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1. Peter G. Klein | Mises Academy 20121 | Competition and Monopoly
Peter G. Klein
University of Missouri
August 23, 2012
Austrian Microeconomics
Competition and
Monopoly

2. Peter G. Klein | Mises Academy 20122 | Competition and Monopoly
The meaning of competition
► Competition as rivalry
► Competition as freedom
(absence of legal restrictions)
 Anyone can try to compete in any
particular market
 Not everyone can effectively
compete!
► The common-law meaning of monopoly
► The imaginary constructions of “perfect” and “imperfect”
competition

3. Peter G. Klein | Mises Academy 20123 | Competition and Monopoly
A simple theory of “monopoly” pricing
► Menger and his followers: monopoly (and monopsony)
defined in terms of characteristics of buyers and sellers in the
market (exogenously determined)
► Theory virtually forgotten after “imperfect
competition revolution” of the 1930s
(Chamberlin, Robinson)
► Revived by Mises (1949) and Rothbard (1962),
who emphasized the role of legal restrictions

4. Peter G. Klein | Mises Academy 20124 | Competition and Monopoly
Monopoly pricing I
► Seller possesses one unit of the good
 Good goes to the most capable buyer at a price between his reservation
price and the reservation price of the next most capable buyer (and
above the seller’s reservation price).
Buyers
B1
B2
B3
B4
B5
Pmax
$300
$275
$250
$225
$200
Seller’s
reservation price
$150
Q* = 1
$275 < P* < $300

5. Peter G. Klein | Mises Academy 20125 | Competition and Monopoly
Monopoly pricing II
► Seller possesses multiple units of the good
 Goods go to the most capable buyers who value the good at a price
above the seller’s reservation price, at a price between the reservation
price of the last buyer and the first non-buyer.
Buyers
B1
B2
B3
B4
B5
Pmax
$300
$275
$250
$225
$200
Seller’s
reservation price
$150
Q* = 3
$225 < P* < $250

6. Peter G. Klein | Mises Academy 20126 | Competition and Monopoly
Monopoly pricing III
► Multiple sellers, same reservation prices
 Goods go to the most capable buyers who value the good at a price
above the sellers’ reservation prices, at a price between the reservation
price of the last buyer and the first non-buyer.
Buyers
B1
B2
B3
B4
B5
Pmax
$300
$275
$250
$225
$200
Pmin
$150
$150
$150
$150
$150
Sellers
S1
S2
S3
S4
S5
Q* = 5
$150 < P* < $200

7. Peter G. Klein | Mises Academy 20127 | Competition and Monopoly
Monopoly pricing IV
► Multiple sellers, same reservation prices
 Goods go to the most capable buyers who value the good at a price
above the sellers’ reservation prices, at a price between the reservation
price of the last buyer and the first non-buyer.
Buyers
B1
B2
B3
B4
B5
Pmax
$300
$275
$250
$225
$200
Pmin
$240
$240
$240
$240
$240
Sellers
S1
S2
S3
S4
S5
Q* = 3
$240 < P* < $250

8. Peter G. Klein | Mises Academy 20128 | Competition and Monopoly
Monopoly pricing V
► Multiple sellers, different reservation prices
 Price and quantity determined by the valuations of the “marginal pairs”
(Böhm-Bawerk)
Buyers
B1
B2
B3
B4
B5
Pmax
$300
$275
$250
$225
$200
Pmin
$150
$170
$190
$210
$230
Sellers
S1
S2
S3
S4
S5
Q* = 4
$210 < P* < $225

9. Peter G. Klein | Mises Academy 20129 | Competition and Monopoly
Monopoly pricing: implications
► Equilibrium prices and quantities depend not on the numbers
of buyers and sellers per se, but the reservation prices of the
buyers and sellers in the market.
 If all sellers have the same reservation prices (below at least some
buyers’ reservation prices), then equilibrium prices are decreasing in
the number of sellers, ceteris paribus.
 If all buyers have the same reservation prices (above at least some
sellers’ reservation prices), then equilibrium prices are increasing in
the number of buyers, ceteris paribus.
 But no reason to believe these are the “usual” cases!
► No particular normative implications, absent legal
restrictions!

