04. The Theory of Monopoly Price: From Menger to Rothbard (video)

0:00Okay, today's lecture, or this afternoon's lecture, has as its topic the history of Austrian, the Austrian theory of monopoly price from Menger to Rothbard, okay? There's a number of important reasons for surveying the theory of monopoly price as it developed in Austrian economics. The first is really that nothing has been written on monopoly price, on Austrian monopoly price theory prior to Mises. All recent survey articles that began coming out in the 1970s usually compare Mises to Rothbard or Mises to Rothbard and Kirzner. But did the theory of monopoly price, did it just emerge full-blown from Mises's brow?

0:52Or was there a prehistory of the theory of monopoly price? Did other Austrian economists talk about monopoly price? As we'll see in fact, the theory of monopoly price goes back to Menger. Secondly, there's been an over-emphasis on the difference between the theory of Mises and the theory of Rothbard regarding monopoly price. We know that Rothbard believes that there can be no monopoly price formed on the free market, whereas Mises allows that or concedes that in certain very, very narrow circumstances a monopoly price could emerge on the free market. as in the case of maybe diamond mines or where some firm has a trademark or a certain amount of goodwill, we'll talk about that.

1:39But what I want to do is to actually emphasize these similarities between their two theories and show how both theories have developed out of Menger's original theory of monopoly price. One interesting point that you might want to note is that both Rothbard and Mises noticed the similarity between their two theories. Rothbard, for example, justified the significant amount of space he devoted to the analysis of monopoly price theory and its consequences The Theory, though invalid on the free market, will prove very useful in analyzing the consequences of monopoly grants by government. So he thought it was just misapplied to the free market. He believed that the theory itself was essentially correct.

2:29Mises also either completely accepted Rothbard's correction of the theory, or at least thought that Rothbard's reformulation was extremely important, depending on which source we believe. Of course we believe. Mises' wife, Margit von Mises, recounted an incident at the 1965 Mont Pelerin Society with Joaquin Rigue, a Spanish economist, and the one who translated Human Action to Spanish. Anyway, Rigue, or Reg, I don't know how to pronounce it, asked Mises his opinion of Rothbard's disagreement with his treatment of monopoly theory in Man Economy and State. According to Mrs. Mises, her husband replied, quote, whatever Rothbard has written in this work is of the greatest importance.

3:16On the other hand, the Spanish economist Jesus Huerta de Soto reports that Rieg himself used to retell the incident in a slightly different way. He quoted Mises' reply as, I agree with every word Professor Rothbard has written on the subject. So in either case, Mises recognized a close kinship between the two theories. Another reason for surveying the theory before Mises is that, in fact, it was the main theory of monopoly in the United States from about the late 1800s until the 1930s when we had the imperfect competition revolution. So it was the main neoclassical theory of monopoly.

4:06And finally, certain elements in the theory allows us to better critique the current neoclassical theory, which is based on monopolistic competition and downward sloping demand curves. So let's start with Menger. Menger viewed the explanation of the formation of monopoly prices under monopoly conditions or the formation of price under monopoly conditions as part of his general theory of price, as part of what I call the causal realistic theory of price. He pointed out that just as in the case of competition, the monopoly price would come to rest between the maximum buying price of the least capable buyer that purchases the unit of the monopolized good and the most capable buyer that does not purchase the unit of the good.

5:03Now let me just show you what I mean by that graphically. Let's assume you have a seller with three horses, a single seller. He monopolizes the horses in the area and you have six buyers that are interested in purchasing the horses. So you have the monopoly seller on the left side with three horses, now you have six buyers, each one represented by a maximum buying price, the highest price they're willing to pay for a unit of the good. The horses would obviously be sold to buyers B1 through B3, and the price would be 70.

5:54That would be the price. That is the same price that would emerge if you had three sellers there, each selling a horse. The price would be such that the entire stock of horses would be sold to the three most capable buyers. The price could not be any higher than 70, and it could be somewhere between 65 and 70. It couldn't be any lower than 66, let's say, because if it was 65, you would have the demand exceeding supply. You'd have a shortage. So Menger points out that the same analysis that we use to show what determines competitive price is the analysis that applies to monopoly price. It doesn't matter how many units or how many sellers we have of those horses. If there are three horses on the market, the price is going to be exactly the same.

6:41Now, he also points out that the lower the supply that the monopolist brings to market, the higher the price. So if the monopolist were to withhold one horse, and this is something that under competitive conditions could not occur, if the monopolist withheld one horse, then the price would be somewhere between 70 and 85. It would rise from the range 65 to 70 to exclude the third most capable buyer. If there's only two units, and let's say the monopolist destroys the third horse, he has no use for it, he brings two units to market and the price rises to at least above 70, okay, and bargaining will determine whether it's near 85 or near 70.

7:27If he brings one horse to market, the price rises further, okay, above 85, somewhere between 100 and 85. So this is the general rule that the larger the supply, the lower the monopoly price will be. Same rule that applies in the competition. The only difference is that when you have one seller or a group of sellers acting in concert, acting together, they can determine how many units are brought to market. So Menger also mentions, by the way, that generally monopolists will set the price. set the price, so if they set the price at 85, then only two horses will be sold. And they allow the quantity to adjust, but that's just a matter of choice on the part of the seller.

8:14One thing that cannot be done, and Menger points this out, the monopolist is unable to set both the price and quantity. In other words, let's say he wants a high price of $100 and wants to sell all three horses, that's impossible. He has to either choose the price of $100, in which case he'll have one buyer, he'll sell one horse, or if he wants to sell three horses, he gives up his control over the price. The price is somewhere then between $65 and $70 if he wants to sell three horses. So you can either fix price of quantity, but not both. All this is, Menger is really the first one who's setting this forth.

9:00That is that he believes that this theory of monopoly has to be integrated with general price theory, unlike the classical economists. Also, very importantly, he realized that the power to realize a monopoly price is dependent on the structure of the demand curve. In other words, he recognized, even before Marshall wrote about elasticity of demand, he doesn't use the term elasticity, but he recognized that differences in elasticity of demand will determine if a single seller can get a monopoly price. And this is the example that he gives. The prices are in terms of Austrian florins. What he tells us is the following. Assume you have a monopolist.

