 Hello and welcome to our third and final session of competition and monopoly Today, we're going to be talking about some applications of monopoly theory and my suggested readings for today are Dominic Armentano's book and I trust the case for repeal an article by Don Boudreau and Tom De Lorenzo called the protectionist roots of antitrust and then Some material from the econ log blog written by David Henderson on The minimum wage or labor market monopsony. We'll be talking about that a little bit later But let's start by reviewing briefly what we've learned up to this point so mainstream or neoclassical economists have a particular understanding of competition and monopoly that seems strange to many lay persons and Certainly doesn't square with what? We Austrian economists believe so in the neoclassical approach to competition and monopoly Competition is a situation or a scenario in which you have a large number of very small firms Each of which faces a perfectly elastic demand curve for its product in other words Each firm can sell as much or as little as it wants at the going price Without influencing that price at all in other words the firms are what they call price takers The result is that all firms set prices equal to marginal cost in order to maximize their profits And in the long run all firms earn exactly zero profit. This is thought to be the most efficient the most most fair Most productive sort of way of organizing production in an economy in contrast Monopoly in the neoclassical perspective is the situation or scenario in which you have a single firm in a market This firm faces a downward sloping demand curve for its product because it's the only firm in the market So it sets the price in that market or rather it chooses a point It chooses a price quantity combination on the market demand curve in other words here There's no difference between the demand curve facing an individual firm and the demand curve facing the market as a whole Because there's only one firm in the market that firm is the market So this firm is able to increase its profits by setting a price not equal to marginal cost But by setting a quantity where marginal revenue is equal to marginal cost and then Bumping the price up to charge the maximum the market will bear and this firm is able to earn profits Even in the long run by exercising its so-called market power Now as we've discussed in the last two meetings There are many problems with this particular approach to competition and monopoly Austrian economists by contrast view competition as a situation in which there are no legal barriers to production and exchange Anyone is free to enter a market to try his or her hand at producing and either to succeed or fail Based on entrepreneurial skill based on the productivity of the resources that firm has at its disposal Consumers decide which products they favor or disfavor and the result can be Can have many different? Outcomes you could have a few small firms or rather a few large firms You can have many small firms some large firms some small firms Even just one large firm at that particular moment as long as any entrepreneur is free to To enter the market or to exit then that market is competitive Regardless of how many firms we tend to see at any particular point in time in other words The emphasis for the Austrians is not on the particular structure of the market at that moment How many firms? What's the size distribution of firms? What's the distribution of profit among firms, but rather the emphasis is on entrepreneurship uncertainty and change Monopoly by contrast for the Austrians is a situation where you have some artificial restriction on entry You have something that limits the ability of entrepreneurs to enter and compete in that market Now for Mises that situation existed in the very rare and unusual case where a firm Has some unique input that is required to produce a good or service So that firm is the only plausible producer in that particular market Plus you have an inelastic demand for the firm's product Above the price that otherwise would have obtained in the absence of the firm having a unique resource The so-called competitive price and for Mises this situation can be analyzed, but it's it's rare And it's not particularly important Rothbard and and Armantano following Rothbard's lead I have a different view in which the only thing you need for competition is the absence of legal restrictions in other words Monopoly exists when you have legal protection when a particular firm has legal protection against competition The only way Monopoly prices can emerge according to Rothbard and Armantano is when the government has effectively Deemed a particular producer as the only legitimate or only legal producer in that market Otherwise the prices that obtain are necessarily competitive prices no matter how high or low And no matter how many firms there are and so forth again The emphasis here is on entrepreneurship uncertainty and change if the government puts artificial barriers in the way of entrepreneurs seeking to bear those uncertainties by trying out different combinations of Resources by trying to produce different goods and services and so forth as long as you don't have that you don't have Monopoly Now why is this so important well according to neoclassical economists the situation of Monopoly as they understand it Leads to some very harmful consequences for the public right consumers pay prices that are higher than the otherwise would be and Consumers don't get as much output from the industry as they would if the industry were not monopolized And therefore the government needs to step in and do something about it Now what should the government do well one option would be for the government according to neoclassical economists We'll be for the government to leave the monopolist in place To leave the sort of structure of the market as it is But simply to dictate a price or a quantity that corresponds to the so-called competitive level So if you look at this a diagram here on slide number three, this is the sort of Standard neoclassical analysis of monopoly as we looked at it before So you have a firm facing a downward sloping demand curve for its product That's the red line and an upward sloping marginal cost curve. That's the blue line But when the demand curve is downward sloping Associated with that demand curve is a marginal revenue curve the green one the green line Which is also downward sloping but is more steeply sloped than the demand curve and lies to the left of the demand curve So the monopolist chooses the quantity Qm where the blue marginal cost line Intersects the green marginal revenue curve, but then sets the price all the way up at PM In other words the highest price you can charge and still clear that quantity still sell that quantity of goods And that's found by going up to the red Demand curve. So according to the neoclassical analysis, this is harmful Because there's a deadweight loss the yellow triangle Representing sort of potential output that could have been produced and could have been sold to consumers But it's not because the monopolist is trying to maximize its profits so What could the government do about this in the neoclassical framework? Well, the government could simply