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10. Monopoly and Competition > 5. The Theory of Monopolistic or Imperfect...

A. Monopolistic Competitive Price

The theory of monopoly price has been generally superseded in the literature by the theories of “monopolistic” or “imperfect” competition.71 As against the older theory, the latter have the advantage of setting up identifiable criteria for their categories—such as a perfectly elastic demand curve for pure competition. Unfortunately, these criteria turn out to be completely fallacious.

Essentially, the chief characteristic of the imperfect-competition theories is that they uphold as their “ideal” the state of “pure competition” rather than “competition” or “free competition.” Pure competition is defined as that state in which the demand curve for each firm in the economy is perfectly elastic, i.e., the demand curve as presented to the firm is completely horizontal. In this supposedly pristine state of affairs, no one firm can, through its actions, possibly have any influence over the price of its product. Its price is then “set” for it by the market. Any amount it produces can and will be sold at this ruling price. In general, it is this state of affairs, or else this state without uncertainty (“perfect competition”), that has received most of the elaborate analysis in recent years. This is true both for those who believe that pure competition fairly well represents the real economy and for their opponents, who consider it only an ideal with which to contrast the actual “monopolistic” state of affairs. Both camps, however, join in upholding pure competition as the ideal system for the general welfare, in contrast to various vague “monopoloid” states that occur when there is departure from the purely competitive world.

The pure-competition theory, however, is an utterly fallacious one. It envisages an absurd state of affairs, never realizable in practice, and far from idyllic if it were. In the first place, there can be no such thing as a firm without influence on its price. The monopolistic-competition theorist contrasts this ideal firm with those firms that have some influence on the determination of price and are therefore in some degree “monopolistic.” Yet it is obvious that the demand curve to a firm cannot be perfectly elastic throughout. At some points, it must dip downward, since the increase in supply will tend to lower market price. As a matter of fact, it is clear from our construction of the demand curve that there can be no stretch of the demand curve, however small, that is horizontal, although there can be small vertical stretches. In aggregating the market demand curve, we saw that for each hypothetical price, the consumers will decide to purchase a certain amount. If the producers attempt to sell a larger amount, they will have to conclude their sale at a lower price in order to attract an increased demand. Even a very small increase in supply will lead to a perhaps very small lowering of price. The individual firm, no matter how small, always has a perceptible influence on the total supply. In an industry of small wheat farms (the implicit model for “pure competition”), each small farm contributes a part of the total supply, and there can be no total without a contribution from each farm. Therefore, each farm has a perceptible, even if very small, influence. No perfectly elastic demand curve can, then, be postulated even in such a case. The error in believing in “perfect elasticity” stems from the use of such mathematical concepts as “second order of smalls,” by which infinite negligibility of steps can be assumed. But economics analyzes real human action, and such real action must always be concerned with discrete, perceptible steps, and never with “infinitely small” steps.

Of course, the demand curve for each small wheat farm is likely to be very highly, almost perfectly, elastic. And yet the fact that it is not “perfect” destroys the entire concept of pure competition. For how does this situation differ from, say, the Hershey Chocolate Company if the demand curve for the latter firm is also elastic? Once it is conceded that all demand curves to firms must be falling, the monopolistic-competition theorist can make no further analytic distinctions.

We cannot compare or classify the curves on the basis of degrees of elasticity, since there is nothing in the Chamberlin-Robinson monopolistic-competition analysis, or in any part of praxeology for that matter, that permits us to do so, once the case of pure competition is rejected. For praxeology cannot establish quantitative laws, only qualitative ones. Indeed, the only recourse of monopolistic-competition theorists would be to fall back on the concepts of “inelastic” vs. “elastic” demand curves, and this would precisely plunge them right back into the old monopoly-price vs. competitive-price dichotomy. They would have to say, with the old monopoly-price theorists, that if the demand curve for the firm is more than unitarily elastic at the equilibrium point, the firm will remain at the “competitive” price; that if the curve is inelastic, it will rise to a monopoly-price position. But, as we have already seen in detail, the monopoly-competitive price dichotomy is untenable.