9:48And this monopolist has 2,000 units of a good, so you'll see in each example A, B and C has 2,000 units of a good, okay? Under what conditions will he restrict supply, let's say it's pounds of tomatoes. Under what conditions will he allow 1,000 pounds of tomatoes just to rot and bring only 1,000 to market? Well, let's start with C, okay? Would he do it under condition C? Well, certainly not. Why? Because, if you'll note, the demand curve is very elastic, meaning when you raise the price, consumers or buyers are very responsive, and they cut back sufficiently. He raises the price by 20% from five florins a pound to six florins a pound, and that results in his sales dropping by 50%.

10:40That's a highly elastic demand curve. What happens to his total revenue? He earns actually 4,000 florins less. So under this case, even though he's the only seller of tomatoes in that district, he will still charge the competitive price. Under situation B, the demand curve is unit elastic, meaning that the percentage by which buyers cut back on quantity is exactly equal to the percentage by which price rises. So total revenue doesn't change. He would be indifferent between selling 2,000 or 1,000 tomatoes. Given that they're on hand already, he doesn't have to produce them. If he had to incur costs to produce them, if he hadn't produced them yet, then he would only produce 1,000 because he would earn higher profits.

11:29But we're assuming that the tomatoes are there. Only under condition A, where you have an inelastic demand curve, will he destroy 1,000 a thousand pounds of tomatoes and bring one thousand pounds to market. Under that situation, he increases price enough, he triples his price by cutting his quantity marketed in half, notice, price goes from two to six, and his total revenue increases. This is very sophisticated in 1871 that Menger came up with this analysis. All of this is in Rothbard and Mises.

12:08So, for Menger, the monopolist, like the competitor, is always guided by economic calculation in choosing supply. He's guided by economic calculation. In this case, if the supply is on hand, you're not guided by profit. You've already produced the good, so your costs are sunk. You're guided by your total revenue. So Menger concluded, let me just read his conclusion, Even the fact that it is in the power of the monopolist to choose either his price or the quantity sold does not imply an indeterminacy of the economic phenomena resulting from his decision. Although the monopolist has the power to set higher or lower prices or to market larger or smaller quantities of the monopolized good, there is only one particular price and only one particular quantity of the monopolized good brought to market that corresponds most exactly to his economic interest.

13:02So, in this example, if the demand curve is as it is under scenario A, he will charge six forints and bring a thousand pounds to market. If the demand curve, which is controlled by consumers, is the same as in scenario C, he would bring two thousand pounds to market and charge five forints. That maximizes his revenue in this case and therefore his marginal utility. He goes on to say that each given economic situation sets definite limits within which price formation and the distribution of goods must take place. Any other price and distribution of goods that is outside these limits is economically impossible. The phenomena of monopoly trade present us therefore with a picture of strict conformity in every respect to definite laws.

13:53Laws. So even looking at this seller here, we can figure out if the horses are available. If he sells three, let's say you get the highest price possible for each group. If he sells three, that would be $210. If he sells two, that would be $170 in total revenue. If he sells one, you get $100. So it would be in his economic interest to bring and sell three horses to market. That's a very elastic demand curve for horses. Therefore, he wouldn't withhold or destroy any of the horses. So what he's trying to do is to show that the monopolist, just like the competitor, is subject to definite economic laws, and they're the same laws that govern price formation under competition. Also, interestingly, Menger talks about what he calls true competition. It's not a matter of numbers to Menger.

14:48to Menger. Menger says that, for example, if you have two rivals, we call it in economics a duopoly, you have only two sellers in the market, whether they're two or they're many, all of them face a downward sloping demand curve. And if it's elastic above the competitive price then they're not going to try to, whether it's two or a thousand sellers, if the two Do sellers find that people will cut back a great deal in their purchases in response to a higher price? They'll act just like a thousand competitors would. They bring the same quantity to market as would a thousand smaller competitors.

15:34He also distinguishes between monopoly as an actual condition and social restriction on free competition. So, Monopoly has an actual condition he finds no problem with. In the former case, an increase in demand will always call forth more competitors. So, he gives an example, he says, for example, If you have very few people that initially demand computers when they first come out, you have one seller of computers, but there's no barriers to entry.

16:22When the demand for computers increases, you'll get more and more firms entering the market, which is what happened. Or when hand calculators, Texas Instruments was the first one to market these electronic hand calculators, the prices were $200. As demand increased, more people entered the market, more other companies entered the market and we had an additional competition. So that's not harmful monopoly in any sense. The other one, the restriction on free competition, he gives the example of the Dutch East India Company and Medieval Guilds. The Dutch East India Company was the only company that was permitted to import goods from the Far East into the Netherlands.

17:08Just as the British East India Company was given a monopoly on importing goods from the Far East into Great Britain. So, in that case, even if demand goes up and price and profits go up, you cannot have, entry is not permitted, an expansion of supply by competitors is not permitted, okay? So that's very, very Rothbardian, to distinguish between monopoly as an actual condition, which is beneficial to consumers, okay? because you only need one if there's very few consumers demanding the good. You may only need one producer, but as demand increases, additional producers come in. Okay, so that's the basis of monopoly price theory.

17:54It's based on Menger's analysis. Now, most Austrian economists, Fedder, Davenport, Wixsey, the people we spoke about yesterday and today, also believed in monopoly price theory, in mangarian monopoly price theory, John Bates Clark also. The person before Mises though that developed it the furthest was a student of Frank Fedder who was a follower of the Austrians in the United States. His name was Vernon Mund, he's been very neglected. There were two famous books on monopoly published in 1933, and these books were the books that diverted monopoly theory away from its correct development.

18:42One was by Joan Robinson, the British economist, The Theory of Imperfect Competition, and one by Edward Chamberlain, the Harvard economist, in which he introduced the concept of monopolistic competition. Basically, in both cases, if you didn't have a million tiny sellers in any given market, you had a monopoly. So, if the market didn't resemble the wheat market, in which you have hundreds of thousands of farmers competing on a worldwide market, in which demand curves are supposedly horizontal, that is, any seller can sell as much as he or she wishes without lowering their price. If you didn't have that situation, which never exists in the real world, even in the wheat market, if you are a seller and you increase your output enough, you can push the price down slightly.