order this monopolist Set up a regulatory agency that has the legal authority to choose prices and quantities and just say hey You're not gonna charge PM. We hereby order you to charge a lower price PC and We hereby order you to increase production to QC, right? So that price quantity pair PC and QC That's the price and quantity that would obtain under perfect competition so-called And therefore you can keep the company there keep the monopolist there, but just say hey We legally force you to act like a perfectly competitive Market so, you know, maybe this is the steel industry and the government sets up a steel board with the authority to Command prices and quantities or this might be a regulated public utility a Water company or an electric company, which is privately owned the way. It's typically done in the US, right? So in the US most public utilities water electricity gas and so forth our private companies They're privately owned companies with with shareholders who receive a dividend and so forth But the government chooses one company and says you're the only company that can operate in this market in exchange for having the legal right to Sell water to sell electricity or gas in this market You have to be subject to our price-setting authority. So we choose the price and we tell you what price to charge in Reality they typically don't charge require the monopolist to price at something like PC. They choose something You know lower than PM But greater than PC and the exact price that they charge depends on kind of the The political power of the electric company or the gas company and the water company or the water company Compared to the voting power of consumers There's a slightly more complicated case that some of you may have studied in school of what's called natural monopoly What natural monopoly means in the neoclassical framework is a situation where because of the the technical aspects of production if you're very high Initial investment high fixed cost, but low marginal cost in other words to supply electricity First you have to build a very expensive nuclear power plant But once you have it built you can produce marginal units of electricity At a very low marginal cost, you know, you've already got the plant you just run it a tiny bit harder So therefore the average cost of production rather than being u-shaped as in the typical case is You know sort of continually downward sloping so you have a marginal cost curve that is also continually downward sloping and therefore Requiring the firm to to produce where price is equal to marginal cost would make the firm earn a loss Because the revenues would be less than its costs at any at any level of output because marginal cost is always below average cost So in that case the regulator is supposed to set a price that's kind of in between the competitive price and the monopoly price Sort of a break-even price. What's the The lowest price we can force this firm to charge Such that it still is able to cover its costs or is able to cover its costs plus earn You know a 5% rate of return for shareholders or something like that so The point is in either case the solution supposedly in this model is you know, whatever Whatever the market structure may be if you have a single firm with an upward sloping marginal cost curve Or a single firm with a downward sloping marginal cost curve The regulator just works with the firm to to set a price that is Reasonable that allows the firm to break even or maybe make a tiny little bit of profit But is not the level it's not the price and quantity that the firm would choose on its own That gives it the highest possible profit So this is the regulator supposedly stepping in and protecting consumers from high prices While allowing the firm to make enough to sort of get by Now there are a number of problems With using price regulation and quantity regulation as a remedy for the inefficiencies and harms that are supposedly caused by monopoly one obvious problem is a Sort of version of Hayek's knowledge problem In other words, it's fine for us to draw these pretty pictures We can draw these diagrams, you know on the blackboard or in a PowerPoint file and say oh, yes Obviously the the price that maximizes overall efficiency is this one right here and point to it Therefore I command the firm I the omniscient regulator, you know to produce this quantity and charge this price but of course In reality these curves are not given to us Right demand curves don't actually exist in reality. They're artificial Explanatory devices their mental constructs that economists use to try to explain particular market outcomes Marginal cost curves average cost curves. They also don't exist in reality They have to be estimated by the entrepreneur who may or may not find these kinds of curves useful But the point is I mean nobody knows what the quote-unquote optimal price and quantity is Even the best intention regulator would have no way of knowing exactly what the right price and quantity should be and if we allow for more realistic i.e. Not perfectly benevolent regulators into our model They might systematically set the price way too high or way too low depending on their political preferences their cognitive biases and all kinds of problems, you know in mainstream economics in recent years So-called behavioral models have been all the rage Supposedly showing how market participants are irrational from a psychological point of view and how people make all these unwise decisions and so forth Well, if you take behavioral economics seriously, why would you want a biased? Cognitively limited regulator having the power to set prices and quantities It's sort of a version of this critique is what is sometimes called the theory of the second best and What this what this theory? Suggests is that, you know all real-world markets Very or different from their sort of blackboard representations in a number of different ways Right, so the monopoly diagram. We just looked at on the previous slide Supposedly tells us that, you know, the firm in the real world is producing too low a quantity and charging too high a price Compared to the you know, the sort of the nirvana price and quantity That would occur in this hypothetical perfectly competitive state But even mainstream economists will acknowledge Yeah, but there might be other sort of imperfections or what they would call market failures So for example, suppose that this this is an electric utility and as a byproduct of producing electricity Let's say it's a coal a coal plant The firm is also polluting right it's it's got too high a carbon footprint It's contributing to climate change and global warming and therefore You know, the blackboard model is not taking into account This negative externality This harm of pollution and you know, if an omniscient regulator knew about the pollution Then as a remedy for the pollution the regulator would call for the firm to produce a lower quantity So to solve the inefficiency of monopoly the regulator is supposed to Make the firm increase quantity To alleviate the pollution problem the negative externality Negative externality problem the regulator is supposed to force the firm To restrict quantity and there might be a dozen other forms of so-called market failure That the