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Frank A. Fetter, Chapter 20: Business Price Practices and Social Price Policies

  • Frank Fetter

Tags PricesPrivate Property

03/31/2017Frank A. Fetter

Competition as a social price policy

The political organization and legal institutions of all nations, in their treatment of private property and the rights of citizens, involve various social price policies. The term "social price policies" is used here in contradistinction to the individual price policies of private enterprisers. Our own economic order known as capitalism, with its complex system of laws, traditions, and business practices, assumes the policy of competition as the general rule. Competition is rivalry, the seeking of the same desired end by two or more living beings. Even plants compete for their places in the sun and a chance to live. Competition may be contrasted with co-operation, which is the seeking of the same end or two or more creatures working together without rivalry but with the intention of sharing the fruits of their efforts. All gregarious animals, even wolves which hunt in packs, co-operate in some degree among themselves at the same time that they compete against other groups of animals. In human society men both co-operate in their various group activities and compete as individuals or as groups in other activities.

Economic competition, in particular, is the process by which men, individually and in groups, are given the opportunity to earn their living by producing desirable things and performing useful services, and by selling them for what others will pay. More and better goods, lower prices made possible by the steady march of science and technological invention, material progress constantly shared by the masses of the people — these are the ideal social purposes of competition.

In the main, Anglo-Saxon institutions, as they developed through the centuries out of feudalism, not only permitted but more and more encouraged free competition in the choice of occupations, in the exchange of goods and services, and in the management of private business. This general trend continued till near the end of the nineteenth century. However, social price policies always have been and still are a mixture of competition and other features more or less monopolistic and restrictive of free market relations. Let us consider first the competitive aspect.

Economic conditions for effective competition

In order that economic competition may be effective, three essential conditions must be united in some degree at certain times and places: (1) ability, (2) choice, and (3) freedom.

Ability on the part of a seller to compete means the capacity to perform the service, or to produce or procure the goods that are to be sold. On the part of a buyer it means the possession of sufficient purchasing power. One who cannot play a musical instrument cannot effectively compete for a place in an orchestra, nor can a blacksmith effectively compete for a watchmaker's job. An enterpriser's ability depends on his possessing proper personal and technical qualifications — physical strength, intelligence, education, practice, experience, prestige, character — the necessary material equipment of various kinds, and sufficient financial means.

Combined with ability must be choice, or willingness to do, in order that there shall be effective competition. Many a man is better able to do a certain kind of work than are those whom he employs to do it for him, but he prefers to do something else — or nothing. Many a merchant could perform the duties of janitor, bookkeeper, sales clerk, or delivery man as well as or better than his employees do, but he can hire them for less than his services are worth for managing the business. If one who has the ability to compete chooses not to do so, it shows that his alternative valuation (the opportunity cost considered in the last chapter) of his own services and capital is greater in some other occupation. The explanation of this situation in the special case of international trade is known as the doctrine of comparative advantage.

Ability and choice to compete are the two essential economic conditions to competition, but in order that competition may be effective another condition is necessary which is primarily political, in character — freedom to compete.

Custom and caste as restrictions on freedom to compete

In human society the individual is free to act only within more or less definite limits set by his fellow men. Individual action is restricted partly by formal law and partly by numerous other subtle influences of custom, caste, status, tradition, training, beliefs, superstition, religion, and individual and class interests. In most savage tribes certain kinds of goods and some offices and occupations are tabu or forbidden to all but privileged members of the tribe. Rules and institutions are maintained and enforced by public opinion with penalties of social disapproval; the extreme is social and economic ostracism, banishment, and sometimes death for the offender. As was the case in many ancient highly-developed societies, so in India today many occupations are the hereditary monopolies of certain castes. Even now in some advanced countries of Europe the conception of social status is such that a talented individual can only with great difficulty rise above the station in life to which he was born.

Modern extralegal restrictions on freedom to compete

Even in our society, limitations of a similar sort are temporarily and deliberately created by some groups for their own purposes. These groups foster prejudices and hatreds against competing persons and groups of workers or of employers, and coerce them by epithets, social ostracism, picketing, and boycotts. Driven further by passion as the mob spirit grows, as, for example, during strikes by laborers, various groups frequently embroil the whole community and disturb all civic relations by threats and by violence to property and to persons. The modern "racketeers" in American cities, sometimes disguised as leaders of organized labor, sometimes merely criminal gangsters, have levied tribute on all honest citizens. In degrees varying from the least to the greatest, such conditions restrict the economic freedom of men to compete. Those who act in this way create a sort of State within the State, usurp and for a time exercise the normal political powers of government, justifying their conduct on the ground of necessity. It is plain, however, that under these conditions free and therefore effective competition is impossible.

