Chapter 10—Monopoly and Competition (continued)
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Chapter 10—Monopoly
and Competition (continued)
B.
The Paradox of Excess Capacity
Perhaps the most important conclusion of the theory of monopolistic or
imperfect competition is that the real world of monopolistic
competition (where the demand curve to each firm is necessarily
falling) is inferior to the ideal world of pure competition
(where no firm can affect its price). This conclusion was expressed
simply and effectively by comparing two final equilibrium
states: under conditions of pure and monopolistic competition
(Figure 70).
AC is a firm’s average total-cost
curve—its alternative dollar costs per unit—with
output on the horizontal axis and prices (including costs) on the
vertical axis. The only assumption we need in drawing the average-cost
curve is that, for any plant in any branch of production, there will be
some optimum point of production, i.e., some level
of output at which average unit cost is at a minimum. All levels of
production lower or higher than the optimum have a higher average cost.
In pure competition, where the demand curve for any firm is perfectly
elastic, Dp,
each firm will eventually adjust so that its AC
curve will be tangent to Dp,
in equilibrium; in this case, at point E. For if
average revenue (price) is greater than average cost, then competition
will draw in other firms, until the curves are tangent; if the cost
curve is irretrievably higher than demand, the firm will go out of
business. Tangency is at point E, price at 0G,
and output at 0K. As in any definition of final
equilibrium, total costs equal total revenues for each firm, and
profits are zero.
Now contrast this picture with that of monopolistic
competition. Since the demand curve (Dmf) is
now sloping downward to the right, it must, given the same AC
curve, be tangent at some point (F), where the price
is higher (JF) and the production lower (0J)
than under pure competition. In short, monopolistic competition yields
higher prices and less production—i.e., a lower standard of
living—than pure competition. Furthermore, output will not
take place at the point of minimum average cost—clearly a
social “optimum,” and each plant will produce at a
lower than optimum level, i.e., it will have “excess
capacity.” This was the “welfare” case of
the monopolistic-competition theorists.
By a process of revision in recent years, some of it by the
originators of the doctrine themselves, this theory has been
effectively riddled beyond repair. As we have seen, Chamberlin and
others have shown that this analysis does not apply if we are to take
consumer desire for diversity as a good to be satisfied.
Many other effective and
sound attacks have been made from different directions. One basic
argument is that the situations of pure and of monopolistic competition
cannot be compared because the AC curves would
not, in fact, be the same. Chamberlin has pursued
his revisionism in this realm also, declaring that the
comparisons are wholly illegitimate, that to apply the concept
of pure competition to existing firms would mean, for example, assuming
a very large number of similar firms producing the identical product.
If this were done, say, with General Motors, it would mean that either
GM must conceptually be divided up into numerous fragments, or
else that it be multiplied. If divided, then unit costs would
undoubtedly be higher, and then the “competitive
firm” would suffer higher costs and have to subsist on higher
prices. This would clearly injure consumers and the standard
of living; thus, Chamberlin follows Schumpeter’s criticism
that the “monopolistic” firm may well have and
probably will have lower costs than its “purely
competitive” counterpart. If, on the other hand, we conceive
of the multiplication of a very large number of General Motors
corporations at existing size, we cannot possibly relate it to the
present world, and the whole comparison becomes absurd.
In addition, Schumpeter has stressed the superiority of the
“monopolistic” firm for innovation and progress,
and Clark has shown the inapplicability, in various ways, of this
static theory to the dynamic real world. He has recently shown its
fallacious asymmetry of argument with respect to price and quality.
Hayek and Lachmann have also pointed out the distortion of dynamic
reality, as we have indicated above.
A second major line of attack has shown that the comparisons are much
less important than they seem from conventional diagrams,
because cost curves are empirically much flatter than they appear in
the textbooks. Clark has emphasized that firms deal in long-run
considerations, and that long-run cost and demand curves are both more
elastic than short-run; hence the differences between E
and F points will be negligible and may be
nonexistent. Clark and others have stressed the vital importance of potential
competition to any would-be reaper of monopoly price, from firms both
within and without the industry, and also the competition of
substitutes between industries. A further argument has been that the
cost curves, empirically, are flat within the relevant range, even
aside from the long- vs. short-run problems.
All these arguments, added to our own analysis given above, have
effectively demolished the theory of monopolistic competition,
and yet more remains to be said. There is something very peculiar about
the entire construction, even on its own terms, aside from the
fallacious “cost-curve” approach, and practically
no one has pointed out these other grave defects in the theory. In an
economy that is almost altogether “monopolistically
competitive,” how can every firm
produce too little and charge too much? What happens to the surplus
factors? What are they doing? The failure to raise this question stems
from the modern neglect of Austrian general analysis and from undue
concentration on an isolated firm or industry.
The excess factors must go
somewhere, and in that case must they not go to other monopolistically
competitive firms? In which case, the thesis breaks down as
self-contradictory. But the proponents have prepared a way
out. They take, first, the case of pure competition, with equilibrium
at point E. Then, they assume a sudden shift to
conditions of monopolistic competition, with the demand curve for the
firm now sloping downward. The demand curve now shifts from Dp to Dmo.
