This section is from the "Elementary Principles of Economics" book, by Richard T. Ely and George Ray Wicker. Also available from Amazon: Elementary Principles Of Economics: Together With A Short Sketch Of Economic History
In the preceding chapter we reached the conclusion that in the case of goods freely produced under competitive conditions, value is determined on the side of demand by the marginal utility, and on the side of supply by the marginal cost of production. At the same time it was pointed out that not all goods are thus produced. The largest and most important class of such exceptional goods consists of those produced by monopolists. In order to complete our theory of value, therefore, we must now inquire how monopoly value is determined ; and that we may do this the more understandingly, let us first see what monopoly is.
Definition and Classification. It will be well for the student to study very carefully the following definition, inquiring at every step just what the words and phrases mean : Monopoly means that substantial unity of action, on the part of one or more persons engaged in some kind of business, which gives exclusive control, more particularly, although not solely, with respect to price.
I. General Welfare Monopolies.
4.Public consumption monopolies.
H. Special privilege monopolies.
1.Those based on public favoritism.
2.Those based on private favoritism.
I. Those arising from limitation of supply of raw material. II. Those arising from peculiar properties inherent in the business. III. Those arising from secrecy.
Social Monopolies. Businesses are social monopolies when they are made monopolies not by their own inherent properties, but either by legislative enactment or by forming so close a connection with great natural monopolies that they partake of the nature of the latter.
In old times kings and queens frequently granted exclusive business privileges to favored persons, and permitted no one except those named to engage in such undertakings. Such monopolies, however, became so odious that sovereigns were compelled to cease granting them. Governments still create exclusive privileges by patent and copyright laws, but they do so in behalf of the general public. Authors and inventors are given exclusive rights over their productions for a limited period. These monopolies have perhaps justified themselves through the stimulus which they have given to invention and authorship. Yet it must not be forgotten that all intellectual achievements are in part a social product, that they are due in great measure to earlier achievement. The telephone was preceded by a century of scientific invention and discovery along the line of sound transmission, and most of that investigation was very ill rewarded. On the whole, experience seems to justify the conclusion that patents and copyrights are beneficial, but that patents do not rest on so strong a basis as do copyrights, since no two persons would ever write precisely the same book.
The trademark is a legal monopoly similar to the patent and the copyright. In connection with lavish advertising, trade-marks in recent days have been made the basis of enormous profits.
Public consumption monopolies and fiscal monopolies call for a word of special comment. They are to be distinguished the one from the other only by the object which the government has in view in establishing them. If the government manages for itself or grants to another a monopoly of the liquor traffic with the object of regulating the consumption, the monopoly is a public consumption monopoly. If, on the other hand, the chief object is not regulation but income, the monopoly is a fiscal one. Often the two objects are so blended that it is difficult or impossible to name the resulting monopoly.
Our classification names two kinds of special privilege monopolies. Those monopolies which are due to special tariff advantages or to other legislation are rightly said to be based on public favoritism. The other class of special privilege monopolies consists of those which grow up through special favors granted by other monopolies, especially natural monopolies, such as railways.
Natural Monopolies. Natural monopolies are those which depend for their existence on natural forces as distinguished from social arrangements. They grow up independently of man's will and desire, and sometimes even in direct opposition to it. The words which we have used in our classification will sufficiently explain the different sources from which they arise. By far the most important of all monopolies are natural monopolies of the second class, chief among which are the following: wagon roads and streets, canals, docks, bridges and ferries, waterways, harbors, lighthouses, railways, telegraphs, telephones, the post-office, electric lighting, waterworks, gasworks, street railways of all kinds. Whenever there is a decided increment in gain resulting from combination, we have a tendency to monopoly which will overcome all obstacles. This increment of gain, which is the cause of monopoly, is always present in businesses that occupy peculiarly favorable spots or lines of land, and that furnish services or commodities which must be used in connection with the plant. This may be said to be the law of natural monopolies.
