Prof. Bryan Caplan

Econ 370


Week 2:  Government as a Cause of Monopoly

I.                     Preconceptions about Monopoly

A.                 When most people today think about "monopoly," they think about firms gaining a dominant position in an unregulated free market

1.                  Standard Oil & Rockefeller

2.                  Railroads

3.                  Microsoft?

B.                 Problem: Might not their dominant position be due to superior efficiency?  If so, what is so bad about "monopoly"?

C.                Frequently overlooked: Government-created monopoly in industries that would otherwise be competitive.

1.                  The government might be the monopoly supplier itself.

2.                  Alternately, it might give a private supplier a monopoly privilege

D.                Government-created monopoly is unlikely to have won its position through superior efficiency; in fact, the reverse is true.

E.                 After voluntary cartels fail, firms often turn to the government to enforce monopoly.

II.                   Historical Examples

A.                 Monarchical monopolies

1.                  Russia.  “Peter the Great set up numerous government monopolies. Resin, potash, rhubarb, glue, salt, tobacco, vodka, chalk, tar, fish, cards, dice, and even coffins were made the exclusive province of government production. The monopolized commodities' prices were generally set at two to four times their prices under free competition. Witte continued this monopolistic tradition by making the entire liquor industry a state monopoly, and nationalizing private liquor shops.”

2.                  Britain. “As a last resort the queen [Elizabeth] also offered monopolies for sale.  These were licenses, granted in return for heavy payments, which gave the holder the sole right to manufacture or trade in certain articles.  To get back the money he had spent in buying the monopoly, the holder would put up the price of his articles, and since no one could offer similar goods for sale, the public had to pay or go without.”; also Navigation Acts, Stamp Act, etc.

B.                 New Deal farm cartels (preceded by failed voluntary cartels)

1.                  Cotton – In 1933, government paid $100,000,000 in benefits to get farmers to plow up a quarter of the cotton crop.  Gradual shift to “loans” and acreage controls.

2.                  Wheat – not plowed up in ’33 because of bad weather conditions, but loan & acreage program

3.                  Hogs – in ’33, six million baby pigs bought and slaughtered by the feds

C.                CAB and ICC

1.                  Civil Aeronautics Board severely restricted competition in commercial airlines.  It set minimum air cargo and passenger rates, keeping rates 10-20% above unregulated rates (deregulation since late ‘70s).

2.                  Interstate Commerce Commission severely restricted competition in inter-state trucking.  It originally fixed railroad rates – generally working to keep prices up from the start.  In the ‘30’s, ICC took over trucking (railroads were suffering from competition from trucks).  Trucking rates regulated, and licenses required (and almost no new licenses were ever issued, so you had to buy out an existing owner).  Kept prices 20-40% above market rates.  (Crazy aspects – only being able to have cargo 1-way; round-about routes based on licensing)

3.                  Anecdote on intra-state trucking in Jersey

D.                Nazis’ anti-chain and department store laws

1.                  One long-term Nazi cause was protecting mom&pop stores from department and chain stores.  Once the Nazis came to power, there were numerous official and unofficial penalties imposed on them...

2.                  Unofficial: Boycotts by the Frauenshaft (Women’s Organization) and local Party leaders; 29 Jewish department strores burned during Kristallnacht.

3.                  Official: Extra Winterhilfe taxes, advertising restrictions, kept out of trade in Party paraphernalia, higher state taxes on department stores

III.                  The Theory of Monopoly

A.                 Previous models all assumed the constraints imposed on a firm by actual or potential competitors.  What if competition is illegal - i.e., one firm has the sole legal privilege of producing a good?

B.                 Simple answer: Raise price above marginal cost (equivalent to: produce less than competitive quantity)

C.                Complicated answer: set Marginal Revenue= Marginal Cost

D.                Result: Monopolist earns a monopoly profit due to the illegality of competition

IV.               What is Inefficient About Monopoly?

A.                 Allocative inefficiency - P>MC; remember "Why Taxes Are Bad"

B.                 Piracy and Monopoly, or Deadweight Losses vs. Transfers

1.                  For pirates: The Transfer is the captured loot; the Deadweight Losses include the sunken ship, goods destroyed during fighting...

2.                  For monopolist: The Transfer is the monopoly profit; the Deadweight Losses stem from the marginal units not produced

C.                Productive inefficiency - AC above minimum

1.                  Simple theory of monopoly does not predict productive inefficiency.  Monopolist wants to make as much profit as possible, and the lower costs are, the greater profits are.

2.                  However, if different potential producers have different cost curves (some are more efficient than others), then there will be productive inefficiency unless the most efficient producer also receives the monopoly privilege.

3.                  There may also be productive inefficiency if the monopolist's profits are regulated.  Why?

V.                 Contemporary Examples

A.                 Tariffs and Quotas – “Voluntary Export Restrictions” - quotas on Japanese cars; Bovard quote: “Fair trade means that Jamaica is allowed to sell the United States only 970 gallons of ice cream a year, that Mexico is allowed to sell Americans only 35,292 bras a year, that Poland is allowed to ship us only 350 tons of alloy tool steel, that Haiti is allowed to sell the United States only 8,030 tons of sugar.(3) Fair trade means permitting each American citizen to consume the equivalent of only one teaspoon of foreign ice cream, two foreign peanuts, and one pound of imported cheese per year. Fair trade means the U.S. government imposes import quotas on tampons, typing ribbons, tents, twine, table linen, tapestries, and ties. Fair trade means that the U.S. Congress can impose more than 8,000 different taxes on imports, with tariffs as high as 458 percent.”

B.                 Licensing – medical licensing, taxis, barbers, electricians...

C.                Corporate Income Tax – penalty on the corporate form of organization, since corporate income is double-taxed.  Current rate is 35%, though some corporate forms (S-corps) can avoid double-taxation.

VI.               Political Competition for Monopoly Privilege

A.                 Bidding for Monopoly

1.                  Imagine the government holding an auction, in which firms bid for the monopoly license.  (Many monarchs used this sort of technique to raise revenue).

2.                  Who now gets the monopoly profits?

3.                  What happens to the DW loss of monopoly?

B.                 Lobbying for Monopoly

1.                  Bidding (or cash bribes) is no longer very common.

2.                  Lobbying - hiring lawyers, political insiders, etc. - to plead one's case is now the standard method.

3.                  Even though the law may ban competitive production, it rarely bans competitive lobbying.  Thus, each would-be monopolist can (and does!) invest in lobbying.

C.                How Competitive Lobbying Can Make Monopoly Really Inefficient

1.                  With competitive lobbying (i.e., zero profits for investment in lobbying), who now gets the monopoly profits?

2.                  What does competitive lobbying do to the DW loss of monopoly?