Competition and Monopoly

0:00The topic is Monopoly and Cartels, and to introduce the topic, let me just draw your attention to a very interesting article that was in the LA Times.com yesterday on real estate brokers, a cartel, a consumer group that makes this claim. The consumer group is the Consumer Federation of America. I never know anyone who belongs to any of these consumer groups. I don't know any other consumers, any of my friends or acquaintances that belong to these consumer groups. In any case, this group said its report showed that traditional real estate firms, the National Association of Realtors and its state affiliates, and tightly controlled regional multiple listing services constituted, quote, the last remaining unregulated cartel functioning in America, unquote.

0:55So, they go on to claim that these traditional brokers try to maintain or seek to maintain high commission rates of 6 to 7 percent of a home sale price, regardless of the experience or level or service level that they give. And they also stifle competition from non-traditional firms such as discount brokers and internet-based listing services. Yet, anyone go on the internet and you find these listing services. Many agents also try to increase chances of a double dip, which means that they take both the seller and buyer halves of a commission by promoting their own listings to buyers they represent, the group said. Well, of course, if they were actually, you know, if they did that and people disliked that and there are reasons not to want to do that, your selection or why consumers or homebuyers would not want that because the selection of homes is narrowed, they could simply go to other realtors.

1:52Finally, they make the claim, the $24,000 most brokers try to charge for the sale of a $400,000 home would purchase many new car models or expensive medical procedures, said Steven Brobeck, the consumer group's executive director. Well, so they're telling us that the price is somehow high. They're claiming that it's too high. They're not telling us what standard they're using. They're just saying, well, I can buy a new car. Well, my salary can buy a number of new cars. Does that mean I'm overcharging my employer? That's absurd. And the National Association of Realtors did respond. First they said that there are 80,000 brokerages, and these are just traditional brokerages, these aren't the online listing services, and more than 2 million licensed agents.

2:41They also pointed out that Home Sales Commission have fallen to 5.1% in 2003 from 5.5% in 1998. And the 6% fixed rate that was charged for a long time, they went below that a long time ago, back in the early 90s, late 80s. Whereas the consumer group is claiming they're trying to maintain these rates of 6 or 7%. Well, they're not. Anybody can try to do anything they want. As we'll see, on a market, everyone is free to ask any price they want or to bid any price they want. Everybody has control of their own money if they're a buyer and their own property, goods, if they're producers and sellers. They can either make an exchange or not make an exchange at any price.

3:28Nobody can force a price on anyone else. And the realtors point out adding another level of regulation at the federal level could add cost and stifle innovation. That's certainly true. Well, what we're going to talk about today bears on this. What is a cartel? How can a cartel be formed? Can one exist on the market? Are cartel prices, when they do exist on the market, monopolistic in any real sense? And before we get to the cartels, we're going to start with monopoly and theory of monopoly. There's a number of definitions of monopoly. The oldest definition, the most literal definition, is a single seller of a given good.

4:14It comes from the Greek, monos, which is single, and polin, which is to sell. This is not a very good definition. It's meaningless, it's not useful for analysis. First of all, all goods have substitutes on the free market, because all individuals compare various goods on their value scales against one another. So all goods, to some extent, are substitutes for each other. And then, on the other hand, it's meaningless in the sense that everyone owns their own, Everyone is a monopolist over their own property, because all of us are differentiated. Every lawyer monopolizes his or her own services.

5:02No one has exactly the same personality. No one has exactly the same location and space. No one has exactly the same experiences and education. So do we call all lawyers monopolists? All sellers of chicken, because they brand their chicken, they're all monopolists over their own property. So this really is not helpful to us. All new products that come on the market, hand calculators, the Mac, the automobile when it was first invented, All of these radio, television, they all come on the market as a property of someone who first introduces them. They all come on as monopoly. Does this stop other people from coming in and competing? Certainly not.

5:52So the market is inherently competitive. That's one thing to point out. When left alone, when there's free entry, entrepreneurs will always enter those areas where there are prospective profits. So, if someone does introduce a new product, then others will begin to come in and engage in what we call rival-risk competition. So, competition is rivalry. Not only introducing a new product, but coming in with the same product that has a different quality or different quality dimensions, coming in at a lower price or increasing the quality of the product and coming in at a higher price.

6:39There's continuous, persistent, relentless competition on the market in every dimension of the product, not just in price. So a few years ago, airlines were actually competing down to one or two inches of legroom. That is, some airlines were removing one row of seats and just moving all the other seats up slightly to make people more comfortable. So there's continuous adjustment of all products on the market. As entrepreneurs try to find the package of qualities that's going to give them a profit, at least for a time. And when they do discover that package and introduce it, and it's successful, others are going to emulate them. So we don't have the same amount of competition except that as long as there is free entry, the entrepreneurial process will operate. New goods will be introduced all the time, competitors will come in and try to improve on those goods, brand names will be introduced to ensure that consumers know that this has a certain quality.

7:43McDonald's is a monopolist. There's no other hamburger like McDonald's hamburger because of not only the ingredients that they might use but because of that brand name that gives certain information. Does that mean that the fast food market is not competitive? It's intensely competitive. The NFL monopolizes, we talked about it a little bit, the services of professional football in the U.S. And yet, the NFL is continuously changing the rules, continuously experimenting with rules that they think are going to be more appealing to consumers. They're continuously trying to speed the game up in various ways, but at the same time make the calls by referees more accurate by introducing instant replay and fiddling and adjusting that.

8:31Why? Because the owners of the NFL, the owners of the teams that make up the NFL, and that might be called a cartel because there's different owners, they know that people can simply turn off the television set, or they can change the channel and watch something else, or that they can go to their health club, or that they can go out to eat. There are many, many goods that compete with NFL football, despite the fact that, in some sense, it's monopolized. We're not going to waste any more time on monopoly as a seller of a given good. We're going to come back to a form of that theory, but in a much more sophisticated way.

9:16The second definition of monopoly is that the seller has some power to set his or her price. Now, that sounds kind of scary. It sounds like we're talking about a large firm like GM or Microsoft determining the price. Well, that's not the case. In fact, this theory is based on a view of competition that looks on every firm as an infinitesimal part of the market, like a wheat farmer, which we talked about, who contributes a very little bit to the supply of the market, so little that his decision about how much to produce does not affect the price.