10. Peter G. Klein | Mises Academy 201210 | Competition and Monopoly
“Perfect” and “imperfect” competition
► Imaginary constructions, but not useful ones
► Markets characterized by
 Type of product (homogenous, differentiated, unique)
 Numbers and sizes of buyers and sellers
 Entry and exit conditions (legal and non-legal)
 Information conditions (perfect or imperfect)
► Examples: perfect competition,
monopolistic competition, oligopoly,
monopoly

11. Peter G. Klein | Mises Academy 201211 | Competition and Monopoly
The perfectly competitive firm
P
Q
MC
D = MRPPC
Firm maximizes
profit by producing
the quantity at
which MR = MC
Demand curve
assumed to be
perfectly elastic
QPC

12. Peter G. Klein | Mises Academy 201212 | Competition and Monopoly
Demand and marginal revenue
Example
Demand curve
P QD TR MR
10 1 10 —
9 2 18 8
8 3 24 6
7 4 28 4
6 5 30 2
5 6 30 0
4 7 28 -2
P
Q
D
MR
6
10 elastic
unit elastic
inelastic

13. Peter G. Klein | Mises Academy 201213 | Competition and Monopoly
The firm with “market power”
P
Q
MC
D
PM
QM
MR
Firm maximizes
profit by producing
the quantity at
which MR = MC
“Market power” =
downward-sloping
demand curve
Firm “restricts”
output to increase
profit (assuming
demand curve is
inelastic above the
“competitive” price
P1
P2
Q1

14. Peter G. Klein | Mises Academy 201214 | Competition and Monopoly
Problems with the market-power approach
► No infinitesimally small units, so every firm faces a downward-
sloping demand curve.
► Requiring firms to increase output beyond the profit-
maximizing quantity violates owners’ property rights, lowering
social welfare (movie star example).
► Elasticity of demand reflects consumer preferences
 Existence of close substitutes (an economic, not a technological,
concept)
► Sellers are constrained by potential competition.
 “Predatory pricing” example

15. Peter G. Klein | Mises Academy 201215 | Competition and Monopoly
The role of potential competition
► Example with one-sided competition among buyers
 Case I: seller faces no potential competition
Buyers
B1
B2
B3
B4
B5
Pmax
$300
$275
$250
$225
$200
Seller’s
reservation price
S1 $290
Q* = 1
$290 < P* < $300

16. Peter G. Klein | Mises Academy 201216 | Competition and Monopoly
The role of potential competition
► Example with one-sided competition among buyers
 Case I: seller faces a potential competitor.
Buyers
B1
B2
B3
B4
B5
Pmax
$300
$275
$250
$225
$200
Seller’s
reservation price
S1 $290
(S2 $280)
Q* = 1
$280 < P* < $300

17. Peter G. Klein | Mises Academy 201217 | Competition and Monopoly
Government-granted monopoly
► Obvious sources of monopoly privilege
 Patents
 Exclusive grants, charters, and concessions
 Licenses
 Tariffs and quotas
► Less obvious sources
 Progressive taxation (limits capital accumulation, which favors
incumbent firms)
 Labor and environmental restrictions (Clean Air Act, Americans with
Disability Act)

18. Peter G. Klein | Mises Academy 201218 | Competition and Monopoly
Antitrust policy
► Two “free-market” views
 Government should refrain from granting monopoly privilege.
 Monopoly arises naturally, on the market, and government should
intervene to promote competition.
► US antitrust laws to “promote competition”
 Sherman Act (1890): outlaws “restraints on trade” through
monopolistic practices
 Clayton Act (1914): outlaws price discrimination, “tying”
 Robinson-Patman Act (1936): outlaws
“predatory pricing”

19. Peter G. Klein | Mises Academy 201219 | Competition and Monopoly
Practical problems with antitrust policy
► Large market share is the consequence, not the cause, of
superior financial performance.
► The relevant market is hard to define.
► Suits can be filed either by government agencies (FTC and
DOJ) or by rival firms, which may use the law to punish a more
efficient competitor.
 The historical origins of antitrust
► Suits can last a long time, but markets change very rapidly
(IBM case).

20. Peter G. Klein | Mises Academy 201220 | Competition and Monopoly
The dilemma of antitrust
“You’re gouging on your prices if
You charge more than the rest.
But it’s unfair competition
If you think you can charge less!
A second point that we would like to make
To help avoid confusion:
Don’t try to charge the same amount!
That would be collusion!”
— R.W. Grant, Tom Smith and His Incredible
Bread Machine (1964)

21. Peter G. Klein | Mises Academy 201221 | Competition and Monopoly
Theoretical problems with antitrust policy
► No scientific means of distinguishing, in the real world,
“monopoly prices” from “competitive prices” (other than the
existence of government-created entry barriers)
► Legal problem: antitrust laws are ex post facto

22. Peter G. Klein | Mises Academy 201222 | Competition and Monopoly
Takeaways from the course
► Austrian microeconomics
 Focus on “mundane” economic topics, not esoterica
 Not simply a verbal representation of neoclassical economics
► Emphasis on cause and effect
► Focus on real market behavior (prices, quantities, other actions)
► Hence, “causal-realist” economics
► For further study
 Rothbard’s Man, Economy, and State; Mises’s Human Action
 Austrian Macroeconomics with Joseph Salerno
 Applications of mundane economics to business cycles,
entrepreneurship, regulation, trade, education, . . . .
 Mises.org

23. Peter G. Klein | Mises Academy 201223 | Competition and Monopoly