A Theory of Dual Monopolies

From the perspective of many, on the one hand, and the perspective of non-Austrian economists, on the other, neoclassical and Austrian definitions of monopoly markets fail to address the question of barriers to entry in order to abolish the monopoly. To an extent, both schools offer another solution – government intervention – yet given the more limited definition of monopoly within the Austrian school, as argued by Mises, this explanation is weak. Indeed, Mises specifies the second form of monopoly is one established by government. With this in mind, it is helpful to understand the respective monopoly models concerned here, before proceeding further.

A neoclassical monopoly may be found when a firm within a market has a price elasticity of zero. In effect, they may set any price for their product such that all buyers within the market must be price-takers. Of course, one may be tempted to charge an infinite amount for one’s product in this circumstance; yet as buyers may withdraw themselves from the market when given prices exceed the buyer’s willingness to pay (given demand is characterised by a buyer’s capacity and willingness to pay), there exists instead a price effective for achieving profit maximisation. Therefore, this monopoly firm will set prices at the point of profit maximisation.

Within the Austrian school, and as offered by Mises, the neoclassical definition of a monopoly market is not a monopoly, because competition may eliminate the state of monopoly. A classicist may disagree with this logic, arguing that high barriers to entry will prevent competitors entering the market. However, the Austrian rebuttal is that a market may not be a market without competition; further, competitive advantage will always exist as monopolies do not have perfect knowledge of the market they control, and as such they will forgo profitable opportunities out of ignorance or error. This enables competitors to lucratively enter these markets. Further to this point, an Austrian economist might argue the presence of a neoclassical monopoly is not due to a lack of competition, but rather because of competition, as the individual who enters a market and is able to exploit a monopoly of profitable activity has simply exploited knowledge and expectation – which is to say out-competed rivals – that others have forgone.

Austrians, therefore, draw an important distinction between entrepreneurial profit through better knowledge, and profit achieved through the exploitation of an Austrian-defined monopoly, which shall be discussed shortly. The reason such entrepreneurial and better knowledge exists is because market participants do not have perfect knowledge, as markets do not occur as equilibrium positions between buyers and sellers, but rather are processes that occur over time. For example, a supplier will not know their future demand curve, and as such they may miss-price their product in the future. Such an error may be exploited by rivals for profitable gain; further, such an error occurs because of the firm’s uncertain expectations of the future. Given this argument, Austrian’s dismiss the neoclassical argument of barriers to entry, as they suggest sufficient competition always exists within neoclassical monopolies (and all scenarios which we might call markets) to – over time – eliminate such monopoly positions.

It is Mises that offers two monopolies that may be deemed as such within the Austrian school. The first are those monopolies that are created by the state, and as such warrant limited theoretical discussion. The second occurs when a single firm controls the entire supply of a demanded resource. In this latter monopoly, it is argued, the firm may purposefully manipulate the supply of the monopolised resource to establish the point of profit maximisation. Such a practice is indicative of a neoclassical monopoly, and prompts the same criticism as such a monopoly for not addressing the problem of barriers to entry. Yet Austrians will argue such a monopoly is not a monopoly in the sense that the Misesian monopoly is not a market, for no better information may offer a competitive advantage to rivals, and thus no competition exists. Any gain by the monopoly-firm is not due to entrepreneurial knowledge, but due to circumstantial control of a resource that is demanded by some and that has not no substitute. Following this logic, to argue the issue of barriers to entry is to define or misunderstand this monopoly as a market – there is no competition, and thus no market, and thus Austrian theory does not have to explain such a state of affairs.

It is this paper’s argument, contrary to the logic presented above, that the problem of barriers to entry may be solved for both the Austrian resource monopoly and the neoclassical monopoly by considering the presence of monopolies of demand, and invoking the notion of processive competition employed by prior Austrian theory.

Both monopolies offered are monopolies of supply, achieved by a lack of competition and thus restriction in the neoclassical case, and by purposeful restriction of supply of resource in the Austrian case. The result is that monopoly firms operating in both models will set a price that maximises profit.