10:06that's called the price taker and the demand curve looks is horizontal, this does not exist in the real world but according to this theory of what's called the theory of perfect competition there are a number of assumptions each producer is infinitesimally small as I mentioned they're tiny their actions do not affect the price on the market everyone has perfect knowledge All sellers and buyers know exactly the costs and prices that their competitors have and that people on the other side of the market have, okay? So all buyers know all prices of all the sellers in the world of that particular product. Also, the product is homogeneous, physically identical. There are absolutely no brand names, no advertising.

10:56The sellers can't even be differentiated if, for example, the legal industry is perfectly competitive. competitive, then all lawyers are clones of one another. They all look exactly alike, they all have the same experience, and so on. That's absurd. It doesn't exist in the real world. Their products are not homogeneous. Even two restaurants that serve basically the same meals, are at least in different areas, and they have different sales staff who have different personalities. So, this idea that anyone who's able to have any influence on his price or her price is some sort of a monopolist or has monopoly power, as they use the term, simply means that people face a downward sloping demand curve.

11:53So that any seller that faces a downward sloping demand curve, whatever its shape, can change the price. That is, when you face a horizontal demand curve, even if you raise the price by one cent, so if the price of wheat on the world market is $4 and you charge $4.01 or you try to charge that, you go from being able to sell as much as you want to being able to sell nada. Nothing, okay? So you have no control over your price, according to this theory of perfect competition. But once you recognize that all products are differentiated, then you recognize that everybody has some control over their price, which simply means that they can rate, they can set higher prices and not lose all their customers, okay?

12:43There's a range of prices they can set without losing all their customers. So what? So, Budweiser changes the price of its six-pack by ten percent. It faces a very elastic demand curve because there's many other brands of beer, okay? So if it changes its price by ten percent, it may lose fifty percent or sixty percent of its customers. Whether you face a downward sloping demand curve or not, there's still one price which will maximize your profit. of Profit. Every seller, whether that seller is GM or Microsoft or the hot dog vendor I talked about in New York City outside my university, every seller faces a downward sloping demand curve. That hot dog vendor can raise his price from $2 a hot dog to $2.10 or $2.25 and not lose all his student customers. He has no monopoly power. There are delis, there are coffee shops, there are fast food restaurants all within, you know, a quarter of a mile, there's probably, in the area where I am, probably over

13:43100 eating establishments within a quarter of a mile or half a mile or something like that. It's a few blocks walk. So, as we'll come back to this, every seller simply attempts to set the price in the elastic range of their demand curve. So this is not a good theory of monopoly. It's not a sensible theory of monopoly. A theory of monopoly does not apply to the real world, because it implies that everybody is a monopolist. Even if you go on, when you go on the job market, like I tell my undergraduates when they graduate, I mean, you know, when I teach this, I say, when you graduate, when you go on your job interviews, do you want to look just like the person that came before you, Do you want to differentiate yourself and make yourself more appealing to your prospective buyer, which is your prospective employer?

14:43Well, everybody is a monopolist because everybody wants to look different, better, more appealing to the person that they're selling their services to. and the theory of prices too. So this whole theory breaks down to saying that everybody is a monopolist. And that is absurd and it's useless for economic theory and analysis. Now we come to a much more sophisticated and older theory of competition. And that is that in order to... it's not a theory of monopoly, it's a theory of monopoly price. and that on the free market it is possible to achieve a monopoly price in certain very limited circumstances.

15:28Ludwig von Mises held this theory, as did other early neoclassical economists that were fairly Austrian. In fact, it was the theory of monopoly at the end of the 19th and the beginning of the early 20th centuries, up until about 1930 or so. And it's a much better theory than the two theories we just talked about, especially the last theory, which is the modern theory of monopoly power. And what this theory says is that if these two things are present, then the firm could have monopoly. What are they? First of all, the firm or the seller must own or control the entire supply of a necessary input.

16:14So, if someone controls or owns all the diamond mines, well, then that's one precondition for having a monopoly over the production, let's say, of gem-quality diamonds. If someone owns all the mercury deposits, and there are very, very few mercury deposits, so I'm trying to give you examples where there may be a possibility of this, And then that person may have achieved a monopoly price for selling mercury, okay? But that's not enough, okay? Someone can own the entire supply, but depending on the structure of their demand curve and the substitutes for the good that they're selling, they may not be able to achieve a monopoly price.

17:05Okay, so let me give you the example here. So there's two conditions. Let's say we have someone who owns all the diamond mines in the world.

17:23Okay, this person owns all the diamond mines in the world, and there's some competitive price for gem quality diamonds, certain amount of dollars per carat of diamonds. And that's the competitive price. Now, we'll talk about how they know that that's the competitive price later. Let's ignore that for a moment. If their demand curve is very, very flat like this, if they try to raise their price, the PM, which is a monopoly price, let's say, they're going to lose more than half their market here, the way I've drawn that. And it will not be profitable for them to raise their price. So even if they control all of one resource, but there are a lot of substitutes for their product, they may not be able to achieve a monopoly price. So, if they try to raise the price of these diamonds, then maybe people will start substituting emeralds or semi-precious stones, such as tanzanite, which is alexandrite, and number one, my wife knows all of these semi-precious stones, and they've become precious gems now, because people have shifted to these low-price gems.

18:26Also, I'll talk about substitutes. There are two companies now in the last two years that are capable of producing, through different technologies, absolutely flawless diamonds. These are not zirconium. These are real diamonds. And in fact, the diamond industry is fighting back against them by saying, well, they're too perfect. They're too flawless. Real diamonds, any given diamond is individual because it has a slight flaw in it. These are so perfect, they cannot be distinguished from regular diamonds that are mined, not even by a very, very expert jeweler. They have to be subjected to a spectrograph or some sort of electronic analysis to determine whether or not they were actually, they actually are natural diamonds or they were made through these two different technologies.

19:20So, as we'll see, even if somebody were to monopolize the entire supply of a given natural resource, that simply means that other people would begin to, if they restricted their supply and raise their price, other people would begin to search for technological substitutes for this. And consumers could very well substitute other types of close, in this case, stones, emeralds, rubies, and so on. But now, let's assume that there aren't good substitutes. So, the demand curve is inelastic above the competitive price. Those are the two preconditions. Then they can raise the price from PC to PM, okay? They can restrict supply, reduce the amount that they're selling to consumers, and raise the price and earn a higher total revenue.

