3. Competition and Monopoly: Theory and Evidence

Much of the support for antitrust policy depends upon the correctness of the standard theories of competition and monopoly. These can be briefly summarized as follows.

The Theories

Some economists define competition as a state of affairs in which rival sellers of some homogeneous product are so small—relative to the total market supply—that they individually have no control over the market price of the product.¹ These atomistic sellers take the market price as given and then attempt to generate an output that maximizes their own profit. The final outcome (equilibrium) of such a market organization of firms is that consumers obtain the product at the lowest possible cost and price. Such markets are said to be “purely” competitive (“perfectly” competitive if there is perfect information), and resources are said to be allocated efficiently.

Free-market monopoly involves some voluntary restriction of market output relative to the output forthcoming under competitive conditions. Economists usually assume that monopoly means that there is only one supplier of a product with no reasonable substitutes or that several major suppliers of a product collude to restrict production. The economic effect of such monopolization is that market outputs are restricted—the monopoly restrains trade—and prices are increased to consumers. Such restrictions of production are also said to misallocate resources and reduce social welfare.

The expression “misallocation of resources” is a powerful one in economics. It signifies that scarce economic resources are not being put to their greatest economic advantage. The implication is that some alternative allocation of these resources could improve overall economic performance.

Monopoly is said to misallocate resources in two fundamental ways. The first is termed “allocative inefficiency.” It implies that the price consumers pay for a product under monopoly—the monopoly price—exceeds the marginal cost of producing that product. Consumers indicate their willingness to have suppliers produce more of some product by paying a price that exceeds the marginal cost of producing it. Firms with monopoly power, however, can maximize their profits by restricting their production and keeping their prices up. Suppliers with monopoly power are said to have no incentive to expand production to the point where market price and marginal cost are equal. The consequence of such supply decisions is that resources are at least somewhat misallocated and social welfare is reduced.

Monopolists are also said to be likely to expend resources to obtain monopoly positions and then expend additional resources to retain them. Further, in the absence of direct seller rivalry, monopoly suppliers can afford to be less efficient than competitive firms with respect to their own use of resources. All of these extra expenses and inefficiencies can increase the cost function under monopoly relative to competition and contribute to what is termed “technical inefficiency.” In short, firms with monopoly power can produce less, charge more, and misallocate economic resources. Society would be clearly better off under conditions of competition, and the rationale for antitrust enforcement against monopoly is said to be obvious.

The Problem with Competition Theory

Although the standard theories of competition and monopoly seem reasonable and would appear to rationalize some antitrust enforcement, they pose some very serious difficulties. Resource allocation under atomistic competition might well be efficient if perfect information existed or if tastes and preferences never changed, but it is difficult to understand the relevance of such a theory in a real world of differentiated preferences, economic uncertainty, and dynamic change. The economic problem to be solved by competition is emphatically not one of how resources would be allocated if information were perfect and consumer tastes constant; with everything known and constant, the solution to a resource-allocation problem would be trivial. Rather, the economic problem lies in understanding how the competitive market process of discovery and adjustment works to coordinate anticipated demand with supply in a world of imperfect information. To assume away divergent expectations and change, therefore, is to assume away all the real problems associated with competition and the resource-allocation process. Thus, although the standard efficiency criteria may be technically correct for a static world, they are irrelevant to actual market situations.

Market uncertainty and change may require differentiated products. They may also require some interfirm coordination, instead of independent rivalry, and even some price cooperation. They may require some product and service advertising, although none is required in the atomistic equilibrium. These variables do not indicate that competition does not exist or that the competitive process is defective or inefficient. They mean, simply, that the competitive process is in a necessary state of disequilibrium. The market process may, in the abstract, tend toward some theoretical equilibrium, but it never reaches one.

Much of traditional antitrust enforcement has been based on erroneous notions of efficiency under static equilibrium conditions. Outputs falling short of the purely competitive—theoretical—output were said to have been “restricted.” Market advertising, product differentiation, and innovation were often said to be elements of monopoly power—not elements of a competitive process—that could misallocate resources and lower social efficiency. Any control over market price was termed “monopoly power,” and interfirm cooperative agreements were regarded by economists and the antitrust authorities with great suspicion. Yet, if the purely competitive equilibrium is not an appropriate welfare benchmark, none of these traditional conclusions makes any sense.

