A great number of people think that free market is just a way for monopolies to prey on poor customers. The same people think that only government is able to protect us against that monopoly. Is that true? Let’s find out!
Firstly, we need to stress out that not every monopoly is harmful for customers. Let’s start with the harmful one, though.
Imagine that there are 4 companies in Poland prospering on the free market basis. Their names are A, B, C and D. Each of them is producing rectified spirit which contains 95% of alcohol. They all got the same production costs – 90 zł per litre and they sell their product for 100 zł per litre. Company “A” decided to monopolize the market. They lower their price to 80 zł,. 10 zł below the production cost. They want to eliminate their competitors. That practice is called Dumping, or predatory pricing. Companies “B”, “C” and “D” are declaring bankruptcy. There is only company “A” remaining on the market, which is monopoly now and they can do whatever they want. They are increasing prices to 200 zł per litre, decreasing quality, and poor customers have no other way than being overcharged for the product which has lower quality now.
Is that sort of policy can be profitable on the free market?
Firstly, Companies „B, C and D” are able to buy all company’s „A” stock and sell it with higher profit, while the „A” will trade loss. In that case, “A” wouldn’t be able to monopolize the market and moreover it will lose its market share. If you are interested in implementation of that tactics in real life read the story about bromine producer – Herbert Henry Dow and his quarrel with German chemical cartel.
Secondly, company „A” while selling its product below the production cost, will have to take on debt. To pay the debt later on, they would need to increase prices above 100zł per litre. The moment they increase price, three new companies are going to set up, let’s name them “X”, “Y”, “Z” and they are going to sell their product for 100 zł. That way the monopoly will disappear. Perhaps even companies X, Y and Z might buy assets from failing „B”, „C” and „D” and sell their products even cheaper.
Another reason is that the spirit is just one of the alcohols on the market among beer, vine, whiskey or rum. If the prices grows, and quality decreases, customers will just choose another product.
Finally – after the company A eliminates domestic competition, there is also foreign competition ready to step in.
For that reasons, those prices strategies are considered suicidal and unethical.
What the company that wants to monopolize the market needs to do then in a free market capitalism?
It needs to convince all customers to buy only its product. To claim that, it need to have the cheapest and the best product, comparing to the competitors. Next thing to do is to inform all customers that the company is selling that. Moreover the company need to supply entire demand on the market. Then yes, monopoly on the free market is theoretically possible, however it is really unlikely. In addition that kind of monopoly is not harmful for customers. Just the opposite, they can buy the cheapest and the best product. If it wasn’t like that the possibility of eliminating the competitors would be impossible.
But, the company, after eliminating the competitors can increase the prices and lower the quality!
Yes it can, but then it opens doors for competitors who can take its market shares and that way the company wouldn’t be a monopoly anymore. In the free market each company needs to watch out not only for current competitors, but for potential ones as well. Moreover each monopoly is limited by law of supply and demand. There is a risk that with higher price, sales will significantly fall or people will choose substitutes.
Other way to create a monopoly is the situation when one company is owner of all sources of specific good like for instance oil. We need to bear in mind that it would need to control of every single source in the entire World, otherwise the company would need to compete with foreign investments. Is that any possible for one company to take control over all resources of oil or grains without government intervention? You need to answer this question by yourself.
Other possible situation when monopoly may occur is when the company will launch new product that did not exist on the market before. This kind of monopoly, however is really short term one, because all competitors want to catch up with the market leader. The best example is iPhone, which dominated market of smartphones for a while, but shortly other companies started to produce those devices too.
Water supplies and roads, motorways etc. are examples of so called „natural monopoly”. It doesn’t make any sense to lay water pipes from several suppliers to one house, or to build few parallel roads from one city to another. However, free market is still able to keep in line companies that want to abuse their infrastructural advantages. It is because instead of using roads we can choose either trains or planes. We can buy bottled water or simply dig the well instead of using provided water. What’s more, when the prices are high enough it is profitable to build double infrastructure. It is the owner who decides if it worth to install another water or gas pipes. There is no evidence of existence of permanent natural monopoly on the free market economy.
The very last one type of monopoly is cartelization. It is the situation when group of firms of the same business are making an agreement, to decrease production and increase prices to earn more. As we can find out from brilliant economist Murrey Rothbard, there were thousands of attempts of creating cartels at the turn of XIX and XX century in USA and all of them collapsed for two reasons. One reason was free competition. All it took, was that one company saw an opportunity and started selling product in regular price and took the cartel’s market share. Another reason was the fact that after some time one of the sides of agreement just broke the rules and introduced the product in regular price to sell more, taking market shares from the rest of the cartel. The situation then was revealed and cartel collapsed in the atmosphere of scandal and mutual accusations. You can find Murray Rothbard’s speech about the topic below the video on our site.
How is that possible that there are cases of permanent, and harmful for customers monopoly then?
In the late XIX century, during second industrial revolution, there was a general opinion that government’s intervention and not a free market economy leeds to monopoly. It was very true statement because permanent and harmful monopoly is caused by prices control, regulations, exclusive contracts, tender rigging, tariffs, government guarantees, tax reliefs for chosen people, grants, guaranteed loans, certificates, permissions, licences, or resources’ nationalization. All of those above are examples of interference into free market economy, by which governments can give a favour to one organisation at the expense of the other one. In Poland good example of monopoly is social security. Everyone is obliged to pay contributions. Theoretically we can choose other way of saving for our retirement but it is just additional way and we still have to pay to social security. Let’s imagine that we had free market economy in Poland. Would we choose government social security as a guarantee of our wealth during retirement? Probably some people would, but definitely the organisation wouldn’t be a monopolist.
In the free market economy there is no way that permanent and harmful for customers monopoly can exist. I invite you to take part in our survey at our website econclips.com. If you don’t want to miss our next videos, subscribe to our channel on YouTube and like us on Facebook.
You can listen to Murray Rothbard’s speech about cartels on free market.