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Middle School MBA Blog

Monopoly. Oh My!

It fascinates me to see how flimsy (and widely accepted) the arguments for regulating “monopolies” are.

The story goes that there’s no way you could have two competing electric companies so the gov’t has to grant a franchise to one (a monopoly) and then regulate that monopoly.  But the historical record shows that prior to the granting of franchises, multiple utility providers were common.

One thing I hadn’t realized is that as part of the regulation, the utility pays the gov’t a fee.  Hmmm.

So the utility gets to charge higher rates.   These are typically “cost plus”, which the regulators will tell you means that citizens only have to pay a smidgen over actual costs, thus profits are minimal.  In practice “cost plus” means that the utility wants its costs to be higher so the “plus” is bigger.  Thus, prices are higher than under a competitive situation.   Therefore the utility is happy to kick back part of the higher profits to the gov’t (what do you want to bet that even the kickback amount falls into the company’s costs so there’s also a “plus” on the kickback?).  Government-Industry partnership at its finest!

The paper I cite below isn’t the last word on the matter as others disagree, but you have to ask which is more likely;

  • a) the flimsy story that everyone has heard and accepted uncritically: it’s impossible to have multiple providers and thus essential to have franchises and regulation (even though there are historical cases which defy said impossibility), or,
  • b) some crony business people convinced some slimy politicians to share the higher profits available by blocking competition (as the English explicitly did under mercantilism) and this model was copied in other jurisdictions until it became the norm, perpetrating the flimsy story as cover.

Hmmm.  Let me think on that a while…

More details at these links:

https://mises.org/library/myth-natural-monopoly

In 1880 there were three competing gas companies in Baltimore who fiercely competed with one another. They tried to merge and operate as a monopolist in 1888, but a new competitor foiled their plans: “Thomas Aha Edison introduced the electric light which threatened the existence of all gas companies.”[21] From that point on there was competition between both gas and electric companies, all of which incurred heavy fixed costs which led to economies of scale. Nevertheless, no free-market or “natural” monopoly ever materialized.

When monopoly did appear, it was solely because of government intervention. For example, in 1890 a bill was introduced into the Maryland legislature that “called for an annual payment to the city from the Consolidated [Gas Company] of $10,000 a year and 3 percent of all dividends declared in return for the privilege of enjoying a 25-year monopoly.[22] This is the now-familiar approach of government officials colluding with industry executives to establish a monopoly that will gouge the consumers, and then sharing the loot with the politicians in the form of franchise fees and taxes on monopoly revenues. This approach is especially pervasive today in the cable TV industry.

