Putting in Some Good Words for Monopoly

Long ago and far away, when I studied economics, one of the first things that was drummed into my head was the badness of monopoly, oligopoly, and other forms of imperfect competition. The ideal, of course, is perfect competition because it

provides both allocative efficiency and productive efficiency:

  • Such markets are allocatively efficient, as output will always occur where marginal cost is equal to average revenue i.e. price (MC = AR). In perfect competition, any profit-maximizing producer faces a market price equal to its marginal cost (P = MC). This implies that a factor’s price equals the factor’s marginal revenue product. It allows for derivation of the supply curve on which the neoclassical approach is based. This is also the reason why “a monopoly does not have a supply curve”. The abandonment of price taking creates considerable difficulties for the demonstration of a general equilibrium except under other, very specific conditions such as that of monopolistic competition.
  • In the short-run, perfectly competitive markets are not necessarily productively efficient as output will not always occur where marginal cost is equal to average cost (MC = AC). However, in long-run, productive efficiency occurs as new firms enter the industry. Competition reduces price and cost to the minimum of the long run average costs. At this point, price equals both the marginal cost and the average total cost for each good (P = MC = AC).

All of this assumes that a market for a particular product or service is amenable to perfect competition. Economists recognize that such isn’t always the case (e.g., natural monopoly), but most of them nevertheless preach about the evils of market concentration (i.e., monopoly and other forms of less-than-perfect competition).

Contrarian economist Robin Hanson attacks the general view about the badness of market concentration in a pair of recent posts at his blog Overcoming Bias (here and here):

Many have recently said 1) US industries have become more concentrated lately, 2) this is a bad thing, and 3) inadequate antitrust enforcement is in part to blame….

I’m teaching grad Industrial Organization again this fall, and in that class I go through many standard simple (game-theoretic) math models about firms competing within industries. And occurs to me to mention that when these models allow “free entry”, i.e., when the number of firms is set by the constraint that they must all expect to make non-negative profits, then such models consistently predict that too many firms enter, not too few. These models suggest that we should worry more about insufficient, not excess, concentration.

*    *    *

My last post talked about how our standard economic models of firms competing in industries typically show industries having too many, not too few, firms. It is a suspicious and damning fact that economists and policy makers have allowed themselves and the public to gain the opposite impression, that our best theories support interventions to cut industry concentration.

My last post didn’t mention the most extreme example of this, the case where we have the strongest theory reason to expect insufficient concentration: [multi-monopoly]….

The coordination failure among these firms is severe. It produces a much lower quantity and welfare than would result if all these firms were merged into a single monopolist who sold a single merged product. So in this case the equilibrium industry concentration is far too low.

Hanson’s posts caught my eye because I am pleased that at least one practicing academic economist agrees with me. Somewhat long ago, I put it this way (with light editing and block-quotation format omitted for ease of reading):

Regulators live in a dream world. They believe that they can emulate — and even improve on — the outcomes that would be produced by competitive markets. And that’s precisely where regulation fails: Bureaucratic rules cannot be devised to respond to consumers’ preferences and technological opportunities in the same ways that markets respond to those things. The main purpose of regulation (as even most regulators would admit) is to impose preferred outcomes, regardless of the immense (but mostly hidden) cost of regulation.

There should be a place of honor in regulatory hell for those who pursue “monopolists”, even though the only true monopolies are run by governments or exist with the connivance of governments (think of courts and cable franchises, for example). The opponents of “monopoly” really believe that success is bad. Those who agitate for antitrust actions against successful companies — branding them “monopolistic” — are stuck in a zero-sum view of the economic universe, in which “winners” must be balanced by “losers”. Antitrusters forget (if they ever knew) that (1) successful companies become successful by satisfying consumers; (2) consumers wouldn’t buy the damned stuff if they didn’t think it was worth the price; (3) “immense” profits invite competition (direct and indirect), which benefits consumers; and (4) the kind of innovation and risk-taking that (sometimes) leads to wealth for a few also benefits the many by fueling economic growth.

What about those “immense” profits? They don’t just disappear into thin air. Monopoly profits (“rent” in economists’ jargon) have to go somewhere, and so they do: into consumption, investment (which fuels economic growth), and taxes (which should make liberals happy). It’s just a question of who gets the money.

But isn’t output restricted, thus making people generally worse off? That may be what you learned in Econ 101, but that’s based on a static model which assumes that there’s a choice between monopoly and competition. In fact:

  • Monopoly (except when it’s gained by force, fraud, or government license) usually is a transitory state of affairs resulting from invention, innovation, and/or entrepreneurial skill.
  • Transitory? Why? Because monopoly profits invite competition — if not directly, then from substitutes.
  • Transitory monopolies arise as part of economic growth. Therefore, such monopolies exist as a “bonus” alongside competitive markets, not as alternatives to them.
  • The prospect of monopoly profits entices more invention, innovation, and entrepreneurship, which fuels more economic growth.

(See also “Socialist Calculation and the Turing Test“, “Monopoly: Private Is Better Than Public“, and “The Rahn Curve in Action“, which quantifies the stultifying effects of government spending and regulation.)