Then the firm restricts production and raises its price accordingly,
reaps profits, attracts new firms entering the industry, the
new competition reduces the output salable by each firm, and the demand
curve shifts downward and to the left until it is tangent to the AC
curve at point F. Hence, say the
monopolistic-competition theorists, not only does monopolistic
competition suffer from too little production in each firm and
excessive costs and prices; it also suffers from too many
firms in each industry. Here is what has happened to the
excess factors: they are trapped in too many uneconomic firms.
This seems plausible, until we realize that the whole example has been
constructed as a trick. If we isolate a firm or an industry, as does
the example, we may just as well start from a position of monopolistic
competition, at point F, and then suddenly shift to
conditions of pure competition. This is certainly just as legitimate,
or rather illegitimate, a base for comparison. What then? As we see in
Figure 71, the demand curve for each firm is now shifted from Dmf to Dpo. It
will now be profitable for each firm to expand its output, and it will
then make profits. New firms will then be attracted into the industry,
and the demand curve will fall vertically, until it again
reaches tangency with the AC curve at point E.
Are we now “proving” that there are more
firms in an industry under pure than under
monopolistic competition?
The fundamental error here
is failure to see that, under the conditions established by the
assumptions, any change opening up profits will
bring new firms into an industry. Yet the theorists are supposed to be
comparing two different static equilibria, of pure and of monopolistic
competition, and not discussing paths from one to the other. Thus, the
monopolistic-competition theorists have by no means solved
their problem of surplus factors.
But, aside from this point, there are more difficulties in the theory,
and Sir Roy Harrod, himself one of its originators, is the only one to
have seized the essence of the remaining central difficulty. As Harrod
says:
If
the entrepreneur foresees the trend of events, which will in due course
limit his profitable output to x – y units, why not plan to
have a plant that will produce x – y units most cheaply,
rather than encumber himself with excess capacity? To plan a plant for
producing x units, while knowing that it will only be possible to
maintain an output of x – y units, is surely to suffer from
schizophrenia.
And yet, asserts Harrod puzzledly, the “accepted
doctrine” apparently deems it “impossible
to be an entrepreneur and not suffer from
schizophrenia!”
In short, the theory
assumes that, in the long run, a firm having to produce at F
will yet construct a plant with minimum costs at point E.
Clearly, here is a patent contradiction with reality. What is wrong?
Harrod’s own answer is an excellent and novel discussion of
the difference between long-run and short-run demand curves, with the
“long run” always being a factor in
entrepreneurial planning, but he does not precisely answer this
question.
The paradox becomes “curiouser and curiouser” when
we fully realize that it all hinges on a mathematical technicality. The
reason why a firm can never produce at an optimum cost point is that (a)
it must produce at a tangent of demand and average-cost curves in
equilibrium, and (b) if the demand curve is falling,
it follows that it can be tangent to a U-shaped cost curve only at some
point higher than, and to the left of, the trough point. There are two
considerations that we may now add. First, there is no reason why the
cost “curve” should, in fact, be curved. In an
older day, textbook demand curves used to be curves, and now they are
often straight lines; there is even more reason for believing that cost
curves are a series of angular lines. It is of course (a)
more convenient for diagrams, and (b) essential to
mathematical representation, for there to be continuous curves, but we
must never let reality be falsified in order to fit the
niceties of mathematics. In fact, production is a series of
discrete alternatives, as all human action is discrete, and
cannot be smoothly continuous, i.e., move in infinitely small steps
from one production level to another. But once we recognize
the discrete, angular nature of the cost curve, the
“problem” of excess capacity immediately
disappears (Figure 72). Thus the falling demand curve to the
“monopolistic” firm, Dm, can
now be “tangent” to the AC
curve at E, the minimum-cost point, and will be so
in final equilibrium.
There is another way for this pseudo problem to disappear, and that is
to call into question the entire assumption of tangency. The tangency
of average cost and demand at equilibrium has appeared to
follow from the property of equilibrium: that total costs and total
revenues of the firm will be equal, since profits as well as losses
will be zero. But a key question has been either overlooked or
wrongly handled. Why should the firm produce anything,
after all, if it earns nothing from doing so? But it will earn
something, in equilibrium, and that will be interest
return. Modern orthodoxy has fallen into this error, for one
reason: because it does not realize that entrepreneurs are also
capitalists and that even if, in an evenly rotating economy, the
strictly entrepreneurial function were no longer to be
required, the capital-advancing function would still be emphatically
necessary.
Modern theory also tends to view interest return as a cost
to the firm. Naturally, if this is done, then the presence of interest
does not change matters. But (and here we refer the reader to foregoing
chapters) interest is not a cost to the firm; it is
an earning by a firm. The contrary belief
rests on a superficial concentration on loan interest and on
an unwarranted separation between entrepreneurs and capitalists.
Actually, loans are unimportant and are only another legal form of
entrepreneurial-capitalist investment. In short, in the evenly
rotating economy, the firm earns a
“natural” interest return, dictated by social time
preference. Hence, Figure 72 must be altered to look like the diagram
in Figure 73 (setting aside the problem of curves vs. angles). The firm
will produce 0K, its optimum production level, at
minimum average cost, KE. Its demand curve and cost
curve will not be tangent to each other, but will
allow room for equilibrium interest return, represented by the area EFGH.
(Neither, as some may object, will the price be higher in this
corrected version of monopolistic competition; for this AC
curve is lower all around than the previous ones, which had
included interest return in costs. If they did not include interest,
and instead assumed that interest would be zero in the ERE, then they
were wrong, as we have pointed out above.)
