6. Monopoly and Cartels

Consumer preferences ultimately drive a market economy.  Producers (to the extent that they seek monetary returns) are influenced by consumer spending decisions to allocate resources most effectively to satisfy consumer wants. 

A cartel is an alleged evil wherein a group of businesses restrict output in order to raise prices and hence profits.  A closer analysis however reveals that this view of cartels as evil is deeply flawed.  Firstly, what is the essential difference between a cartel agreement and a corporate takeover or merger?  There is none.

In a free market, firms will tend to be the optimum (from the consumers’ point of view) size.  On the one hand, lower unit-costs of large-scale production will tend to increase firm size, but on the other hand, overhead costs of bureaucracy eventually check this trend. 

On a free market any cartel will be inherently unstable:

• First, there will always be an incentive to cheat on the cartel agreement and produced more than the assigned quota.
• Second, the more efficient members will demand larger and larger quotas over time; why should they restrict their own output in order to benefit inefficient competitors?
• Third, even if the members of the cartel can reach an agreement and obey it, if they are truly earning “above normal” returns, outsiders will enter the industry.

The term monopoly has traditionally been defined as either:

1.        A single seller of a good or service.

2.        A business that can achieve a monopoly price.

The first definition is vacuous; everyone is a monopolist in this sense.  McDonald’s, for example, have a monopoly in Big Macs, because they are the only seller.  Why do McDonald’s not restrict the supply and raise the price of Big Macs?  It is because, while every producer’s product is unique, they are also all substitutable.  If the price is raised, consumers will substitute the Big Mac with something else, perhaps another hamburger, or another food item entirely. 

The second definition depends on the existence of a “monopoly price”, as opposed to a “competitive price”.  But on a free market these terms have no meaning; there is only the market price.  The supply of Big Macs is optimal for the given demand; profits are being maximized.  The Law of Marginal Utility determines the limit of supply.

The true definition of a monopoly is:

3.        The recipient of a government privilege, blocking outsiders from entering the industry.

Hence, on a free-market no monopoly can exist, and no cartel can survive for very long.  If a firm, or group of firms, are earning “above normal” returns, outsiders will enter the industry, and profit rates will return to normal.  Only when the government grants a privilege backed up by force is the concept of monopoly price significant.

>>> Next Page: 7. The Money Supply and Inflation