20:12So those are the two preconditions. You must own the entire supply of a necessary input, which is difficult to conceive of. But even if you do that, you still must have a demand curve that is inelastic above the competitive price. In this case, the individual can, the owner, can achieve a monopoly price, which violates consumer sovereignty, even Mises says this. But now notice, what they're doing implicitly is setting up consumers as sovereign over producers. Now, we know that in a market economy, not everybody tries to maximize their monetary income, okay?

21:03People may have other motives that, in other words, what everyone maximizes is their psychic, what we call their psychic income. Not everybody takes the highest paying job, okay? Working conditions matter, or the fact that the product that's being produced, they like. Someone might not want to work in the cigarette industry because they don't like the output, They'll take a lower-paying job, working, producing various kinds of foods. And the same will be true of producers. As Walter Block pointed out in a famous article, let's say you can restrict supply. Why is it necessarily monopolistic? The owner might restrict supply just out of motive of conservation. That is, they own this land and it has trees on it, on it and they could increase the amount of output of the lumber but they don't because they like keeping in its natural state, okay, or someone could restrict supply and raise price not just to increase their total revenue but because they want to, let's say, enjoy leisure, okay, or they might want to speculate

22:16that is that they believe they see a higher price in the future so they'll They'll withhold production today, this natural resource, they'll withhold exploiting as much as they can today and they'll produce, use it to produce goods in the future. So that's not, you can't charge that person with monopolizing. However, if you can do both, that's even better, right? If you can reduce your supply of some good, produce less, and earn higher total revenue, then you achieve two goals. You have, let's say, more leisure, or you have more of the good to sit around and contemplate, let's say a forest, and you have more monetary revenue. So no one can really separate out your motives. The motives are intertwined.

23:07Remember, everyone's goal is psychic income, and that's not necessarily solely to maximize their money income. Now, let me give you an example. One of the people that, one of the economists that developed this theory of monopoly, or at least expounded, William Hutt, who was an Austrian, was pushed on the point and said, well, what about a boxer? Let's take a famous boxer, Muhammad Ali. This is the demand for his boxing services, okay? Let's say that he's boxing, he can box four matches a year and he can earn two million dollars a match, and his total revenue would be eight million dollars, okay? And someone says, well, that's a competitive price for a boxer of his caliber, two million dollars a boxing match.

23:55Let's say, then, he cuts back on his supply because he has an inelastic demand curve, or because he wants more leisure. We don't know why. Okay, we can't determine why. Both things are goods. He has more leisure and a higher price and total revenue. So now he fights two times a year instead of four times a year. Price rises to five million dollars a fight. And lo and behold, he increases total revenue. Is he acting as a monopolist? We can't say for sure. What we do know is that he certainly enjoys more leisure and he enjoys a greater amount of money. Well, Professor Hutt said, he can and should be, and he was a free market economist, if it can be determined that he's cutting back his prices, withholding his labor services purely to raise price and increase his total revenue, and not for reasons of leisure, I don't know how you would know this, then he should be forced to fight four times a year, okay?

24:51So on the market, on the free market, we don't have consumer sovereignty in the sense that everyone is totally subjected to consumers, You're only subjected to consumer sovereignty if your sole goal is to maximize profit. In that case, then, you have to produce what consumers want or you're not going to maximize your profit. However, people, since human beings have a broad range of goals and people use their property in different ways, they don't have to use it to maximize their profits, then what we have is really individual sovereignty. So everyone decides when, at what price, and how much of their property to exchange on the market, and how much to withhold, and if the price is higher, well, the price is higher, okay?

25:40So we're still allowing for the moment that you can say that this is a monopoly price, okay, because the two conditions are there. The personality, in this case, owns a specific resource that no one else owns, that is, his own boxing services, which are unique, when boxing were unique, and secondly, he faces, we're assuming here, an elastic demand curve above the, quote, competitive price, unquote. So this is the older neoclassical theory of monopoly price. It seems to make some sense. It does point out that on the market there's continual competition, they would even admit that over time people could come in with various substitutes for the product, various substitutes, let's say, for diamonds or for mercury, and the demand curve could become more elastic and they would have to lower their price.

26:35But still in all, they admit the theoretical possibility, and Israel Kirzner, a contemporary Austrian economist, also holds this theory. They admit that on a free market, it's theoretically possible that in certain very, very rare circumstances, there can be monopoly or a monopoly price. All right, what I want to do now is to go on and talk about cartels, and then I want to come back and give a criticism of this theory, okay, because this theory also holds in the case of cartels, and will show that there is a grain of truth in this theory, but that it's not, this cannot happen on the market, it happens as a result of government intervention into the market.

27:30Okay, now what about a cartel? Cartel is a situation in which a number of producers are competing initially against one another and there's a lower price, they're producing more than they, they're producing a certain amount and then they notice that, now remember, each individual demand curve is more elastic than the single demand curve for the entire product, so if you have a lot of coffee producers, Each one faces a very elastic demand curve. That is, if one coffee producer raises his price, let's say, from the equilibrium price or the competitive price of $2.50, well then he'll lose a lot of his market and it will be profitable for him to raise it above $2.50.

28:18That's why the price stays at $250. However, if all of the coffee producers get together and they all pool their resources and they make an agreement, a cartel agreement, to each cut back by 20% on their output, then what's going to happen is that the overall amount of coffee in the market, the overall supply, we're assuming it's a homogeneous good here, will decrease by 20%. and they will be able to take advantage of an inelastic industry demand curve. Each firm's demand curve, each coffee producer's demand curve was very elastic. That is, they cut their price, consumers would easily substitute other brands of coffee, because consumers perceive them as very, very close substitutes.

29:08So, you know, if Maxwell House raised the price, then people would substitute Folgers. Maxwell House would lose a lot of its customers, so it wouldn't be profitable to raise the price. However, if all of these producers got together, and they produced coffee together, and they marketed it, and they set one price, let's say $4, then you would get a situation where consumers would get less coffee, and the total revenue would rise. It would rise from $250 million, let's say, per year or per month, to $320 million. So, you would have the cartel, they'd be earning higher prices. In fact, what they might initially do, if they have coffee, if they have 100 million already, it's already produced, and they realize they have an inelastic demand curve, it would pay them to burn 20% or 20 million pounds of coffee.