19:32But anyway, if you didn't have that situation, then you had a downward sloping demand curve, meaning that you could raise your price. For example, let's say there's Budweiser. There are many, many competing brands of beer. But the fact that Budweiser can increase its price and still retain some of its customers, let's say it raises its price by 10%, this is monopolistic. This is an example of monopoly power, according to these two book books. But there was a third book that came out in 1933 that was very neglected, was completely neglected. This was a book by Vernon Mund, it was called Monopoly, A History and Theory by Vernon Mund. And it's very interesting what he writes in the book. He has his quote at the beginning of the book and it says the following.

20:23He says, Menger's logical analysis of monopoly trade was an original piece of work. Therefore, economists had always made a distinction between the fundamental nature of monopoly price and competition price. Menger found, however, that all prices are determined by subjective valuation and that the effect of competition is only to call forth a different supply or a different set of prices. This new and unified analysis of monopoly and competition made Menger's work a signal contribution to economic theory. So he recognized and based his development of monopoly theory on Menger. He points out right at the beginning that, Munn does, that monopoly is exclusively an exchange phenomenon.

21:12It doesn't depend on the structure of costs, on technical factors which we find both in Joan Robinson's book and Chamberlain's book. It depends on someone having complete control over supply and being able to set either the price or the quantity. He makes the following statement, he says, It is in the act of exchange that the phenomenon of monopoly makes its presence felt. In an economic sense, monopoly does not exist until competition is restrained among actual traders. A significant thing about monopoly is that it has meaning only when considered with regard to the marketplace, the center of economic activity. It has nothing to do with production conditions and the shapes of cost curves and all this other nonsense that we see in our microeconomic textbooks.

22:03It simply has to do with market conditions. Therefore, the logic of Mann's approach led him to deny that, strictly speaking, an enterprise, that is a firm, as a producer, could be characterized as a monopoly. Because a monopoly describes a specific state of supply and demand. That is, a state that results in the emergence of a monopoly price. So that's why Austrians talk only in terms of monopoly price. That directs your attention to supply and demand. Whereas classical economists talk in terms of a monopoly, a firm as a monopolist. Or in terms of an imperfect competition or monopolistic competition. And they talk about various technical aspects. But that's not what MUN did.

22:54Very interestingly, he anticipated Kirzner and defined competition as a state of rivalship. Today we say that, in the Austrian terms, competition isn't perfect competition, it's what we call rival-risk competition. So Mann used the term a state of rivalship, meaning actual real-world firms trying to outdo each other by either selling at lower prices, or better quality, or new products. And for Mund, the presence of two or more persons offering to buy or to sell goods of a similar type, each endeavoring to out-vie the other as to price or as to quality and price, and each acting with no outside restraint.

23:44So as long as there's at least two people in the market, you don't need a million, You don't need all these teeny firms. You just need at least two people that are acting independently of one another and trying to better serve consumers. And then you have competition, and that's profoundly Austrian insight. In fact, he rejected Chamberlain's claim, the father of monopolistic competition, that competition required a large number of buyers and sellers. And he argued that it, quote, misinterprets the working of economic processes. According to Mund, whether sellers are 40 or 2 in number, competition among them will result in a market price being formed somewhere between the limits set by the valuation of the first excluded seller, as I showed with Menger, and that of the first excluded buyer.

24:36Even a non-collusive duopoly, that is two different firms, let's say Coke and Pepsi, let's say there were no other soft drink firms in the country. If it's only Coke and Pepsi and they're acting independently, they're going to be competing. And there's a great book written on the Cola Wars. I think it's written by the then CEO of Pepsi. And that's back in the early 80s, late 70s, early 80s, when Coke and Pepsi really dominated the soft drink market. And it shows how bitter and how vigorous competition was between these two firms. Of course, neoclassical economists would call them oligopolists and they'd start talking about how they would tacitly wink at each other and raise the price somehow, none of that is in MUN, none of that is in MENGER, none of that is in Austrian economics.

25:37He points out that even if one butcher shop controlled three-quarters of the trade in in a town that would not be ipso facto monopoly. True rivalship requires only a market opportunity for two or more sellers or buyers and freedom, willingness and capability on their part to compete. Also, it doesn't require equal efficiency. Some firms tend to be better than other firms. The National Football League here in the United States has driven out every other football Football League, despite the fact that in the 1970s we had the World Football League trying to compete with them, in the 1980s we had the United States Football League trying to compete with them, for a while the Canadian Football League expanded into the United States, that lasted one year.

26:26The NFL is more efficient, serves consumer wants for professional football, entertainment, more efficiently than any other potential competitor. There are no barriers to entry, and that's what counts. Also we're told, and you're told in your microeconomics courses or in your industrial organization courses, that differentiation of product is monopolistic. The fact that, let's say Pepsi goes on television, and back in the 80s, I remember they stressed That Pepsi was for active people and they showed all these people, you know, good looking men and women with, you know, having fun, you know, out, you know, on the beach and so on.

27:15And supposedly that's somehow monopolistic. It's manipulating consumer demands and so on. But not according to, and they're trying to differentiate their product from other types of soft drinks. Well, Mundt also said that this has, you know, this is irrelevant, okay? Products are non-homogeneous because firms are trying to better serve consumer preferences. If you think about it, when you go for an interview, you know, for your first job, if you haven't already, many of you have gone for interviews for a job, do you try to come in and be just like the last guy who was interviewed and just like the guy that's coming in? You want to be homogenous or identical with these other people? No. All of us attempt to show our boss that we're the one that fits their needs the best.

28:06So in the labor market, even where you have thousands and thousands of accountants or thousands and thousands of lawyers, let's say in New York City, Each one is different from the next, in terms of experience, in terms of their poise, in terms of other abilities and other qualities, personal qualities.

28:31And in fact, Munn pointed out that there was a qualitative dimension to actual competition. It's not just price competition, but quality competition. And that's continually going on as we see among the auto companies, for example. They're continually changing the types of automobiles to better suit consumer need. A few years ago there was an interesting article in the Wall Street Journal about airline companies. You know, they compete on everything, including how many inches of space your knees have. They actually measure this. They try to outdo, without losing a lot of revenue from getting rid of a row of seats, They find out what is the marginal cost of getting rid of one row of seats and expanding the amount of a quarter of an inch or a half an inch that people, legroom of people have.

