Monopoly The Elements

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Can a monopolist just announce a higher price? How do unions, professional associations, and governmental agencies act as monopolies? What is monopsony? What is price taking and price searching? How does a higher output spoil the market of a monopolist? What is the algebraic relation between marginal revenue, price, and spoilage? How do you construct a marginal revenue curve for a straight-line demand curve? What areas represent total revenue? How does a monopolist with no costs follow the Rule of Rational Life? Does a monopolist produce the socially optimal output? Does a monopolist ever produce along an inelastic segment of his demand curve?

Monopolies Must Adam Smith observed that "people of the same trade seldom meet together, Restrict Output even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices." His observation is not to be wondered at, because, as he observed elsewhere, "it is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest." Their own interest is to raise the prices, and if their mutual competition drives the price down to marginal cost, it is no wonder that their thoughts turn to raising the price by conspiracy or, a still better contrivance, by law.

A conspiracy, cartel, central selling agency, combination, corner, exclusive franchise, marketing board, pool, professional society, public utility, regulated industry, syndicate, trade association, trade union, trust, or monopoly can raise its price only by restricting the output supplied to demanders. If at a new High Price the members of the European Coal and Steel Community or the American Medical Association (known to its friends as the AMA) attempt to sell more than their customers wish to buy at that price, the price will fall (see Figure

Figure 17.1

The AMA Must Restrict Output to Raise the Price

A monopoly cannot merely set a High Price. Because it must stay on the demand curve of its customers (finding the best possible place on the curve), it must set and enforce a Restructed Output to sustain the price.

Competitive Point

Competitive Point

Medical Services' Price

Medical Services' Price

17.1). Each member of the AMA, facing the High Price for medical services and knowing that his or her individual decision will not affect it, has an incentive to cut the price a little or, equivalently, to offer a larger quantity than the proper share of the Restricted Output. To be precise, summing each of these decisions, the members have an incentive (namely, the incentive of more profit for each cheater on the agreement) to offer the quantity Too Much. But if they do so, the price will fall, initially all the way to Low Price and eventually back to the Competitive Point.

To prevent such a distasteful result, the AMA as an organization must find some effective way to prevent individual doctors from cutting prices. One way is to restrict the number of doctors to a number that will wish to offer only Restricted Output, less than the competitive amount. This the AMA, with the help of state legislatures, has been able to do. Since the Flexner Report of 1910 (which recommended that the number of medical schools be cut) and subsequent enactments (which recommended that the AMA have charge of the cutting), the number of doctors relative to the population has fallen. The demand curve for medical care on the other hand has moved out: Real income per head has more than doubled and medical care has a high income elasticity,- subsidized medicine (Medicare) and medical insurance (Blue Cross) have moved the demand curve out still farther and made it less price elastic. The result is apparent in the incomes of doctors. From 1939 to 1959, for example, the average doctor's iftcome grew two-and-a-third times faster than did the average manager's income ©r'j.r^ and three-and-a-third times faster than did the average industrial employee's.1 _^ c__

Entry Must Be Such are the rewards of monopoly. The key to the rewards is a limitation on Blockaded entry. Without a way of punishing interlopers (such as shooting them, the method favored by monopolies of gangsters), or a patent (such as Polaroid had on the taking of instant photos), or a crushing natural advantage (such as an expensive railway line is said to have once it has been built), or a law (such

1 L. E. Davis and D. C. North, Institutional Change and American Economic Growth (Cambridge: Cambridge University Press, 1971), pp. 204-208.

as those that enrich undertakers by requiring embalming of bodies even if they are to be cremated), monopolies cannot survive.

Q: Chicago Local 546 of the Amalgamated Meat Cutters & Butcher Workmen of North America limits membership in its union and compels supermarkets in Chicago to employ only its members. Until recently, furthermore, it prohibited its members from working after 6 p.m. (one could not buy freshly cut meat from union supermarkets in Chicago after 6 p.m.). True or false: The 6 p.m. restriction can be interpreted as an additional limitation on entry, raising the income of union members.

A: Without the 6 p.m. restriction, the union would not have full control over the number of hours its members supplied, for some members would be willing to work overtime or at unusual hours (for instance, at 6:01 p.m.). By restricting the total number of hours supplied to supermarkets, the union raises the wage that supermarkets are willing to pay for each hour. That is, true.