According to the monopolistic-competition theorists, the two influences sabotaging the possible existence of pure competition are “differentiation of product” and “oligopoly,” or fewness of firms, where one firm influences the actions of others. As to the former, the producers are accused of creating an artificial differentiation among products in the mind of the public, thus carving out for themselves a portion of monopoly. And Chamberlin originally attempted to distinguish “groups” of producers selling “slightly” differentiated products from old-fashioned “industries” of firms making identical products. Neither of these attempts has any validity. If a producer is making a product different from that of another producer, then he is a unique “industry”; there is no rational basis for any grouping of varied producers, particularly in aggregating their demand curves. Furthermore, the consuming public decides on the differentiation of products on its value scales. There is “artificial” about the differentiation, and indeed this differentiation serves to cater more closely to the multifarious wants of the consumers.72 It is clear, of course, that Ford has a monopoly on the sale of Ford cars; but this is a full “monopoly” rather than a “monopolistic” tendency. Also, it is difficult to see what difference can come from the number of firms that are producing the same product, particularly once we discard the myth of pure competition and perfect elasticity. Much ado indeed has been made about strategies, “warfare,” etc., between oligopolists, but there is little point to such discussions. Either the firms are independent and therefore competing, or they are acting jointly and therefore cartelizing. There is no third alternative.

Once the perfect-elasticity myth has been discarded, it becomes clear that all the tedious discussion about the number and size of firms and groups and differentiation, etc., becomes irrelevant. It becomes relevant only for economic history, and not for economic analysis.

It might be objected that there is a substantial problem of oligopoly: that, under oligopoly, each firm has to take into account the reactions of competing firms, whereas under pure competition or differentiated products without oligopoly, each firm can operate in the blissful awareness that no competitor will take account of its actions or change its actions accordingly. Hiram Jones, the small wheat farmer, can set his production policy without wondering what Ezra Smith will do when he discovers what Jones’ policy is. Ford, on the other hand, must consider General Motors’ reactions, and vice versa. Many writers, in fact, have gone so far as to maintain that economics can simply not be applied to these “oligopoly” situations, that these are indeterminate situations where “anything may happen.” They define the buyers’ demand curve that presents itself to the firm as assuming no reaction by competing firms. Then, since “few firms” exist and each firm takes account of the reactions of others, they proceed to the conclusion that in the real world all is chaos, incomprehensible to economic analysis.

These alleged difficulties are nonexistent, however. There is no reason why the demand curve to a firm cannot include expected reactions by other firms.73 The demand curve to a firm is the set of a firm's expectations, at any time, of how many units of its product consumers will buy at an alternative series of prices. What interests the producer is the hypothetical set of consumer demands at each price. He is not interested in what consumer demand will be in various sets of nonexistent situations. His expectations will be based on his judgment of what would actually happen should he charge various alternative prices. If his rivals will react in a certain way to his charging a higher or a lower price, then it is each firm's business to forecast and take account of this reaction in so far as it will affect buyers’ demand for its particular product. There would be little sense in ignoring such reactions if they were relevant to the demand for its product or in including them if they were not. A firm's estimated demand curve, therefore, already includes any expected reactions of rivals.