29:22Will we have added revenue because more people want to fly with us than the revenue we lose from taking out one row of seats? Okay, so that type of thing, they're continually trying to differentiate to the consumer's benefit. He defined monopoly as the antithesis of competition, a state of affairs in which rival producers lack either the freedom, willingness or capability to compete. He, like Menger, pointed out there's two types of monopoly. One he called formal monopoly and the other he called true monopoly. And he defined them in the following way. He said formal monopoly is monopoly shorn of its power by potential competition.

30:11So you have the National Football League, use that example again, or you can use Major League Baseball. There's always potential competition. Notice that those professional sports leagues are continually trying to better their product. They're continually experimenting with new rules. They're continuously experimenting, for example, football is, with somehow shortening the game because it's gotten so long on television. Why should they do that? There's no other football league. Why should they care about what consumers think? Why shouldn't they just say, here, here's the product, tough, you know, no one else is competing? So we consider only a formal monopoly, according to Mann. They're not a true monopoly. There is always potential competition. And potential competition can be expanded. In other words, people can turn the television off or turn to other types of entertainment on television.

31:02Or they can go to other types of sporting events or entertainment events. So there's always potential competition operating. So he goes on and says, No monopolist can exercise monopoly power if the way is clear for others to enter the market whenever profits are tempting. The ever-present possibility of potential competition has the same effect as actual competition, and the monopolist is effectively precluded from charging a price that yields more than ordinary returns. This is, again, straight Austrian economics. Ludwig points out that potential competition, like actual competition, keeps the elasticity of demand for the single producer's good extremely elastic, meaning that people have the option of cutting back tremendously in the amount they purchase because new firms will come in.

31:53So, effectively, the demand curve is very, very elastic. And he went on to maintain that currencies of formal monopoly are widespread and he pointed to examples of a small town where there exists a single physician, a single drugstore, a single bakery, a single dairy farm and a single bookseller. If any of them tried to raise their prices significantly, profit, potential profits would appear and others would enter and begin to compete. Now, what about true monopoly? He says that true monopoly is one that possesses genuine monopoly power. He defines monopoly power as consisting in the ability to regulate either market supply, as we saw with Menger, or market price so as to maximize profit.

32:41He points out, like Menger does, that usually what a monopolist will do, if he is a true monopolist, will be to set a price and then allow the quantity to adjust itself. He makes sure that he emphasizes that a monopolist cannot say, I'm going to charge a price, let's say the National Football League, I'm going to charge a price of $1,000 a game and I'm going to fill my stadium with 80,000 people. They can't do that. If they want to charge $1,000 a game, Well, then they have to be comfortable with the fact that only maybe a thousand people will come. On the other hand, if they want to sell 80,000 seats, they have to charge an average of maybe under $100 again.

33:30Now, what are the factors underlying monopoly price? He points out, like Mises does later on, that there has to be an elasticity of demand for the product that is inelastic. Also, costs of production come in when we're talking about determining how much to produce for the future. And he talks about the attitudes of courts and the public themselves towards monopoly and the interest in future business. In other words, in a sense, you're competing against yourself in the future. If the buyer purchases the product now, he may still carry some sort of resentment because he feels that he or she has been ripped off and therefore you'll lose their business in the future. So entrepreneurs take into account the future effect of price increases, and sometimes are detriment.

34:19For example, when a new, very popular movie opens, you see lines around the block in many places. You know, the first day, let's say Star Wars, okay? Why don't they raise the price, they could probably fill the theater if they raise the price the first weekend to $50 or $75? Because even though there are people that may very well come to the movie theater at that price and fill the movie theater, and there won't be any lines, it'll be the equilibrium price, they're standing below the equilibrium, there'll be many people that are excluded by that very, very high price that will not come back to that movie theater. So, let me show you the first graph, show you where a monopolist, the difference between monopoly and competition, or a monopoly price and competitive price, that looks pretty good.

35:17Let's assume that the cost is three, you see the normal cost line I have there, it's three dollars per unit. And let's assume for the moment that the firm has already produced seven and a half units, That's where that point should be. It should be at seven and a half right there. This is taken from Munn's book, this diagram. Now, the downward salty curve is known as the buyer's reserve valuations. Each point represents the highest price that they'll pay for that quantity.

36:05So the highest price that the monopolist can get for, let's say, 11 units is $3. The highest price they can get for three units is $11. On the other hand, the highest price they can get if they want to sell five units, if you follow that line up, if five units is $9. The highest price they can get for seven and a half units right there is $3. That's the competitive price. This is the problem with monopoly price theory, which will show it's also a problem with Mises. That's the competitive price because that's the normal cost. $3 not only includes the cost of producing the good, but it includes the interest on the capital invested. So in other words, at $3, this monopolist would be earning a normal profit.

36:54But looking at that demand curve, we can tell it's extremely inelastic. So what the monopolist will do, if it's before he's actually produced, If he knows what his cost curve is and he knows what this demand curve is going to look like, he's going to try to maximize his profit. The profit is the rectangle between the difference between $9 per unit and $3 per unit cost times the number of units produced. So if he charges $9, he can produce five and sell five units. That's $45 minus the $3 per unit, $15. He can earn a profit of $30. You'll find that it's the highest possible profit that can be earned there.

37:40So, however, he cannot say, I'm going to sell at $9 and I'm going to sell all 7.5 units that I produced. If he's already produced them, let's say. He can't do that. Because he wants to sell 7.5 units, he has to reduce the price to $3. So again, he can control either the price or the quantity, but not both. So, if he already produced the output, and he had it in inventory, what would he do with the other two and a half units, assuming that they're perishable? He would destroy them. On the other hand, if this is a situation that he sees in the future, he would not produce more than five units. He'd produce the five units and he'd earn a large profit, much above the normal profit. If there were two competing firms, and given the same data, they would produce seven and a half units and the price would be three.

38:34As long as you have two or more non-colluding firms competing with one another, you would get the competitive outcome according to MUN. The fact that you have one guy allows him to determine the supply. That's the key here. The ability to set the supply or the price, but not both. And he draws another demand curve that I don't want to put in here, which is much more elastic, meaning it's flatter, and he shows that there, he can only raise his price from three to six. And he can only cut back to six units, and that would maximize his profits. I didn't draw that demand curve in, it would kind of clutter things up. But he realizes back in 1933 that the more elastic the demand curve, the lower the monopoly price that can be gotten.