Of late years there have been many economists who argue that monopoly may naturally arise without any of the advantages that have been indicated, through the superior power of great capital and the superior economy of great concentration. They would call such monopolies capitalistic. There is not space to give all the reasons for dissenting from this conclusion regarding so-called capitalistic monopolies. One or two very cogent reasons may, however, be stated. An exhaustive study of the cases cited in support of the alleged tendency to monopoly inherent in large capital has failed to reveal a single one in which the monopoly did not enjoy one or many of those monopoly advantages which we have already mentioned and explained. Moreover, many cases in which the possession of large capital seemed on the surface to be a dominating influence, have been cases in which the monopoly was so short-lived as to furnish little support to the argument of those who cited them. After all, whatever may be the advantage conferred by large capital, we must remember that capital is so plentiful that one gigantic plant can always find a rival whenever a slight margin of profit invites its establishment.
Our conclusion then may be stated as follows: There is a great and growing field of industry in which competition is not natural or permanently possible, for reasons explained in the text; there is another field within which monopoly may easily be engendered by unwise social action, and which is likely to become narrower as the nation grows in intelligence and thoughtfulness; and finally there is a third field within which natural monopoly does not and cannot exist, and within which social monopoly is unlikely to arise.
Determination of Monopoly Price. And now, having seen what monopoly is, we may attempt an answer to the question, How is monopoly value or monopoly price determined ?
First of all, we may say that monopoly value, like any other value, is determined by the relation between demand and supply, and that demand is here as elsewhere determined by marginal utility. But the supply is not determined as under competition by the cost of production, but by the desire of the monopolist to secure the maximum of revenue possible in the existing state of demand. In other words, the monopolist, freed from competition, and governed only by demand, is able to adjust supply to demand in such a way that the price will stand at the point of highest net return. In determining what price shall be fixed and what quantity supplied,in other words, what is the point of highest net returns, the monopolist consciously or unconsciously proceeds according to the following principles:
1.He realizes that every increase in the supply of his monopolized product will result in lowering the marginal utility, and hence the demand price of the product, while every decrease in the supply will result in a higher marginal utility, and hence a higher price.
2.Of the expenses of production there are some that vary in almost regular proportion with the variation in the supply. Thus if the product is doubled, the cost of raw material will be just about doubled. Such expenses are called variable expenses.
3.Other expenses, within certain limits, remain more nearly the same, no matter what may be the amount of the product. These, called the fixed expenses, would include the cost of plant, salary of superintendent, interest on bonds, etc.
It follows from the above principles that the monopolist, since he is seeking the maximum net revenue from his business, will pay no attention to fixed charges in establishing the price of the product, but will consider only the variable expenses in connection with the probable demand for his goods at various prices.
An Illustration. We may illustrate by an example the operation of these principles. The following table shows in parallel columns the number of sales of a monopolized good at different prices; the total resultant earnings ; the variable expenses; the fixed expenses; the total expenses; and finally the net revenue or monopoly profit:
Variable Expenses per Unit
Total Variable Expenses
Study of the table will show why, in the case assumed here, the monopoly price will stand at six cents. Competition, if it were present, would keep on increasing the supply as long as normal profit could be obtained. In our illustration the lowest price at which production could be carried on so as just to secure a profit above the expenses of production would be four cents ; and four cents would therefore be the competitive price or the price determined by the balancing of marginal utility against marginal cost of production. But since the monopolist has such control over the production that he can control the supply, he will cut off production at 2,500,000 units, at which point the marginal utility, and hence the demand, will fix a price of six cents, and will give the largest net return, $25,000.
The student may be interested in seeing the same thing illustrated by a diagram. In the following diagram, we take only one possible case that in which the monopolist is producing a commodity the making of which falls under the law of increasing returns.
In the diagram the curved line ab is taken to represent the varying cost of production, and is hence called the supply curve: the line cd, representing the state of demand, is similarly called the demand curve. The line ox would represent the price under competitive conditions. The perpendiculars fh and il represent the prices that would be fixed by the demand if the monopolist were to limit the supply to eh or el respectively. The lines gh and kl would represent the total cost per unit of producing these various quantities. The parallelograms ghqe and klne represent the total costs of the different quantities, and the parallelograms fhpe and ilme represent the total returns from sales. Consequently the smaller parallelograms fgpq and ikmn, which equal the parallelograms representing total income, minus the parallelograms representing total costs, represent the net return. If the character of the two curves be known, it is possible to determine by mathematical formulae where the parallelogram of greatest net return will fall, and consequently what will be the monopoly price. It will be well for the student to draw a similar diagram and find by experimentation the parallelogram of greatest area, and from this the monopoly supply and monopoly price.
