? How are monopoly formed?

A short video to inform how to monopoly formed.

▪ John story

John is a shoe producer in a far country of Los Zapatos. He achieved his significant market position in an honest manner, i.e. through offering desirable products to customers, introducing innovation and making sure to be up to date with current trends. For many years he managed to correctly anticipate his client tastes, and this has led to huge success and handsome profits. Unfortunately, success made John a little lazy. He started to invest a little less in his business, he was basing on “good old bestsellers”, rather than seek for new trends as well. He certainly didn’t expand his business as before, rather focusing on maintaining status quo. The competition, however, had a different approach. When John slowed down, competitors rapidly expanded. Both domestic and foreign competitors increased their market shares, and lured John’s clients away with lower prices and better quality. John observed his tumbling sales records with great worry. He still had a powerful market position, but he knew something had to be done to maintain it. He had two choices.

Either he could increase his productivity, once more focus on innovation, cut costs, invest in better capital goods OR… he could simply start lobbying for some regulations, which would constrain his competition. John chose option number two. Why? Well, for one: because he could, and second: because it was much easier than the option number one.

▪ Start lobbying

After he made his decision, he had to think about what should be done, for his plan to be successful. Oh, but he had so many potential tools to use! He could, for example, lobby that the government should grant him an exclusive license to sell shoes in his country, or mandate people to buy at least one pair of shoes a year from him. He quickly realized, that this would be excessive and no one would go for that. Not with shoes anyway. He knew that he must be much more subtle with his demands. The best option would be, to present his demands in a way, that people would think that he cares, not for his profits, but rather about the common good, about employees or about customers. He also knew that he wouldn’t be able to be a sole monopolist, so he decided to join forces with the other existing domestic producers in order to constrain (maybe even eliminate) all foreign competition, and also to make it almost impossible for a new domestic competition to emerge.

He presented his ideas to his main domestic competitors, and when they were on board, together they started a Shoe Producers Association of the Great Nation of Los Zapatos. John was elected a new president of the association, which quickly started working on bills proposals. The point of the first bill proposal was to impose a very high tariff on shoe imports. The explanation was, that the foreign competition was “unfair” as they use price dumping. The argument was made, that the new tariff would also save domestic jobs, which were endangered by foreign competition. John and other associates gave many tv and radio interviews, in which they were presenting arguments in favor of the bill’s proposal, they wrote articles, statements and declarations, and tried to convince local politicians of their cause. The clients were very much against this proposal, as it would limit their possible choices, but their voice wasn’t heard enough. After all, it wasn’t as if they were in some kind of “consumer association”. The shoe producers thus won, and the new bill was passed. From now on, if a consumer wanted to buy shoes, he had to go to a domestic producer, because the foreign competition’s products were too expensive, due to tariffs. So, that’s one of Johns problems solved!

▪ Blocking foreign competition

There was one more problem however. John knew, that the lack of foreign competition would lead to higher profits for domestic producers, and higher profits would eventually lead to new domestic competition. Blocking new domestic competition was harder than blocking foreign competition. In the case of foreign competition, the association could invoke job saving or unfair competitive advantage as an argument, but it wouldn’t make sense in the case of new domestic competition.

John proposed a different approach, and said that bad shoes are a cause of various afflictions, which is not the case for quality shoes. And because everyone should want to have good quality shoes, shoemaking should be licensed, and shoes certified, to make sure that clients feet would be protected from bad producers, who produce low quality shoes. Licensing would not be free of course. Quite the opposite, it would be very expensive – and – if anyone wanted licensing, they would have to fulfil some harsh requirements. The requirements were to be set by the Shoe Producer Association of the Great Nation of Los Zapatos, as they were clearly the experts on this matter. The certificate would be granted by the special commission, in which members of the association would participate as well. From now on, new shoe producers would have to follow detailed instructions during the production process, to have a chance to get a certificate, and sales without the certificate would be forbidden, for the good of the customer – of course.

The association once more created a bill proposal, which quickly passed, because who wouldn’t want to protect the customers from low quality shoes!

John and the other “old” producers could afford to buy an expensive license, but unfortunately the cost was too big for the “new players”. This effectively discouraged potential competition. “Luckily” John and the “old players” met every production requirement, that they themselves created, so their shoes could be certified. This was a smart move from John, because he started small, and although he always cared very much about the quality of his product, it took him years to meet all the high requirements, that the Association now imposed on everyone, thus he knew very well that this would discourage potential competition even more. Of course John would never admit publicly, that his ideas had anything to do with discouraging the competition. He would always talk about the good of the customer and his healthy feet.

▪ Monopoly

And that’s how John and the others created a monopoly, or should we say, oligopoly in Los Zapatos. From now on, someone who wanted to enter the shoe manufacturing market, would have to have a huge determination, and much higher financial means. Entry barriers went up significantly. Who gained and who lost?

The obvious benefactors of these monopoly privileges are John and other “old” domestic producers. They can rest easy, that a new domestic or foreign competition is very unlikely to emerge. They will be able to achieve monopoly price, if their, as Rothbard writes, “demand curve is inelastic, or sufficiently less elastic, above the free-market price.” ¹ It is possible that Johns’ employees would also benefit, as they would keep their jobs, otherwise lost if John would have lost his market position.

Who loses? The foreign competition, who are blocked by the high tariff. Also, potential domestic competition, as the entry barrier is much, much higher, and the customers, who now have less choice and pay higher prices due to lower shoe supply and/or monopoly prices.