And so the paradox of the
monopolistic-competition theory is finally and fully interred.
C.
Chamberlin and Selling Cost
One of Professor Chamberlin’s most important contributions is
alleged to have been his sharp distinction between “selling
cost” and “production cost.”
“Production
costs” are supposed to be the legitimate expenses needed to
increase supply in order to meet given consumer
demand schedules. “Selling costs,” on the other
hand, are supposed to be directed toward influencing consumers
and increasing their demand schedules for the
firm’s product.
This distinction is completely spurious.
Why does a
businessman invest money and incur any
costs whatever? To supply a hoped-for demand for his product. Every
time he improves his product he is hoping that consumers will respond
by increasing their demands. In fact, all costs
expended on raw materials are incurred in an attempt to increase
consumer demand beyond what it would have been in the absence of these
costs. Therefore, every production cost is also a
“selling cost.”
Conversely, selling costs are not the sheer waste or even tyranny that
monopolistic-competition theorists have usually assumed. The various
expenses designated as “selling costs” perform
definite services for the public. Basically, they furnish
information to the public about the goods of the seller. 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. Selling costs are
therefore important in providing information about the product as well
as about the firm. In some cases, e.g., displays, the
“selling cost” itself directly
improves the quality of the product in the mind of the consumer. 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.
The view that a selling cost is somehow an artifact of
“monopolistic competition” stems only from
the peculiar assumptions of “pure competition.” In
the “ideal” world of pure competition, we remember,
each firm’s demand is given to it as
infinitely elastic, so that it can sell whatever it wants at
the ruling price. Naturally, in such a situation, no selling costs are
necessary, because a market for a product is automatically
assured. In the real world, however, there is no perfect knowledge, and
the demand curves are neither given nor infinitely elastic.
Therefore, firms have to
try to increase demands for their products and to carve out market
areas for themselves.
Chamberlin falls into another error in implying that selling costs,
such as advertising, “create” consumer demands.
This is the determinist fallacy. Every man as a self-owner freely
decides his own scale of valuations. On the free market no one can
force another to choose his product. And no other individual can ever
“create” someone’s values for him; he
must adopt the value himself.
6.
Multiform Prices and Monopoly
Up to this point we have always concluded that the market tends, at any
given time, to establish one uniform market price for any good, under
competitive or monopoly conditions. One phenomenon that sometimes
appears, however, is persistent multiformity of prices. (We
must consider, of course, a good that is really homogeneous; otherwise,
there would merely be price differences for different goods.)
How, then, can multiformity come about, and does it in some sense
violate the workings or the ethics of a free-market society?
We must first separate goods into two kinds: those that are resalable
and those that are not. Under the latter category come all intangible
services, which are either consumed directly or used up in the process
of production; in any case, they themselves cannot be resold
by the first buyer. Nonresalable services also include the rental
use of a tangible good, for then the good itself is not being bought,
but rather its unit services over a period of time. An example may be
the “renting” of space in a freight car.
Let us first take resalable goods. When can there be persistent
multiform pricing of such goods? One necessary condition is clearly ignorance
on the part of some seller or buyer. The market price for a certain
kind of steel, for example, may be one gold ounce per ton; but one
seller, out of pure ignorance, may persist in selling it for half a
gold ounce per ton. What will happen? In the first place, some
enterprising person will buy the steel from this laggard and resell it
at the market price, thus establishing effective uniformity.
Secondly, other buyers will rush to outbid the first buyer for
the bargain, thus informing the seller of his underpricing. Finally,
the persistently ignorant seller will not long remain in business. (Of
course, it may happen that the seller may have a strong desire to sell
steel for lower than market price, for
“philanthropic” reasons. But if he persists in
doing so, then he is simply purchasing the consumers’
good—to him—of philanthropy and paying the price
for it in lower revenue. He is here acting as a consumer rather than as
an entrepreneur, just as he would if he hired his
ne’er-do-well nephew at the expense of a cut in profits.
This, then, would not be a genuine case of multiform pricing, where the
good must always be homogeneous.)
Nor is the buyer in a different condition. If a buyer were
ignorant and continued to buy steel at two gold ounces a ton
when the market price was one gold ounce, then some other seller would
soon apprise the buyer of his error by offering to sell him the steel
for much less. If there is only one seller, then the cheaper buyer can
still resell at a profit to the buyer charged a higher price. And a
persistently ignorant buyer will also go out of business.
There is only one case where a multiform price could possibly
be established for a resalable good: where the good is being sold to
consumers—the ultimate buyers. For while entrepreneurial
buyers will be alert to price differentials, and a buyer of a good at a
lower price can resell to another buyer charged a higher price,
ultimate consumers do not usually consider reselling once they buy. A
classic case is that of American tourists at a Middle Eastern bazaar.
The tourist has neither
the time nor the inclination to make a thorough study of the
consumer markets, and therefore each tourist is ignorant of the going
price of any good. Hence, the seller can isolate each buyer, charging
highest prices to the most eager buyers, less high prices to the next
most eager, and much lower prices to the marginal buyers, of the same
good. In that way the seller achieves a generally unfulfilled objective
of all sellers: the tapping of more of the
“consumers’ surplus” of the buyers. Here
the two conditions are fulfilled: the consumers are ignorant
of the going price and are not in the market to resell.