39:32Now, he wants to analyze the effects of changes in costs of production on equilibrium in a monopoly market. And he begins with the case that usually Mengerian price theories, including Rothbard, begin with. And that is the case in which the monopoly good is a fixed stock. For example, you have your harvest. This is agriculture, let's say, and you dominate the tomato market in some area. You're the only one who produces tomatoes in that area. And they're already produced. How many will you sell? How many will you destroy? And I can show you a graph that, again, comes from the book.

40:22He shows, once again, that the buyers have a certain demand curve that they control. They determine, and you can think of this in terms of thousands of pounds of tomatoes that are sold. It's a downsloping demand curve and let's say the cost of producing these tomatoes were a dollar a pound and that then is the competitive price. The competitive price is one dollar and eleven thousand pounds would be sold. All eleven thousand have been produced.

41:28Now this doesn't happen usually on the free market. We know that under agricultural price supports, the U.S. government, the Canadian government, for example, years ago had billions of eggs destroyed to keep prices up. The destruction of a stock is really something that entrepreneurs want to avoid. They want to make sure that they tailor their production to the highest profit price that they can get. But according to Munn, this can happen on the free market. And notice Munn says the costs don't matter. Once you have the tomatoes, what you're looking for is to maximize your revenue.

42:13And you maximize your revenue by producing or by selling six thousand pounds at six dollars each which would give you thirty-six thousand dollars in total revenue. Any other point in that curve if you figured it out would give you less total revenue. Okay, then in the final graph I'm just going to show you what Munn does is to show price formation under conditions of continuous production in which the monopolist is in the long run position of planning for future demand and therefore does consider his production cost in establishing his, what's called And that's right here. This is the normal cost curve. It's more or less U-shaped. And what he points out here is that the competitive price will be at five, where cost, including foregone interest on the capital invested, is returned to the investor.

43:33He's earning a normal profit at $5, but he's able, because of the elasticity of his demand curve, to raise the price to $9, but remember he has to produce less than 9,000 units. He can only produce, let's say, 5,000 units, which corresponds to a price of $9. That's his maximum profit area, or that's his maximum profit quantity and price. Now we come to Mises. Given that there was a very sophisticated theory of monopoly developed by the early 1930s, what did Mises add to this?

44:20Well, Mises, basically, his whole point was to resuscitate this theory or revive it in human action because in the 1930s it was swept away with all other Mangerian price theory. By 1939, 1940, when his German version of Human Action came out, the profession as a whole had all gone over to the monopolistic competition revolution and had all been affected by it. They all believed that monopoly power existed when there was a downward sloping demand curve. What's interesting is that in this chapter on prices and human action, there are five sections on monopoly price that take up half of the section on prices.

45:18There are 70 pages on prices and 35 is on monopoly price. The reason he's trying to do is to survey and to refine the theory of monopoly price that developed from Menger to Mund.

45:37One thing I want to point out before I go into Mises is that we don't give him enough credit for his theory of monopoly price. He did make some improvements in it. And the reason why we don't do that is because we're looking back at his theory through Rothbardian analytical glasses. In other words, Mises made this horrible error, or so we think, of claiming that there could, in certain very limited circumstances, be a monopoly price on the market, whereas Rothbard showed that, in fact, there could not be. And Mises did, in fact, make that error, but that doesn't mean we should ignore his monopoly price theory, because Rothbard develops right out of that. It really just takes a slight correction to get the right theory. Also, we tend to look at Mises' theory as a predecessor of Kirzner's theory in which he believes that there can be, in again, limited circumstances, a monopoly that emerges on the free market.

46:36Mises in an article that he wrote in the 1940s but was not published until the late 1990s in the Quarterly Journal of Austrian Economics sets out the following very, very simple schedule. Mises almost never has tables, schedules or graphs in any of his works. This is one of the few times that he does. And basically you see that his theory of monopoly price is exactly Menger's, but he makes it a little bit more, he deepens it a little bit, but let me just look at this as a copper market, let me just show you superficially what the theory says. Mises holds that if there's a copper mine, or a single company, and it owns a number of copper mines, and it completely exploits its copper mine, the price will be $5 per pound and the production will be £100 million of copper.

47:43The total revenue of the firm will be $500 million. Now what Mises says is this, how do we know that $5 is the competitive price? He says $5 is the competitive price because in the marginal mine, in the least efficient copper mine, now we're talking about competition, so you have all these different firms, but the least efficient copper mine, that $5 will just cover the wages for labor and the interest on the investment of capital. There will be nothing left over for the rent of that least efficient copper mine. So he says that you know that you have a competitive situation when production is such that you've pushed it to the point where the last units of the good produced just covers the non-specific factors, that is the laborers and the capital which could be taken away and invested in other areas.

48:43Now, if one person owned all those mines, that person would restrict production, okay? Now we're talking about, or restrict in this case, the amount he brings to the market. Let's say for whatever reason he's produced 100 million tons, right? What he would do is restrict it so that his total revenue would rise from $500 million to a level that's higher than that. And notice, that could be at a price of $10 where you're only selling about 52 or 53 million tons, or it could be at $7 where you're selling 75 million tons. The monopolist would be indifferent between those two prices, $7 or $10, because given that his costs are sunk, that's what maximizes his revenue at $525 million.

49:32So now, why is this bad for society according to Mises? It's bad for society because there are nonspecific factors, labor and so on, that have been forced out of producing copper to producing goods that have a lower value to consumers. How does Mises prove that? He says, well, in fact, if you had more than one owner or if you had more than one copper firm competing here, You would have more labor coming into the area from the lower wage areas that they've been forced into and copper output would expand from 52 million to 100 million. That tells him that labor is misallocated. It's producing lower valued goods for consumers.

50:17Does everyone see that point? So, in a competitive situation, Mises says that the specific factor, the diamond mine, the wheat field, and so on, will be exploited to the point where the last unit of the specific factor has zero rent. The price will be high enough to cover the labor and the capital invested, and there'll be a zero rent return to the mine, to the forest, if we're talking about a lumber company, and so on. All right, now let's talk a little bit about what the other things that Mises says here.