30:05Now, surely this is injuring consumers in some sense. This is inconsistent with the free market. Well, we have to say a number of things about this. First of all, when these coffee producers reduce the output, what happens to the non-specific factors of production? Those workers that are laboring in the production of coffee, let's say. They're fired, they're let go. And they go to work on banana plantations and they become jungle guides. So now the free market is providing less coffee and more bananas to consumers. The price of bananas are now lower. Whenever a cartel restricts supply, some resources are released.

30:50Obviously they don't want to pay these people to do nothing, they fire them. And a certain amount of electricity, a certain amount of machinery, all these things are released and go into other industries. And let's assume the other industry is bananas, so you get more bananas. Who is to say that consumers don't want more bananas and less coffee? So if you say that this is injuring consumers because they're paying higher prices for coffee and there's less coffee, you're also saying it's bad for consumers to have more bananas and lower prices of bananas. All that these people are doing is that they're reallocating their investments. They're also reducing the amount that they're investing in coffee and they're investing it in something else, either in increasing production of bananas or they're loaning it out on the market and it's going into producing, let's say, more automobiles being loaned out.

31:38So you get more goods being produced on the market when you have the restriction. Secondly, the production of any good is necessarily restricted by the fact that there's a scarcity of capital. Consumers want a lot of different goods. So what if the total was of anything, let's say it's 100 million pounds, well, why is that competitive? Why shouldn't it be 120 million pounds? Why shouldn't these producers all produce a little bit more? That would give consumers even more coffee and lower prices. In fact, if you follow the logic, reducio ad absurdum, meaning that you follow it to its logical conclusion, Any price above zero in an industry is restricting supply, but supply is always restricted because there are more profitable, as you increase the supply of one good, and the marginal utility of that good falls, it becomes more and more profitable to produce other goods that people want.

32:41So, you're blaming the people that are producing the goods. People that are anti-cartel, they think there's too little coffee. There's no government restrictions here. It's a voluntary cartel. Why don't they enter and produce more coffee? Or why don't other entrepreneurs produce more coffee? If it's really that profitable. And I'll show you that cartels will break down if they're not really adjusting to consumers.

33:11Another point is that all production takes place under uncertainty. No one knows the demand curve. No one knows the future demand curve. They don't know what the demand curve for coffee will be next year. Whether people will shift to wanting more cocoa or a report will come out by the FDA or by the surgeon general that coffee is very, very unhealthy for you and the demand might shift back. They don't know any of this. So, they produce a certain amount, okay, somebody can produce, let's say, and everyone acts like this, not just cartels, they produce a hundred million pounds of coffee, and they find that they produced in the inelastic range of their demand curve. They produced too much. So, they produced a sub-competitive amount. Why not, I mean, every seller, if they find that their demand curve is actually more inelastic than they estimated, will adjust in the next period by doing what?

34:08Cutting their supply, okay. So even if the hot dog vendor finds that, you know, he's selling a certain number of hot dogs at two dollars a piece and that Pace students like his hot dogs a lot and they like his personality and so on, even though they're competitors close by, and he finds that, you know what, I can raise my price from two dollars, cut back the amount of hot dogs I have to buy, sell fewer and sell them to Pace University students for 250. Well, we would just say, well he's just adjusting his price. to the demand. He miscalculated his demand. The cartel is not doing anything differently than that, okay? There's nothing to say that there should be ten coffee producers instead of one, right? Someone could respond to me, well, okay, yeah, but, you know, he's one of many food vendors in the area.

34:59Here, there's ten producers and they're going down to one. Isn't that less competitive, okay? Well, is it less competitive or less satisfying to consumers that we have one football league instead of ten football leagues? In fact, every time we've had multiple football leagues or basketball leagues, there's tended to be a merger, which better satisfies consumers. If they continue on and there's no new competition and they earn profits, then it's a better adjustment of resources to consumers. Why isn't the cartel adjusting better to consumers? Now remember, when you combine all these, you save on marketing and so on, so your costs go down. So as Murray Rothbard points out, a cartel is an unstable form of organization. If it doesn't benefit consumers, a couple things can happen.

35:47Number one, it doesn't lower costs, then other producers are going to come in and say, you know what, there's huge profits being made in coffee at $4. So instead of producing bananas, I'm going to increase my... I'm going to shift my land over to producing coffee, so other tropical products will be shifted over to coffee. And that would expand the supply and the cartel will initially say, you know what, if you agree to pay to charge $4, we'll let you in to the cartel. So they can do that for the first few producers, but whenever you allow someone else new into the cartel, what do the existing members have to do? And this is the problem that OPEC has. They always have to cut back more on their production.

36:33Because if you want to keep the price of $4, you still have to produce only $80 million. If you're letting a new guy in that's producing two or three million pounds of coffee, then that means everybody else has to cut back. So there begins to be dissension in the cartel. So you have external pressure. And adding to the external pressure from outside entrepreneurs, If people that enter are invited into cartels, into the cartel, then that's going to give other entrepreneurs an incentive to come into this profitable cartel. So eventually people are going to continue to enter the industry because it's high profits and the cartel is not going to be able to absorb them and they're going to just out-compete the cartel. They'll just lower their price and the whole cartel will fall apart. That's what happened to OPEC. OPEC raised prices to something like $36. More and more people got into producing oil, discovering oil in 1979 onward.

37:24By 1985, despite inflation, the price of a barrel of oil went from $36 all the way down to $12. The whole cartel had collapsed. So OPEC is really a cartel in name only. Now, there's internal pressure, too. If there's really profit in this being earned, high profit being earned, then a few of the producers are going to want to produce more. There's going to be a big fight, first of all, setting up the cartel. Some people are going to say, you know what, we're small producers. And we were growing. And it's usually the bigger producers that want the cartel. They want to freeze everybody where they are. So the small producers stay small. Well, everybody cuts back by 20 percent, the large producers stay larger.

38:10The small producers many times will say, that's not fair, I want to produce, I want to grow. So you take a bigger cutback, you cut back by 50 percent, I'll cut back by 5 percent. That's what happened in OPEC. Saudi Arabia, as the biggest producer, was forced many times to cut back much more than it was supposed to because other countries like Iran and Iraq and so on were producing more than they were supposed to produce in the cartel. That causes internal pressure. Eventually, to get more business, the smaller members, or the members that bring in new technology and lower costs, what they do is that they secretly give rebates. They secretly cut prices. And when they do that, they begin to steal customers from other producers.