regulator is supposed to take into account I mean unless the regulator knows all of these And is able to accommodate all of these By addressing just one or two through price regulation The regulator might be pushing the actual price even farther away From this hypothetical optimum price rather than pushing it closer Right, so maybe the best thing for the regulator to do in this case is not to do anything Because the regulator would have no way of knowing if trying to solve one market failure is making the situation on the whole better Rather than worse Institutional economists and by here. I mean people like ronald koase Harold dem sets oliver williamson and others have pointed to another problem They say look if you take a realistic perspective on regulatory agencies regulatory bodies, you know human beings as regulators leaving aside the behavioral issues that we were talking about You know, what makes us think that an imperfect real world regulator Would be able to fix the problems caused by an imperfect real world firm Harold dem sets famously called this the nirvana fallacy And what he meant was, you know nirvana is a state of perfection in the nirvana world You know everything is just like the perfectly competitive general equilibrium model All prices and quantities are exactly at their perfect levels and so forth The dem sets pointed out. Well, here we have in front of us a realistic a real world monopoly Yes, it's going to look like a failure compared to this nirvana model that we draw on the blackboard But a a real world regulator is also going to be a failure Relative to the nirvana regulator or the nirvana of the regulator of the nirvana world So rather than comparing, you know a realistic unregulated market With a nirvana regulated market We should be comparing the realistic unregulated market with the realistic regulated market in which the regulator, you know Could be bribed the regulator couldn't have a political agenda The regulator could just not be very smart The regulator could simply not have the necessary information You know, if we do an apples to apples comparison of a realistic Unregulated unregulated market and a real world Realistic regulated market. We might find that the former is preferred to the latter Even on kind of neoclassical grounds. There's a great line from ronald coasts in one of his articles where he says something like You know the problem with the term market failure Is that all realistic forms of organization are failures relative to some hypothetical idea So what we should be comparing is the extent of market failure with the extent of government failure And it may of course depending on the particulars of the situation be the case that The the government failure is bigger than the market failure So even if we think the market is imperfect, we should just let it alone Because trying to fix it with regulation is sort of a cure. That's worse than the disease Another potential solution according to mainstream economists would be To have the government intervene in a different way But rather than leaving This this one large firm to dominate the market and then ordering it to choose a different price or quantity or both The government could simply split up this large firm into several smaller firms using antitrust policy So antitrust laws in most countries or the more general term would be competition laws or competition policy These laws are designed to prevent a single firm from coming to dominate a market either by Restricting or outlawing certain kinds of mergers and acquisitions Or by giving the government the authority if it finds one large firm dominating a market To split that firm up to to have the court's order that that firm be You know separated into two or three smaller firms. So for example In the united states the the standard oil company was split up into multiple regional or state level oil companies as the result of an antitrust decree In in u.s federal court. So antitrust is kind of a weird A Kind of a weird issue For economists because even many sort of free market economists or economists Who would consider themselves to be defenders of the free market but come from a neoclassical perspective Are very favorable towards antitrust law This sort of the chicago school milton freedman george stigler and others are famous for expounding this particular view They say that well Under the free market Monopolies tend to emerge Naturally and it's the responsibility of the government to break them up to make markets more competitive, right? So markets are more closely approximate perfect competition Now what uh austrian economists like mary roth barter dominic armantana would say is no That's the wrong free market view the correct free market view is that the government should refrain from granting monopoly privilege In other words any from this point of view anything that emerges in a free and unhampered market is competitive And the role of government is to stop granting monopolies So here you have a disagreement among different Economists coming from different intellectual traditions all of whom would consider themselves to be defending the free market But to the neoclassical economists the chicago style economists What they mean by the free market is something that is as close as possible to perfect competition So defending the free market means you know, they might say well unfortunately or regrettably Sometimes we do need the government to interfere to break up monopolies to make sure we have a truly free market But to austrian economists Free market doesn't mean perfect competition. It means the absence of government interference So having the government break up a large firm into several smaller ones would be the opposite of promoting the free market This would be government interference with the free market So using the u.s as an example Because most countries have something similar In the late 19th century there were a number of important pieces of legislation passed by congress The most important being the sherman act named after one of its sponsors senator sherman This was the first major piece of antitrust legislation in the united states and one of the first in the world And the the the legislation is written So that it outlaws what are called restraints on trade Through monopolistic practices. So, you know, one large firm dominating a market And keeping other firms out simply by virtue of its large size or its superior efficiency would be considered a restraint on trade There are other actions like a group of firms forming a cartel So if two or three firms got together and agreed that they would all charge the same price for a good or service They agreed to to uh, refrain from competing against each other in price This would also be considered a restraint on trade and would be illegal under the sherman act So the whole series of so-called monopolistic practices that are outlawed by this legislation and Dominic armantano's little book goes through them in great detail A later piece of legislation or some some later pieces of legislation expanded the notion of restraints on trade For example, the clayton act pastoring 1914 outlawed price discrimination Which is charging different prices to different consumers for the identical good or what's called