Neocon -
...First, you are assuming that the monopolist cannot be in a coercive position. ...
No, I am assuming that the producer acts in his own self-interest, pricing so as to maximize profits or minimize losses, which is often effectively equivalent to maximizing revenue.
...Second, you are assuming that the monopolist cannot have an adverse affect on the economy overall. ...
Actually I am claiming that mandating actual competition, as by enforcing anti-trust laws, can itself directly have an adverse effect on the economy even as it succeeds in producing lower consumer prices.
The following example compares a monopoly provider pricing for maximum revenue with the actual competition of two providers --
Monopolist One Competitor Both Comp's
Unit Price $50 $25 $25
Unit Quantity 1000 800 1600
Revenue $50,000 $20,000 $40,000
Fixed Cost $10,000 $10,000 $20,000
Material Cost $ 4,000 $ 3,200 $ 6,400
Labor Cost $ 4,000 $ 3,200 $ 6,400
Total Cost $18,000 $16,400 $32,800
Profit $32,000 $ 3,600 $ 7,200
In the first column we have a monopoly provider responding to his estimation of the consumer demand schedule by setting a unit price of $50, which results in a consumer demand of 1000 units for total revenue of $50,000. If the provider's estimate of the consumer demand schedule is correct, increasing the price above $50 would encounter an elastic demand above that reduces quantity demanded in such a way as to reduce the total revenue below $50,000. In a similar way, reducing the price below $50 would encounter inelastic demand below that increases quantity demanded, but not by enough to keep the total revenue from falling below $50,000. Thus a unit price of $50 is the single price which entices consumers to allocate the largest total of their expenditures for this product, balancing quantity purchased against dollars expended for this product as opposed to being reserved for the purchase of all other possible products and services. Far from being an overprice, this is a favorite price for consumers in terms of satisfaction received per marginal dollar expended, and when a producer prices here he is responding to consumer demand, or at least his estimation of it.
In column two, we show one of two identical competitors who exist as a result of an anti-trust mandate and who have competed to drive the unit price down to $25.
In column three, we combine the results of the two competitors so as to be able to compare with the monopoly producer in column one.
As the competition has cut the unit price in half from $50 to $25, the total unit demand has increased by 60% from 1000 units to 1600 units, but reducing the total revenue from $50,000 to $40,000. Consumers now have an additional $10,000 to spend on other products, but we now need to look at what has been given up for that $10,000.
First, extra economic resources have been consumed, with material and labor variable cost expenditures both increasing by 60% from $4,000 to $6,400. Secondly, fixed costs have doubled from $10,000 to $20,000 as two independent companies must be created and maintained. Between these increases, total costs have increased more than 82% from $18,000 to $32,800, a total increase of $14,800. Combining this increase in total cost of $14,800 with the reduction in total revenue of $10,000, total profits have fallen by 77.5% from $32,000 to $7,200, a decrease of $24,800.
In summary, forced competition has freed up an additional $10,000 in consumer spending that may now be applied to other products and services. However, it has come at a cost of $24,800 in reduced profits, which ultimately results in a combination of a reduction in investment income to consumers and a reduction in funds available for future capital investments for both new products and increased productivity in the production of existing products. In addition, an increase of 60% in the consumption of material and labor resources was noted above.
While the above analysis is wide open to alternate interpretations, the point should be clear that forced actual competition and low consumer prices do not, by any means, represent a cost-free, unalloyed benefit. In the example shown above, productivity remained constant as prices were chopped in half. In the real economy, over time, the re-investments of profits enables productivity to be increased, and thus prices to be reduced with far smaller reductions in profits. However, this simply reinforces the point that the pursuit of low consumer prices cannot be allowed to destroy the profits that enable the productivity improvements that are essential to improvements in the standard of living.
Regards, Don
PS - It should be noted that the above example applies to the condition where no competition is possible if it is not mandated. Thus, the $50 unit price and 1000 unit demand provide a net profit margin of 64%, which in the real world would almost certainly attract new entrants even without mandated competition. This means that the $50 unit price is not really likely to serve the monopolist's intermediate and long term self-interest, and he would almost certainly voluntarily tend to price well below $50. This voluntary reduction in price in response to potential competition, as opposed to actual competition, has the advantage that the additional fixed costs associated with actual competitors, $10,000 in the example, are not required, resulting in a significant improvement in overall economic efficiency. |