38:56And the other producers begin to worry about this, and they cut their price, and the cartel falls apart. Even if demand has fallen and there is no real cheating, some of the producers that are losing because demand has fallen begin to suspect others are cheating and they begin to cheat and then the cartel breaks down. So it's unstable in that sense. If it's not really a better adjustment of resources to consumers, it breaks down on the free market. If it is a better adjustment of resources, that is, if it lowers costs, then what happens is that these firms merge into one like the NFL. So a cartel will either break down the free market or because it's a more productive organization than having separate producers it will merge into a permanent firm. And the final point of course here is what's the difference between a cartel in which people simply pool their resources partially and make only pricing decisions and output decisions together but no other decisions

39:53and a corporation where people pool all their capital and they make all decisions together. So in other words, why can't you call McDonald's a cartel or McDonald's a corporation? How does that differ from a cartel? You have all of these people, the owners, the stockholders, owning all of these resources spread throughout the country and the McDonald's are adjusting their policies to one another. They're not competing against one another. Why is a cartel bad and a corporation that owns a lot of different resources, why is a corporation okay? Really there's no difference. This is unstable in the sense that it's either a way station to a corporation if it's really more productive or it will break down on the free market.

40:43Okay, so they're unstable, okay, now let's, and once again, the theory of monopoly price is applied here, it said that 250 was the competitive price, he had 10 people, you know, 10 competitors, and $4 is the monopoly price, okay, the 10 competitors own all of the... Let's somehow say that they own all the land that's fit to grow coffee on, they get together and then they raise, they have an inelastic demand curve, they raise their price. Okay, so that fits the theory of monopoly price. Now that wouldn't happen with coffee because there isn't one necessary input. There's a lot of different kind of land that can be used to produce coffee.

41:31So what I want to do now is to give a critique of this theory of monopoly price and then we'll talk about what is behind monopoly and cartels, what keeps them when they're inefficient, what keeps them in business. One other point I want to make about cartels is this. If people really didn't like having less coffee and paying a higher price, they could do one of two things that would make the demand curve more elastic. One is they could boycott the coffee cartel. That is, consumers could get together and they could all consciously buy less at $4 than they would have anyway.

42:21That is, they can consciously change their value scales and begin buying tea and cocoa and so on. If they do that, what will happen to the shape of that demand curve? Well, they'll buy less, so the demand curve will become much flatter, and the total revenue that the cartel is earning at $4 will drop and the cartel will then lower the price. Or secondly, they can bribe the cartel to lower the price. How can you bribe the cartel to lower the price? You can offer to buy more at $250, okay, than you did before, and that means that the total revenue at $250 would go up above the total revenue at $4. That would also make your demand curve flatter and they could lower the price. The key to remember is there is no monopoly exploitation here because who controls the demand curve?

43:13Consumers, it's consumers that are placing coffee high on their value scales, okay? So, they're controlling, they can completely control the shape of the demand curve. It emerges from voluntary actions. It's consumers plus substitutes that are available to consumers. So, if either consumers lower the values of coffee on their value scales, or if others come in with good substitutes for coffee, The demand curve is going to become, as a result of voluntary action, much flatter and the cartel is going to break down. So there is no coercion involved in this.

44:02Okay, now why is the monopoly price on a market, whether it's developed from someone, you know, via a cartel or via an outright monopoly? Why is it an illusion, something that really does not exist and cannot exist on a completely free market, okay, where there are, there's no infringement of property rights, okay? Well, you cannot distinguish a competitive price from a monopoly price, right? First of all, why is 250 the competitive price? Who says it's a competitive price? If there were more producers in there, it would be even lower. If there were fewer producers, because maybe they saw better opportunities elsewhere, and maybe that's what the people in the cartel did, they said, you know what, we're going to take our resources out of coffee because we think there's going to be a big boom in people eating bananas, or people coming down to South America, Latin America and going into, who want to go on guided tours of the jungle.

45:04So we're going to expand our jungle guide business or whatever it is. So we're going to move resources, our investments.

45:16On the free market, every producer, large or small, whether they are the exclusive owner of some factor like Muhammad Ali or someone who owns all the diamonds in the world, diamond mines in the world, all of them have to estimate their demand curve and all of them have to adjust supply to the point at which they think their profits are going to be the highest if then when the market conditions emerge, when their goods are ready to be sold they find that the demand curve, whoever they are, is more inelastic than they initially thought they will restrict supply and raise price So, there is no way to tell the difference between a competitive price and a monopoly price, okay? If the demand curve is inelastic above a given price that emerges on the market, the incentive is to raise prices, to maximize your profits.

46:09So why can't we call it a sub-competitive price? That is, they made a mistake about estimating the demand curve and now they're adjusting to the inelasticities in that demand curve. There is no way to say that they're moving from a competitive to a monopolistic price. Prices are never, people are never completely right about what prices will maximize profits. They're always making mistakes and they're adjusting. They're either lowering the price or they're raising the price. And raising price means you have to restrict supply. And as I mentioned, you know, the hot dog vendor is doing the same thing continually, as the demands that the students exercise for his product are changing over time.

46:51So it's meaningless to define a monopoly price as a price that's higher than a competitive price that involves restriction of supply because a sub-competitive price is defined the same way. That is that the price above the sub-competitive price or the demand curve above the sub-competitive price is inelastic. You can earn higher total revenue by raising a price. So, there's no distinction. Now, what then is monopoly? Is there any sort of a meaningful definition of monopoly? Well, in fact, yes, and it's based on this theory. It's a development, an extension of this theory. And it was really Murray Rothbard that developed this price. And actually, it's the oldest theory of monopoly.

47:38Monopoly, and that is that monopoly is always a grant of legal privilege to sell, to produce and sell, to a single seller or a group of sellers, so it's a grant of legal privilege, or to put it another way, it involves a legal exclusion, the exclusion by the force of law of competing entrepreneurs. So, to give you one example, this is an example I gave earlier in the seminar, when the Reagan administration placed tariffs on foreign automobiles, or I'm sorry, placed some voluntary export restraints on Japanese automobiles, What it did was it coercively or forcibly changed the structure of the demand curve.

48:47The demand curve now D2 became more inelastic because there were no good substitutes in the range of $10,000 to $12,000, let's say. Those substitutes were reduced because there were fewer substitutes. Consumers had a coercively restricted choice. They would have freely made their exchanges, many of them would have, with the Japanese auto producers. And they were prevented from doing that. So what Rothbard points out is that, first of all, you must have a legal privilege. Now the legal privilege is what we might call the control over a particular resource, but it's an artificial resource.