51:02He says, is there a situation in which there would be too much production? He says, certainly there would be here. He says, at $4, the firm would be losing money. The firms would be losing money because they wouldn't even be covering the cost of wages per pound of copper and the interest. So, restricting supply from 115 to 100 benefits society because you're allowing laborers that have a higher value elsewhere to go elsewhere and produce higher value products to consumers. He's saying therefore, just because you've left part of your mine unused doesn't mean you're monopolizing.

51:47Let's say you've built a factory that's too big and you only are using half of the factory space to produce automobiles. Let's say in the 1980s when the demand for large cars fell because of the high price of gasoline. In that situation, it was rational to cut back on the number of cars you were producing because the prices were so low, they weren't even covering the wages of labor and the investment in the raw materials. So Mises says that just because you've restricted supply doesn't imply monopoly. What implies monopoly is that if you restrict supply above the zero rent margin, if laborers go to places that have lower value, that is that their marginal revenue product is lower.

52:34Now, he says, what are the necessary preconditions for the emergence of monopoly price? He says first there has to be a monopoly of supply, there has to be one firm that owns the entire supply of the specific resource, in this case one firm owning either all the diamond mines or all the copper mines. Now Mises believes that this is very very rare in the real world. He basically mentions possibly diamond mines. He goes on to say that the second condition is that the demand curve above the competitive price must be inelastic, meaning that at a higher price you must be able to generate a higher total revenue.

53:28Now, what if above $5, people cut back sufficiently on the amount of output that they were producing that you wouldn't have total revenue at any higher price, let's say above $480 million? Would it be beneficial even for the sole owner of that copper mine to restrict supply? No, because he's earning the maximum total revenue at $5. So, those are the two conditions. There has to be sole ownership of a specific resource, and that's a very rare, difficult condition to fulfill. And secondly, even if that's the case, you still might not get a monopoly price because of the elasticity of the demand curve.

54:15In other words, it could be substitute products, closed substitutes that people could turn to. Also, Mises points out that you cannot say that the monopolist earns a monopoly profit, because profit comes from serving consumers better than other competitors are currently doing. He says you earn a monopoly gain. And the monopoly gain is a return not to your entrepreneurial ability, it's a return to the control of this resource, as well as to a certain structure of the demand curve, by the way, which is voluntarily the structure that's determined by consumers.

55:08Let me give you an example. In New York City, in the late 1930s, taxi cab drivers got together at taxi cab companies. They petitioned the city, because it was during the Depression, to limit the number of taxi cabs by awarding licenses. There used to be free competition before 1939. And so the Taxi and Limousine Commission was developed and put in place. The Taxi and Limousine Commission issued 11,700 licenses. Basically, they grandfathered in all the current taxi cab competitors. And yet, since 1939, there's been a tremendous increase in income in New York City and a corresponding increase in the demand for taxi cabs.

55:55Guess how many additional licenses the Taxi and Limousine Commission has issued? Zero. They did, after a while, Mayor Koch tried to issue 400 more, and the lobby for the taxi cab companies prevented it from going through the city council. They did at some point, maybe it was under Giuliani or under Dinkins, they added two or three hundred more, but of course in order to go in and compete in the taxi cab industry in New York City, Since you can't get a license from the Taxi and Limousine Commission, you have to purchase an already existing license. There may be over $200,000 apiece now, but at that point, when I looked at this data back in the 1980s, they were up to $160,000.

56:45So it wasn't enough, as in Washington, D.C., where there is no Taxi and Limousine Commission, where there is no licensing requirement. There, all you have to do is to prove that you have a valid driver's license, you've never committed a felony, and you pay $200 registration fee, and you can go in and compete. And if you'll notice that the taxi cab situation in Washington is great. You can find a taxi cab during a rainstorm, which you can't do in New York City. They fill the taxi cabs up. In New York City, one person in a taxi cab that could accommodate four people will pass In Washington DC, you have many, many different cab companies. They're not all yellow cabs like they are in New York City. Also, students and new immigrants, it's a very cheap way of starting your own business. It takes a small amount of capital.

57:38So you'll find students owning their own cabs and driving them part-time in Washington. Whereas in New York City, you have a few huge cab companies that controls business. Try getting a cab in New York City, for example, when the theater's let out, or around a train station. It's impossible. In Washington, when I used to go down to Washington, D.C., back in the 80s, they've since straightened things up a little bit, you'd come out of Union Station, I'd take the train down from New Jersey, and they would be rushed by all these cabbies that were trying to grab your bags and put them in their cab. Eventually they had Amtrak personnel standing outside Union Station making them line up, which made it even better, but it was very easy to get a cab at any point in time.

58:28Also, you don't have the meters running. There's a certain price for rides within the city and then a certain price for rides in different districts outside the city and so on. and so on. Mises also points out something else, that patents and copyrights have a price because they're a monopoly game. In other words, if someone has a copyright on some book or on some machine, you can copyright machines, that allows them to restrict supply. And it causes a return to this artificial right to enter, or right to compete.

59:17And since it's not the zero rent margin, this is anti-competitive. It's monopolistic. Now, Mises doesn't say that you shouldn't have patents and copyrights. He's saying, though, that it's certainly a monopoly. Also, he believes that trademarks, brand names, and goodwill can result in monopoly. So, for example, the fact that, let's say, IBM in the 1960s and 70s, that was synonymous with computers or Xerox during the same period, was synonymous with copy machines, because they had this tremendous goodwill, that permitted them to have a more inelastic demand curve and allow them to raise their price to a monopolistic level.

1:00:04May have been the case, so it may result in elastic demand and a higher price. But Mises does point out, like Rothbard, the monopolist himself does not distinguish between monopoly and competitive price. All the monopolist is trying to do is to attain the highest possible profit. Now here's where Mises is, without realizing it, contradicting his own case. The key point is this, how can we really identify the competitive price? You can only identify the competitive price which consists of basically a long-run equilibrium price in which there are no profits, in which the marginal mind, the least efficient producer, just gets a normal rate of return.

1:00:49That only exists in long-run equilibrium, which is, as Mises has pointed out in other parts of Human Action, The ERE is only what we might call an imaginary construct that allows us to separate profit from interest. We should not be using it in dynamic price theory. Mises himself says that the ERE is not something that we can use to grasp the dynamic pricing process. And yet he's trying to do it. He's giving us an equilibrium definition of what the competitive price is. And I'll show you, this is one of Rothbard's important critiques. Something else that Mises points out that contradicts his monopoly theory.

