A reader has commented on my discussion of the market for electricity in Ontario. On the question of whether or not central planning by government is to be recommended over the free market, he writes: “What about the issue of natural monopolies? It’s not a problem for the toaster industry, but it is for utilities.”
Let’s examine this contention.
A so-called “natural monopoly,” also referred to as a “public utility,” is an industry in which competition is deemed not feasible. Critics of monopoly often point to the supply of electricity and water to a city as examples of this phenomenon. Because, in their view, space for competition is limited, government intervention is encouraged in order to prevent the greedy monopolists from restricting supply and “price gouging” hapless consumers.
Much confusion exists insofar as the meaning of the term monopoly is concerned. Regardless, it is critical to realize that the issue of “monopoly” is meaningless unless a “monopoly price” is realized. For example, if, through greater efficiency, a firm is able to achieve monopoly status by out-competing its rivals through lower prices, this directly benefits consumers. In other words, no harm, no foul.
Alternatively, as the publisher of this copyrighted blog, I may be viewed as a monopolist. That being said, I may not be able to sell a single article regardless of how high or low the price may be.
On the other hand, a monopoly price is said to occur if a monopolist obtains a higher monetary return by restricting the saleable quantity of his product and charging a higher price. In order for such a situation to result, the good in question would require an inelastic demand curve. Otherwise, consumers would substitute other goods in its place, and higher net monetary returns would not be realized. The monopoly price is said to be in contrast to the competitive price, which occurs in the absence of a monopoly. It was the great economist Murray Rothbard, however, who demonstrated that the concept of monopoly price is entirely illusory.
Consider, for example, a producer who must decide how much of a good to produce in the future. Ultimately, his goal will be to produce that quantity which maximizes his monetary earnings (other psychic factors being equal), for which he has sufficient capital to invest. After producing this stock of goods, the question becomes: is the resulting price a “monopoly price” or a “competitive price”? Clearly, it is impossible to know the answer. Similarly, if the producer later discovers that he can increase profits by producing less goods and charging a higher price, does the increased price reflect a “monopoly price” or is it merely the substitution of a “competitive price” for a “subcompetitive price”? Once again, there is no way to distinguish between the two.
Because of this, we may conclude that all prices on a free market are competitive prices. With this in mind, we may return to the shibboleth of the “natural monopoly.” Rothbard described it as follows:
In the first place, such a “limited-space monopoly” is just one case in which only one firm in a field is profitable. How many firms will be profitable in any line of production is an institutional question and depends on such concrete data as the degree of consumer demand, the type of product sold, the physical productivity of the processes, the supply and pricing of factors, the forecasting of entrepreneurs, etc. Spatial limitations may be unimportant; as in the case of the grocers, the spacial limits may allow only the narrowest of “monopolies” – the monopoly over the portion of sidewalk owned by the seller. On the other hand, conditions may be such that only one firm may be feasible in the industry. But we have seen that this is irrelevant; “monopoly” is a meaningless appellation, unless monopoly price is achieved, and, once again, there is no way of determining whether the price charged for the good is a “monopoly price” or not. And this applies to all circumstances, including a nation-wide telephone firm, a local water company, or an outstanding baseball player. All these persons or firms will be “monopolies” within their “industry.” And in all these cases, the dichotomy between “monopoly price” and “competitive price” is still an illusory one. Furthermore, there are no rational grounds by which we can preserve a special sphere for “public utilities” and subject them to special harassment. A “public utility” industry does not differ conceptually from any other, and there is no nonarbitrary method by which we can designate certain industries to be “clothed in the public interest,” while others are not.
It should now be clear that, in his objection, our reader has implied a false dichotomy. We are not faced with a choice between “natural monopolies” and government monopolies. Instead, the choice we face is one of voluntarism versus coercive intervention by government. Either we treat the electricity industry like the toaster industry or we do not. As Rothbard explained:
In this world, there are two, and only two, ways to settle what the prices of goods will be. One is the way of the free market, where prices are set voluntarily by each of the participating individuals. In this situation, exchanges are made on terms benefiting all the exchangers. The other way is by violent intervention in the market, the way of hegemony as against contract. Such hegemonic establishment of prices means the outlawing of free exchanges and the institution of exploitation of man by man – for exploitation occurs whenever a coerced exchange is made. If the free-market route – the route of mutual benefit – is adopted, then there can be no other criterion of justice than the free-market price, and this includes alleged “competitive” and “monopoly” prices, as well as the actions of cartels. In the free market, consumers and producers adjust their actions in voluntary cooperation.
In conclusion, let’s consider the original meaning of the word monopoly, from which it has inherited its many negative connotations. Originally, it was defined as “a grant of special privilege by the State, reserving a certain area of production to one particular individual or group.” Stated differently, monopoly is a barrier to entry facing would-be competitors that is erected and enforced by government. It holds true today.
Clearly, monopoly, as defined above, cannot exist in a free market.