This afternoon's lecture has as its topic the history of the Austrian theory of monopoly price from Menger to Rothbard. 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 of 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' brow? Or 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 overemphasis 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. Okay, well, we'll talk about that. But would the theory of monopoly price, did it just emerge full-blown from Mises' brow?
Or 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 overemphasis 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 a firm has a trademark or a certain amount of goodwill. Okay, well, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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.
Okay, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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. Okay, we'll talk about that.
But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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. Okay, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow?
Or 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 overemphasis 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. Okay, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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.
Okay, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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. Okay, we'll talk about that.
But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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. Okay, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow?
Or 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 overemphasis 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. Okay, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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.
Okay, we'll talk about that. But did the theory of monopoly price, did it just emerge full-blown from Mises' brow? Or 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 overemphasis 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 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 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. He also distinguishes between monopoly as an actual condition and social restriction on free competition. So monopoly as 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. For example, if you have very few people that initially demand computers when they first come out, you have one seller for computers, but there's no barriers to entry. When does the demand for computers increases, you'll get more and more firms entering the market, which is what happened.
Or when a hand calculator, Texas Instruments was the first one to market these electronic hand calculators. The price was $200. As demand increased, more people entered the market and other companies entered the market and we had 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. Just 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 prices and profits go up, you cannot have, entry is not permitted.
An expansion of supply by competitors is not permitted. So that's very, very Rottbardian to distinguish between monopoly as an actual condition, which is beneficial to consumers, because you only need one if there's very few consumers demanding the good. You only need one producer. But as demand increases, additional producers come in.
So that's the basis of monopoly price theory. It's based on Menger's analysis. Now, most Austrian economists, Fetter, Davenport, Wittke, the people we spoke about yesterday and today, also believed in monopoly price theory, in Mengerian monopoly price theory. John Bates Clark also.
The person before Mises that developed it the furthest was a student of Frank Fetter who was a follower of the Austrians in the United States. His name was Vernon Munn. 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. One 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'd have 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 the wheat market, if you are a seller and you increase your output enough, you could push the price down slightly. But 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 books. But there's a third book that came out in 1933 that was very neglected. It was completely neglected.
This was the book by Vernon Munn. It was called Monopoly, A History and Theory, by Vernon Munn. And it's very interesting what he writes in the book. He has this quote at the beginning of the book, and it says the following.
It says, Menger's logical analysis of monopoly trade was an original piece of work. Therefore, economists had always made the 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 single 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. It 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. It simply has to do with market conditions. Therefore, the logic of Munn'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 the state that results in the emergence of a monopoly price.
That's why Austrians talk only in terms of monopoly price. That directs your attention to supply and demand, whereas neoclassical economists talk in terms of a monopoly, a firm as a monopolist, or in terms of imperfect competition or monopolistic competition. They talk about various technical aspects. But that's not what Munn did.
Very interestingly, he anticipated Kirzner and defined competition as a state of rivalship. Today we say that, in the Austrian terms, competition is an imperfect competition. It's what we call rivalrous competition. So Munn 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 Munn, the presence of two or more persons offering to buy or sell goods of a similar type, each endeavoring to outbuy the other as to price or as to quality and price, and each acting with no outside restraint. So as long as there's at least two people in the market. You don't need a million. You don't need 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 a profoundly Austrian insight. In fact, he rejected Chamberlain, Chamberlain's claim, the father of monopolistic competition, that competition required a large number of buyers and sellers.
And he argued that, quote, this is in terms of the working of economic processes. According to Munn, 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, okay, as I showed with Menger, and that of the first excluded buyer. Even a non-collusive duopoly, that is two different firms, like Coke and Pepsi, let's say there were no other soft drink firms in the country. It's only Coke and Pepsi, and they're acting independently.
They're going to have, 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 about the, 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, you know, oligopolists, and they'd start talking about how, you know, they would tacitly, you know, wink at each other and raise the price somehow. None of that is in Munger. None of that is in Austrian economics. He points out that even if one butcher shop controlled three quarters of the trade in the town, he said that would not be ipso facto monopoly, okay.
