Competition and Monopoly

Markets, Entrepreneurs, and Competition

Peter G. Klein
Baylor University and NHH
Mises Institute

January 2017
Distinctive Austrian contributions
Vigorous defense of the market and private property
Critiques of central planning
Analysis of government intervention
Causal-realist account of price determination
Emphasis on the entrepreneur
Business-cycle theory
Approach to competition and monopoly
Markets
Property rights
The gains from trade
Specialization and the division of labor
Ricardos law of association
The market as a coordination mechanism
I, Pencil
Market pricing
Mengers utility and value theory
Law of diminishing marginal utility
Law of demand
Bhm-Bawerks analysis of exchange
Main insight: prices determined by the subjective valuations of marginal
buyers and sellers
No role for objective cost
Prices not set unilaterally by sellers
Limited (and realistic) assumptions about knowledge and expectations
The real prices paid in real markets!
The role of prices in a market economy
Prices allocate resources to their highest-valued users and uses; price
controls lead to misallocations of resources.
Prices provide feedback to entrepreneurs about the accuracy of their
forecasts and prior investment decisions.
The allocation of resources under market competition in which
these real prices are paid maximizes individual welfare, in the
only meaningful sense of the term.
Note on Hayeks idea of prices as signals
Basics of production
Production: the use by man of available elements of his environment
as indirect means as co-operating factors to arrive eventually at
a consumers good that he can use directly to arrive at his end
(Rothbard, Man, Economy, and State, p. 9).
Central idea: transformation (form, place, and time)
Focus on purposeful human action not automatic!
Implications
Passage of time
Original factors (land, labor) versus produced factors
Firm: locus of productive activity
Entrepreneurs
Factors of production
Austrian theory of imputation
Entrepreneurship, profit, and loss
Long-run equilibrium
Factors of production earn their discounted marginal revenue
products.
Capitalists earn interest (reward for forgoing current consumption).
No profits and losses!
Day to day
Entrepreneurs earn profits and losses based on anticipations of
future prices
Unique role of the entrepreneur: arranging the factors
of production under uncertainty (Mises, Knight, me)
Different from innovation (Schumpeter)
or discovery (Kirzner)
Implies ownership and judgment
What profit is not
Interest
Interest: reward for foregoing consumption
Profit: reward for successfully bearing uncertainty
Accounting income
Accounting income includes profit, interest, and the entrepreneurs
implicit wage
Economic concept of profit as a functional category, not a line item on
the income statement
An automatic return to capital
A markup over production costs
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
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
The perfectly competitive firm

P
MC Firm maximizes
profit by producing
the quantity at
which MR = MC

PPC D = MR Demand curve

assumed to be
perfectly elastic

Q
QPC
The firm with market power

Firm maximizes
profit by producing
P the quantity at
MC which MR = MC
Market power =
downward-sloping
demand curve
PM
P1 Firm restricts
output to increase
P2
profit (assuming
demand curve is
D inelastic above the
Q competitive price
QM Q1
MR
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
Summary
Markets depend on private property and economic freedom.
Competition refers to the freedom to act.
Buying and selling
Investing, producing, transforming
Real-world markets can be competitive!
The entrepreneur is at the heart of the competitive process.