This section is from the "Economics In Two Volumes: Volume I. Economic Principles" book, by Frank A. Fetter. Also available from Amazon: Economic
§ 12. Large production and the two types of prices. If there is a situation where two or more establishments are able steadily to decrease unit costs by the economy of size, and there is normal competition among them, the result should be a decrease of price. When furniture is made in small shops, where most of the work is done with hand tools, the radius and area of the market are small; the improvement of transportation widens the markets and makes possible large production with its economies. These two conditions might be represented in a map, or ground-plan, as in Figure 51.
Each circle represents schematically an entire country, divided into markets, or regions of influence, each supplied by one establishment. At first it would appear as in the circle at the left, but after concentration had gone on to a large degree, the whole territory might be controlled almost entirely by a few large concerns such as A, B, C, and D A factory located at B, for example, would market its product in all directions (as shown by the small lines leading out from B) until it came into contact with the competition of A, C, and D. The limits of influence would be determined mainly by navigable rivers, railroads, supplies of natural materials, distribution of population, etc., but also by various psychic influences, such as habit, personal acquaintance, etc.
4 The discussion of these cases must be left until the treatment of the trust problem.
Prices both in the small and the large market may vary according to two main principles shown in Figures 52-55. (1) The prices may be uniform to every one at the factory, or at the nearest railroad station. Such a price is called f.o.b. (free on board, i.e., of the cars), the buyer having to pay the freight (Figure 52). The price to the various buyers' doors varies throughout the territory in accordance with the differences in freights, and at the outer edge of each area the advantage of buying in one market or the other falls to zero. The cost is reckoned by the maker to be uniform on all the output and each factory has by this rule what appears to be its natural, or normal territory. (2) The prices may be uniform to all buyers for goods delivered within specified areas (Figure 53) ; as one manufacturer of scales at Binghamton, N. Y., advertised widely for many years, "Jones pays the freight." Here the different units of products contribute unequally to profits, and the market extends to the point where price will cover variable costs and little more.
§ 13. Monopoly element in price-fixing*. These two principles of price-fixing may be combined in various proportions, and especially in the case of goods not sold at an advertised price, but by agents, there is a strong temptation to depart from the f.o.b. price, not regularly but as appears necessary to effect a sale. Factory B (in Figure 54) may maintain the f.o.b. price within its own natural territory, and cut prices so as to invade the rival's territory. If this is successful it may so limit the output of rival A, as to raise the average cost (Figure 55). The wider the territory over which a factory gets a market the greater its degree of monopoly control in the inner portions of its own territory. Instead of making its own costs a basis of price, it may make its smaller competitors' costs the standard. Establishment A's uniform price f.o.b. plus freight to destination is shown (Figure 55) on line ab. If B just meets these prices, a gross profit shown at bc would be possible at the center of its territory, falling to zero at d. Under such conditions the price in a large portion of the territory of large production would be much higher than before with smaller production, and the large profit would offer a motive to some one to start a small factory, even if its costs would be higher per unit than those of B. But the fear, the certainty, that prices would be reduced could, after a few lessons, effectually prevent such an extra-hazardous investment.
* This shows a cross section of prices to buyers at each point along the diameter of the market supplied from the factory at the middle. The next figure (53) is on the same plan, with the factory at the middle; but in the two following figures (54 and 55) the factories A and B respectively are at the edges of the figures, and only the radii of their markets are shown.
This conquest of the market by one establishment can hardly happen in as simple and complete a way as that supposed. The competitor can play at the same game, and even tho smaller (as A in Figure 55) would struggle with like pricetactics to retain or recover the border territory (that between d and e). Then the competitors are not always divided territorially. Smaller factories exist alongside of larger ones in districts well suited to the kind of industry (iron, textiles, woodworking, etc.), and maintain their existence by serving special classes of customers in a special way. They are latent competitors for related lines of business in case prices are raised much above those yielding usual profits. For most kinds of goods some substitutes, or some other source of supply, can be had, if prices are greatly raised by monopoly power. With all these limitations, however, there still remains a considerable measure of monopoly power in many cases, and a wide range of apparent caprice in prices. Any one of the large competitors by a change in his policy may greatly alter the price situation in a certain territory, introduce a period of what may be called abnormal competition and abnormally low prices, and bring upon himself and others either loss or an increased monopoly power. In either case there is a return to higher prices later. The search for a prevention of this irregularity constitutes the large part of the practical problem of monopoly.