1:01:41One thing he points out that actually is important to note and that is correct is that the monopoly The ability of the supply of some factor of production in and of itself does not result in the emergence of a monopoly price. For example, Mises would say, well, just because Coke has a certain amount of goodwill, doesn't mean it has an elastic demand curve, because Pepsi is out there, and because many other brand names are out there. It's only when this goodwill allows you to have an inelastic demand curve, So people don't see good substitutes that in fact you get a monopoly price. And that goes back to what I mentioned before that as long as there's potential competition, you may have an elastic demand curve.

1:02:29Now Mises, the contradiction comes when Mises talks about what he calls or what he says is a multi-product firm. He points out that, let's say you're a textile producer, and you produce many different articles of clothing. You produce men's pants, you produce dresses for women, you produce children's clothing and so on. In the same firm, he says you don't produce up to the point where the marginal revenue, the revenue from the last unit of output is equal to the cost of that output. He says, you have a limited amount of capital. So in using your capital to decide what goods to produce, you allocate it to these different types of clothing in a way that will maximize your profit.

1:03:18So you stop short of going to the point where your factory has a zero rent margin. And he says the same thing is true with auto firms. Auto firms allocate their scarce capital among the different models of automobiles according to what they believe will bring the highest profit. They do not push the output of any given model up to the point where the marginal revenue equals the marginal cost. In other words, they are not somehow in long run equilibrium, in the real world. So, Mises admits that the economy is not in equilibrium and that it's profits that direct production, okay? No one cares what cost or what price would be in some never-never land where production has been, over time, completely adjusted to consumer demand, because that never happens.

1:04:10Things are continually changing, okay? Just when profits are being wiped out in the hand calculator industry, you get the introduction of personal computers. and the first personal computers sell for $20,000 and their cost might be $10,000 and new entrants come in and prices are pushed down but profits exist for a long period of time and when prices finally reach the average cost of production you get new technology coming in lowering the cost of computer even more and prices follow it down so that today you can get computers that are many times more powerful are powerful and have much more memory than the $2 million mainframes did in the 1970s because of technology.

1:04:57So profits are continually recreated. You never get to a situation where the dynamic market process comes to a halt and all prices are equal to cost, which is what you need to determine some sort of competitive price. Which brings me then, lastly, to Rothbard's critique. Rothbard makes the great point, the important point, that all entrepreneurs seek to obtain the highest profit. Number one. Number two, all demand curves are downward sloping. All demand curves. There is, outside of my university, Pace University in downtown New York, there's a vendor who sells hot dogs, and he sells them for $2 a piece. There are many, many eating places within a few blocks, maybe near a hundred of that university, of my university.

1:05:50Yet, if this vendor, who is right outside the school, if he raised his price by 50 cents a hot dog, would he lose all his customers? No, he wouldn't lose all his customers. Many of the students, he's built up some goodwill, he's a nice guy, many of the students like his hot dogs and so on. I think they're just floating in dirty water, but it's besides the point, I don't even, but many do. The point being that even small sellers, not just GM has it down, all sellers have downward sloping demand curves. Now what does that mean? That means that if you've produced too much, and I'll show you an example in a moment, if an entrepreneur makes a mistake about what his demand curve looks like, and he's produced more than, Let's say he's produced an amount at which he can sell at a price that if he raised the price, he could get more total revenue and cut his costs because he would produce less.

1:06:48Your costs go down. So he would in fact do so. Anybody would do that. GM would do that and the vendor would do that. In other words, if the vendor is currently selling 50 hot dogs, that's his quantity, and his price is $2, and he realizes, hey, I might be able to raise my price to $3 and sell 40 per hour. So, what happens? My total revenue is $100 per hour when I charge $2 and sell $50, but if I sell $40 at $3, it's $120.

1:07:33Well, my costs go down because I'm selling, my inputs costs have gone down because now I only have to purchase 40 hot dogs wholesale rather than 50, and secondly, my total revenue has gone up, so my profits have gone up. So, is he a monopolist because he's restricted supply? No, of course not. Anyone's free to compete with him? And there's a lot of actual competition. Now, the same thing would occur to... Is he doing anything different than this so-called monopolist is when he raises his price from $5 to $7 or $10? Absolutely not. Entrepreneurs make mistakes, meaning that they may produce more than is efficient from the point of view of maximizing their profits.

1:08:22They can be small sellers or they can be large sellers. So Mises cannot identify the competitive price just because someone restricts supply. If we're not in lower equilibrium and people restrict supply, whether they're big or small, they're all doing so for the same reason, which is what? to Maximize Your Profit, period, end of story, even in the case where a single individual or single firm owns the entire supply or the entire input, specific necessary input of a good, like all the diamond mines are owned by one person, or for example where you have I have an individual such as Muhammad Ali who owns very specific boxing skills.

1:09:14I'll just take him as an example. In that case, there's still competition. For example, very recently, two new technological techniques or two new technological methods have been developed that will allow the production of perfect diamonds. I'm not talking about Zircon. I'm talking about perfect diamonds. These diamonds are actually too perfect. They're flawless. And even skilled gem appraisers cannot tell the difference between real diamonds. These are real diamonds. It's just that they're highly pressurized, and the raw material is turned into diamonds within a couple of days.

1:10:03I saw something on 60 Minutes about two years ago on this, and I saw an article on Wall Street Journal. Now I don't know what has happened with that market, but certainly, if there's high profits in producing gem quality diamonds, you're going to have people trying to come up with new technological methods to undercut that. So there's going to be potential competition restraining the price that even the monopolist of a diamond mine, The diamond mine, which we do not have, the beers come close, but I think they only dominate about 80% of the gem quality diamonds. The Russians are always underselling them. So, by the way, the owners of diamond mines and the beers have struck back by saying, well, you know, it's not genuine and a woman wants a genuine diamond as evidence of commitment and so on.

1:11:07But, you know, hey, this diamond is perfect. You can't tell the difference. I don't see the problem, you know. Come on. Also, what Rothbard points out is, in the case where an individual has, and all of us as individuals have, complete monopoly over our own specific skills, let's say somebody like Muhammad Ali, the market for Muhammad Ali's boxing matches, Let's say Muhammad Ali could box at his peak. He could have boxed every month. Let's say he boxed 12 of his fights per year. It could be 12.

