Monopolies And Cartels

Sometimes one company produces the total output of a given good or service in a region or a country. For many years, each local telephone company in the United States was a monopoly in its region of the country and that remains true in some other countries. For about half a century before World War II, the Aluminum Company of America (Alcoa) produced all the virgin ingot aluminum in the United States. Such situations are unusual, but they are important enough to deserve some serious attention.

Most big businesses are not monopolies and not all monopolies are big business. In the days before the automobile and the railroad, a general store in an isolated rural community could easily be the only store for miles around, and was as much of a monopoly as any corporation on the Fortune 500 list, even though the general store was usually an enterprise of very modest size. Conversely, today multi-billion-dollar nationwide grocery chains like Safeway or Giant have too many competitors to be able to price the goods they sell the way a monopolist would price them.

Just as we can understand the function of prices better after we have seen what happens when they are not allowed to function, so we can understand the role of competition in the economy better after we contrast what happens in competitive markets with what happens in markets that are not competitive.

In earlier chapters, we have considered prices as they emerge in a free market with many competing enterprises. Such markets tend to cause goods and services to be produced at the lowest costs possible under existing technology and with existing resources. Take something as simple as apple juice. How do consumers know that the price they are being charged for apple juice is not far above the cost of producing it? After all, most people do not grow apples, much less process them into juice and then bottle the juice, transport and store it, so they have no idea how much any or all of this costs.

Competition in the marketplace makes it unnecessary to know. Those few people who do know such things, and who are in the business of making investments, have every incentive to invest wherever there are higher rates of return and to reduce their investments where the rates of return are lower or negative. If the price of apple juice is higher than necessary to compensate for the costs incurred in producing it, then high rates of profit will be made-and will attract ever more investment into this industry until the competition of additional producers drives prices down to a level that just compensates the costs with the same average rate of return on similar investments available elsewhere in the economy. Only then will the in-flow of investments from other sectors of the economy stop, with the incentives for these in-flows now being gone.

If, however, there were a monopoly in producing apple juice, this whole process would not take place. Chances are that monopoly prices would remain at levels higher than necessary to compensate for the costs and efforts that go into producing apple juice, including paying a rate of return on capital sufficient to attract the capital required.

Many people object to the fact that a monopolist can charge higher prices than a competitive business could. But its ability to transfer money from other members of the society to itself is not the sole harm done by a monopoly. From the standpoint of the economy as a whole, these internal transfers do not change the total wealth of the society, even though this redistributes that wealth in a manner that may be considered objectionable. What adversely affects the total wealth in the economy as a whole is the effect of a monopoly on the allocation of scarce resources which have alternative uses.

When a monopoly charges a higher price than it could charge if it had competition, consumers tend to buy less of the product than they would at a lower competitive price. In short, a monopolist produces less output than a competitive industry would produce with the same available resources, technology and cost conditions. The monopolist stops short at a point where consumers are still willing to pay enough to cover the cost of production (including a normal profit) of more output because the monopolist is charging more than the usual cost of production and making more than the usual profit. In terms of the allocation of resources which have alternative uses, the net result is that some resources which could have been used to produce more apple juice instead go into producing' other things elsewhere in the economy, even if those other things are not as valuable as the apple juice that could and would have been produced in a free competitive market. In short, the economy's resources are used inefficiently when there is monopoly, because these resources would be transferred from more valued uses to less valued uses.

Fortunately, monopolies are very hard to maintain without laws to protect the monopoly firms from competition. The ceaseless search of investors for the highest rates of return virtually ensures that such investments will flood into Whatever segment of the economy is earning higher profits, until the rate of profit in that segment is driven down by the increased competition caused by that flood of investment. It is like water seeking its own level. But, just as dams can prevent water from finding its own level, so government intervention can prevent a monopoly's profit rate from being reduced by competition.

In centuries past, government permission was required to open businesses in many parts of the economy, especially in Europe and Asia, and monopoly rights were granted to various businessmen, who either paid the government directly for these rights or bribed officials who had the power to grant such rights, or both. However, by the end of the eighteenth century, the development of economics had reached the point where increasingly large numbers of people understood how this was detrimental to society as a whole and counter-pressures developed toward freeing the economy from monopolies and government control. Monopolies have therefore become much rarer, at least at the national level, though it remains common in many cities where restrictive licensing laws limit how many taxis are allowed to operate, causing fares to be artificially higher than necessary and cabs less available than they would be in a free market.

Again, the loss is not simply that of the individual consumers. The economy as a whole loses when people who are perfectly willing to drive taxis at fares that consumers are willing to pay are nevertheless prevented from doing so by artificial restrictions on the number of taxi licenses issued, and thus either do some other work of lesser value or remain unemployed. If the alternative work were of greater value, and were compensated accordingly, then such people would never have been potential taxi drivers in the first place.

From the standpoint of the economy as a whole, this means that consumers of the monopolist's product are foregoing the use of scarce resources which would have a higher value to them than in alternative uses. That is the inefficiency which causes the economy as a whole to have less wealth under monopoly than it would have under free competition. It is sometimes said that a monopolist "restricts output," but this is not the intent, nor is the monopolist the one who restricts output. The monopolist would love to have the consumers buy more at its inflated price, but the consumers stop short of the amount that they would buy at a lower price under free competition. It is the monopolist's higher price which causes the consumers to restrict their own purchases and therefore causes the monopolist to restrict production to what can be sold. But the monopolist may be advertising heavily to try to persuade consumers to buy more.