Does multiform pricing, as has often been charged, distort the
structure of production, and is it in some way immoral or
exploitative? How is it immoral? The seller aims, as always,
to maximize his earnings in voluntary exchange, and he certainly cannot
be held responsible for the ignorance of the buyer. If buyers do not
take the trouble to inform themselves of the state of the market, they
must stand prepared to have some of their psychic surplus tapped by the
bargaining of the seller. Neither is this action irrational on the part
of the buyer. For we must deduce from the buyer’s action that
he prefers to remain in ignorance rather than to make
the effort or pay the money to inform himself of market
conditions. To acquire knowledge of any field takes time,
effort, and often money, and it is perfectly reasonable for an
individual on any given market to prefer to take his chances on the
price and use his scarce resources in other directions. This choice is
crystal clear in the case of a tourist on holiday, but it is also
possible in any other given market. Both the impatient tourist, who
prefers to pay a higher price and not spend time and money on learning
about the market, and a companion who spends days on an intensive study
of the bazaar market are exercising their preferences, and praxeology
cannot call one or the other more rational. Furthermore, there is no
way to measure the consumer surpluses lost or gained in the case of the
two tourists. We must therefore conclude that multiform pricing, in the
case of resalable goods, does not at all distort the allocation of
productive factors, because, on the contrary, it is consistent
with, and in the case of the tourist, the only
pricing consistent with, the satisfaction of consumer preferences.
It must be emphasized here that no matter how much the seller at the
bazaar taps of his customers’ psychic surplus, he does not
tap it all; otherwise the sale would not be made at
all. Since the exchange is voluntary, both parties still benefit from
making it.
What if the good is not resalable? In that case,
there is far greater room for multiform pricing, since ignorance is not
required. A vendor can sell an intangible service at a higher
price to A than to B without fear that B can undercut him by
reselling to A. Hence, most actual cases of multiform pricing
take place in the realm of intangible goods.
Suppose now that seller X has managed to establish multiform prices for
his customers. He might be a lawyer, for example, who charges higher
fees for the same service to a wealthy than to a poor client. Since
there is still competition among sellers, why does another lawyer Y not
enter the field and undercut X’s price to the wealthy
clients? In fact, this is what will generally happen, and any
attempt to establish “separate markets” among
customers will lead to an invasion of the more profitable,
higher-price field by other competitors, finally driving the price
down, reducing revenues, and re-establishing uniform pricing. If a
seller’s service is unusual and it is universally recognized
that he has no effective competitors, then he might be able to sustain
a multiform structure.
There is one simple but very important condition that we have not
mentioned which must be fulfilled to establish multiform pricing: the
total proceeds from multiformity must be greater than from uniformity.
Where one buyer can buy only one unit of a good, this is no problem. If
there is and can be only one seller of a nonresalable good, and
each buyer can buy no more than one unit, then multiform pricing will
tend to be established (barring undercutting by competitors), since the
total revenue to the seller will always be greater through tapping more
of the consumer surpluses of each buyer.
But if a buyer can buy
more than one unit, revenue becomes a problem. For then each buyer,
confronted with a higher price, will restrict his purchases. This will
leave an unsold stock, which the seller will then unload by lowering
his prices below the hypothetical uniform price in order to
tap the demands of hitherto submarginal buyers. Thus, suppose that the
uniform price of a good is ten gold grains per unit, at which a hundred
units are sold. The seller now decides to isolate each buyer as a
separate market and tap more consumer surpluses. Aside from
the barely marginal buyers, then, all the others will find their prices
raised. They will restrict their purchases, say to an aggregate of
eighty-five units, and the other fifteen units will be sold by lowering
the price to new, hitherto submarginal buyers.
Multiformity can be established only when total proceeds are greater
than uniformity provides. This is by no means always the case, for the
supramarginal buyers may restrict their purchases by more than the
submarginal buyers can compensate.
Multiform pricing has been accorded a curious reception by economists
and laymen. In some cases it is deemed vicious exploitation of
the consumers; in others (e.g., medicine and education) it is
considered praiseworthy and humanitarian. In reality, it is
neither. It is certainly not the rule in pricing
that the most eager should pay in proportion to
their eagerness (in practice, usually gauged by their wealth),
for then everyone would pay in proportion to his wealth for everything,
and the entire monetary and economic system would break down; money
would no longer function. (See chapter 12 below.) If this is clear in
general, it is difficult to see a priori why specific goods should be
singled out for this treatment. On the other hand, the
consumers are not being “exploited” if
there is multiformity. It is clear that the marginal and submarginal
buyers are not exploited: the latter obviously gain. What of the supramarginal
buyers who are receiving less consumer surplus? In some cases, they
gain, because without the greater revenues provided by “price
discrimination” the good would not be supplied at
all. Consider, for example, a country doctor who would leave
the area if he had to subsist on the lower revenues provided by
uniformity. And even if the good were still supplied, the fact
that the supramarginal buyers continue to patronize the seller at all
shows that they are content with the seemingly discriminatory
arrangement. Otherwise, they would quickly boycott the seller,
either individually or in concert, and patronize competitors. They
would simply refuse to pay more than the submarginal buyers,
and this would quickly induce the seller to lower his prices. The fact
that they do not do so shows that they prefer
multiformity to uniformity in the particular case. An example is
private school education, which able but poor youths may often attend
on scholarships—a principle that the wealthy parents who pay
full tuition demonstrably do not consider unjust. If, however,
the sellers have received grants of monopolistic privilege by
the government, enabling them to restrict competition in the
serving of the supramarginal buyers, then they may establish
multiformity without enjoying the demonstrable preference of these
buyers: for here governmental coercion has entered to inhibit the free
expression of preferences.