1:11:56And he would earn half a million dollars for each fight. His total revenue would be $500,000 per fight, times 12, $6 million. Well, what if Muhammad Ali restricts the number of fights to six, fighting every two months? Well, then his total revenue would rise to 12 million. But he's so much in demand, there's such an inelastic demand to see him fight at his peak, he could fight just, and he was fighting very, very infrequently, he could fight twice a year, and earn 10 million dollars per fight, and increase his total revenue even more. Now you might call that a restriction of supply, but what Rothbard points out very shrewdly, or insightfully, is this. He's not only restricting supply, he's also doing what? He's enjoying more leisure.

1:12:48Everybody wants more leisure and more money. So, as Walter Block in an article on this points out, You don't know if, in restricting supply, he's doing so to obtain a higher price, or he's doing so to obtain more leisure. And in fact, if you can do both at the same time, you're getting more consumer goods. Alright, so this is a critique of... Now, Mises never pushed it this far, but William H. Hutt actually pushed it to the point where he said, Yes, Boxer's a great free market economist, except on Monopoly Theory he was sort of... Excuse me, I'm going to shut that off.

1:13:37Somebody from New York, that's bad news, that's my university, okay.

1:13:43So, yeah, actually William H. Hutt somewhere says that, yes, it is true, You could have consumers being hurt by the withholding of boxing services by a boxer and that, yes, in theory, that he should be forced to increase his output. That really results in slavery. Finally, what does Rothbard think about monopoly? When can monopoly come about? We have a very interesting real world example here, the numbers aren't accurate, the numbers are only hypothetical, but in 1981, the U.S. auto industry was losing a lot of money and because of the influx of compact and sub-compact Japanese cars, the U.S. auto companies had had not yet adjusted to the higher price of gasoline and they were still producing large gas guzzling cars.

1:14:54So what happened was instead of trying to compete with the Japanese, they went to the Reagan administration in this particular case and what they did was they asked for the implementation of V.E.R.s, voluntary export restraints, which means that the Reagan administration officials went to the Japanese government and basically blackmailed them. If you don't voluntarily restrict the number of automobiles you're exporting to the U.S. to about 1.6 million per year instead of 2 million, well, we can't help it then if Congress imposes even tighter quotas and restricts imports even more, so this is the voluntary export restraints. Okay, now, here's where true monopoly comes in, okay, with the unimpeded importation of Japanese cars, demand curve is D2, which means this, if at $10,000 Ford is producing $100,000 and selling $100,000 units of the Ford Taurus per year and they're losing money at $10,000, which they were doing, there was a lot of money during those first few years, In any case, let's say they try to raise their price to $12,000, which will allow them to fully cover their costs and give them a profit.

1:16:20If they did that, their demand curve is highly elastic because of the competition from similarly priced Japanese automobiles. So, what you get then is a lower total revenue, so total revenue drops from $1 billion when you produce and sell $100,000 to much less, you get a total revenue of $0.48 billion when you restrict your supply or when you raise your price. So they raise their price, they have no control over the quantity, remember you need to control price or quantity, and as a result you get a decrease in quantity from 100,000 units to 40,000 units.

1:17:07People cut back by 60% because they can easily purchase similarly priced and at the time better quality Japanese automobiles. So it's not in the interest of Ford, because of the highly elastic demand curve, to raise its price of $12,000. Now, after you've gone to the Reagan administration and voluntary export restraints are put in place, Japanese cars rise in price by something like $2,500 during that period of time. And so now they're priced above American cars. What happens then to the demand curve for American cars? The demand curve is coercively changed in shape because through coercion, through legal coercion, sales and purchases between Japanese automakers and U.S. consumers are impeded.

1:18:03So U.S. potential purchases of new cars are no longer able to turn to purchase of Japanese automobiles at these lower prices. So what they do is, when price goes from $10,000 to $12,000, they don't cut back by 60%, they cut back by 5%. They cut back from $100,000 to $95,000 per year. And what happens to their total revenue? Total revenue rises from $1 billion to $1.14 billion. So this is a true monopoly price. It's not a free marketing price. It doesn't arise on a free market. it arises as a result of a coercive change in the demand curve that's brought about by a government prohibition or restriction on competition in this case competition from abroad there was some other point I wanted to make about this particular case oh, I know what I wanted to say So what was very interesting is while we were attacking OPEC as a cartel, guess what the American government did?

1:19:16It set up a cartel among the Japanese and American producers of cars, because what they in effect did was to restrict the number of Japanese cars in the United States. What happened to the price of Japanese cars? They shot up. And because they shot up, American producers were able to raise their prices. So, in effect, the US created a cartel by putting into place these voluntary export restraints. So while we were attacking OPEC for raising the price of oil and therefore gasoline, we were doing the exact same thing to American consumers. So American consumers were hit by a double whammy, okay? All right, I'll stop here and take questions. Yes? Did anyone in the Austrian School ever consider the possibility of price discrimination, especially as an alternative to strong stuff?

1:20:07Yes, Mises did. I didn't go into it because I didn't want to get too technical. But he has a good discussion in the article that we published in QJAE, especially, but also in Human Action, of price discrimination and how, again, Again, those conditions under which price discrimination takes place are very, very limited. That's a good point. Other questions, comments?

1:20:35So, the Rothbardian theory then, I think it's important to stress, does develop out of Menger and Mund and Mises. It's just that Mund and Mises applied the theory to certain situations on the free market. Whereas Rothbard pretty much uses the same theory but says that it's not a difference between what's a competitive price and what's a monopoly price. The difference is between a monopoly price and a free market price. The free market price is never necessarily what we might call the competitive price. The price that would emerge in long run equilibrium. It's simply the price that emerges from rivalry among firms trying to serve consumers better than other firms.

1:21:24In other words, it's the price that comes out of rival competition. That price always arises on the free market. And as long as you have free entry, you're going to have a situation in which there can be no coercive distortion of the shape of the demand curve The Man Curve, which makes it profitable to raise price. And in some cases, by the way, you could have The Man Curve made more inelastic, but not inelastic enough to force up or to make it profitable to raise the price. So Rothbard points that out too. Okay, unless there's other questions, we can stop. Thank you.