Competition legally regulated in the public interest

The basic function of government is to prevent competition by brute force, and in this connection it should be remembered that economic competition is only one of many species of competition between men. Organized government places restrictions upon competition in many legal and orderly ways: by the common law, by statute laws, by executive agencies of enforcement, and by courts which interpret the statutory and common law.

Governmental action in relation to competition is of two distinct types. The first merely determines the scope, methods, and kinds of competition that the community desires, leaving prices to be adjusted by competition. The second directly fixes or manipulates prices, instead of leaving the forces of legalized competition to operate.

The extent to which economic competition is regulated by government is rarely recognized. We hear much loose talk about laissez faire as a policy of keeping hands off competition; but no government has ever followed such a policy to its extreme. Governments are constantly seeking to limit economic competition to honest and peaceful efforts in producing and selling goods. The whole body of business law regulating contracts; much of the criminal law punishing crimes against persons, and preventing fraud, embezzlement and gambling; and all laws punishing crimes against property are designed to eliminate certain sorts of competition deemed to be uneconomic and to retain only those peaceful activities which are deemed to be economically beneficial to the community.

The nature of fair competition

Of recent years the term "fair competition" has been increasingly used to designate the economic competition that is limited to actions in accord with prevailing standards of integrity and legality. Fair competition is the only kind that society desires because it is the only kind that confines rivalry in business to acts which tend toward greater production and service. Bribing a competitor's employees to betray his business secrets, hiring ruffians to dynamite a competitor's factory, and a thousand other such reprehensible or downright criminal acts, are not fair economic competition. Criminal injury of competitors and unfair competition are not economic competition, as is often assumed; rather they make it impossible. The purpose and nature of such behavior is usually monopolistic, that is, it prevents capable and willing competitors from competing. These have been among the most telling methods by which the present monopolistic organization of industry has been brought about.

Fair competition has been too narrowly understood as applying to the behavior of competitors toward each other, rather than toward the buying public. Such a view of competition, however, stresses the means or the methods of economic activity rather than its main purpose — the furthering of the public welfare. There is some tendency for the courts to broaden the meaning of fair competition, and it is to be hoped that they will do so. In the discussion of the N.R.A. in the years 1933–1935, the term "unfair competition" was often curiously twisted to mean any competition that tended to lower prices against the will of the dominant monopolistic interests.

The nature of monopoly; limited monopoly

The root meaning of monopoly is unified selling, and the term is applied to a person or group of persons acting in unison in the sale of all the units of an important class of goods offered in a market. Such a single seller could withhold a part of the supply and thus greatly enhance price. But such a complete, or absolute, monopoly is an extremely rare condition. The far more frequent case is partial, or limited, monopoly. The limitation may be in respect to the proportion of the whole supply under a single control. Or it may be in respect to place, time, kinds, and qualities of goods, urgency of desires, and the possibility of meeting these desires by the substitution of other goods. The theory of monopoly has to explain how monopolistic power, however limited, may operate to raise prices above the level that would result from effective competition.

A single seller controlling a small portion of the total stock of goods in a free market could often for a brief time cause the price of his goods to rise by refusing to sell. But only his competitors would profit by this, while the withholder forfeits his usual profit on the unsold goods and the unused capacity of his enterprise. However, one seller or a unified group of sellers may control such a large fraction of all the goods of a certain kind produced in a single market, that he or they will gain more by raising prices than will be lost through limiting production. If by the use of any of the devices of collusive, criminal, and unfair competition sellers are able to force others to limit their production, the total monopolistic gain may be much greater than otherwise would be the case. In some instances monopoly is inclusive. This is the case when there are agreements and common action to restrict sales. In other instances monopoly is exclusive in that it compels others to restrict their sales partially or completely.

