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"Monopoly" Is No Excuse for Government Intervention

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Chapter 10 of Rothbard’s Man, Economy, and State with Power and Market ([1962, 1970] 2009), “Monopoly and Competition,” proffers a compelling reelaboration of monopoly theory: it highlights, indeed, some inconsistencies within the neoclassical analysis conventionally held as true and taught in undergraduate and graduate microeconomics classes.

Rothbard’s monopoly analysis differs from the neoclassical one in (at least) three main elements. First, it adopts a different definition of monopoly. Second, it lays out the pointlessness of contrasting monopoly with “pure” (or perfect) competition—whose theoretical framework rests upon fallacious premises. Third, it dismantles the “monopoly’s loss of efficiency” argument—consumers retain their sovereignty over production.

Monopoly: Define It Properly

The conventional neoclassical definition of monopoly is quite blurred insofar as it identifies the monopolist as “the sole seller of the good”: however, what constitutes a particular good is hard to tell. In fact, such a definition would make it difficult—if not impossible—to discern monopoly (defined as such and earning an alleged monopoly rent) from consumers voluntarily distinguishing between two goods that they do not perceive as homogeneous (thus voluntarily paying different prices and a premium).

As Rothbard clearly explains,

only consumers can decide whether two commodities offered on the market are one good or two different goods. This issue cannot be settled by a physical inspection of the product. The elemental physical nature of the good may be only one of its properties….No one can ever be certain in advance—least of all the economist—whether a commodity sold by A will be treated on the market as homogeneous with the same basic physical good sold by B. (pp. 665–66)

So, the simple fact of being “the sole seller of a given good” is not sufficient to identify a monopolist—it’s too vague a criterion and would lead to paradoxes such as “every single producer is potentially a monopolist.” Hence, Mises approached the subject from a different perspective:

If conditions are such that the monopolist can secure higher net proceeds by selling a smaller quantity of his product at a higher price than by selling a greater quantity of his supply at a lower price, there emerges a monopoly price higher than the potential market price would have been in the absence of monopoly. (Human Action, [1949] 1998, p. 278)

The idea here is pretty much straightforward: a monopolist firm, if consumers’ demand so permits, can sell an allegedly suboptimal quantity—compared with “pure” competition (see below)—while nonetheless reaping profits higher than it would earn under “pure” competition. However, as we shall see below, the very idea of a comparison with the “pure” competition scenario makes no sense and invalidates the whole concept of monopoly.

Monopoly, “Pure” Competition, and Consumers’ Demand

The idea underlying “pure” competition is that firms are small enough to individually face a locally horizontal demand curve—each one being individually negligible, or “infinitesimal,” when it comes to the total supply—thus being able to increase supply without reducing the output’s price (cf. Rothbard [1962, 1970] 2009, p. 720). Thus, under “pure” competition, any firm can supposedly increase revenues simply by increasing output, without facing a tradeoff between greater quantities supplied (positively influencing revenues) and lower prices paid by consumers for these quantities (negatively influencing revenues). More formally this is the idea of constant marginal revenues (marginal revenue is how much revenue varies—positively or negatively—overall if the firm produces and sells a marginal—i.e., further—unit of output).

However, the whole idea of “pure” competition so defined makes little sense. Human action, including demand and production, indeed, does always occur in discrete units, never in infinitesimal ones: hence, it is absurd to think of a firm small (“infinitesimal”) enough to make no difference whatsoever whether it produces one further unit of output or not. As Rothbard ([1962, 1970] 2009, p. 721) puts it,

there can be no such thing as a firm without influence on its price….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.

Because of the law of decreasing marginal utility, indeed, any further (“marginal”) unit of output available will be valued less than the previous ones—since it will satisfy a less urgent want—and will thus command a lower price on the market. It doesn’t matter whether the marginal unit is bidden by a marginal consumer—who was not consuming earlier—or satisfies a person already consuming previously produced units of that same good: the further unit will always be subjectively valued less.

But if pure competition does not even exist, then why bother contrasting it with monopoly? One possible answer could be that pure competition is sort of a useful abstraction, helpful in order to expose monopoly’s inefficiencies. However, looking more closely at monopoly, such inefficiencies—often labeled “market failures”—can always be perfectly settled, in the free market economy, by consumers’ spontaneous action and preferences.

Monopoly, Efficiency, and Consumers’ Sovereignty

The reason why “pure” competition is thought to be more efficient than monopoly can be seen in figure 1. The idea is that whereas a monopolist firm faces a decreasing marginal revenue curve—i.e., the abovementioned tradeoff between the greater quantity sold and the lower price this quantity is sold at—which it equates to its marginal cost, the same would not obtain under “pure” competition.

Figure 1

In fact, under “pure” competition it’s assumed that firms would earn on every further unit supplied the price that consumers are willing to pay, thus neglecting that all the units producers could have sold at a higher price will now be sold at the same lower price as the last one. In other words, the assumption is that the demand curve and the marginal revenue curve coincide—but that’s impossible, because any further unit produced and sold will lower the price of all the previous units produced and sold!

So, we are left with two questions: Is there any loss of efficiency under monopoly? Are consumers deprived of their sovereignty?

First, if the industry is such that a monopolist emerges—say, because of strongly decreasing average cost and scale economies—there is no way to allocate resources more efficiently. Any resource allocation different from QM sold at PM (figure 1) would be tantamount to squandering scarce means of production to satisfy not-so-needed consumers’ wants. In fact, between QM and QPC any further unit of output sold costs the (monopolist) producer firm more than consumers overall are willing to compensate it for.

That said, the argument brought forth by the neoclassical analysis of monopoly is: “Okay, the monopolist firm can produce efficiently; however, by doing so, it reduces consumers’ surplus1 more than it increases its profit. (In figure 1 the reduction in consumers’ surplus amounts to the orange and yellow areas, while the increase in firm’s profit amounts to the positive difference between the yellow and blue areas). Hence, there is inefficiency in terms of lost social welfare (equal to the orange area) and room for government intervention—which should fix the price at its purely competitive level P PC.”

And this brings forth the answer to the second question. Consumers, in fact, do not need government intervention to fix the price. Instead, they can command the price they want simply by changing their own demand—thus shifting the demand curve and increasing the opportunity cost for the firm of restricting production. As a matter of fact, were consumers not so willing to pay higher prices while scrambling for the reduced available output (or were they willing to pay more than they do for an even slight increase in output), the monopolistic firm would face a huge incentive not to reduce output (or to increase it). In other words, the demand curve would flatten—and so consequently would the marginal revenue curve, thus dampening the tradeoff between higher production and lower prices (cf. Rothbard [1962, 1970] 2009, pp. 634–35).

Hence, even under monopoly, consumers are sovereign and their demand steers production. There is no inefficiency issue that government should intervene to settle .

Conclusion

In the unhampered, free market economy, monopoly there is no framework distinguishable from “pure” competition. In fact, inefficient monopolies arise only in cases of government interventionism (e.g., through requirement of patents, licenses, etc.). In the free market, consumers willing to access a larger quantity of (technologically producible) goods are always enabled to do so provided that they are willing enough to increase their demand—thus increasing the opportunity cost for the monopolist in “restricting” supply.

  • 1. The idea behind consumers’ surplus is simple: consumers who value the good more than its market price gain additional benefit from its purchase.
Author:

Fabrizio Ferrari

Fabrizio Ferrari holds a M.Sc. in Economics from Catholic University, Milan. Follow him on Twitter and Linkedin.

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