tying? which is Having as a condition of sale that the customer also buy another good So you can you can buy my water bottle, but only if you also buy my my soft drink This is also illegal under antitrust laws the robinson patman act of 1936 outlaws so-called predatory pricing Which is the term for situation where one firm that might be more efficient than its rivals Tries to undercut its rivals by charging a price below their average cost Which would be unprofitable for these rivals and this would sort of drive them out of the market Um, of course, this would also potentially result in losses for the firm engaged in so-called predatory conduct But armantano has a nice description of how this How these laws work and and some of the problems with them Now there are a number of practical problems with the standard approach to antitrust policy or competition policy in most countries I mean one i've sort of i've sort of already hinted at And that's that it's not obvious that you should infer monopoly power in the neoclassical sense merely by observing firm size So you could have a market in which one firm has all of the sales or a large You know 75 of the sales not because it engaged in monopolistic practices Not because it engaged in predatory pricing or because some There was some sort of secret cartel agreement Or because the firm has some nefarious way of keeping others out of the market It may be that the firm is simply more efficient than its rivals right so large market share rather than being The cause of superior performance as in neoclassical monopoly theory Maybe the consequence of superior efficiency and hence superior financial performance Right so competition law provides a built-in disincentive For any firm to be particularly Effective right i mean if i enter some market, you know to sell water and i'm a very clever entrepreneur I have some innovative technology or a new way of marketing or distributing water You know if i am so successful that i come to be the dominant water company in My location in my city or region or whatever Then i'm you know subject to potential antitrust prosecution And so why would i want to be why would i want to be that good right? I don't want to be so large that i am a subject to to prosecution by the feds second practical problem is relates to defining the relevant market So i'm broadcasting here from my office at baler university in waco texas Suppose that i am such you know so good at producing and selling bottled water that i end up having a hundred percent Of the share hundred percent market share here in waco texas So am i a monopolist well I mean if we define the market as you know Water bottles that are let's see what how big is this one how many ounces this is 20 ounces if we define the market as 20 ounce bottles of purified water, then we'd say yeah, i have a hundred percent of that market Here in in waco texas, but what about you know, what if i don't sell 10 ounce bottles of water that some other firm does I don't have total I don't dominate the market for smaller bottles of water or larger bottles of water Our our large bottles of water. I you know, do they represent competition to my water bottles? Well, I mean that's up to the consumers many consumers might think yeah I mean if if klein tries to jack up the price of these We're simply going to buy large jugs of water and and and you know fill smaller bottles ourselves What about tap water is if tap water is safe to drink then is that a competitor to my bottled water? What about Bottled tea what about soft drinks what about coffee? There's any number of beverages that under certain circumstances could be substitutes for water Is the market just waco texas or does it include the surrounding areas? Is it the entire state of texas? I mean in principle I could ship my water I could I could put it up on ebay or or uh alibaba or something and sell it all around the world uh, so There's no objective scientific way to determine What is the relevant market that a particular firm? You know has supposedly monopolized That's really sort of just just an arbitrary decision of some economist or some government official who who simply decides Oh You're dominating this market. Well, what market right? I mean for almost any good or service We can imagine potential competitors You say oh well in most countries Uh, the government has a legal monopoly on postal mail So in the united states we say we say the u.s. Postal service has a monopoly on on mail Which is why a lot of people hate using the mail, right? But um, you know, what about email is email a substitute for A send sending a printed letter. Yeah, in most cases it is you can you can have a document you can scan it and you can email it to somebody Uh overnight shipping companies like ups fedx dhl to some degree they compete with postal mail Uh, you know shouting Uh a message to somebody could be a substitute calling somebody on the phone and having a conversation as opposed to sending A paper letter is a kind of Competitor, right? So I mean it's always ultimately arbitrary what we define to be the relevant market So the whole concept of market share is really not a scientific concept because it depends on a potentially arbitrary and subjective decision Determination of what the market is There are a number of practical problems with antitrust law in most countries So in the united states, for example A government agency can file an antitrust suit against a company both the federal trade commission and the Just department of justice antitrust division can file suits But also private competitors can file antitrust suits Right, so some some other entrepreneur in my town who you know Maybe the guy I've totally out competed by selling superior bottled water And he could file an antitrust suit in federal court against me Saying that I've engaged in some nefarious tactics to drive him out of the market Well, maybe consumers just preferred my product to his But now I face the the prospect of a potentially long and very costly antitrust suit Filed by my competitor. So antitrust law can be used opportunistically by politically connected or You know, sort of legally sophisticated But economically inefficient rivals to punish their more efficient competitors And the article by budro and dilorenzo does a great job looking at the actual legislative history of antitrust in the us And they show that Contrary to what, you know, high school students are told and college students are told That in the us antitrust law was created To prevent these horrible monopolists like john d rockefeller and andrew carnegie and so forth from You know exploiting the consumer and and driving other firms out of the market. No, in fact it was These large industrialists and so-called robber barons who were extremely efficient They were continually expanding output and continually lowering lowering prices Such that less efficient firms couldn't compete So these less efficient firms went to the government and said, oh, they're engaged in predatory pricing They're pricing so low that we can't compete. We want you to force them to stop doing that In other words, we want prices to be higher so that we can compete and make more money Another practical problem is that You know, even if you believe that yeah in