Monopoly may be defined as follows: It is unified control by sellers over such a proportion of the whole supply of certain goods or classes of goods in a market that a net gain may result by withholding or excluding from sale some goods that would be offered for sale if ownership were not unified. A similar unification on the side of demanders, a comparatively rare occurrence, is often called buyers' monopoly.1

Demand and supply in monopoly price

When the conditions determining sellers' valuations were considered in the preceding chapter, it was seen that all sellers competitive as well as monopolistic, charge what the traffic will bear. The true contrast between competitive and monopolistic valuations is that where competition is effective, the traffic usually will not bear so much as under monopolistic conditions. It is misleading to say that the contrast lies in the fact that monopoly prices are fixed or determined solely by demand, whereas competitive prices are fixed by the equilibrium of demand and supply. The essential contrast is this: In the case of exercised monopoly power, the supply is restricted by common action below what would result from independent competitive action. When monopolistic sellers find that they can get more by restricting supply, they raise their reserve valuations accordingly. Monopoly price is determined by the equilibrium of demand and supply. But while demand is competitively unrestricted, supply is artificially restricted.

Monopolistic sellers may effect the restriction in several ways. They may by collusion reduce their own sales, or they may use either rewards or punishments to induce competitors to reduce their sales in whole or in part, or they may persuade some public authority to limit or exclude possible competitors. In all these ways and by numberless devices, supply is more or less manipulated in many industries today, according to favoring conditions.

Crude monopoly price

A distinction may be made between crude and net monopoly prices. Crude monopoly price is that which yields the maximum receipts (units sold times unit price) rather than, necessarily, the greatest net gain. The aim is to obtain the maximum receipts when goods are either costless (as might be the case with some agents of production) or are perishable, as are some foods in the markets on Saturday night or before a holiday, or where for temporary gain some part of the existing stocks of goods is destroyed without regard to first costs or to replacement valuations.

Suppose that at various prices the supply of and demand for certain goods correspond with the latent valuations as set forth in the following table:

At the true competitive market price of $5, there will be 50 units sold and the receipts will be $250. If, however, all the sellers unite and restrict production to 45 units, price will rise to $6 and receipts to $270, which is the maximum possible, Further restriction of supply to 35 units would raise unit price to $7 but receipts would fall to $245. This is shown in Figure XVII.

Elasticity of demand and supply

Elasticity of demand means the extent to which changes in price initiated by active changes of supply are followed by passive inverse changes in demand. This is usually expressed as a ratio of the rate per cent of the demand change to the rate of price change, the two rates having opposite signs, plus or minus. For example, if the price falls 10 per cent and as a result the demand rises 10 per cent, the rate of elasticity of demand at that point is unity. But if a fall of price from 10 to 9 (10 per cent) is followed by a rise of demand only from 100 units to 105 (5 per cent), the rate of elasticity is .50.

Figure XVII. Crude, Uniform Monopoly Price

Elasticity of supply is similar in nature to elasticity in demand but varies directly with price changes, supply rising passively as prices rise and falling as prices fall.2

Drawn on the same scale, a graph of more elastic demand (or supply) is more nearly horizontal, and one of less elastic demand (or supply) is more nearly vertical.

Inelastic demand makes monopoly easier

Consider a situation, as in Table VIII, in which the latent demand at higher prices is somewhat less elastic than in Table VII, for example:

Under these conditions, if the monopolistic group has 50 units on hand which will sell for only $5 if all are offered, it will pay them to destroy 20 units, if that is necessary to make sure that the remainder may be sold at $10 per unit. This sort of waste and destruction of goods has often been practiced, as for example, when East Indian spices were sunk in European ports— a case made famous by Adam Smith — and when certain foodstuffs were occasionally dumped into the waters of New York harbor.

Figure XVIII. Monopoly Uniform Price with Less Elastic Demand

The foregoing examples involve the assumption (1) that the monopolist controls the whole supply; (2) that the monopoly price is uniform to all buyers without discrimination, and (3) that actual costs and alternative valuations are disregarded. Let us consider how a difference in each of these conditions might influence the result.

Limited monopoly; influence of partial competition

If a considerable fraction of the supply remains outside of the monopolistic agreement, the control of price is more difficult. If competitors (in Table VIII) supply 10 units at the competitive price, and the monopoly group supplies 40 and then cuts down its supply by 10 units, the monopoly group would be selling 30 units, and its competitors 10 at a price of $7. Its receipts at the competitive price would be $200 (40 X 5); at the $7 price they would be $210. There is therefore a gain of $10 for the monopoly if it restricts production and obtains the $7 price. But if the monopoly restricts its output by 20 units to raise the price to $10, it would then sell only 20 units, and its receipts would be only $200.