The relevant consideration is not the fewness of the firms or the state of hostility or friendship existing among firms. Those writers who discuss oligopoly in terms applicable to games of poker or to military warfare are entirely in error. The fundamental business of production is service to the consumers for monetary gain, and not some sort of “game” or “warfare” or any other sort of struggle between producers. In “oligopoly,” where several firms are producing an identical product, there cannot persist any situation in which one firm charges a higher price than another, since there is always a tendency toward the formation of a uniform price for each uniform product. Whenever firm A attempts to sell its product higher or lower than the previously ruling market price, it is attempting to “discover the market,” to find out what the equilibrium market price is, in accordance with the present state of consumer demand. If, at a certain price for the product, consumer demand is in excess of supply, the firms will tend to raise the price, and vice versa if the produced stock is not being sold. In this familiar pathway to equilibrium, all the stock that the firms wish to sell “clears the market” at the highest price that can be obtained. The jockeying and raising and lowering of prices that takes place in “oligopolistic” industries is not some mysterious form of warfare, but the visible process of attempting to find market equilibrium—that price at which the quantity supplied and the quantity demanded will be equal. The same process, indeed, takes place in any market, such as the “nonoligopolistic” wheat or strawberry markets. In the latter markets the process seems to the viewer more “impersonal,” because the actions of any one individual or firm are not as important or as strikingly visible as in the more “oligopolistic” industries. But the process is essentially the same, and we must not be led to think differently by such often inapt metaphors as the “automatic mechanisms of the market” or the “soulless, impersonal forces on the market.” All action on the market is necessarily personal; machines may move, but they do not purposefully act. And, in oligopoly situations, the rivalries, the feelings of one producer toward his competitors, may be historically dramatic, but they are unimportant for economic analysis.

To those who are still tempted to make the number of producers in any field the test of competitive merit, we might ask (setting aside the problem of proving homogeneity): How can the market create sufficient numbers? If Crusoe exchanges fish for Friday's lumber on their desert island, are they both benefiting, or are they “bilateral monopolists” exploiting each other and charging each other monopoly prices? But if the State is not justified in marching in to arrest Crusoe and/or Friday, how can it be justified in coercing a market where there are obviously many more competitors?

Economic analysis, in conclusion, fails to establish any criterion for separating any elements of the free-market price for a product. Such questions as the number of firms in an industry, the sizes of the firms, the type of product each firm makes, the personalities or motives of the entrepreneurs, the location of plants, etc., are entirely determined by the concrete conditions and data of the particular case. Economic analysis can have nothing to say about them.74

  • 71. In particular, see Edward H. Chamberlin, Theory of Monopolistic Competition, and Mrs. Joan Robinson, Economics of Imperfect Competition. For a lucid discussion and comparison of the two works, see Robert Triffin, Monopolistic Competition and General Equilibrium Theory (Cambridge: Harvard University Press, 1940). The differences between the “monopolistic” and the “imperfect” formulations are not important here.
  • 72. Recently, Professor Chamberlin has conceded this point and has, in a series of remarkable articles, astounded his followers by repudiating the concept of pure competition as a welfare ideal. Chamberlin now declares: “The welfare ideal itself ... is correctly described as one of monopolistic competition. ... [This] seems to follow very directly from the recognition that human beings are individual, diverse in their tastes and desires, and moreover, widely dispersed spatially.” Chamberlin, Towards a More General Theory of Value, pp. 93–94; also ibid., pp. 70–83; E.H. Chamberlin and J.M. Clark, “Discussion,” American Economic Review, Papers and Proceedings, May, 1950, pp. 102–04; Hunter, “Product Differentiation and Welfare Economics,” pp. 533–52; Hayek, “The Meaning of Competition” in Individualism and the Economic Order, p. 99; and Marshall I. Goldman, “Product Differentiation and Advertising: Some Lessons from Soviet Experience,” Journal of Political Economy, August, 1960, pp. 346–57. See also note 28 above.
  • 73. This definition of the demand curve to the firm was Mrs. Robinson's outstanding contribution, unfortunately repudiated by her recently. Triffin castigated Mrs. Robinson for evading the problem of “oligopolistic indeterminacy,” whereas actually she had neatly solved this pseudo problem. See Robinson, Economics of Imperfect Competition, p. 21. For other aspects of oligopoly, see Willard D. Arant, “Competition of the Few Among the Many,” Quarterly Journal of Economics, August, 1956, pp. 327–45.
  • 74. For an acute criticism of monopolistic-competition theory, see L.M. Lachmann, “Some Notes on Economic Thought, 1933–53,” South African Journal of Economics, March, 1954, pp. 26 ff., especially pp. 30–31. Lachmann points out that economists generally treat types of “perfect” or “monopolistic” competition as static market forms, whereas competition is actually a dynamic process.