He says true rivalryship 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 people of 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 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 to the United States. That lasted one year. The 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 products is monopolistic. The fact that, let's say, Pepsi goes on television 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 on the beach and so on. And supposedly that's somehow monopolistic.
It's manipulating consumer demands and so on And he defined them in the following way. He said, formal monopoly is monopoly shorn of its power by potential competition. So, you have the National Football League, okay, 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 leagues 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 what consumers think? Why should they just say, here, here's a product, huh, you know, no one else is competing. Well, because they're only a formal monopoly, according to Munn.
They are not a true monopoly. There is always potential competition. And potential competition can be expanded out, in other words, people can turn the television off or turn to other types of entertainment on television. Or they can go to other types of sporting events or entertainment events.
So, there's always potential competition operating, okay. 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.
Okay, this is, again, straight Austrian economics. He also 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 on the amount they purchase because new firms will come in. So, effectively, the demand curve is very, very elastic.
And he went on to maintain that the 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, potential profits would appear, and others would enter and begin to compete. Okay, now, what about true monopoly? He says a true monopoly is one that possesses genuine monopoly power.
He defines monopoly power as consisting in the ability to regulate either market supply, okay, as we saw with Menger, or market price to maximize profit. Okay, he 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 1,000 people will come. On the other hand, if they want to sell 80,000 seats, they have to charge an average of maybe a little under $100 a game. Now, what are the factors underlying monopoly price? We point out, like Mises does later on, that there has to be an elasticity of demand for the product that is inelastic.
Also, cost 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 to our detriment. For example, when a new, very popular movie opens, you see lines around the block at many places the first day, let's say Star Wars, okay? Why don't they raise the price? They could probably fill the theater if they raised 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 equilibrium price, it'll be slightly below equilibrium, there'll be many people that are scutted by that very, very high price that will not come back to that movie theater.
So let me show you the first graph to show you where a monopolist, the difference between monopoly and competition, or a monopoly price and a competitive price. Let me, do I need to, does everyone see that? Let's assume that the cost is $3. You see that in the normal cost line I have there?
It's $3 per unit. And let's assume for the moment that the firm has already produced 7.5 units, because that's what that point should be. It should be at 7.5 right there. I'm taking this, this is taken from Munn's book, this diagram, okay.
Now, the curve, the downward sloping curve is known as the buyer's reserve valuations, okay. Each point represents the highest price that they'll pay for that quantity. So the highest price that the monopolist can get for, let's say, 11 units is $3. I'm sorry, 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, five units is $9, okay. The highest price they can get for 7.5 units right there is $3. That's a competitive price. This is the problem with monopoly price theory, which we'll show is also a problem with Mises.
That's a 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. But looking at that demand curve, we can tell it's extremely inelastic.
So what the monopolist will do is, 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. And the profit is the rectangle between the difference between $9 per unit and $3 per unit cost times the number of units produced, okay. 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 that's the highest possible profit that can be earned there, okay. So, however, he cannot say, I'm going to sell at $9 and I'm going to sell all 7.5 units that I produced. He's already produced them, let's say.
He can't do that. Because if 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, okay, and he had it in inventory, what would he do with the other 2.5 units assuming that they're perishable?
He would destroy them, okay. 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 7.5 units and the price would be $3, okay.
So if you have two or more non-colluding firms competing with one another, you would get the competitive outcome according to Munn. The fact that you have one guy allows him to determine the supply. That's the key here, right. 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 $3 to $6. And he can only cut back to six units, and that would maximize his profit. I didn't draw that demand curve because 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, okay. Now, 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 Mengarian price theories, including Rockwell, begin with. And that is in 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 would dominate the tomato market in some area. You're the only one who produces tomatoes in that area, okay. And they're already produced, right.
How many will you sell? How many will you destroy? And I can show you a graph that, again, comes from the book. He shows once again that the monopolists, that the buyers have a certain demand curve that they control, okay.
They determine, you can think of this in terms of thousands of dozens of tomatoes, or thousands of pounds of tomatoes that are sold, okay. It's a downward sloping demand curve. And let's say the cost of producing these tomatoes were $1 a pound. And that then is the competitive price.