Tendency of monopoly to overreach. — Theory and abundant practical experience unite to show that under such conditions the other competitors would be likely to increase their outputs, while new forces would be set into operation by the higher prices, causing substitution of goods, stimulation of new competitors near and far, and the discovery of new methods. In all cases of limited monopoly the long-time gains of restrictions are certain to be smaller than they appear in the short-time view, and large immediate gains sometimes turn ultimately into large losses.

The history of monopoly is full of evidence that it usually overreaches itself in the exercise of newly acquired powers over prices. Notable recent examples are the British policy of restricting rubber production by which the price of rubber was driven up to about $1.50 a pound, to fall later to 5 cents a pound; the copper monopoly which drove copper up to 24 cents a pound, to see the price collapse to 5 cents, the lowest in all history; and the efforts since 1933 to fix American cotton prices, which have stimulated competition in cotton growing in many parts of the world where it threatens to continue even at prices lower than those at present, with disastrous results to our Southern farmers.

But this is not to say that the problem of monopoly always solves itself, or that monopoly power is always temporary, or that it usually is unprofitable to the monopolists, or that no one is injured by its exercise, or that the public may safely follow a policy of laissez faire toward the monopoly problem.

Discriminatory monopoly prices

In practice, uniform monopoly price is unusual and theory makes it clear why this must be so. Except when demand is highly inelastic, the gain from uniform monopoly prices is likely to be limited. It has been observed that with rare exceptions monopoly power is not complete but is partial and limited. The most general limitation of monopoly power is the newly aroused competition which it has to meet at each successive higher level of prices. To meet such competition by a uniform lowering of its price would compel the monopoly to give up some of the monopolistic gains derived from those buyers that are already fully within its power. But if monopoly can find a way to classify the buyers, even roughly, and make those in each class pay a price approximating their reserve valuations, it can gain much more than it can from a uniform price.

Price discrimination is nonuniform treatment of customers by making a difference in the price of goods without a corresponding difference in quality, service, or conditions in the terms of sale. When the monopoly discriminates against such buyers as are within its power by charging them higher prices while it sells at lower prices where competition must be met, it succeeds in accomplishing the proverbially impossible — "it eats its cake and has it too."

The price discriminations practiced by a monopoly are often at certain geographical points or market area boundaries. Or again they are found in certain grades and kinds of goods and services. Or they may be seen in the methods of making sales to certain persons. The monopoly may undercut certain competitors' prices while continuing to charge its other customers monopolistic prices. So discrimination takes manifold forms, but it always means nonuniformity in the prices exacted from buyers by the sellers.

Monopoly gains from discrimination. — In Table IX total receipts at a uniform price of $7 would be only $245; but they may be increased to $330 by discriminating prices down to the normal competitive price of $5, as follows:

Table IX

          Price       Units Salable at Various Discriminatory Prices           Receipts

            $7                                     35                                                            $245
             6                                      10 additional                                             60 additional
             5                                        5 additional                                             25 additional
                                                     __________                                         ____________
Total                                              50                                                           $330

In a similar manner the effect of further discrimination by creating a higher price class would be as follows:

Table X

          Price       Units Salable at Various Discriminatory Prices            Receipts

           $10                                      30                                                            $300
               7                                      10 additional                                             70 additional
               6                                        5 additional                                             30 additional
               5                                        5 additional                                             25 additional
                                                     __________                                         ____________
Total                                                50                                                           $425

Cutthroat discrimination

Discrimination in prices, while it wears the guise of competition, is, in fact, the most potent instrument of monopoly. A strong combination or monopolistic association, when discriminating by lowering prices, need not stop at a truly competitive price level which yields a normal profit. It can and often does go lower, even accepting a loss, for the purpose of warning, disciplining, forcing into the monopolistic group, or driving into bankruptcy any smaller competitor who is interfering with the price plans of the monopoly. This is cutthroat competition in the proper sense of that often misused term. It is much more agreeable and profitable to a monopoly if competitors can be made to restrict their production than for the monopolists, by cutthroat means, to do it themselves. In that way, a monopoly gets all the gain and the would-be competitors bear the losses along with the consumers.