An alternative perspective on competition is to see it as an entrepreneurial process of discovery and adjustment under conditions of uncertainty.² A competitive process implies that business organizations of various sizes continually strive to discover which products and services consumers desire, and at what prices, and continually strive to supply those products and services at a profit to themselves and at the lowest cost.

This process of discovery and adjustment may encompass explicitly rivalrous behavior in the usual sense—direct price and nonprice competition—and it may also include various degrees of interfirm cooperation, such as joint ventures and mergers. Interfirm cooperation and rivalry are not opposing paradigms from a market-process perspective. There is no a priori way, for example, to define the optimal size of a cooperative business unit or, alternatively, the optimal number of rival firms for efficient market coordination. Even price agreements between firms may serve to reduce risk and uncertainty—during a recession, for example—and lead to an increase in market efficiency. (See chapter 6.) Cooperation and rivalry are voluntary alternative institutional arrangements by which entrepreneurs, under conditions of uncertainty, strive to discover opportunities and coordinate plans in a continuous search for profits. Public policy should not hinder the development, or collapse, of these arrangements.

In competition, profits and losses serve to provide the necessary information and incentive for continuous entrepreneurial alertness. Some business organizations may be more successful than others in this process and may earn significant market share; other organizations may do poorly, lose market share, and even fail. Both the growth and decline of companies is a necessary part of the discovery procedure. Finally, while individual markets may tend to clear during this process, error and changing information, among other things, must prevent the realization of any final equilibrium condition.

The Problem with Free-Market Monopoly Theory

Similar theoretical difficulties discredit free-market monopoly theory as well. The primary one concerns the actual ability of a monopoly firm, or a group of colluding firms, to restrict the market supply and realize monopoly prices and profits. Although a firm may intend to restrict market supply and garner monopoly profits, the ability of free-market monopoly to achieve that result is questionable.

The standard textbook treatment often assumes a monopoly output restriction and then proceeds to compare that restricted output, unfavorably, with an atomistic equilibrium output level.³ But both the assumption and the comparison are entirely misleading, for the atomistic equilibrium output level is neither possible nor relevant and cannot serve as the welfare benchmark for any comparison. Moreover, it is difficult to understand how any output level that is inefficient or generates substantial profits can be sustained in an open market in the face of strong incentives to expand production.

Free-market monopoly power created through merger or collusion is presumably the primary concern of the antitrust authorities. But if the economic effect of monopolization is to raise prices above costs—marginal and average—strong economic incentives then exist to expand current production and to encourage output by new firms. If production increases, prices will fall and the market will tend, other things being equal, toward a situation in which prices and costs are equal.

What happens if a free-market monopolist attempts to subvert this competitive process and discourage rivalrous entry by lowering prices? The reduced prices would induce additional sales, and the market situation would then tend toward the traditional competitive equilibrium. What happens if a monopolist discriminates in price? Indeed, there might be strong economic incentives to do so, but a monopolist that price discriminates will end up selling additional output at some lower price, and, again, the market will tend toward the traditional competitive output. Certainly a monopolist that is inefficient cannot deter market entry; inefficiency will act as an invitation to entry and additional output. On the other hand, a monopolist that is clearly more efficient than potential rivals can deter entry, but it would be the efficiency of the monopolist that would keep competitors out. Resources are not misallocated and the competitive process is not subverted when high-cost firms are restrained from entering markets by the superior product or efficiency of existing suppliers.

Firms may intend to restrict market output through collusion and cartel agreements, but the realization would be even more tenuous than that possible through a one-firm monopoly. Not only would a cartel of suppliers encounter the same incentives to expand production reviewed above, it would also face such difficulties as coordinating and policing its own supply-restriction schemes.⁴ Interfirm agreements to restrict rivalry could exist in a free market, as they did occasionally under common law prior to the Sherman Act, and they might even be able to stabilize temporarily some price fluctuations, but there is little reliable evidence that free-market collusion can allow conspiring firms to capture monopoly profits.⁵ Moreover, interfirm cooperation may well have significant benefits that could overwhelm any possible negative output restriction. (See discussion in chapter 6.)