49:32It's a recourse to government violence that is given as a privilege. So there is a resource that, and it has a value, we'll talk about it when we talk about the taxi industry in New York City. To have a license to get into driving taxi cabs costs you a lot of money, and I'll explain why. So there is a resource, but it's a resource that comes from government creating it through some sort of policy that forcibly bars competing entrepreneurs, either partially or completely, from coming into the market. So you have that control, but it's really a legal control, and secondly, if the demand curve didn't change that much in shape, if it stayed at D1 or a little bit more steep but still pretty flat, you could not have a monopoly price even though you restricted the competition.

50:25So Rothbard points out that you have to have legal exclusion or legal prevention of entry plus a demand curve that's inelastic above the current price. So there are two, he distinguishes between a monopoly price and a free market price. The price that arises on a market in which the demand curve is not coercively changed in shape versus a price that arises when the government gives a monopoly privilege to a seller or group of sellers. There are two preconditions, and this is a theory of monopoly price, but it substitutes for control over a given resource legal privilege to keep competitors out of the market.

51:16And then, it is a meaningful definition because the demand curve is being changed in shape. It's not a voluntary demand curve, or it's not completely a voluntary demand curve. It's one that arises out of, let's say, restricted choice.

51:34So there is no such thing as a difference between competitive and monopoly price on the free market. There's a difference between competitive price and free market price, I'm sorry, monopoly price and free market prices in general. In general, all prices on the free market are competitive. They're inherently competitive because entrepreneurs are always free to offer a better package, to engage in rivalry. To the extent that they're not, then you have the change. Then you have the change in the shape of the demand curve and you have potential for monopoly price. Now, even if the auto industry was unable to raise its prices, consumers were still forced, many of them, not to make exchanges with Japanese auto producers, so they're still injured, they still have lower utility, even though there's no monopoly price that is possible.

52:29Also, on this market, what happens now to the people that were producing automobiles, all the workers? They are let go because now there's fewer automobiles being produced, okay, and they're in a higher total revenue. So they let go of these nonspecific resources, resources that can be used in other industries. So we do get an increase. Let's say they go into the production of shoes or of clothing, okay, the people that are laid off in the auto industry. So we have more shoes and we have more clothing on the market, lower prices for those things, but we have fewer automobiles. Can we say that that's an inefficient allocation of resources? We can.

53:14Because when they leave this industry, let's assume that they were earning, let's say, $15 in either industry, $15 per hour. What's going to happen is that as the ones that are laid off go into another industry, the value falls, the marginal revenue product in the other industry falls. It goes from, let's say, $15 to $12 because they pushed out the supply. So resources are forced into lower valued uses. So it does serve consumers less well. We do not want fewer automobiles. Consumers will voluntarily, if there's no legal restriction, shift their demand curve back to what it was and we would have more automobiles. So, the shift of resources is a result of a government legal compulsion, okay?

54:04And that restriction of supply causes a misallocation of resources to lower value users.

54:14There's also the lack of potential competition. In this condition, the industry will become more and more inefficient, okay, under these conditions because not only do they not face active competition, okay, well, the NFL doesn't face active competition, but it maintains a product that's continually changing and improving because they're always afraid of potential competition, someone else coming in, another league coming in. And that goes away once you have a monopoly. We know we can see that with the post office, okay, how bad their service is, and I'll give you an example in a moment. Now, last thing, do monopolists, monopolists in Rothbard's sense, do they earn profit? No, profit is an entrepreneurial return, which tends to disappear because other entrepreneurs will come in and produce substitutes and rival them with other products.

55:08products. But if they don't earn a monopoly profit, profit is a free market return. What do they earn? They earn what we call monopoly gain. And the gain is to the restriction that they enjoy, the license or the tariff. And now I'll give you some examples and I'll show you, you know, what types of monopoly gains or what they look like, how it engages the monopoly gains, excuse me. So let me just go into a few examples here. One of the best examples of a coercive cartel is a taxi industry in New York City.

55:58Back in 1939, taxi owners who were hit hard by the Depression, as everyone was, got together and they appealed to the city government, the city of New York, to restrict the supply of taxis. So the New York Taxi and Limousine Commission was formed back in 1939. They allowed, they awarded, they grandfathered in the people that were already in the industry, and those people were given licenses. They're called medallions, taxi medallions. Those medallions, the number of medallions given out at the time was 11,700. So there were 11,700 taxis permitted in New York City at the time.

56:48Now, since 1939, income has risen tremendously. The demand for taxi rides has shifted to the right. People's incomes have gone up. Guess how many more medallions have been awarded? Zero. Zero. Okay. There was a bit, Mayor Koch, back in the 1980s, seeing, you know, if you're in New York City during rush hour, you can't get a taxi. During a rainstorm, you can't find a taxi. When the theater lets out, you can't find a taxi. Around train stations, very difficult to find a taxi. And yet, taxis will whiz by you with one person in them. Now compare that to Washington, D.C. Washington, D.C. has a pretty open market in taxis.

57:36in taxis, okay, it's pretty free. All you have to do is pay a $200 registration fee and then prove you're not an ex-felon and you can invest, buy a taxi and begin operating and competing. And it was very interesting back in the 1980s when I'd be going down to Washington, I would take the train down. It was so competitive that taxi drivers, as you were coming out of the train station, the big union station there in Washington, They'd be running up to you and they'd be grabbing at your bags to try to get them into their taxi. And they would fill the taxi up. They wouldn't just pick up one person. They'd fill the taxi up and they'd stop at different places. Also, there was no taxi meters. There was no meters. Here's where it was a little bit controlled. Within a certain area in the inner part of the city, around the central part of the city, around the train station, it was something like $2 for the ride.

58:29Yeah, but they've done... you see that they're spending in regulated prices, because like you said, they have the zone prices, right? Instead of... There's zone pricing. ...instead of like other cities where it's a fair rate that's a little bit more... But there's still... but it's high enough that... you know, I don't think it's a binding price ceiling. It's high enough that it's profitable to have a lot of people who are going to be able to buy a lot of things. But it's high enough that, I don't think it's a binding price ceiling. It's high enough that it's profitable to have a lot of taxis. So it might be set at the equilibrium price or slightly above it or maybe even slightly below, but I've never noticed any shortage at all of taxis. Finally, they have Amtrak personnel, the train personnel actually force them back behind a line and then people would line up and get the taxis and it moves very quickly.