The practice of cutthroat competition is much easier for a financially powerful corporation than it is for a smaller competitor. It is particularly easy for a large combination owning a number of plants in various geographical areas and turning out a large variety of products. It can cut prices on some products by the use of "fighting brands," and in some localities by the use of "fighting mills," while continuing to charge higher prices and to earn ample profits from its other products and plants. On the other hand, it is financially impossible for a comparatively small independent enterprise with a single plant, no matter how efficient it may be technically or how able to meet fair competition, to compete against its large competitors by the use of cutthroat prices. It can only cut its own throat in that way.

Without a clear understanding of discriminatory prices there is no hope: for effective public control of monopoly.

Monopoly profit above costs; net monopoly prices

Cases of crude monopoly price are comparatively rare. Much more frequently the aim of a going concern is to get the maximum price over the costs of replacement — the greatest net monopoly price. In the continuous production and sale of goods, costs have to be considered — that is, the alternative valuations of indirect agents. Normal competitive prices of goods contain an element of profit both on fixed and variable costs necessary to attract and to keep enterprisers in the business. The normal competitive price contains no additional profit above this: costs and prices are, or tend to be, just equal. Assume the competitive price to be $5 (as in Table VIII; the fixed costs (including a fair profit) to be $150; and the variable costs (also including a fair profit) to be $100 (receipts $250, costs $250). Under these conditions costs, prices, and normal profits would be in equilibrium, as shown in Figure XIX.

Figure XIX. Costs and Competitive Price Showing Also Possible Additional Pure Monopoly Profits Through Discrimination

Now if the monopoly reduces its production from 50 to 30 units, fixed costs would be unchanged at $150; variable costs would be $60 (3/5 of $100); and total costs (including normal competitive profit) would be $210. As the receipts are $300, there is a pure monopoly profit of $90 over and above the normal profit which investment would give under competitive conditions. These figures are illustrative of the fact that a monopolistic increase of competitive prices increases the profits of monopoly in greater proportion than it does the total receipts. This is shown in Figure XX.

Figure XX. Pure Monopoly Profit Above Costs, With Uniform Price

Expressed generally net monopoly price: is that price which maximizes the remainder left after subtracting from the total receipts the costs of production. The many complexities in the calculation of costs according to whether they are constant, increasing, or decreasing per unit, or total, go beyond the scope of our treatment.

Public or legalized monopolies

The innumerable and varied monopolistic controls over prices in modern business may be broadly classified as public and private. Public monopoly is that which is legalized, including direct public ownership and operation of enterprises. Monopoly power is also exercised by private persons, organizations, and industries acting under authority of patents, copyrights, charters, and statutes which confer special or exclusive privileges on them.

The professed public motive in all these legalized forms of monopoly is to advance the general welfare, but frequently they are determined by the private and class interests of "pressure groups" acting upon legislators and executive or judicial officials. Organized groups of citizens are constantly seeking the authorization and grant of monopolistic powers for themselves with the plea that this is the best way to help the public. The "bootstrap doctrine" of economic welfare became known as mercantilism from its wide exercise by governments on behalf of the merchant class in the seventeenth century. It has been followed in the United States through extensive grants and subsidies to railroads, water carriers, and other industries, and in tariffs to favored groups of manufacturers, farmers, and owners of natural resources such as coal, iron, lumber, oil, copper. In these and many other ways, the power of taxation exercised by local, state, and Federal authorities has been diverted from its primary purpose of raising public revenues to promote the general welfare, to that of making gifts to private citizens, on the apparent assumption that somehow these gifts will filter through their pockets back to the taxpayers, magnified by some magic power in the process.

Restrictive tariffs and monopoly

A peculiar case of monopoly by public action is presented by so-called protective tariffs on imports, more accurately called restrictive tariffs. The purpose of such protective tariffs is not to raise revenue for the government but to restrict imports and thereby to raise the prices which domestic producers may receive from domestic users. Inasmuch as domestic producers are thus relieved practically or wholly from the competition of foreign products with their own, this is a monopolistic measure. This is true even though domestic producers are not thereby authorized to unite in monopolistic selling but are expected to compete actively with each other. If they do so compete, they may reduce the rate of profits in their industries to the general level of other industries. Nevertheless prices almost certainly will remain higher than they would be with free importation (with the possible exception of bona fide infant industries). The higher domestic prices due to restrictive tariffs are in many cases reflected back to the natural resources involved in the manufacture of the product. These natural resources would often be much less valuable if imports were free. Tariffs are thus the source of large private fortunes. Though it is extreme to say that "the tariff is the mother of trusts," it can hardly be doubted that the exclusion of foreign goods facilitates the formation of domestic monopolistic agreements. Moreover, domestic monopolistic industries such as oil, lumber, copper, and cement have been able to exert a peculiarly strong pressure to procure higher tariffs on their products.