theory Uh antitrust law is a good way to prevent firms from dominating the market or exercising monopoly power I mean in practice if you're going to use, you know, we talked about regulatory bodies before if you're going to use the court system to enforce antitrust laws, well, I mean antitrust trials Can take a very long time. They're very complicated You know, all these issues about market definition that I referred to before Different experts arguing about whether a price really is a monopoly price or not I mean these suits can take months or years or in some cases even decades But you know actual markets competition in real markets is very rapid Competition is quick especially in markets where there's a lot of technological innovation a great example of this is Uh, they have famous antitrust case against IBM in the United States in the 1970s Which lasted for I think I think 13 years Before the government finally dropped the suit and the reason that they dropped the suit was because IBM had been accused of monopolizing the market for mainframe computers well A decade or more into the trial People all of a sudden realized that that market didn't exist anymore right because the desktop pc Had uh been introduced and had basically wiped out the mainframe computer industry So the industry that IBM was alleged to have monopolized no longer existed There's a great book on this by a neoclassical economist frank fisher called folded spindled and mutilated published in 1985 which is a great history of You know the huge waste of time and effort and money that went into this Antitrust suit more recent example would be several antitrust suits Filed both in the us and europe against microsoft So in the 1990s microsoft was accused of using its so-called monopoly on the desktop Right the fact that 90 something percent of new pc's were being shipped with microsoft windows pre-installed To dominate the emerging market for web browsers So some i don't know how many of you use internet explorer as your primary browser I'm guessing not very many and probably even fewer use microsoft's newer version edge It's called most of you use google chrome or maybe most of the firefox Or use the browser on your phone, whatever that might be safari, etc um But as in the mid 90s when uh The federal trade commission filed this antitrust suit against microsoft Accusing them of trying to drive other browsers out of the market. I mean the funny thing is that uh That suit dragged on for years microsoft finally signed a consent decree Where it agreed not to Require manufacturers to put internet explorer on the desktop as a precondition of allowing them to pre-install microsoft windows On their computers, but i mean again the whole thing is technologically obsolete now Because the market decided that it preferred other browsers in particular google's chrome browser And apple safari to internet explorer. So internet explorer would have died anyway I mean the point is even you know firms with very large market shares Cannot impose their will on consumers Consumers can always choose the products and services that they like And if a product is not good in the mind of the consumer subjectively determined The no amount of bundling or tying No attempt to leverage market power is going to succeed in forcing consumers to buy something that they don't want Now there are a number of theoretical problems as well And we've already discussed them right according to rothbard There is no scientific means of determining or distinguishing in the real world monopoly prices from competitive prices Other than the existence of government created entry barriers And therefore i mean there's no monopoly problem to solve with antitrust law Right, there's no purpose to antitrust law the only role of government in terms of Mitigating monopoly problems is is simply not to grant monopoly privilege Right, so i mean if you accept the theoretical apparatus of the austrian school The case for antitrust law just sort of dissolves I mean it addresses a problem that doesn't exist in the austrian understanding of the competitive market process There's also kind of you know a legal problem namely that antitrust laws are what they call expost facto Meaning there is no way for a firm to determine ahead of time if a particular behavior or conduct violates antitrust law Right, i mean the hallmark of a well functioning legal system is objectivity and transparency In the sort of the nature of the law and people's ability to understand the law Right, I should know ahead of time whether i'm committing robbery or not It would be uh, it would be very strange to have a law that says well You know if you if you break into someone's house And you take something that belongs to them that may or may not be robbery depending on how the court is feeling that day I mean then I I wouldn't really know if what i'm doing is legal or not That would be confusing that would be you know difficult and so forth That's kind of a silly example because it's obvious to us that breaking into somebody's house and taking their stuff is not right But you know and then I trust it doesn't work that way. Actually, there's a great article by alan greenspan Back in his randy in days That he uh where he discussed this problem in in uh in in some detail that you know No firm can know ahead of time whether it's violating an antitrust law or not because antitrust laws is deliberately vague Right firms are forbidden from engaging in actions. For example, that would constitute an illegal restraint of trade Okay, well, uh, I've expanded my output of water bottles with new Production equipment and I've increased my market share from 70 percent here in waco, texas to 80 percent of the market for 20 ounce bottles of purified water Uh Have I violated the the Sherman act? I don't know. I mean maybe I have a court could rule that. Oh, yeah 80 percent is too high But another court could rule that no that's perfectly fine Right, so I don't have any way of knowing whether my actions are legal or not Which puts you into kind of this bizarro world Where you live, you know, not under the rule of law but the rule of men and so It's a real problem for companies, especially large companies And I think in a free market in if we you know absent antitrust law There might be competitive pressures that would allow firms to grow even larger than they do now So this is an artificial limit on firm size and scope in the real world You know the smaller you are the less likely you are to be a target of an antitrust suit But the larger and more successful you are the more likely You'll be the the target of a government launched or a competitor launched antitrust suit And this is a real cost The uncertainty And the actual legal costs of going through a suit are something that is really harmful to large companies There's a very funny book a cartoon book That nicely illustrates this point. It's by A RW grant called Tom Smith and his incredible bread machine. I think if I think you can find the whole thing online it's it's a sort of A comic yet tragic story of an entrepreneur who invents this wonderful machine but then Is sort of attacked by the government and by inefficient rivals and he's sort of quashed by the state But there's a great line as it's written as poetry