So far we have discussed price discrimination by sellers in
consumers’ markets, where consumer surpluses are
tapped. Can there be such discrimination in producers’
markets? Only when the good is not resalable, total proceeds are
greater under multiformity, and the
supramarginal buyers are willing to pay. The latter will happen when
these buyers have a higher DMVP for the good in their firms than other
buyers have in theirs. In this case, the seller of the good with
multiform prices is absorbing a rent formerly earned by the
supramarginal buying firm. The most notable case of such pricing has
been railroad freight “discrimination
against” the firms shipping a cargo more valuable per unit
weight than that of other firms. The gains are not, of course, retained
by the railroad in the long run, but absorbed by its own land and labor
factors.
Can there be price discrimination by buyers when
the good is not resalable (and ignorance among sellers is not assumed)?
No, there cannot, for the minimum reserve price imposed by, say, a
laborer, is determined by the opportunity cost he has foregone
elsewhere. In short, if a man earns five gold ounces a week for his
labor service in firm A, he will not accept two ounces a week (although
he would take two rather than earn nothing at all) since he can earn
nearly five ounces somewhere else. And the meaning of price
discrimination against sellers is that a buyer would be able to pay
less for the same good than the seller can earn elsewhere (cost of
moving, etc., omitted). Hence, there can be no price discrimination
against sellers. If sellers are ignorant, then, as in the case of the
ignorant consumers at a bazaar, we must infer that they prefer the
lower income to the cost and trouble of learning more about the market.
7.
Patents and Copyrights
Turning now to patents and copyrights, we ask: Which of the two, if
either, is consonant with the purely free market, and which is a grant
of monopoly privilege by the State? In this part, we have been
analyzing the economics of the purely free market, where the individual
person and property are not subject to molestation. It is
therefore important to decide whether patents or copyrights will obtain
in the purely free, noninvasive society, or whether they are a function
of government interference.
Almost all writers have bracketed patents and copyrights
together. Most have considered both as grants of exclusive
monopoly privilege by the State; a few have considered both as
part and parcel of property right on the free market. But almost
everyone has considered patents and copyrights as equivalent: the one
as conferring an exclusive property right in the field of
mechanical inventions, the other as conferring an exclusive
right in the field of literary creations.
Yet this bracketing of
patents and copyrights is wholly fallacious; the two are completely
different in relation to the free market.
It is true that a patent and a copyright are both exclusive property
rights and it is also true that they are both property rights in innovations.
But there is a crucial difference in their legal enforcement.
If an author or a composer believes his copyright is being
infringed, and he takes legal action, he must “prove that the
defendant had ‘access’ to the work allegedly
infringed. If the defendant produces something identical with the
plaintiff’s work by mere chance, there is no
infringement.”
Copyrights, in other
words, have their basis in prosecution of implicit theft. The plaintiff
must prove that the defendant stole the former’s
creation by reproducing it and selling it himself in violation
of his or someone else’s contract with the original seller.
But if the defendant independently arrives at the same
creation, the plaintiff has no copyright privilege that could prevent
the defendant from using and selling his product.
Patents, on the other hand, are completely different. Thus:
You
have patented your invention and you read in the newspaper one clay
that John Doe, who lives in a city 2,000 miles from your town, has
invented an identical or similar device, that he has licensed the EZ
company to manufacture it. . . . Neither Doe nor the EZ company . . .
ever heard of your invention. All believe Doe to be the inventor of a
new and original device. They may all be guilty of infringing
your patent . . . the fact that their infringement was in
ignorance of the true facts and unintentional will not
constitute a defense.
Patent, then, has nothing to do with implicit theft. It confers an
exclusive privilege on the first inventor, and if anyone else should,
quite independently, invent the same or similar machine or product, the
latter would be debarred by violence from using it in production.
We have seen in chapter 2 that the acid test by which we judge whether
or not a certain practice or law is or is not consonant with the free
market is this: Is the outlawed practice implicit or explicit theft? If
it is, then the free market would outlaw it; if not, then its outlawry
is itself government interference in the free market. Let us consider
copyright. A man writes a book or composes music. When he publishes the
book or sheet of music, he imprints on the first page the word
“copyright.” This indicates that any man who agrees
to purchase this product also agrees as part of the exchange not
to recopy or reproduce this work for sale. In other words, the author
does not sell his property outright to the buyer; he sells it on
condition that the buyer not reproduce it for sale. Since the
buyer does not buy the property outright, but only on this condition,
any infringement of the contract by him or a subsequent buyer
is implicit theft and would be treated accordingly
on the free market. The copyright is therefore a logical
device of property right on the free market.
Part of the patent protection now obtained by an inventor could be
achieved on the free market by a type of
“copyright” protection. Thus, inventors must now mark
their machines as being patented. The mark puts the buyers on notice
that the invention is patented and that they cannot sell that
article. But the same could be done to extend the copyright system, and
without patent. In the purely free market, the inventor could mark his
machine copyright, and then anyone who buys the
machine buys it on the condition that he will not
reproduce and sell such a machine for profit. Any violation of this
contract would constitute implicit theft and be prosecuted
accordingly on the free market.