Public utility monopolies

The enterprises known as public utilities present a special problem of monopoly. The chief enterprises of this type have appeared somewhat in this historical order: ferries, toll turnpikes and bridges in private hands, water- and gasworks, railroads, streetcar lines and interurban trolleys, electric power and light, and telegraph and telephone companies. A public utility, as the name indicates, is an industry which, with the progress of society, is deemed necessary to the public welfare. But so are many other industries that have developed in the last century and a half. In contrast with industries supplying such products as textiles, iron and steel, cement, gasoline, or automobiles, the really distinctive character of a public utility lies in technical conditions which call for the extension of physical lines of rails, pipes, poles, wires, and other apparatus into the particular locality, and usually into each home or factory, to be served. It is impossible for this to be done unless these industries are granted (by charter or franchise) special legal privileges not accorded to citizens generally. These usually include the right to occupy, cross, excavate, and use the public highways for their rails, pipes, conduits, wires, and other equipment, and the power to exercise the right of eminent domain. By this right a public utility can compel others to sell their property at an appraised valuation, even against their will. Hence such enterprises are quasi-public, for they enjoy not merely the ordinary rights of private business but become in some respects public agencies exercising public rights.

Experience soon showed that it was physically impossible and financially wasteful to multiply the physical equipment of rails, pipes, wires, poles, and so on, in each locality so that the buyers of services could choose and shift back and forth among competing bidders. Under these conditions local monopolies were inevitable, however limited they might be on the geographical margins and by substitution of goods such as candles and kerosene for gas or electricity. The term "natural monopolies," often used loosely, may with some reason be rightly applied to such industries. The public did not, as is sometimes assumed, purposely create them as monopolies. But it soon discovered that they inevitably had be­come monopolies. Therefore the public undertook by regulation to keep their prices down to what prices supposedly would be if competition were possible. The purpose of regulating such industries is not to create monopoly, but to remove the clement of extortion. Public utility rates, as fixed by commissions, are attempted copies, or estimates, of competitive rates. Thus far, however, they have been pretty crude imitations of the real thing.

Private industrial and commercial monopolies

Many of the monopolistic forces in our present economy are not derived from, or sanctioned by, public authority, as are those described in the preceding sections. The commodities and services sold by most commercial and industrial enterprises, unlike those of public utilities, can be distributed to every part of the land by the aid of common carriers. Thus they may come into continual competition in many localities and in many ways with the commodities of other enterprises. Buyers may shift at any moment from one seller to another, under the inducement of lower prices. As long as production and distribution were much decentralized and shared by large numbers of small enterprises (a condition continuing substantially until after 1865 in this country), competition and uniform prices to buyers at each mill or market were the general rule. But since that time there has been a steady trend toward larger production in single plants, and greater centralization of industries at certain localities. In the process many neighborhood factories have disappeared.

Concentration of control facilitating monopoly

Much more important in facilitating monopoly has been the concentration of ownership of factories and stores in the same industry, sometimes in the same locality, sometimes widely distributed geographically. This great unification of ownership en­sures complete unification of price policies of formerly competing companies, and often gives a dominating position in matters of price policy over the remaining so-called independents. In many great industries such as steel, other metals, cement, machinery and implements, the principal kinds of building materials, and in many tariff-protected industries, some one great corporation or friendly group of smaller corporations has become known as the market leader. In industries where concentration had not proceeded so far, trade associations have been organized in great numbers since 1912 ostensibly to deal with unfair competitive practices between independent enterprises but chiefly to make possible collusive agreement on more or less monopolistic prices and practices. Under these conditions monopolistic influences have penetrated into nearly every corner of the price system.

The foregoing brief discussion of monopoly theory suggests the devices by which prices can be monopolistically controlled and also the methods by which such practices could be prevented and corrected. A growing body of evidence indicates that the capitalistic system, whose basic assumption is free markets and a free price system, cannot continue to work with an ever-widening range of prices fixed by monopolies.