By Don Boudreaux
Nearly everyone I know who uses Uber is, like me, mightily impressed by this transportation service.  It makes transportation within urban and suburban areas far less pricey and far more convenient than it was in the pre-Uber-era dominated by government-regulated taxicabs.  Uber is a boon to consumers and to people who work as drivers.
Uber is a shining example of creative destruction – in particular, in this case destroying not only an older, established way of serving consumers but, more importantly, destroying the government-granted monopoly privileges that that older, established way enjoyed.
Douglas Rushkoff, however, is unimpressed with Uber.  In his new book,Throwing Rocks at the Google Bus, Rushkoff alleges that the true monopolist is Uber, the success of which “involves destroying the dozens or hundreds of independent taxi companies in the markets it serves” [p. 86].  It is significant that in this book Rushkoff never mentions the entry restrictions and other government-granted privileges that protect traditional taxicab owners from competition.
So what evidence does Rushkoff present for this counterintuitive (to say the least) proposition that Uber, by using new technology to destroy a long-entrenched monopoly, is itself a lamentable, monopolizing development?  None – at least no evidence that any economist would regard as relevant or as supporting Rushkoff’s proposition.
Rushkoff dislikes Uber because it is aggressive (and because it doesn’t promote as much personal connection as he’d like between drivers and passengers [!]).  He hypothesizes – or, rather, asserts – that Uber somehow must monopolize all taxi service for it to succeed.  Rushkoff’s economic theory for this alleged requirement for complete domination by Uber is vague.  Here it is (pages 86-87; original emphasis):
Creative destruction?  Perhaps – but with a twist: the new businesses of the digital era aren’t stand-alone companies like stores or manufacturers but, as they say, entire platforms.  This makes them capable of reconfiguring their whole sectors almost overnight.  They aren’t just the operators – they are the environment.
To become an entire environment, however, a platform must win a rather complete monopoly for its sector.  Uber can’t leverage anything if it’s just one of several competing ride-sharing apps.  That’s why the company must behave so aggressively.
The best that I can make of this word salad is that Rushkoff assumes that a ride-sharing app has all the properties of a natural monopoly – that is, as its customer base expands its cost of serving each customer falls, and that this relationship between expanding customer base and falling costs continues to hold until all customers are served by one company.
Overlook problems with the very notion of natural monopoly.  What reason is there to believe that the cost of supplying ride-sharing services with apps, as Uber (and Lyft) do, is minimized when only a single such service serves the entire market?  I can think of none.
More importantly (because my imagination, being limited, hardly supplies a definitive test), Rushkoff offers no such reason.  He merely asserts it.  Rushkoff’s assertion, in turn, springs from an illogical inference that he draws from Uber’s aggressive effort to expand its ridership.  He infers that, because Uber is aggressive, not only is Uber intent on “becom[ing] our delivery service, errand runner, and default app for every other transportation-related function” [p. 87], but also that Uber is destined to succeed in this quest unless and until the rules of the traditional free-marketplace are rewritten.  But of course any company worth the weight of its corporate charter wants as large a market share as it can possibly achieve and will act aggressively in pursuit of that as-large-as-possible market share.  That’s what competition is supposed to incite firms to do!  It doesn’t follow, though, that this widespread desire and attendant action result in genuine monopoly power.  As long as competition is channeled toward pleasing consumers rather than toward pleasing politicians, genuine monopoly power is practically impossible.  (Good luck finding a single historical example of consumer-harming monopoly power that is not rooted in government grants of special privileges to incumbent producers.)
Again, Rushkoff is characteristically unclear here.  I infer from his word salad that he has in mind some problem akin to natural monopoly, but that inference might well be mistaken.
How ironic that one of the most successful monopoly-destroyers of recent years – Uber – is demonized by Douglas Rushkoff as introducing monopolization into the market that this company has, in fact, made genuinely competitive for the first time in decades.  How ironic that a supposed enemy of The Man – an energetic crusader for economic ‘justice’ – a visionary theorist of the future – laments the destruction of the decades-old cronyism of taxicab monopolies as he peddles baseless myths about the technology and the company that has done the most to finally put an end to this cronyism.

MR=MC… or not.

Marginal revenue equals marginal cost is a mainstay of neoclassical economics. I learned it in school and I’ve taught it to kids. While you work through the math it’s very plausible, but the Austrians object. They say that businesses maximize their revenue without regard to their costs and thus aim for the midpoint of their demand curve, not for the price that makes MR=MC. This reflects my actual experiences managing businesses.

We never targeted marginal cost. In fact, we hardly knew what our “marginal economic cost” was. Gross margin is as close as we come to measuring something like that. I kept track of my actual incremental cost to be sure I didn’t go below that, but I would sometimes sell below gross margin to maximize revenue and profit.

Also, I tried to keep the cost figures to myself; I didn’t want the sales people to know our costs bc they would tend to think they had more “room” to go down in a negotiation. I told them, “get the highest price the market will bear. Don’t worry about what our costs are; that has nothing to do with you. You’re job is to know the market and find the highest prices.” That is, I explicitly sought to keep the sales side (price) and the production side (cost) separate.

So I’m now very skeptical of MR=MC. Econ students blurt it out the way geometry students say “pi-r-squared”. It’s keystone doctrine.

But interestingly, the article below from a mainstream source does mention that “some economists (Austrians are like Voldemort: he-who-can’t-be-named) reject the core assumptions of neoclassical economics as unrealistic… …based on achieving economic utopia, not explaining how real markets operate.” This is actually a fair portrayal of the position of the school-who-must-not-be-named in a mainstream piece. Refreshing! They also credit Menger as part of the marginal revolution.

If you haven’t taken Jeff Herbener’s video class, “what’s wrong with textbook economics”, www.supportinglisteners.com/whats-wrong-with-textbook-economics/ you really should. He goes thru Samuelson’s book chapter by chapter with surgical precision and demolishes fundamental things like MR=MC. Point by point, he says, “this claim is not realistic… here’s what really happens…” And I’m going, “Yeah! That’s what I’ve seen happen! That’s what I’ve actually done!”

http://www.whatiseconomics.org/neoclassical-economics