Similar principles apply to a cartel-that is, a group of businesses which agree among themselves to charge higher prices or otherwise avoid competing with one another. In theory, a cartel could operate collectively the same as a monopoly. In practice, however, individual members of cartels tend to cheat on one another secretly lowering the cartel price to some customers, in order to take business away from other members of the cartel. When this becomes widespread, the cartel becomes irrelevant, whether or not it formally ceases to exist.

Because cartels were once known as "trusts," legislation designed to outlaw monopolies and cartels became known as "anti-trust laws." However, such laws are not the only way of fighting monopolies and cartels. Private businesses that are not part of the cartel have incentives to fight them in the marketplace. Moreover, private businesses can take action much faster than the years required for the government to bring a major anti-trust case to a successful conclusion.

In the nineteenth-century heyday of American trusts, Montgomery Ward was one of their biggest opponents. Whether the trust involved agricultural machinery, bicycles, sugar, nails or twine, Montgomery Ward would seek out manufacturers that were not part of the trust and buy from them below the cartel price, reselling to the general public below the retail price of the goods produced by members of the cartel. Since Montgomery Ward was the number one mail-order business in the country at that time, it was also big enough to set up its own factories and make the product itself if need be.

The later rise of other huge retailers like Sears and A & P likewise confronted the big producers with corporate giants able to either produce their own competing products to sell in their own stores or to buy enough from some small enterprise outside the cartel to enable that enterprise to grow into a big competitor. Sears did both. It produced stoves, shoes, guns, and wallpaper, among other things, in addition to subcontracting the production of other products. A

& P imported and roasted its own coffee, canned its own salmon, and baked half a billion loaves of bread a year for sale in its own stores.

While giant firms like Sears, Montgomery Ward and A & P were unique in being able to compete against a number of cartels simultaneously, smaller companies could also take away sales from cartels in their respective industries. Their incentive was the same as that of the cartel-profit. Where a monopoly or cartel maintains prices that produce higher than normal profits, other businesses are attracted to the industry. This additional competition then tends to force prices and profits down. In order for a monopoly or cartel to succeed in maintaining profits above the competitive level, it must find ways to prevent others from entering the industry. That is easier said than done.

One way to keep out potential competitors is to have the government make it illegal for others to operate in particular industries. Kings granted or sold monopoly rights for centuries, and modern governments have restricted the issuance of licenses for various industries and occupations, ranging from airlines to taxicabs to trucking to the braiding of hair. Political rationales are never lacking for these restrictions, but their net economic effect is to protect existing enterprises from additional potential competitors and therefore to maintain prices at artificially high levels. For much of the late twentieth century, the government of India not only decided which companies it would license to produce which products, it imposed limits on how much each company could produce.

Thus an Indian manufacturer of scooters was hauled before a government commission because he had produced more scooters than he was allowed to and a producer of medicine for colds was fearful that the public had bought "too much" of his product during a flu epidemic in India. Lawyers for the cold medicine manufacturer spent months preparing a legal defense for having produced and sold more than they were allowed to, in case they were called before the same commission. All this costly legal work had to be paid for by someone and that someone was ultimately the consumer.

In the absence of government prohibition of entry, various clever schemes can be used privately to try to erect barriers to keep out competitors and protect monopoly profits. But other businesses have incentives to be just as clever at evading these barriers. Accordingly, the effectiveness of barriers to entry have varied from industry to industry and from one era to another in the same industry. The computer industry was once difficult to enter, back in the days when a computer was a huge machine taking up a major part of a room, and the costs of manufacturing such machines was likewise huge. But the development of microchips meant that smaller computers could do the same work and chips were now inexpensive enough to produce that they could be manufactured by smaller companies. These include companies located around the world, so that even a nationwide monopoly does not preclude competition in an industry. Although the United States pioneered in the creation of computers, the actual manufacturing of computers spread quickly to East Asia, which supplied much of the American market with computers.

In addition to private responses to monopoly and cartels which arise more or less spontaneously in the marketplace, there are government responses. In the late nineteenth century, the American government began to respond to monopolies and cartels by both directly regulating the prices which monopolist and cartels were allowed to charge and by taking legal punitive action against these monopolies and cartels under the Sherman Anti-Trust Act of 1890 and other later antitrust legislation. When railroads were first built in the nineteenth century, there were many places where only one rail line existed, leaving these railroads free to charge whatever prices would maximize their profits where they had a monopoly. Complaints about this situation led to the creation of the Interstate Commerce Commission in 1887, the first of many federal regulatory commissions to control the prices charged by monopolists. During the era when local telephone companies were monopolies in their respective regions and their parent company--A.T& T-had a monopoly of long-distance service, the Federal Communications Commission controlled the prices charged by A. T&T, while state regulatory agencies controlled the price of local phone service.

Another approach has been to pass laws against the creation or maintenance of a monopoly or against various practices, such as price discrimination, growing out of monopolistic behavior. These anti-trust laws were intended to allow businesses to operate without the kinds of detailed government supervision which exist under regulatory commissions, but with a sort of general surveillance, like that of traffic police, with intervention occurring only when there are specific violations of laws.

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