Rigid and flexible prices

Whenever monopoly by agreement is possible in periods of normal business, it becomes effective in boom times. When all producers are well booked up with orders, and buyers' reserve valuations are unusually high, it is easier than at any other time to get competitors to agree to restrict production in order to raise prices. But it is more difficult to maintain such price agreements when business falls off and factories are running below capacity. Then the enterprisers that are in greatest need of orders are tempted to break away and reduce prices, and this precipitates fierce retaliation by the dominant corporation or group in the industry. In any industry, but especially in one that has been pegging its prices at a high level, price reductions serve to stimulate orders to increase production, and to give employment to more workers, and thus somewhat to alleviate the depression.

Rigid monopoly prices in depression periods

In recent decades, spontaneous, competitive lowering of prices in depression periods has not occurred promptly nor in many in­dustries. This tends to throw the price system further out of equilibrium. Competitive industries reduce their prices, while in­dustries that are monopolistically organized peg their prices. The whole burden of readjustment in getting production, employment, and exchange started again is thrown upon those industries and occupations in which prices and wages are already most deflated. In the world depression beginning in 1929, this contrast between rigid and flexible prices (or sticky and fluid prices) has been more noticeable than ever before. Rigid, or inflexible, prices are pretty closely correlated with monopoly, partly because of the increasing number of prices fixed on static principles by public authority (as public utility commission rates), and partly by the multiplying controls of private monopoly of various kinds over wages and commodity prices. There is much reason to believe that this rigidity tends first to induce depressions, and then to prolong and to increase their severity by keeping excess capacity unused and by aggravating unemployment. If only a few industries peg their prices, in defiance of the ordinary competitive motives to reduce prices when there is unused capacity and unemployed labor, they may gain at the expense of the rest of the community, which behaves differently. But as price fixing during a depression becomes more and more the general practice, even the monopolists lose more in the end than they gain. The remedy for monopoly is not more monopoly but the policy of competition impartially applied.

Figure XXI. Comparison of the Behavior of Prices and Production in Agriculture (Competitive) and Industry (Now Largely Monopolistic) in the Depression Period 1929–1934. While Employment in Industry Greatly Decreased, the Number of Farm Operators Actually Increased by More Than 500,000.

Overhead costs and rigid prices

Apologists for monopoly, while not denying the growing practice of artificial price rigidity in many industries regardless of changes in demand, have lately sought to justify it as the necessary result of overhead costs because of the heavy investment of capital in durable plants. They say that the prices of the products must provide a fair return on invested capital, including any interest on bonded debt (an actual cost); also a return on stockholders' actual investment at the rate the management expected to get; and finally a return at the same rate on watered stock issued as promoters' profits in forming combinations and reorganizations. These together constitute a heavy burden of so-called overhead costs, which, it is said, the industries are justified in shifting to the public in the form of higher prices, regardless of the general collapse of business conditions. This argument assumes the validity of the erroneous theory that cost prices of indirect agents cause and determine product prices, instead of the reverse.

Those who argue that rigid prices are the normal and justifiable result of overhead costs admit that overhead costs did not so dominate industry in the past. But they maintain that this was because such costs are essentially a new feature in modern industry. In fact, however, overhead costs are at least as old as the practice of expressing the capital value of the investment in durable agents such as machines, buildings, and lands. Every farmer has a large burden of overhead costs, yet the products of agricultural industry (except for recent public measures) are usually sold under competitive conditions at flexible prices.

It is monopoly power, not overhead costs, which make it possible today for some industries to maintain their prices at monopolistic levels regardless of changes in competitive conditions. Industries without monopoly power (such as most kinds of agriculture) have to forget overhead costs, and they continue to produce and sell at any price they can get that covers their actual out-of-pocket outlays. A price system of rigid, or monopoly, prices is not truly a system, for it is out of balance and cannot easily recover. It is the function of market price changes to restore demand and supply to equilibrium, and only a competitive price system can do this.

Summary and conclusions

This chapter carries the study of the price system further into the region of reality where free exchange between individuals in accordance with their own valuations is so often and in manifold ways restricted and controlled either by some public authority or by private monopoly.

The true nature of fair competition in business must be carefully studied to determine what limitations must be placed upon it to ensure the general welfare. Monopoly is essentially unified action by sellers to restrict production artificially and thereby to cause buyers to bid up prices above the competitive norm. Discrimination by monopolistic sellers, that is, charging different classes of buyers nonuniform prices, enables monopoly still further to evade marginal competition and to increase prices and profits above the competitive level.