The competitive price is $1, and 11,000 pounds would be sold. All 11,000 have been produced, okay. However, if only one person is the producer, that person has the option of restricting the supply, in this case, you would want to, again, this rectangle here than hundreds of thousands of thousands in the market. What's interesting is that in this chapter on price and human action, there are five sections on monopoly price that take up half of the section on prices.
There's 70 pages on prices and 35 on monopoly price. So what Mises is trying to do is to survey and to refine the theory of monopoly price that developed from Menger to Munch. One thing I want to point out before I go into this is that we don't give him enough credit for his theory of monopoly price because 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, it 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 developed 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.
Mises, 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 work. 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 decodes it a little bit, but let me just look at this as a copper mine.
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 $500—will be 100 million pounds of copper. The total revenue of the firm will be $500 million. Now, Mises says 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, okay, 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'll 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. Now, if one person owns all those mines, that person would restrict production.
Now, we're talking about the amount he brings to the market. Let's say that for whatever reason he's produced 100 million tons. 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 of $525 million. So now, why is this bad for society, according to Mises? It's bad for society because there are non-specific 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-value goods for consumers. Does everyone see that point?
So, in a competitive situation, Mises says that the specific factors, 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 thing that Mises says here. He says, in what situation would— 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 firm would be losing money because they wouldn't even be covering the cost of wages per unit, per pound of copper, and the interest. So, restricting supply from 150 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. Let'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, it wasn't even—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 a monopoly. What implies monopoly is that if you restrict supply above the zero-rent margin, okay, if laborers go to places that have lower value, that is, if their marginal revenue product is lower. Now, 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, okay, 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, okay.
It's extremely rare. And mercury, I guess, is also very, very scarce. So it could happen with mercury or 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.
Now, what if above $5 people cut back sufficiently on the amount of output that they were producing that you wouldn't have a 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, very 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. In other words, there could be substitute products, close 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, okay? And the monopoly gain is a return not to your entrepreneurial ability, it's a return to the control of this—the sole 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. Let me give you an example. In New York City, there was, in the late 1930s, the taxicab drivers got together, the taxicab companies.
They petitioned the city because it was during the Depression to limit the number of taxicabs by awarding licenses. There used to be free competition before 1939. And so the Taxi and Limousine Commission was developed and put in place. And the Taxi and Limousine Commission issued 11,700 licenses.
Basically, they grandfathered in all the current taxicab 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 taxicabs. Guess how many additional licenses the Taxi and Limousine Commission has issued? Zero, okay?
They did, after a while, Mayor Koch tried to issue 400 more, okay? And the lobby for the taxicab companies prevented him from going through the city council. They did at some point, maybe it was under Giuliani or under Dinkins, they added 200 or 300 more. But, of course, in order to go in and compete in the taxicab industry in New York City, you have to purchase an already existing license.
And they were up to, they may be over $200,000 a piece now, but at that point, when I looked at this data back in the 1980s, they were up to $160,000. So 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 to raise their price to a monopolistic level, okay? May have been the case.
He says so it may result in inelastic demand and a higher price, okay? 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, okay? That only exists in a long-run equilibrium, which is, as Mises points 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 makes his, that contradicts his monopoly theory. One thing he points out that actually is important to note, and that is correct, is that the monopoly of the supply of some factor of production in and of itself does not result in the emergence of a monopoly price, okay? For example, Mises would say, well, just because Coke has a certain amount of goodwill, doesn't mean it has an inelastic demand curve, because Pepsi is out there, and because many other brand names are out there, okay?
It's only when this goodwill allows you to have an inelastic demand curve where 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 inelastic demand curve. Now, what Mises, the contradiction comes when Mises talks about what he calls, or what he says is a multiproduct firm. He points out that, let's say you're a textile producer, okay?
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, okay?
In the same firm, he says, you don't produce up to the point where the last, 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 how, what goods to produce, you allocate it to these different types of clothing, okay, in a way that will maximize your profit. So you stop short of going to the point where your factory has a zero rent margin.
And it's the same thing with automobile firms. Automobile 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 in some however in long-run equilibrium, okay, in the real world.
So Mises admits that the economy is not in equilibrium and that its profits at 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. Things are continually changing. Just when profits are being wiped out in the hand calculator industry, you get the introduction of the personal computer.
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 the computer even more.