in the book Where some government bureaucrat is explaining to tom smith what he's done wrong and the bureaucrat says the following He says you're gouging on your prices If you charge more than the rest But it's unfair competition if you think you can charge less A second point that we would like to make to help avoid confusion Don't try to charge the same amount. That would be collusion In other words If the protagonist charges a higher price than his rivals, then he is engaged. He's exploiting his market power by price gouging If he charges less than his competitors, he's exploiting his market power Through predatory pricing If he charges the same as his competitors, he's engaged in illegal collusion So no matter what he's doing, it's illegal according to the government So imagine being in that situation yourself and having no idea what you can do That would be legal now my old dissertation advisor and 2009 Nobel laureate oliver williamson Made some interesting arguments Really coming from a neoclassical perspective But a more a more subtle and more savvy neoclassical perspective Against the standard treatment of antitrust and monopoly Well, williamson points out that even within the neoclassical framework A large firm with a large market share, you know might actually have a lower per unit cost Than smaller firms in other words Consumers might actually benefit from the superior efficiency of the monopolist Even while they are you know harmed quote unquote by the monopolist charging higher prices And williamson showed in an article in the 1960s that depending on how you do the math and how you Do the diagrams the efficiency game could outweigh The loss Of consumer welfare from monopoly pricing such that even within the neoclassical framework There might be cases where it's better for the market To permit monopoly rather than competition. I mean what this article I think nicely does is highlight Kind of the arbitrariness of the neoclassical framework in this context that you can Depending on how you set the parameters You can get any number of market structures being sort of optimal from the consumer's point of view And there's simply no way to come up with a consistent policy on what firms should or should not be allowed to do If your goal is to improve consumer well-being But williamson is even better known for his later work on vertical integration vertical integration Describes a case where a particular firm Owns more than one productive stage, right? So if I You know if I'm a bottler if I bottle and sell purified water But I also own the delivery trucks that take the bottled water to retail stores And maybe I own my own retail store that sells the bottled water Then I have a vertically integrated production process And many parts of antitrust law particularly the robinson-patman act Effectively make certain kinds of vertical integration illegal Because this is viewed as a illegitimate Attempt to exploit or leverage monopoly power in one productive stage To sort of dominate another productive stage Williamson in particular attacked what are called vertical restraints So so for example resale price maintenance That that describes the case where suppose that I produce these bottled waters and then I sell them to a number of retailers grocery stores convenience stores It's illegal under antitrust law for me to set a minimum price In other words for me to say to a convenience store. I'll sell you all these water bottles, but I don't want you to charge anything less than a dollar a bottle And maybe that's because I'm also selling them through my own Stores at a dollar a bottle. I don't want the convenience store to Charge a lower price than mine. That would be illegal under the robinson-patman act and williamson argued that no in fact vertical restraints like resale price maintenance and territorial restrictions and other kinds of Complicated contracts between say manufacturers and distributors May actually serve an efficiency purpose In protecting particular kinds of investments that these firms might have to make From sort of opportunistic behavior by other by their trading partners And he contrasted his approach into which vertical integration often increases efficiency To what he called the inhospitality tradition in antitrust and it's actually a pretty fundamental point the what williamson meant by the inhospitality tradition was that the the tendency for antitrust authorities To view any deviation from perfect competition as per se suspicious He was focusing specifically on vertical integration, which doesn't happen in perfect competition Because there's only one stage of production in perfect competition So antitrust authorities would encounter some phenomenon in the real world like resale price maintenance and say, hmm You know that doesn't exist under perfect competition and perfect competition is the ideal Therefore resale price maintenance must be bad. It should be illegal. The antitrust law should take it out Williamson said no, you need to study phenomena like resale price maintenance carefully And you may find and you will find in the typical case that actually resale price maintenance serves an efficiency purpose Right it it protects for example my incentives to invest in certain kinds of water bottling technology I wouldn't do that if I thought that My resellers would be charging a price below the price that allows me to recover my cost for producing that Investing in that technology So I think it's actually a pretty profound point that, you know, essentially we should throw perfect competition out the window Perfect competition should not be used as a welfare benchmark It just misleads regulators and antitrust authorities and economists and journalists and so forth Into thinking that all kinds of complex and innovative market phenomena are suspicious Rather, we should assume as a default that unusual behavior that emerges on the market Is probably in the best interest of consumers absent government intervention Now I want to discuss one final application of monopoly theory One that you might not have been expecting and that's an application to the minimum wage So as you may know over the last 15 20 years, there's been a big controversy and debate within the mainstream economics literature On minimum wages and whether minimum wage laws might actually help workers rather than hurt them Because you see up until the mid 1990s almost every economist Certainly all austrian economists and almost all neoclassical economists believe that minimum wages were not a very good way to help low wage workers and the way Most economists understood this can be illustrated with a simple supply and demand diagram Like the one I have on this slide here on slide 10 Right, so imagine a market for labor in which you have the price of labor the wage on the vertical axis And the quantity of labor The amount of employment on the horizontal axis Right, and if you have a downward sloping demand curve for labor and an upward sloping supply curve for labor You get an equilibrium wage What's indicated here on the diagram is the free market wage, right where the red line and the blue line intersect So remember that labor supply represents Or what underlies that labor supply curve is the willingness of workers to take certain