental subway.
Moreover, there are no physical units with which we can compare the different types of physical factors and physical products. Thus, suppose a producer attempts to determine the most efficient use of two hours of his labor. In a romantic moment, he tries to determine this efficiency by purely abstracting from “sordid” considerations of monetary gain. Assume that he is confronted with three technologically known alternatives. These are tabulated as follows:
Which of these alternatives, A, B, or C, is the most efficient, the most technologically “useful,” way of allocating his labor? It is clear that the “idealistic,” self-sacrificing producer has no way of knowing! He has no rational way of deciding whether or not to produce the pot, the pipe, or the boat. Only the “selfish” money-seeking producer has a rational way of determining the allocation. In seeking maximum monetary gain, the producer compares the money costs (necessary expenses) of the various factors with the prices of the products. Considering A and B, for example, if the purchase of the clay and oven-hour would cost one gold ounce, and the pot could sell for two gold ounces, his labor would earn one gold ounce. On the other hand, if the wood and oven-hour would cost one and a half gold ounces, and the pipe could sell for four gold ounces, he would earn two and a half ounces for his two hours of labor and would choose to make this product. The prices of both the product and the factors are reflections of consumer demand and of producers’ attempts to earn money in its service. The only way the producer could determine which product to make is to compare expected monetary gains. If the boat would sell for five gold ounces, he would produce the boat rather than the pipe, and thus satisfy a more urgent consumer demand, as well as his own desire for monetary income.
There can therefore be no separation of technological efficiency from financial considerations. The only way that we can determine whether one product is more demanded than another, or one process more efficient than another, is through concrete actions of the free market. We may think it self-evident, for example, that the optimum efficient size of a steel plant is larger than that of a barber shop. But we know this not as economists from a priori or praxeological reasoning, but purely by empirical observation of the free market. There is no way that economists or any other outside observers can set the technological optimum for any plant or firm. This can be done only on the market itself. But if this is true in general, it is also true in the specific cases of mergers and cartels. The impossibility of isolating a technological element becomes even clearer when we remember that the critical problem is not the size of the plant, but the size of the firm. The two are by no means synonymous. It is true that the firm will consider the optimum-sized plant for whatever scale its operations will be on, and, further, that a larger-sized plant will, ceteris paribus, require a larger-sized firm. But its range of decisions cover a much broader ground: how much to invest, what good or goods to produce, etc. A firm may encompass one or more plants or products and always encompasses marketing facilities, financial organization, etc., which are overlooked when only the plant is held in view.
These considerations, incidentally, serve to refute the very popular distinction between “production for use” and “production for profit.” In the first place, all production is for use; otherwise it would not take place. In the market economy, this almost always means goods for the use of others—the consumers. Profit can be earned only through servicing consumers with produced goods. On the other hand, there can be no rational production, above the most primitive level, based on technological or utilitarian considerations abstracted from monetary gain.
It is important to realize what we have not said in this section. We have not said that cartels will always be more efficient than individual firms or that “big” firms will always be more efficient than small ones. Our conclusion is that economics can make few valid statements about the optimal size of a firm except that the free market will come as close as possible to rendering maximum service to consumers, whether we are considering the size of a firm or any other aspect of production. All the concrete problems in production—the size of the firm, the size of the industry, the location, price, size and nature of the output, etc.—are for entrepreneurs, not economists, to solve.
We should not leave the problem of the size of the firm without considering a common worry of economic writers: What if the average cost curve of a firm continues to fall indefinitely? Would not the firm then grow so big as to constitute a “monopoly”? There is much lamentation that competition “breaks down” in such a situation. Much of the emphasis on this problem comes, however, from preoccupation with the case of “pure competition,” which, as we shall see below, is an impossible figment. Secondly, it is obvious that no firm ever has been or can be infinitely large, so that limiting obstacles—rising or less rapidly falling costs—must enter somewhere, and relevantly, for every firm. Thirdly, if a firm, through greater efficiency, does obtain a “monopoly” in some sense in its industry, it clearly does so, in the case we are considering (falling average cost), by lowering prices and benefiting the consumers. And if (as all the theorists who attack “monopoly” agree) what is wrong with “monopoly” is precisely a restriction of production and a rise in price, there is obviously nothing wrong with a “monopoly” achieved by pursuing the directly opposite path.