The patent is incompatible with the free market precisely to
the extent that it goes beyond the copyright. The man who has
not bought a machine and who arrives at the same invention
independently, will, on the free market, be perfectly able to
use and sell his invention. Patents prevent a man from using his
invention even though all the property is his and he has not
stolen the invention, either explicitly or implicitly, from the first
inventor. Patents, therefore, are grants of exclusive monopoly
privilege by the State and are invasive of
property rights on the market.
The crucial distinction between patents and copyrights, then, is not
that one is mechanical and the other literary. The fact that they have
been applied that way is an historical accident and does not reveal the
critical difference between them.The crucial difference is
that copyright is a logical attribute of property right on the free
market, while patent is a monopoly invasion of that right.
The application of patents to mechanical inventions and
copyrights to literary works is peculiarly inappropriate. It
would be more in keeping with the free market to be just the reverse.
For literary creations are unique products of the individual; it is
almost impossible for them to be independently duplicated by someone
else. Therefore, a patent, instead of a copyright,
for literary productions would make little difference in practice. On
the other hand, mechanical inventions are discoveries of natural law
rather than individual creations, and hence similar
independent inventions occur all the time.
The simultaneity of
inventions is a familiar historical fact. Hence, if it is
desired to maintain a free market, it is particularly important to
allow copyrights, but not patents, for
mechanical inventions.
The common law has often been a good guide to the law
consonant with the free market. Hence, it is not surprising
that common-law copyright prevails for unpublished
literary manuscripts, while there is no such thing as a common-law patent.
At common law, the inventor also has the right to keep his invention
unpublicized and safe from theft, i.e., he has the equivalent of the
copyright protection for unpublicized inventions.
On the free market, there would therefore be no such thing as patents.
There would, however, be copyright for any inventor or creator who made
use of it, and this copyright would be perpetual,
not limited to a certain number of years. Obviously, to be fully the
property of an individual, a good has to be permanently and
perpetually the property of the man and his heirs and assigns. If the
State decrees that a man’s property ceases at a
certain date, this means that the State is
the real owner and that it simply grants the man use of the property
for a certain period of time.
Some defenders of patents assert that they are not monopoly privileges,
but simply property rights in inventions or even in
“ideas.” But, as we have seen, everyone’s
property right is defended in libertarian law without a
patent. If someone has an idea or plan and constructs an invention, and
it is stolen from his house, the stealing is an act of theft illegal
under general law. On the other hand, patents actually invade the
property rights of those independent discoverers of
an idea or invention who made the discovery after the patentee.
Patents, therefore, invade rather than
defend property rights. The speciousness of this argument that patents
protect property rights in ideas is demonstrated by the fact
that not all, but only certain types of original ideas, certain types
of innovations, are considered patentable.
Another common argument for patents is that
“society” is simply making a contract with
the inventor to purchase his secret, so that
“society” will have use of it. In the first place,
“society” could pay a straight subsidy, or price,
to the inventor; it would not have to prevent all later inventors from
marketing their inventions in this field.
Secondly, there is nothing in the free economy to prevent any
individual or group of individuals from purchasing secret
inventions from their creators. No monopolistic patent is necessary.
The most popular argument for patents among economists is the
utilitarian one that a patent for a certain number of years is
necessary to encourage a sufficient amount of research
expenditure for inventions and innovations in processes and
products.
This is a curious argument, because the question immediately arises: By
what standard do you judge that research expenditures are
“too much,” “too little,” or
just about enough? This is a problem faced by every
governmental intervention in the market’s
production. Resources—the better lands, laborers, capital
goods, time—in society are limited, and they may be used for
countless alternative ends. By what standard does someone assert that
certain uses are “excessive,” that certain uses are
“insufficient,” etc.? Someone observes
that there is little investment in Arizona, but a great deal in
Pennsylvania; he indignantly asserts that Arizona deserves more
investment. But what standards can he use to make this claim? The market
does have a rational standard: the highest money incomes and
highest profits, for these can be achieved only through maximum service
of consumer desires. This principle of maximum service to
consumers and producers alike—i.e., to
everybody—governs the seemingly mysterious market allocation
of resources: how much to devote to one firm or to another, to one area
or another, to present or future, to one good or another, to research
as compared with other forms of investment. But the observer who
criticizes this allocation can have no rational standards for decision;
he has only his arbitrary whim. This is especially true of criticism of
production-relations. Someone who chides consumers
for buying too much cosmetics may have, rightly or wrongly, some
rational basis for his criticism. But someone who thinks that
more or less of a certain resource should be used in a certain
manner or that business firms are “too large” or
“too small” or that too much or too little is spent
on research or is invested in a new machine, can have no rational basis
for his criticism. Businesses, in short, are producing for a
market, guided by the ultimate valuations of consumers on that market.
Outside observers may criticize ultimate valuations of
consumers if they choose—although if they interfere with
consumption based on these valuations they impose a loss of utility
upon consumers—but they cannot legitimately criticize the means:
the production relations, the allocations of factors, etc., by which
these ends are served.
Capital funds are limited, and they must be allocated to
various uses, one of which is research expenditures. On the
market, rational decisions are made in setting research expenditures,
in accordance with the best entrepreneurial expectations of an
uncertain future. Coercively to encourage research
expenditures would distort and hamper the satisfaction of consumers and
producers on the market.
