This section is from the "Economics In Two Volumes: Volume I. Economic Principles" book, by Frank A. Fetter. Also available from Amazon: Economic
§ 8. How prices are limited under competition. The phrase " charging what the traffic will bear" is usually heard in connection with monopoly-price. Yet every competitive seller gets all he can for his goods, and still make a sale. This is "charging all the traffic will bear," but under competition the traffic will not bear as much as under monopoly. Each buyer is following the same principle, giving as little of the price-good as he needs to give to get the sale-good; in popular phrase, he is trying to get the most for his money. Still out of these various desires to get indefinitely high prices, emerges, under true competitive conditions in a market, one common market-price. (See above, Chapter 7.) This is the best price any trader can get on the principle of charging what the traffic will bear in a truly competitive market. In a market for homogeneous products where there are on each side of the market at least two truly competing traders, the attempt of any trader to discriminate, to get more than the common market-price, simply deprives him of that sale. He eliminates himself as a seller in respect to that unit.
This condition of two-sided competition is lacking in countless cases and in many respects in the business world. The slightest lack of homogeneousness in the goods to be sold breaks the market up into more or less separate markets, and there is a chance for the seller to sell the different qualities at different prices, still, however, at a competitive price, alike to all for the same quality.
§ 9. Borderland of monopoly. Ownership of a particular knife, pencil, book, makes one the unique seller of it, but confers no monopoly power, as the power of substitution is practically absolute; the welfare of no one depends in any appreciable measure on that particular pencil. The simplest substitution a buyer can make, ordinarily, is that of a commodity of the same kind, offered by another seller. The effective limitation of the competitive seller is that if he tries to charge more than the fair market price, the buyer is able to buy of some one else.
In many enterprises in this same manner the surplus of selling price over costs as a whole is ruled by a very strict competition in the long run, and yet the prices of the separate products of the enterprise have the appearance of being quite noncompetitive. The organizers of an entertainment, whether for private profit or for charity, hire a hall and assume the expense of the entertainment, the whole cost becoming thus a fixed charge. The prices of the various seats are then fixed with a view to getting the maximum total receipts. As regards that particular entertainment there is literally a monopoly. If half the seats are likely to be empty it will not "pay" to reduce the prices so low that all the seats could be sold. That might cause the price to be a negative one - payment for attending. It pays better to have a graded scale of prices to different parts of the house, and let some seats go unsold.
These examples serve to show that in a literal sense every man is the exclusive seller of the identical thing he has to sell and yet may have no monopoly power to raise prices above a normal, competitive rate. He may withhold the sale-good or place any reserve valuation upon it that he pleases, and a customer must pay that or go without that particular unit of labor or product. But this in most cases gives to the seller a quite negligible degree of power to influence price, and in many other cases where there is some power, there is no motive. There is, therefore, despite some measure of power to restrict supply, no exercise of the power sufficient to constitute a social problem of monopoly.
§ 10. Difficulty of departing from average costs in competition. Consider the case of a manufacturer who has no advantages not open to capable competitors and who can sell his small and easily transported products over a wide area.-Such products, which by their nature seem typically competitive, are shoes, hardware specialties, writing tablets, etc. The manufacturer makes and sells them through agents both to wholesale and retail merchants, realizing a good average profit on the whole. Let him apply the principle (paradox) of price cutting to one pattern and sell it at a price which is nearer to bare cost. He will sell it more easily but it will contribute little or nothing to profits except as it may be an advertisement, "a leader." Another pattern gives a large unit-profit, and is "a money maker." This will be the special target of competition, and will be more difficult to sell. If each competitor has his leaders, keen buyers can make leaders a good share of their purchases. Thus real competition searches out each inconsistency of cost accounting and is constantly leveling down the "money-makers" to a normal profit. Again and again a growing and seemingly prosperous business fails. The management have produced and sold the goods, but have cut the margin of profit too close. Meantime other more conservative competitors, trying to maintain prices, have been pushed almost if not quite into bankruptcy. Many a firm with a stable policy, a golden mean between rash and timid, has passed through many such an ordeal, and has won a substantial success through generations from grandsire to grandson, while competitors have risen and fallen.
In a competitive market, there being several sellers, the buyer stands ready to take from any one of the sellers. If any one of the sellers, whether formerly marginal or not, dropped out, and no one took his place, the price would rise. But the very essence of a condition of competition is this, that it would not pay any one seller to drop out for the purpose of raising the general market-price. He would lose more because of withholding these units (or ceasing to produce them) than he could gain by the additional profit he would make on the units he continued to sell. He has, virtually, to take the market-price as a fixed fact for the time, so far as he is concerned, and to decide whether at that price and the profit it yields him, he cares to continue selling. To put the same thing slightly differently: if he does not continue, other competitors stand ready to sell at the same price, or at a price so little higher that he will not profit on the whole by the change. His limitation of production yields a net gain to his competitors but a net loss to himself.