This applies not only to specific types of goods, but also to the allocation between present and future goods, in accordance with the time preferences of the consumers.
Of course, we may formally salvage the concept of “consumers’ sovereignty” by asserting that all these psychic elements and evaluations constitute “consumption” and that the concept therefore still has validity. However, it would seem to be more appropriate in the catallactic context of the market (which is the area here under discussion) to reserve “consumption” to mean the enjoyment of exchangeable goods. Naturally, in the final sense, everyone is an ultimate consumer—both of exchangeable and of nonexchangeable goods. However, the market deals only in exchangeable goods (by definition), and when we separate the consumer and the producer in terms of the market, we distinguish the demanding, as compared to the supplying, of exchangeable goods. It is more appropriate, then, not to consider a nonexchangeable good as an object of consumption in this particular context. This is important in order to discuss the contention that individual producers are somehow subject to the sovereign rule of other individuals—the “consumers.”
W.H. Hutt, “The Concept of Consumers’ Sovereignty,” Economic Journal, March, 1940, pp. 66–77. Hutt originated the term in an article in 1934. For an interesting use of a similar concept, cf. Charles Coquelin, “Political Economy” in Lalor’s Cyclopedia, III, 222–23.
To be consistent, currently fashionable theory would have to accuse Crusoe and Friday of being vicious “bilateral monopolists,” busily charging each other “monopoly prices” and therefore ripe for State intervention!
See chapter 8, p. 516 above.
 In the words of Professor Mises:
That the production of a commodity p is not larger than it really is, is due to the fact that the complementary factors of production required for an expansion were employed for the production of other commodities. . . . Neither did the producers of p intentionally restrict the production of p. Every entrepreneur’s capital is limited; he employs it for those projects which, he expects, will, by filling the most urgent demand of the public, yield the highest profit.
An entrepreneur at whose disposal are 100 units of capital employs, for instance, 50 units for the production of p and 50 units for the production of q. If both lines are profitable, it is odd to blame him for not having employed more, e.g., 75 units, for the production of p. He could increase the production of p only by curtailing correspondingly the production of q. But with regard to q the same fault could be found by the grumblers. If one blames the entrepreneur for not having produced more p, one must blame him also for not having produced more q. This means: one blames the entrepreneur for the fact that there is a scarcity of the factors of production and that the earth is not a land of Cockaigne. (Mises, Planning for Freedom, pp. 115–16)
Ibid., p. 115.
Much error would have been avoided if economists had heeded the words of Arthur Latham Perry:
Every man who puts forth an effort to satisfy the desire of another, with the expectation of a return, is . . . a Producer. The Latin word producere means to expose anything to sale. . . . We must rid ourselves at the outset of the notion . . . that it is only to be applied to forms of matter, that it means . . . to transform something only. . . . The fundamental meaning of the root-word, both in Latin and in English, is effort with reference to a sale. A product is a service ready to be rendered. A producer is any person who gets something ready to sell and sells it. (Perry, Political Economy, pp. 165–66)
R.H. Coase, in an illuminating article, has pointed out that the extent to which transactions take place within a firm or between firms is dependent on the balancing of the necessary costs of using the price mechanism as against the costs of organizing a structure of production within a firm. Coase, “The Nature of the Firm.”
This spurious distinction was brought into wide currency by Thorstein Veblen and continued in the happily short-lived “technocracy” movement of the early 1930’s. According to his biographer, this distinction was the keynote of all Veblen’s writings. Cf. Joseph Dorfman, The Economic Mind in American Civilization (New York: Viking Press, 1949), III, 438ff.
On the “orthodox” neglect of cost limitations, see Robbins, “Remarks upon Certain Aspects of the Theory of Costs.”
Cf. Mises, Human Action, p. 367.