59:17Now, in New York City, they cannot, if there are two people at a corner, they can pick people up at the same stop, okay? So this is a further restriction of supply. However, if you're down the block and they pick one person up, they can't stop for you. They have to take that first person to their destination, his or her destination, and come back and pick you up or they look for other people. So, not only do they restrict the number of cabs, they restrict the space within the cab, okay? So, as a monopoly cartel, now guess how much it costs you, since you can't get any more licenses from the Taxi and Limousine Commission, to get into the business. Not only do you have to purchase the insurance and the automobile, you have to purchase a medallion from an existing owner of that medallion. And that was $144,000, okay, and I don't have a date on this article, this must be in the mid-90s, and it had fallen to $129,000 in the year that this was written, okay, it had been up as high as $144,000.

1:00:18Back in the 70s and 80s, it was only $80,000, it was $60,000 to $80,000, okay. Now, what does that represent, that $129,000 that that medallion sells for? Yeah, it's the value of being permitted, being given legal permission to enter the industry. If tomorrow New York went to a system like Washington, what would happen to the value of those medallions? They'd fall to zero. Those medallions, the price of that medallion is the discounted present, It's the present value or the discounted stream of future monopoly gains and those gains are returns to the permission to enter.

1:01:06Now what eventually happened was that there was such a scarcity of taxis, especially above 125th Street, Harlem, the lower income part of New York, and they didn't have very good ambulance service up there either. So people used to take taxis to go to the emergency room. But there were very few taxis around. Eventually, there were these illegal taxis that used to cruise secretly. They were called gypsy cabs. They still are. They are quasi-legal now. They're permitted to pick people up above 125th Street, in the outlying boroughs like Queens and Brooklyn, where there are also shortages of taxis, and bring them into Manhattan. But they're not allowed to cruise Manhattan and pick people up and bring them out again. But they do anyway, which is a great thing. And then there's also cars that you can take. They can call to come pick you up. They're allowed to compete with the taxis, so you can call, but they can't cruise, but they all cruise, too.

1:01:58They're all big limousines. So there's a lot of illegal competition in this industry, which of course benefits consumers. It lessens the restrictiveness of this cartel. If you got rid of the cartel arrangement, if you abolished the Taxi Limousine Commission, and those medallions fell to zero, would the people like the original gainers be hurt? What you'd have is a lot of people who just bought those medallions at the full price, losing their capital. In other words, if you go into the industry now, you don't have any monopoly gain. You pay for the full monopoly gain to the last owner of that medallion. So the people who benefited were the people who were originally in the industry, and then their heirs who got those medallions, or the people who bought the medallions when their prices were low.

1:02:51Let's say if they bought them in the 80s, it's $60,000, and now it's $129,000. They have a gain. So that's why it's difficult to get rid of them. Some people are going to be genuinely hurt who have not participated in any of that monopoly gain. That's not to say that you shouldn't get rid of them, from my own personal point of view as a libertarian, yes, get rid of them, I mean, that's tough, I mean, someone is involved in this monopoly scheme and hasn't gained much for it, well, that's too bad. Now let me turn to another one of my favorite and least efficient monopolies, the post office. About 1980, this shows how inefficient the post office is, there was a Cub Scout den on Long Island, New York, that began to hand deliver Christmas cards, they did a free of charge in the neighborhood, just as a good deed, and they promised same day delivery.

1:03:51Now, of course, trying to mail a Christmas card during Christmas time, not only do they not get it there the next day or within two days, sometimes you don't get it for weeks because they're so inefficient. So the local postmaster found out about this and he went to the den mother of these little cub scouts, six and seven year olds, And he told them that they were violating the private express statutes, which were passed in the 1870s, which said that you cannot deliver first class mail, you cannot use mailboxes, that can only be used by the post office. So he wanted to charge them $38.25 for the lost postage, and they were told, oh I know, these were actually just flyers, they had just put flyers in people's mailboxes to advertise the service.

1:04:43and the size of service, so instead of mailing the flyers through the post office, so that they were going to charge them $38.25 and then another a fine up to $76,000, okay, for violating the postal statutes, okay, and so they write here, another threat to the postal monopoly nipped in the bud, okay, and then there was even a bigger article on all this and you know basically saying the same thing, It was a big outcry, fortunately. People were just outraged that they were going to fine this cub scout then, $76,000. So a U.S. District Court judge in New York ruled last April that the cost to free expression imposed by the postal law outweighed the services arguments that the law was necessary to prevent the loss of revenue and to protect against mail fraud.

1:05:35So, they're allowed to put the flyers into the mailboxes. People can put flyers into mailboxes, but they still can't carry, you can't put mail. In other words, you can't compete and put actual mail and cards in there. So, he upheld that part of it. But just think about it. If they're afraid of a den of Cub Scouts, how many weeks would they last if Federal Express and UPS were allowed to deliver first-class mail? I think it would be a number of weeks. I think they would collapse within a few weeks. It wouldn't even take a few months. So, this is incredibly inefficient. It's very interesting. If you go to any other, if you go to a retail outlet, a private retail outlet, Where do the employees park?

1:06:34They park far away in the least successful spots, right? The consumers are given the best spots. When I go to my post office, the spots that are closest to the building are always designated postal employees only. It's really run for the benefit of the employees, not for the consumers. There is no consumer sovereignty here. Another example that I want to give of a very interesting example of a form of monopoly. There was this entrepreneur from Kentucky who found that through experimentation that grapes could be harvested, wine grapes could be harvested on strip mines, strip mines could be turned into vineyards.

1:07:30So, he began to market a wine, and it was on the strip-mined hills, and he's also the president of the Falcon Coal Company, also. StripMind Wine, or actually I guess he rented it out. StripMind, at least the land out. StripMind Wine was the inspiration of William Oliver, a law professor from Indiana University. Oliver, a Kentuckian who runs his own winery in Bloomington, persuaded Jackson, the head of the coal company, and the Falcon Coal Company to plant six acres of French hybrid grapes back in 1972, as an experiment in reclaiming StripMind mountainsides.

1:08:15However, when they tried to bring the wine to market, guess what happened? There were local liquor laws invoked by not only people that were interested in temperance, that didn't want this wine produced, but also the bourbon industry, which is a big industry in Kentucky. Why would the bourbon industry be interested in wine? Well, because it's a competitor. So they use these laws, the company, they use the laws to suppress any further production of this wine or at least marketing of the wine. I don't know whatever happened. He had plans to continue and try and try to do it in other states and get laws changed and so on.