kinds of jobs or to supply certain quantities of labor at particular wages Whereas the demand curve for labor the downward sloping red line represents the willingness of employers To hire certain quantities of labor at particular prices and that comes from What economists call the marginal revenue product of labor rothbard used the term marginal value product, but it means the same thing It's the marginal contribution of a particular unit of labor To the entrepreneurs revenues the employers revenues So the standard story which is still in most of the economics textbooks And and what I would say is a correct story Right is that if the government sets a minimum wage above the free market wage above the market clearing wage That's going to result in an excess supply of labor Right, so you can see on the diagram there if the government sets a minimum wage at that higher level at that price Right the quantity supplied of labor Where that dashed line intersects the blue labor supply curve Is a larger quantity Than what employers would demand at that price Right where that dashed horizontal line hits the red line hits the red curve Right, so at the higher minimum wage at the minimum wage above the free market wage The quantity of labor supplied is greater than the quantity of labor demanded at that wage Leading to unemployment, right? There there are more people wishing to work or there are more hours of work available than The amount that employers are willing to pay for so some people get out of work or thrown out of work, right? So at the higher minimum wage those workers who can still keep their jobs Will actually earn a higher wage than they would have without the minimum wage But many Employees who would like to have worked at a lower wage will be priced out of the market And so there's an increase in unemployment That goes along with the increase in the minimum wage and in most cases that loss will outweigh the the gains So this is why most economists for You know 100 years or more have believed that you know The only way to improve the well-being of low wage workers over time is through productivity gains Right capital investment innovation and entrepreneurship that increases the marginal productivity of labor And thus increases the demand for labor that will increase the price on the free market But if the government to arbitrarily set a price above the market clearing price simply leads to a surplus of the good or service So that was the traditional explanation for a long time There were a number of empirical studies in the 1990s by David card and alan kruger and a number of their students and colleagues claiming to show that where Different cities and states had increased their minimum wage relative to other cities and states unemployment had not in fact gone up And so there must be something wrong with the standard analysis But it was very difficult to come up with theory that could explain this Right as long as the demand curve for labor is downward sloping an increase in the minimum minimum wage above the Market clearing level should generate a surplus of labor and unemployment So there were some attempts to explain away these findings by saying that well maybe In fact workers get paid on multiple margins. They get a money wage, but they also get break time or Free tools or free uniform or if it's say the fast food industry they get free meals And employers respond to an increase in the money wage by cutting back on those side benefits So that in fact, you know, even though the money wage has gone up the actual value of the compensation has stayed the same And that's why firms don't actually End up employing fewer workers. That's why we don't see a spike in unemployment Other there were other economists who critiqued the empirical studies And said that what card and kruger had done was actually not correct They had made a lot of mistakes with their data and so forth So there's a big controversy about this in uh, among labor economists But I think most economists were were pretty uncomfortable with this view that you can increase the minimum wage without causing unemployment But more recently, uh, mainstream economists who favor minimum wages have taken a different approach And that is to appeal to so-called monopsony wages What is monopsony? Monopsony is a less familiar term than monopoly But it does appear in some neoclassical economics textbooks and it's sort of an analogy to monopoly Uh, it also comes from from the greek where monopoly means single seller Monopsony means single buyer So the idea here is what if you have say, uh You know a particular community Where there's one large employer in town, there's one big factory and that's the only factory in town And that employs almost everybody in the town Then according to this argument, uh, you don't really have a competitive market for labor So you can't draw supply and demand curves for labor in the usual fashion and say that well, there You know many workers competing with each other to supply labor and there are many firms competing with each other to hire labor In fact, you only have one firm that hires all the labor So that firm again has a kind of a market power on the buyer side Compared to the monopoly firm that supposedly has market power on the seller side Right, so remember in a in the market for an input like labor The suppliers the sellers are individual workers The buyers are employers firms that hire labor Or whatever the factor is so if you have one large dominant buyer and a lot of small sellers this argument goes The buyer can also exercise a kind of market power So there's a diagram that is analogous to the monopoly diagram in neoclassical economics Here we have a downward sloping demand curve the red line This is a labor market supposedly an upward sloping supply curve But because instead of many competing buyers You only have one dominant buyer That buyer does not have to choose prices where demand equals supply Rather that monopsony buyer chooses what quantity to buy By looking at where the marginal revenue curve intersects the marginal cost curve of labor And the marginal cost of labor under monopsony is higher than greater than and it increases more steeply than the supply curve So you have uh You know whereas under competition According to this argument the the equilibrium wage would be w prime And the equilibrium quantity would be capital l prime under monopsony The monopsonist chooses a lower quantity of labor This uh capital l and then prices the chooses the lowest possible price that will still allow The monopsonist to hire the required quantity of labor. That's this wage l So it's it's kind of analogous to the monopoly diagram, but kind of flipped around So remember in the monopoly diagram the monopolist chooses a quantity where marginal revenue equals marginal cost And then charges the highest possible price the market will bear Here the monopsonist chooses a price. Sorry chooses a quantity to hire Where marginal revenue is equal to marginal cost and then offers the lowest wage the market will bear this wage w So the argument that you find uh coming out just in the last You know five years or so That supposedly justifies minimum wage laws is that well Just like we have monopoly in the real world in the real world. We