Many advocates of patents believe that the ordinary
competitive conditions of the market do not sufficiently
encourage the adoption of new processes and that therefore innovations
must be coercively promoted by the government. But the market
decides on the rate of introduction of new processes just as
it decides on the rate of industrialization of a new geographic area.
In fact, this argument for patents is very similar to the
infant-industry argument for tariffs—that market processes
are not sufficient to permit the introduction of worthwhile
new processes. And the answer to both these arguments is the same: that
people must balance the superior productivity of the new
processes against the cost of installing them, i.e., against the
advantage possessed by the old process in being already built
and in existence. Coercively privileging innovation would needlessly
scrap valuable plants already in existence and impose an excessive
burden upon consumers. For consumers’ desires would not be
satisfied in the most economic manner.
It is by no means self-evident that patents encourage an
increased absolute quantity of research expenditures. But
certainly patents distort the type of research
expenditure being conducted. For while it is true that the first
discoverer benefits from the privilege, it is also true that his
competitors are excluded from production in the area of the patent for
many years. And since one patent can build upon a related one in the
same field, competitors can often be indefinitely discouraged
from further research expenditures in the
general area covered by the patent. Moreover, the patentee is himself
discouraged from engaging in further research in this field, for the
privilege permits him to rest on his laurels for the entire period of
the patent, with the assurance that no competitor can trespass
on his domain. The competitive spur for further research is
eliminated. Research expenditures are therefore overstimulated
in the early stages before anyone has a patent, and they are unduly
restricted in the period after the patent is received. In
addition, some inventions are considered patentable, while
others are not. The patent system then has the further effect of
artificially stimulating research expenditures in the patentable
areas, while artificially restricting research in the nonpatentable
areas.
Manufacturers have by no means unanimously favored patents. R.A.
Macfie, leader of England’s flourishing patent-abolition
movement during the nineteenth century, was president of the Liverpool
Chamber of Commerce.
Manufacturer I.K. Brunel,
before a committee of the House of Lords, deplored the effect of
patents in stimulating wasteful expenditure of resources on searching
for untried patentable inventions, resources that could have been
better used in production. And Austin Robinson has pointed out that
many industries get along without patents:
In
practice the enforcement of patent monopolies is often so
difficult . . . that competing manufacturers have in some
industries preferred to pool patents; and to look for
sufficient reward for technical invention in the . . . advantage of
priority that earlier experimentation usually gives and in the
subsequent good-will that may arise from it.
As Arnold Plant summed up the problem of competitive research
expenditures and innovations:
Neither
can it be assumed that inventors would cease to be employed if
entrepreneurs lost the monopoly over the use of their inventions.
Businesses employ them today for the production of nonpatentable
inventions, and they do not do so merely for the profit which priority
secures. In active competition . . . no business can afford to lag
behind its competitors. The reputation of a firm depends upon its
ability to keep ahead, to be first in the market with new improvements
in its products and new reductions in their prices.
Finally, of course, the market itself provides an easy and
effective course for those who feel that there are not enough
expenditures being made in certain directions. They
can make these expenditures themselves. Those who would like
to see more inventions made and exploited, therefore, are at
liberty to join together and subsidize such effort in any way
they think best. In that way, they would, as consumers, add resources
to the research and invention business. And they would not then be
forcing other consumers to lose utility by conferring monopoly grants
and distorting the market’s allocations. Their
voluntary expenditures would become part of the market
and express ultimate consumer valuations. Furthermore, later inventors
would not be restricted. The friends of invention could accomplish
their aim without calling in the State and imposing losses on
a large number of people.
And the product differentiation
associated with the falling demand curve may well lower costs of
distribution and of inspection (as well as improve consumer knowledge)
to more than offset the supposed rise in production costs. In short,
the AC curve above is really a
production-cost, rather than a total-cost, curve, neglecting
distribution costs. Cf. Goldman, “Product Differentiation and
Advertising.” Furthermore, a genuine total-cost curve would
then not be independent of the firm’s demand curve, thus
vitiating the usual “cost-curve” analysis. See
Dewey, Monopoly in Economics and Law, p. 87. Also
see section C below.
See Chamberlin,
“Measuring the Degree of Monopoly and
Competition” and “Monopolistic Competition
Revisited” in Towards a More General Theory of Value,
pp. 45–83.
See J.M. Clark,
“Competition and the Objectives of Government
Policy” in E.H. Chamberlin, ed., Monopoly
and Competition and Their Regulation (London:
Macmillan & Co., 1954), pp. 317–27; Clark,
“Toward a Concept of Workable Competition” in Readings
in the Social Control of Industry (Philadelphia: Blakiston,
1942), pp. 452–76; Clark,
“Discussion”; Abbott, Quality
and Competition, passim; Joseph A.
Schumpeter, Capitalism, Socialism and Democracy
(New York: Harper & Bros., 1942); Hayek, “Meaning of
Competition”; Lachmann, “Some Notes on Economic
Thought, 1933–53.”
See the above citations by Clark;
and Richard B. Heflebower, “Toward a Theory of Industrial
Markets and Prices” in R.B. Heflebower and G.W. Stocking,
eds., Readings on Industrial Organization and Public Policy
(Homewood, Ill.: Richard D. Irwin, 1958), pp. 297–315. A more
dubious argument—the flatness of the firm’s demand
curve in the relevant range—has been stressed by other
economists, notably A.J. Nichol, “The Influence of Marginal
Buyers on Monopolistic Competition,” Quarterly
Journal of Economics, November, 1934, pp. 121–34;
Alfred Nicols, “The Rehabilitation of Pure
Competition,” Quarterly Journal of Economics,
November, 1947, pp. 31–63; and Nutter, “Plateau
Demand Curve and Utility Theory.”