The key to monopoly, in other words, is stopping a buyer from buying elsewhere. If you buy first-class mail, you must buy it from the U.S. Postal Service. Each year postal inspectors in tan trench coats come around to investigate little children selling you delivery of Christmas cards in the neighborhood. The Service thus prevents you from buying service where you please. The AMA prevents you from buying doctoring where you please. The Amalgamated Meat Cutters union prevents you from buying meat cutting (and therefore meat) where you please.

Monopoly is, then, a restriction on the relation between a buyer and a seller. The analysis is similar and in some points identical to the analysis of taxes and other restrictions. The only difference is that the analysis of monopoly provides a theory of the origin of the restrictions and of the way in which they are exploited.

The theory starts by contrasting monopoly with competition: If buyers and sellers can pair up in any way they wish, and if there are many buyers and sellers, there is no monopoly. Monopoly means one seller (from the Greek, monos, meaning "single," and polein, meaning "to sell"). The seller is the one—one company, one union, one trade assocaition, one licensing body—from whom the buyer must buy. Similarly, duopoly means two sellers, oligopoly means few sellers, and if you like this sort of thing, polypoly (rhymes with Tripoli) means many sellers (that is, competition). Likewise on the buying side, a single buyer is a monopsony: The federal government is a monopsony in the buying of atomic bombs and the single coal mine in a remote village in West Virginia is a monopsony in the buying of labor.

T or F: The "reserve clause" in major league baseball before 1975, which required that the players bargain for their yearly contracts with their present owner alone (and not with other clubs), conferred monopsony power on the owner.

A: The owner was the sole buyer of their services as ball players. Other clubs could not bid for Carl Yastrem-ski or George Scott if the 1967 Red Sox gave them low pay. The rules of the leagues restricted the pairing of buyer and seller, making the owner of the Red Sox the one buyer of the playing services of the Red Sox. The restriction was not slavery, because players had the option of leaving baseball entirely to become journalists or singers. Similarly, in general, monopoly or monopsony is not utter dependence, it is merely an advantage that one person has over another because luck, circumstance, or contrivance makes that person the exclusive buyer or seller. So, true.

The Result Is Price The exclusion of competitors creates a relationship between monopolist and Searching by the victims quite different from the casual and anonymous relationship between Monopolist buyer and seller in the grain pit of the Chicago Board of Trade or in the central food market of Hong Kong. No longer will competing suppliers rush in to fill the victim's demand at a price 1 cent above the competitive price. The monopolist is left alone with the victim. In this delicate situation, the question is, exactly how does the monopolist behave?

The monopolist's behavior is summarized in the phrase price searching. A single competitive firm among many is a price taker—taking its price as given by the market and marketing what it can of it. A monopolist, by contrast, faces not a price but an entire demand curve and is therefore able to search about for the best price to charge. The price that can be charged is fixed by the quantity that the firm offers for sale, so the analysis of a price searcher, like that of a price taker, can focus on the firm's choice of a quantity to offer. The Rule of Rational Life, of course, is to bring the marginal cost of an activity into equality with its marginal benefit, which maximizes the difference between benefit and cost. The monopolist, like the competitor, follows the rule.

Consider the benefit half. The marginal benefit (that is, the marginal revenue) to a competitive, price-taking seller of wheat of selling one more metric ton of wheat is of course the current market price of $150 a ton. Thus, at 100 tons the marginal revenue of 1 more ton is the price; at 101 tons it is the price; at 102 it is the price (see Figure 17.2). The price does not fall when farmer Shlomowitz increases his output (since Shlomowitz is one of millions of farmers in the market), and each additional ton produces additional revenue to him that is equal to the market price.

But the marginal revenue to a monopolistic seller of telephone calls, postal services, photoreproduced copies, or exhibitions of the movie Gone with the Wind of selling one more call, stamp, copy, or exhibition is lower than the

Wheat Price per Ton

$150

Figure 17.2

The Marginal Revenue of a Price Taker Is the Price

If a seller's share of the market is small enough, the seller can disregard any effect that his or her decisions have on the market price and act as if he or she faced a constant price.

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