Monopoly, competition, supply and demand

Posted on September 19, 2010

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Market prices are driven by supply and demand. Competition in a market is the freedom to increase the supply. Markets that are oversupplied may create a situation where prices are so low that no firms can earn profits increasing the supply, or only one gigantic firm can. This is not a monopoly situation, while a government control on the size of this firm does create a monopoly and raise prices by lowering supply growth.

The capitalist revolution of the 19th century changed the economic course of humanity in one most characteristic aspect: it allowed the investment of capital goods at scales previously unimaginable. Where previously production had been done by “putting out” into cottage industries, the early capitalists were setting out to build factories employing hundreds of workers under one roof. In many markets, this model of production achieved economies of scale that made all other centers of production irrelevant.

While scaling is the defining characteristic of capitalism, it has caused nearly perpetual confusion over the workings of the market economy, mainly over how it is possible for industries to scale while markets remain competitive. Under neo-classical perfect competition models, a market becomes more competitive as more firms enter it, while under the capitalist system fewer and fewer firms were supplying increasingly commoditized goods. This reduction in the number of participants led Karl Marx, for example,┬áto assume that the end process of capitalism was the total concentration of all production within one industry, which would achieve unlimited productivity and thus a scarcity-less society that the workers could expropriate from the capitalists and live within a communist utopia. Marx’s prediction turned out to be wrong due to the fact of diminishing returns catching up with capitalist industries; industries who grow too large often collapse in the face of competition from smaller outfits (the General Motors corporation being the latest victim).

Under classical-Austrian economic theory, markets are defined by their supply and demand in time, and not by any particular number of “firms” producing. Supplies are consumed in time, and time is required to expand supplies. For example, there may be hundreds of millions of automobiles in America, but only a few million are produced every year. The supply of automobiles consists of hundreds of millions, not just the current output of the automobile industry. Should all automobile companies mysteriously vanish tomorrow the supply of automobile would still fulfill demand for automobiles, although only so long as used automobiles could be repaired and kept on the road. (Cuba’s vintage 1950′s automobile stock provides an example of this.)

So what makes an automobile market competitive? The purpose of a market economy is to achieve the lowest possible price and the highest possible quality for the consumer, and this is done by increasing the supply of goods as far as is economically possible. As markets become better supplied, a larger portion of demand is fulfilled and, as countless supply and demand graphs show, the price reaches a new, lower equilibrium. For competition, this implies a very peculiar consequence: in order to expand the supply further and still reap profits, industries need to become increasingly productive, and this is achieved by growing bigger and bigger in scale. This creates what, to neoclassical economists, appears to be a paradox: the more competitive a market is, the fewer the number of firms that can continue to produce for it. The equilibrium outcome of this process is that, for consumable goods, only one firm remains to renew the supply at the same rate it is being consumed, or for goods that are durable enough, all firms have exited the market. (The production of real estate would be one case where this is likely to happen.)

In a market economy the existence of only a single firm in a single market is a sign that this market is highly competitive and well supplied, while the existence of multiple firms is a sign that the market is immature and that the marginal value of supplying it is high enough that the least efficient producers can still earn a profit. This is why efforts by governments to “break up monopolies” and increase the number of competitors in a market are anti-competitive. The governments are sustaining producers whose marginal costs are higher by restricting the productivity of the most competitive producer (reducing their scale). The only plausible outcome of such a policy is a lower supply and higher prices of the good. In fact, the government’s anti-monopoly policy is the creation of a monopoly; it limits the right to supply the market only to firms that don’t scale to too large a size.

When Vladimir Lenin introduced his New Economic Policy to reduce the chaos that had gripped the Soviet Union, he promised that, although the market economy would apply for small businesses and collectives, the “commanding heights” of the economy, the large-scale industries, would remain the monopoly of the state. Modern anti-monopolism is exactly the same policy, and stems from the same economic error.

It remains difficult for people to imagine that large scale markets such as the market for roads and cities can be competitive markets only because they have an incorrect model of competition not based on supply and demand, but on sheer numbers of producers. For enormous capital goods, so long as there is at least one such good in the market, and it would be too costly to invest in another good compared to its possible benefits, then the market is competitive. So if there is only one road to any place it makes no sense to build another road due to the competitiveness of the market.

When Murray Rothbard asked Ludwig von Mises to define the boundary between a socialist and capitalist country, Mises replied that a country was capitalist if it had a stock market. This implied two aspects: that individual capital owners could pool their capital together to compete in markets that they could never scale for individually, and that these shares could be valued and economized upon to decide whether or not entering such large markets was economically viable. The stock market is the means through which capitalists compete.

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