Grave questions of public policy are involved in the artificial control of prices by public ownership and by special public favors to private industries in various ways, as by means of restrictive tariffs to some, and by special franchises to other industries known as public utilities. Another outstanding present problem is industrial monopoly, which is not legally authorized but is definitely outlawed, yet which in defiance: of law has been steadily growing in power. The influence of monopoly in making prices more rigid, especially in periods of business depression, throws a disproportionate burden upon those other classes of citizens who are competing in their occupations. Monopoly even threatens to undermine the existing system of free industry and private property.

The student should, at this point, try to get a clear and consistent picture of the price system as a whole, by retracing the line of thought running from first to last through these four chapters. The starting point in the explanation of prices is in the differing choice and valuations of individuals. Exchange of goods, beginning in the simplest forms of barter and developing into a complex system of markets and agencies of trade, widens the range of individual choice and increases the wealth of the community. Market prices are mutually related through many ties. Monopoly gains involve the injury of others. A free price system is the essential condition of economic freedom. A true theory of price under actual conditions of mingled competition and monopoly is a necessary prerequisite to the shaping of sound, social price policies.

Suggested Readings

Berle, Adolph A., Jr. and Means, Gardiner C. The Modern Cor­poration and Private Property. The Macmillan Co. New York. 1933. Reissue, Pp. xiii, 396.

Chamberlin, Edward H. The Theory of Monopolistic Competition. Harvard University Press. Cambridge, Mass. 1933. Pp. x, 213.
Fetter, Frank A. The Masquerade of Monopoly. Harcourt, Brace and Co. New York. 1931. Pp. xii, 464.

——. "Big Business and the Nation." Facing the Facts. (James G. Smith, ed.) G.P. Putnam's Sons. New York. 1932. Pp. xvi, 372. See especially Chap. VII.

Keezer, Dexter M. and May, Stacey. The Public Control of Business. Harper and Brothers Publishers. New York. 1930. Pp. xi, 267. A clear view of the real nature of industrial monopoly.

Laidler, Harry W. Concentration of Control in American Industry. Thomas Y. Crowell and Co. New York. 1031. Pp. xvi, 501. The facts regarding concentration.

Means, Gardiner C. "Growth in the Relative Importance of the Large Corporation in American Economic Life." The American Economic Review. March 1931. Vol. XXI. Pp. 10–42. Factual account.

Mund, Vernon A. "Prices Under Competition and Monopoly: Some Concrete Examples." The Quarterly Journal of Economics. February, 1934. Vol. 48. Pp. 288–303.

Viner, Jacob. "Objective Tests of Competition Applied to the Cement Industry." The Journal of Political Economy. February, 1925. Vol. 33. Pp. 107–111.

Wormser, I.M. Frankenstein, Incorporated. McGraw-Hill Book Co., Inc. New York. 1931. Pp. ix, 242. A lawyer's analysis of ominous corporate abuses.

Questions and Problems

1. What general social price policy is assumed in our political and legal institutions?

2. What is competition? Co-operation? For effective competition what three essential conditions are necessary? Explain.

3. What two types of action in relation to competition may the government take?

4. Give some examples of unfair competition. Can you suggest ways to eliminate such acts or practices?

5. What is the root meaning and definition of the word "monopoly"? Distinguish between absolute and limited monopoly; between in­clusive and exclusive monopoly.

6. What is the essential difference in the determination of monopoly price as compared with the determination of competitive price? Explain.

7. Explain the way in which monopoly may be used to obtain higher prices from purchasers.

8. What is the nature of crude monopoly price? Under what conditions would a monopolist charge this type of price?

9. What is meant by discrimination in prices? Do monopolists usually practice discrimination? Why or why not?

10. Define cutthroat competition. Why, and by whom, is it usually practiced?

11. How would you characterize net monopoly price? Under what conditions does a monopolist aim at this type of price?

12. Give examples of public (Iegalized) monopolies. Are public monopolies in the United States more prevalent than private monopolies?

13. Why does private monopoly always involve a restriction of supply? What are other economic results of private monopoly?

14. How does monopoly tend toward rigidity of prices?

  • 1. For this type of monopoly the name of monopsony has been suggested as being in accord with the meaning of the Greek roots.
  • 2. See Chap. XVIII on passive and active changes in latent valuations.
Note: The views expressed on are not necessarily those of the Mises Institute.

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