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    Dear Prof Herbener,

    I’m really enjoying this course and it’s helping me better understand the mainstream view of economics and what’s wrong with that view. However, I have a question about the Austrian understanding of monopoly that I’d like to clear up.

    In the 9th and 10th lectures you discuss Samuelson and Nordhaus’ views about monopolies and why they are socially detrimental. Their account as I understand is that because monopolists are price-makers, they can charge prices above the marginal cost of their products. The profit they obtain represents a deadweight loss to consumers, since the monopolists could have produced more goods and charged a lower price but were instead able to produce less and charge more.

    The Austrian response as I understand is that production costs do not directly enter into the producer’s selling calculation because production costs are sunk. So in fact the seller only considers opportunity cost when determining the price, which in turn means he sets the price at the point of unit-elasticity on the demand curve, which I think means the market-clearing price (as estimated by the seller at time of sale).

    Does this mean monopolies are no longer socially detrimental? It seems that if we are Austrians we should distinguish between the production decision and the sale decision but that we can still detect a monopoly effect in the decision to produce. I.e. the producer knows that he has a monopoly and almost certainly will still have a monopoly when he comes to sell his goods and therefore chooses to produce less than he otherwise could since he anticipates being able to charge a higher price for a smaller stock. So even though at the time of sale we are only dealing with the stock as it exists at that point, we can still compare it with the alternative scenario where the producer chose to produce more, the stock was larger and the market-clearing price lower.

    If this is true, I’m not entirely sure what the force of the Austrian critique of monopoly is. It seems we are describing the same phenomenon in different ways but it’s still the same phenomenon, i.e. producers able to produce less of a good than they otherwise could without incurring loss because they are the only producers and sellers of that good.

    Jeff Herbener

    The force of the Austrian argument is that no matter the conditions of the market, each entrepreneur behaves in exactly the same way. Therefore, the social consequences of their actions are the same. Every entrepreneur, regardless of market conditions, asks a price that maximizes the revenue from sales (this is the unit elastic point on demand for his product). Every entrepreneur, regardless of market conditions, has a cost structure that is bid up to the point of earning just the interest rate of return. If an enterprise is profitable, then outside investors will bid more intensely for its assets (including share of its stock if it’s a public company). this bids up the opportunity cost for the entrepreneur to continue to use these assets in his production. So price is never permanently above MC, when opportunity cost is considered. There are no monopoly profits.

    Take a look at Murray Rothbard on monopoly in chapter 10 of Man, Economy, and State:


    Ludwig von Mises makes the same point in chapter 16, section 6 of Human Action:



    Thank you for taking the time to reply!


    And presumably this also holds if there is a legally protected monopoly? Even if the government outlaws competition, the company’s costs are still bid up and the company eventually earns no profits. So the social harm lies in the suppression of production; the monopolist does not profit by the monopoly any more than he would if he had competition (except maybe in the period immediately after the monopoly was granted when he might earn a windfall profit and costs have not yet been bid up). Have I got that right?

    Jeff Herbener

    You are correct. Mises discusses this point in the Human Action citation above. The monopolist receives a capital gain on the price of his assets when investors at large recognize the monetary advantage of the monopolist’s position. Proper accounting of the higher price of assets would render a normal rate of return. The historical case often cited to illustrate this is Alcoa’s exclusive ownership of bauxite mines. Once investors at large recognized the extra profitability of such a position, they bid up Alcoa’s stock price reflecting their view of the higher asset prices of the bauxite mines owned by Alcoa.

    Rothbard also discusses the “capitalization” of asset prices in chapter 4, section 4, sub-section b on Property Taxes of his book, Power and Market:



    So I suppose businesses don’t try to gain monopolies because they can expect permanent profits but because they just want that brief capital gain before asset prices are bid up by investors? I guess I’m wondering why monopolies even exist if monopolists don’t profit from them.

    Jeff Herbener

    The additional profit from having a legal-privilege monopoly can be taken either in the form of additional annual net income or in the form of a one time capital gain. They are equivalent. The gain, then, accrues to the initial owner of the special resources used. All latecomers, who must buy the assets to enter the market, earn no additional profit. That is why the latecomers continue to lobby for additional legal privileges.

    Take the case of the taxi medallions in NYC. If you acquired one from the city in the 1950s, its price today might be $500,000, which is the present value of the future additional revenue generated by owning the legal privilege. The original owner of the medallion can either stay in the business and get the additional annual revenue or sell out and get the capital value of the medallion. They are equivalent monetary sums. But the new entrant only earns a normal rate of return because he must pay for the medallion. It is part of his cost structure. Of course, it is also part of the (opportunity) cost structure of the original owner as well if he stays in business.



    If I may chime in here with a question Dr. Herbener; does this process of bidding up asset prices make the market or industry more contestable in the long run (provided that the companies are not protected by the state)? I seem to remember that entry is possible when short selling the existing companies stock, but I’m wondering if there are other ways potential entrants could use this to their advantage?

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