The Effect of a Tax. Our numerical illustration and our diagram may both be made to convey a lesson regarding the influence of taxation upon monopolies and monopoly price. Fixed expenses have no influence in determining the price. If, therefore, a fixed tax, say of $5000 a year, were to be laid upon this monopoly, it would not result in an increase of price. A study of the table will show that with such a tax the net revenue at price .08 would be $5000; at price .07, $17,000; at price .06, $20,000; at price .05, $15,000; at price .04, nothing. Thus price .06 will still be the point of maximum net revenue and hence the monopoly price. On the other hand a variable tax, for instance a tax of one cent per unit, would result in this case in raising the monopoly price. In our illustration, such a tax would make the net revenue at the price .08, - $2000; at the price .07, $4000; at the price .06, nothing; at the price .05, $15,000. Thus, though the monopoly would find its profits greatly curtailed by such a tax, consumers would be compelled to pay one cent more per unit for the monopoly product. The possible advantage which society might draw from the tax would therefore be wholly or in part offset by the increased cost of the commodity. Such a raising of the price will not take place, however, if the demand at the higher price is not sufficient to make as great a net revenue as at the lower price. We may conclude, therefore, that fixed taxes, or taxes on the net revenue of a monopoly, cannot be shifted wholly or in part by a change in price; while taxes laid in proportion to the amount of business, since they contribute an addition to the variable expenses, may be wholly or in part shifted by a change in price.
The student may profitably test these statements regarding monopoly by hypothetical cases after the manner of our numerical illustration, and by drawings similar to the diagram used to illustrate the determination of monopoly price.
A Law of Monopoly Price. It is sometimes said that the price of a monopolized good depends solely upon the will of the monopolist. In the strict sense of the phrase this is not true. As our explanation has shown, the monopolist is forced by economic motives to establish such a price as will give the maximum net revenue. There are certain conditions on the side of demand which therefore have a decisive influence in determining monopoly price. We may group the most important of these in a general statement which may properly be called a law of monopoly price: The greater the intensity of customary use of the monopolized commodity or service, the higher the general average of economic well-being, and the more readily wealth is generally expended, the higher will be the monopoly price which will yield the largest net returns. Thus monopoly, without any effort of its own, shares in the increasing wealth of a country, and absorbs a considerable part of it. It is, for example, among other influences, the larger wealth and the greater willingness to spend freely that makes monopoly more profitable in the United States than in Germany or other European countries. The search for other illustrations of the law should prove an interesting and valuable exercise for the student.
Public Policy regarding Natural Monopolies. It was long ago said by a shrewd English engineer that where combination is possible, competition is impossible. Now combination is always possible in the case of natural monopolies of the second class. (See the classification.) Indeed, combination in such businesses is inevitable. If two gas companies in a city, each with a capital of a million dollars, are able without combining to make 10 per cent profits, they will, when combined, make much more than 10 per cent. The force drawing them together works as constantly, if not as uniformly, as the attraction of gravitation.
The testimony of experience on this point is ample. There is never any competition in this field. There is sometimes " war " to settle the terms of combination, and popular language, when it uses the word " war " in this connection, as in speaking of gas wars, etc., is scientifically correct. What, then, should be the policy of the government in dealing with these industries ? Ought we in the United States to substitute government ownership and management of such monopolies for private ownership and management ? Some of these monopolies have been in public hands so long that we no longer think of them as a possible field for private enterprise. Such, for instance, are the roads and streets, the post-office, and, in many places, the canals. As to the others, it would at least be well to limit the charters and to make such a reservation of public rights as will later permit the government easily and readily to make such changes as the future may show to be wise.