Yet any buyers in these models will desire a lower price. This statement is obvious, but may be mired in difficulty as buyers in monopolies must be price-takers. However, following the Austrian school, firms will compete with each other to gain advantage, with knowledge emerging over time. Such knowledge may be that, for a firm pricing at the point of profit maximisation, the withdrawal of a single buyer would result in a price position that will result in reduced returns for the firm. This gives every buyer in a monopoly a quasi-monopoly of demand. A buyer might gain a competitive advantage over rivals by withdrawing their demand less the monopoly-firm lower the price of its resource. Such action might be called irrational, as the refusal to purchase a necessary, monopoly-controlled resource would result in the ineffective activity (and potential failure) of the firm. This paper cites the findings of Kahneman, Knetsch and Thaler (1986), who argue individuals are willing to punish behaviour they consider unfair, even when at cost to themselves, as justification for this line of thinking (also see Zajac’s (1996) discussion on perceived economic fairness).

Irrespective, if exploiting this quasi-monopoly results in the failure of the buyer before the monopoly-firm must adjust prices in favour of the buyer, such attempt at competitive advantage will result in the emergence of better knowledge for all buyer’s transacting with the monopoly firm (it may also be a successful strategy, though one cannot say that the exploitation of a quasi-monopoly of demand will always result in one outcome or the other). This knowledge is that collective withdrawal will force price-adjustment from the monopoly-firm (of course, such certainty only occurs when all buyers threaten or do withdraw from the market; so long as one buyer remains, there is a theoretical ground that allows for negative – for the buyer – price adjustment to occur).

Such action would turn the monopoly-firm into a price-taker, with each reduction in the price resulting in a weaker collective position on the demand side. The logic for this weakness is that eventually the cost of the monopoly resource will fall to less than the cost of an alternative part of a buyer’s production process, and thus competitive gains will be found in greater proportions, for any particular buyer, in other areas. The monopoly-firm, in the Austrian model, will increase supply of the resource – previously restricted – as a means of maintaining profit levels prior to being a price-taker. In the neoclassical model, such a shift will enable more firms to enter the market, essentially increasing supply. Such a supply side response would be expected in a market where prices fall. The collective response on the demand side, which may be called the monopoly of demand, might be likened to collective bargaining within labour markets, and is not a logical, coordinated response within the neoclassical model.

The comparison to collective bargaining within labour markets in certainly a fair one, and indeed, perhaps serves as an exemplar extension to the Mises resource monopoly. Certainly, it serves as evidence for the premise suggested here: that no monopoly on the supply (demand) side might occur without the emergence of a monopoly on the demand (supply) side to challenge it. Yet this paper will not dwell on the labour comparison, for regardless of the theoretical approach taken here, markets such as those for labour are multifaceted and so should not be used as the sole comparison of theory. It is this multifacetedness on the demand side, which may be called entrepreneurial or competitive rivalry in the Austrian school, which offers an extension of the neoclassical model, which should be addressed.

The neoclassical model supposes that demand is determined by the maximum a buyer is willing to pay. It is, therefore, a fallacy in this model to argue a buyer might decide that the price they are willing to pay is not a price they are willing to pay. It is Austrian arguments of time and competition that address this issue: a buyer’s demand for a product at a certain price might only be stable so long as there are other forms of competitive advantage that offer greater returns to be realised. As these returns are realised over time – in part because demand side coalitions may need time to form and effectively lobby – the demand curve, even at stationary prices, will vary over time. It is this logic that explains why an acceptable price for a buyer may simultaneously not be an acceptable price – because there are alternative costs that are more important to address presently.

This paper has briefly offered an adjustment to the neoclassical notion of monopoly by utilising tools espoused in the Austrian school of economics. In doing so, this paper has offered an address of the barriers to entry criticism of the Mises resource monopoly, with respect to the address already offered by the Austrian school. This paper has argued that all monopolies face the emergence of a counter-monopoly that rectifies the original monopoly position. This counter-monopoly emerges due to competition that occurs in other markets. This logic holds for the neoclassical theory of monopoly if a temporal element is added to the evaluation of the demand curve, and addresses the Mises resource monopoly by suggesting competition on the demand side substitutes for the supply side competition, challenging the monopoly firm.

References

Kahneman, D, Knetsch, J, Thaler, R (1986) ‘Fairness as a Constraint on Profit Seeking: Entitlements in the Market’ The American Economic Review, 76(4), pp. 728-741

Kirzner, I (1998) ‘The Driving Force of the Market: The Idea of “Competition” in Contemporary Economic Theory and in the Austrian Theory of the Market Process’ In Prychitko, D (ed.) ‘Why Economists Disagree.’ 1^st ed. Albany New York: State University of New York

Zajac, E E (1996) ‘Perceived Economic Justice: The example of public utility regulation’ In Peyton Young, H (ed.) ‘Cost Allocation: Methods, Principles and Applications.’ Amsterdam: North-Holland.