don't have perfectly competitive labor markets We have monopsony labor markets Employers have market power which allows them to pay wages lower than the Equilibrium competitive wage therefore we need minimum wage laws to get the actual wage in the market closer to w prime Okay The wage in the market is not good according to this argument because employers have monopsony power They need to be forced to pay higher wages just as monopoly firms need to be forced to charge lower prices for their outputs What's wrong with the monopsony argument well lots of things right, I mean we could start by Approaching this problem the same way that rothbard and armantano approach the monopoly problem Right, we can say well look All supply curves in input markets are upward sloping. There's no such thing as a perfectly competitive supply Perfectly competitive labor market. So in the real world there would be no way to distinguish A competitive input price from a monopsynistic input price In other words, there's no way to know That the wage that actually prevails on the market the w in the previous in the graph on the previous slide Is not you know that there's anything wrong with that There's no way to say that there should be a different wage that would be higher Right again a competitive labor market in rothbard sense does not mean that employers face a perfectly elastic supply curve They can hire as many workers Or as few workers as they want without affecting the going wage. No all Users of resources all employers of labor or all employers of any factor You know have some ability to influence the price and so as long as we don't have government interference in the market As long as new suppliers New firms are free to enter the market And and try to bid those workers away by offering higher prices Then we have a competitive labor market and we can't say that there's anything inefficient about the wages that prevail Right, so again here. We're just using the general austrian notion of competition And we could say just as austrians understand monopoly to be a government grant of special privilege Likewise, they would understand monopsony to have meaning only when you have a government grant of special privilege But on a practical level and I think david henderson does a good job bringing this out in his econ log posts that I asked you to read I mean this doesn't doesn't make any sense at all for the labor market for unskilled workers I mean it's hard to think of any community Where for entry-level work minimum wage work, you know flipping burgers at a fast food joint Or uh, you know stocking warehouse shelves or bagging groceries I mean You know factories employing skilled workers are not paying minimum wages. They're paying much more than the minimum wage Minimum wage jobs are typically for highly unskilled labor Labor is very mobile There are lots and lots of potential employers Of low skilled labor labor in fact in most american towns Or at least in many american towns where there's economic growth in those towns even mcdonald's and burger king and And and the local grocery stores They're all paying higher than the minimum wage to attract teenagers Because there are so there's such a demand for unskilled labor That at the minimum wage if a firm only offered the minimum wage it wouldn't be able to hire anybody So it's hard to imagine an actual market where you have no competition among employers For low skilled labor or we have some kind of buyer's cartel You know all fast food restaurants agree that they will not pay above the minimum wage Well a cartel like that would simply be unsustainable Because it would be in the interest of any individual cartel member to offer a higher wage Than the legal minimum wage to try to recruit low skilled workers away from rivals I mean it just doesn't seem to make any sense when applied to labor markets Remember that labor is the least specific resource Of all the resources that are used in production Unskilled labor in particular unskilled labor can be blind to many many production processes So you'd have to believe for this argument to hold That you know McDonald's workers can only work in fast food. They can only flip burgers And there's only one McDonald's in town or all the burger restaurants in town have somehow colluded to keep wages down That's the only way you could make you know this story Could go through but like I say it doesn't make sense if you can flip burgers You can do any number of unskilled tasks and there are lots and lots of potential employers even in a small town for unskilled labor So to me, this is sort of the last Last gasp Of the minimum wage defenders to try to come up with some theoretical rationale For something they just like they just like minimum wages for political reasons or whatever. They think it's more fair Or who knows what but to me, this is an extremely weak argument but I mean it's it's worth going over because You know once you buy in to the neoclassical notion of perfect competition as the ideal You can find all kinds of ways in which real markets deviate from that ideal And hence all kinds of rationales for the forms of government intervention that you like best So to conclude what have we learned in these three sessions? Or what do I hope that we have learned? Well that to an Austrian economist competition is best understood as a process of rivalry among firms Or we should say among entrepreneurs Workers investors suppliers who are free to compete as they see fit within a given legal framework so Theft is outlawed Maybe certain kinds of fraud are outlawed But subject with with except for those kinds of restrictions Entrepreneurship is free to flourish That is what competition means not a certain market structure Not a certain distribution of firm size Not anything that looks like the perfectly competitive model on the blackboard, right? So under competition true competition or competition properly understood We might see few firms or many firms We might have large firms or small firms Some firms will earn profits some will earn losses Maybe most firms will earn profits or most will earn losses In the short term, right what we would expect to see is entry exit Growth of firms Maybe shrinkage of firms or the industry innovation and experimentation We would expect firms to enter and exit firms to Rise and fall industries to grow and contract. That's part of what a healthy Market economy looks like Examining a particular market at a particular point in time and arbitrarily deciding that some market shares are too large Is simply an arbitrary and unscientific way to think about? markets and competitions And competition government attempts to limit so-called monopoly power or market power cannot improve the well-being of individuals in a society The best government policy towards competition Is for the government not to grant monopoly privilege to its favorite firms So i've really enjoyed having these conversations with you. Thank you for joining us for this mesis academy course Please feel free to contact me at any time at pcline at mesis.org pklin at mises.org And i'd look forward to talking to you about these topics about the readings or about anything related to competition and monopoly So thanks again, and i look forward to seeing you again soon