1:09:03Monopoly isn't just an implication of a large firm. It's not something that you have to be a large firm to exercise. You just have to get the government on your side. Local liquor laws, which restrict the number of liquor licenses, are also Monopoly's scheme. So that restaurants, when they open up, in order to get customers, they have to pay a high price to get a liquor license from existing establishments. So before you can open a restaurant, you usually have to buy, even if you don't like this other restaurant, you only have to buy this restaurant just to get its liquor license. And that return to the liquor license, again, is a reflection of the monopoly gains. Another example is health laws and other sorts of local laws that prevent people from competing.

1:09:53I don't have the article here. Yeah, I do. This occurred back during the gasoline lines in the 1970s. There was a young kid who was extremely entrepreneurial. And he found that people that were waiting on gasoline lines during, in the early morning, from 5 o'clock and 6 o'clock, people getting up very, very early, trying to get some of the gasoline during the shortage, that they didn't want to get out of line, or they couldn't get out of line, and get coffee. But they wanted coffee, so what he did, he and his father, his father helped them, he outfitted a wagon with all these signs and he put a number of thermoses of coffee, had his mother make him coffee and so on.

1:10:41And he went along the line and he sold coffee and also donuts and so on, out of the wagon. And this evil deli owner, evil monopolist deli owner, Barry Wurzel, he was getting very upset about this, he was losing customers. So the 33-year-old owner of Barry's place, okay, where a small container of coffee sells for 35 cents, this is back in the 70s, watched unhappily for several days as drivers purchased coffee from the red wagon which plied the lines in front of his store. So what did he do? He called the Board of Health to find out if his competitor's business was legal. It wasn't. So the Board of Health asked the Roseland Police, that was the town in New Jersey where this occurred, to deliver a letter to Billy yesterday morning, notifying him he was violating borough ordinances because he didn't have a peddler's license.

1:11:33Billy's father, William, who's a supermarket manager, who said he doesn't worry about the store's cookie sales when the Girl Scouts are outside selling theirs, He doesn't try to monopolistically put them out of business. He intends to apply for a license for his kid. And then he goes on to say, the father says, the whole thing is just so ridiculous. The kid is out making $5 profit a day and Barry, the deli owner, tells the policeman and Billy that he has mouths to feed at home and Billy is cutting into his business. Okay, so there's a bigger brouhaha. The luncheonette owner then countered, I'm taking a bum rap. I was a kid and I have three kids. I'm not trying to stop them, but when they're sticking their heads in my door and saying you can get it cheaper outside, the kid was actually selling it at a lower price, it makes you a little bit irritable, okay.

1:12:25Then they go on to say, the Java feud reached the boiling point Wednesday morning when several customers told Werfel, his 60-pound competitor, the kid, had a sign in his wagon containing meaning derogatory references to luncheonette, the sign said, cheaper than Barry's and drinkable too. Hollywood contends, the father contends, that Worf will chase the kid down the street. Then somebody else jumped out of one of the cars on the gas line and told the kid, Don't worry, I'll protect you. He won't hurt you. I don't know what actually finally happened to all this, but I mean it's funny in one sense, but in another sense, whenever anybody can get the government to suppress a competitor, they'll use that legal power.

1:13:15And that shifts back supply and injures consumers and yields a monopoly price to Barry in this case.

1:14:00And local vendors want them to crack down on these people, right? I mean, that's, you know, they have, they contribute to campaigns, you know, the mayor likes to be on good terms with the business community, so he's going to suppress these local, these vendors that move around and who have very low costs and can sell at lower prices, okay? Even though it benefits consumers. Now, there's something to be said about police not allowing vendors to clog up streets, that's a different story, okay? And in New York, all vendors have to have licenses. In New York, the vendors get around it quite a bit. They set up and they see cops and they know how to close their shop up really quickly and pick up their stuff and move down the street. One time I was in New York, I think it was two years ago, and it was actually below zero Fahrenheit.

1:14:49It was horribly cold and I forgot my hat. So I was going to go into a hat store right near Pace University. University, you know, the hats were like 20 bucks and over, and there's this great vendor, right across the street, illegal, and it was like five dollars for a ski cap, and I still have it, it's still good, so I went over there and bought it, so at the cost of two coal to come out, so that's why all the vendors were all out, which is great, I mean, you're right, I mean, there's fulfilling a need there. Okay, any other questions? Yes, Chris? So you're saying, you're asking if there's a difference between the right to exclude people, on the one hand, who people...

1:15:40The question is more specific. In the case of a patent, someone is given a right to exclude other people who do not have the patent, from infringing on his patent rights, so he has a right in some sense. Is that different from the other types of policies that I've been referring to and that we would call monopoly policies, okay? Well, most economists, or many economists, not most, many economists and most Austrian economists think that patents are a monopoly, okay?

1:16:29They're different from a copyright, okay? Two people could discover the same process independently, or even one could discover it before someone else, but someone patents it first, and then they have a right to exclude anyone else from it, from duplicating the process. Yes, that would be a monopoly. Now, you might say it's a beneficial monopoly, on some grounds, but Rothbard is distinguished between a patent and a copyright, a copyright on a book or even a copyright on a machine. In the case of a copyright, the person who comes up with something that's very similar, the person holding the copyright has to prove that they somehow stole that from him.

1:17:18They stole the ideas from him. Whereas in the case of Patton, the burden is on the person who introduces the product independently. He's considered guilty immediately. Now other libertarians such as Stephen Kinsella claim that there shouldn't be any intellectual rights and intellectual property. So this is an ongoing debate, is what I'm getting at here. I would say that I'm pretty certain that patents are a monopoly privilege, because people can independently discover similar products or processes. Why should one person be given the right, the legal right to exclude others from that? In one case it's the Governmental Act, and in another case it's the Prize Act because the government won't enforce that.

1:18:07The government will enforce the patent. It's up to the owner to bring a civil suit. Ultimately there is some sort of threat of violence. That is a threat of prosecution. Even in the case of a civil suit. Or actually a threat of having your property forcibly taken from you. Treble damage, right. Right. So it's still enforceable, it's still enforced ultimately by the state, by the state courts and so on. Any other questions? Okay, thank you.