But cf. Abbott, Quality
and Competition, pp. 180–81.
The author first learned this
particular piece of analysis from the classroom lectures of
Professor Arthur F. Burns, and, to our knowledge, it has never seen
print.
Harrod, Economic Essays,
p. 149.
After arriving at this conclusion,
the author came across a brilliant but neglected article pointing out
that interest is a return and not a cost, and showing the devastating
implications of this fact for cost-curve theory. The article does not,
however, apply the theory satisfactorily to the problem of monopolistic
competition. See Gabor and Pearce, “A New
Approach to the Theory of the Firm,” and idem,
“The Place of Money Capital.” While there are a few
similarities, Professor Dewey’s critique of the
“excess capacity” doctrine is essentially very
different from ours and based on far more
“orthodox” considerations. Dewey, Monopoly
and Economics in Law, pp. 96ff.
Since the erroneous but popular
theory of “countervailing power,” propounded by
J.K. Galbraith, falls with the monopolistic-competition theory, it is
unnecessary to discuss it here. For a more detailed critique of its
numerous fallacies, see Simon N. Whitney,
“Errors in the Concept of Countervailing Power,” Journal
of Business, October, 1953, pp. 238–53; George J.
Stigler, “The Economist Plays with Blocs,” American
Economic Review, Papers and Proceedings, May, 1954, pp.
8–14; and David McCord Wright,
“Discussion,” ibid., pp.
26–30.
Chamberlin, Theory of
Monopolistic Competition, pp. 123ff. Chamberlin
includes in selling costs advertising, sales expenses, and store
displays.
See Mises, Human
Action, p. 319. Also see Kermit Gordon,
“Concepts of Competition and
Monopoly—Discussion,” American Economic
Review, Papers and Proceedings, May, 1955, pp.
486–87.
It is surely highly artificial to
call bright ribbons on a packaged good a “production
cost,” while labeling bright ribbons decorating the store
selling the good as a “selling cost.”
Cf. Alfred Nicols, “The
Development of Monopolistic Competition and the Monopoly
Problem,” Review of Economics and Statistics,
May, 1949, pp. 118–23.
See Mises:
The
consumer is, according to . . . legend, simply defenseless against
“high-pressure” advertising. If this were true,
success or failure in business would depend on the mode of advertising
only. However, nobody believes that any kind of advertising would have
succeeded in making the candlemakers hold the field against the
electric bulb, the horsedrivers against the motorcars. . . .
But this implies that the quality of the commodity advertised is
instrumental in bringing about the success of an advertising campaign.
. . . The tricks and artifices of advertising are available to the
seller of the better product no less than to the seller of the poorer
product. But only the former enjoys the advantages derived
from the better quality of his product. (Mises, Human Action,
pp. 317–18)
See Wicksteed, Common Sense of
Political Economy and Selected Papers, I, 253ff.
It is difficult to conceive of a
case, in reality, to which such a restriction imposed on buyers (called
“perfect price-discrimination”) would apply. Mrs.
Robinson cites as an example a ransom charged by a kidnapper, but this,
of course does not obtain on the free, unhampered market, which
precludes kidnapping. Robinson, Economics of Imperfect
Competition, p. 187 n.
See Mises, Human
Action, pp. 385ff.
An example is medicine, where the
government helps to restrict the supply and thus to prevent
price-cutting. See the illuminating article by Reuben A. Kessel,
“Price Discrimination in Medicine,” The
Journal of Law and Economics, October, 1958, pp.
20–53. Also see chapter 12 below on grants of monopoly
privilege.
Henry George was a notable
exception. See his excellent discussion in Progress and
Poverty (New York: Modern Library, 1929), p. 411 n.
Richard Wincor, How to
Secure Copyright (New York: Oceana Publishers,
1950), p. 37.
Irving Mandell, How to
Protect and Patent Your Invention (New York: Oceana
Publishers, 1951), p. 34.
This can be seen in the field of designs,
which can be either copyrighted or patented.
For a legal hint on the proper
distinction between copyright and monopoly, see
F.E. Skone James, “Copyright” in Encyclopedia
Britannica (14th ed.; London, 1929), VI,
415–16. For the views of nineteenth-century
economists on patents, see Fritz Machlup and Edith
T. Penrose, “The Patent Controversy in the Nineteenth
Century,” Journal of Economic History,
May, 1950, pp. 1–29. Also see Fritz
Machlup, An Economic Review of the Patent System
(Washington, D.C.: United States Government Printing Office, 1958).
Of course, there would be nothing
to prevent the creator or his heirs from voluntarily abandoning this
property right and throwing it into the “public
domain” if they so desired.
See the illuminating article by
Machlup and Penrose, “Patent Controversy in the Nineteenth
Century,” pp. 1–29.
Cited in Edith Penrose, Economics
of the International Patent System (Baltimore: Johns Hopkins
Press, 1951), p. 36; see also ibid.,
pp. 19–41.
Arnold Plant, “The
Economic Theory concerning Patents for Inventions,” Economica,
February, 1934, p. 44.
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