And prices follow it down. So that today, you can get computers that have many times more powerful and have much more memory than the $2 million mainframes did in the 1970s because of technology. So 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 that the important point is 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 100 of that university, my university.
Yet, if this vendor, who is right outside the school, if he raises 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 that's besides the point.
I don't eat food. Many do. The point being that even small sellers, not just GM has downward, all sellers have downward sloping demand curves. Now, what does that mean?
That means that if you produce too much, and I'll show you an example in a moment, if an entrepreneur makes a mistake about what the demand curve looks like, and he's produced more than, or 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 cost if he produced less, okay? Your costs go down, so he would in fact do so. That's not, anybody would do that. GM would do that, and the vendor would do that.
In other words, if, I'll just ignore here, make a very simple example. 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, okay? 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. Well, my cost go down because I'm selling, my input cost has 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, okay? 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, he's doing anything different than this so-called monopolist when he raises the price from $5 to $7 or to $10?
Absolutely not. Entrepreneurs make mistakes, meaning that they may produce more than is efficient from the point of view of maximizing their profits. And they can be small sellers, or they can be large sellers, okay? So Mises cannot identify the competitive price.
Just because someone restricts supply, if we're not in long-run 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 their profit, period, end of story, okay? Even in the case where a single individual or a single firm owns the entire supply of, or the entire input, specific necessary input of a good, like let's say all the diamond mines are owned by one person, okay? Or, for example, where you have an individual such as Muhammad Ali who owns very specific boxing skills.
I'm just taking it as an example. In that case, there's still competition, okay? For example, very recently, two new technological techniques or two new technological methods have been developed that will allow the production of perfect diamonds. Okay, 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, okay? I saw something on 60 Minutes about two years ago on this, and I saw an article in the 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 the diamond mine, which we do not have, okay?
De Beers comes 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 De Beers have struck back by saying, well, you know, it's not genuine and a woman wants a genuine diamond for evidence of commitment and so on. But, you know, hey, this diamond is perfect.
You can't tell the difference. I don't see the problem, you know? Come on. Come on, babe, get off me.
Okay, 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 something like Muhammad Ali, okay? He's market for Muhammad Ali's boxing matches. Let's say Muhammad Ali could box, at his peak, he could have boxed to the Reagan administration in this particular case, and what they did was they asked for the implementation of VERs. Does anyone know what they are?
Voluntary export restraints, which means that Reagan administration officials went to the Japanese government and said, basically blackmail, 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. OK, now, here's where true monopoly comes in.
With the unimpeded importation of Japanese cars, the demand curve is D2, which means this. If at $10,000, Ford is producing 100,000 units of the Ford Taurus per year, and they're losing money at $10,000, which they were doing, they lost a lot of money during those first few years. I think in total, the Ford GM price was something like $5 billion. 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.
If they did that, their demand curve would be 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 half a billion dollars, or $0.48 billion, when you raise your price.
So they raise their price, they have no control over quantity. Remember, you can either control price or quantity. And as a result, you get a decrease in quantity from 100,000 units to 40,000 units. People 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 to $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. So U.S. potential purchasers 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 market price. It doesn't arise on the 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's some other point I want 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? It 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 happens 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 U.S. 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.
All right, I'll stop here and take questions. Yes? Did anyone in the Austrian school ever do the possibility of price discrimination, especially as an alternative to truck stock? Yes, Mises did.
And he had this idea that I don't want to get too technical. But he had a good discussion in the article that we published in the QJAE especially, but also in Human Action, of price discrimination and how, again, those conditions under which price discrimination takes place are very, very limited. That's a good point. Other questions, comments?
So the Rothbardian theory then, I think it's important to stress, does develop out of Menger and Munn and Mises. It's just that Munn and Mises... Menger, it's not clear, but Munn 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 the difference between what's the competitive price and what's the 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 emerges in long-run equilibrium. It's simply the price that emerges from a rivalry among firms trying to serve consumers better than other firms. In other words, it's a price that comes out of rivalrous 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, which makes it profitable to raise price. And in some cases, by the way, you could have the demand curve made more inelastic, but not inelastic enough to make it profitable to raise the price. So Rothbard points that out, too.
Okay, unless there's other questions, we can... Thank you.