Likewise, the usual textbook discussions of inefficiency under monopoly are unconvincing. The standard argument of allocative inefficiency is, in fact, contrived and misleading. With new entry and output blocked by definition, a monopolist is said to misallocate economic resources relative to their allocation under conditions of pure competition. But this “misallocation” occurs only because the competitive process is assumed to be ended in atomistic competition (price, marginal cost, and minimum average cost are all assumed to be equal) and because no competitive market process is allowed to begin under monopoly. If, on the other hand, a competitive process always operates under free-market monopoly, and if it is assumed that no final atomistic equilibrium condition can ever exist, then resource misallocation under free-market monopoly, as some unique social problem, simply disappears. Allocative inefficiency would tend to disappear from the free-market monopoly model, just as it would tend to disappear from the competitive disequilibrium model, and for exactly the same reasons.

Also debatable are the standard assumptions concerning technical inefficiency under monopoly. In any serious attempt to monopolize some free market, businesses are far more likely to lower costs than they are to raise them, and to expand rather than decrease production. The most effective way to gain and hold a free-market monopoly position is to be more efficient than rivals or potential rivals. In addition, larger firms may simply have lower costs than smaller firms, due to scale economies associated with manufacturing, financing, and marketing, or due to innovation. Thus, overall business costs are just as likely to be lower, not higher, as firms seek a monopoly position in a free market. (By contrast, the costs of obtaining and securing legal monopoly are socially wasteful; this matter is discussed later.)

Occasionally the issue of technical inefficiency is confused by allowing the costs of product differentiation to slip into an analysis of increased costs under monopoly. Firms producing differentiated products often incur extra costs, and these costs are sometimes compared unfavorably with the costs incurred by firms under conditions of atomistic competition. But this comparison is not valid, for once goods are differentiated, their costs cannot be compared directly with the costs of homogeneous goods. That consumers choose to pay higher prices to cover the higher costs of differentiated products proves nothing about inefficiency or waste, nor does it misallocate resources. (See chapter 4.)

In summary, the legitimacy of antitrust regulation in the public interest must depend upon a reasonably sound theory of how free-market monopoly can continue to restrict production and increase prices and how it can make the economy less efficient and misallocate resources. Yet, as has been argued here, the standard theoretical approach suffers from serious shortcomings. In the first place, monopoly output is often compared with an impossible atomistic output, hardly a meaningful comparison. In addition, it is difficult to understand how free-market monopoly power can continue to restrict production and sustain prices while allowing firms to earn monopoly profits. (Barriers to entry, including so-called predatory practices, will be discussed in chapter 4.) The inefficiencies alleged to exist under free-market monopoly are, similarly, either contrived or irrelevant. In short, all firms in free markets are engaged in a competitive market process. Standard free-market monopoly theory cannot support its own conclusions in any reasonable fashion, much less support government antitrust intervention into private markets in the “public interest.”

The Evidence

There are two fundamental kinds of evidence concerning monopoly. The first is case-study evidence, much of it taken from classic antitrust cases. The Standard Oil antitrust case of 1911⁶—perhaps the most famous and misunderstood anti-monopoly case in all of business history—illustrates the difficulties associated with free-market monopoly theory.

The Standard Oil Case

The conventional account of the Standard Oil case goes something like this. The Standard Oil Company employed ruthless business practices to monopolize the petroleum industry in the nineteenth century. After achieving its monopoly, Standard reduced market output and raised the market price of kerosene, the industry’s major product. The federal government indicted Standard under the Sherman Act at the very pinnacle of its monopolistic power, proved in court that it had acted unreasonably toward consumers and competitors, and obtained a divestiture of the company that helped to restore competition in the petroleum industry.

This account has almost nothing in common with the actual facts. It is not possible to review the entire history of the case here, but a summary of the government findings against and actual conduct of Standard Oil will serve to make the point.

The Standard Oil Company was a major force in the development of the petroleum industry in the nineteenth century. It grew from being a small Ohio corporation in 1870, with perhaps a 4-percent market share, to become a giant, multidivisional conglomerate company by 1890, when it enjoyed as much as 85 percent of the domestic petroleum refining market. This growth was the result of shrewd bargaining for crude oil, intelligent investments in research and development, rebates from railroads, strict financial accounting, vertical and horizontal integration to realize specific efficiencies, investments in tank cars and pipelines to more effectively control the transportation of crude oil and refined product, and a host of other managerial innovations. Internally-generated efficiency allowed the company to purchase other businesses and manage additional assets with the same commitment to efficiency and even to expand its corporate operations abroad.

Standard Oil’s efficiency made the company extremely successful: it kept its costs low and was able to sell more and more of its refined product, usually at a lower and lower price, in the open marketplace.⁷ Prices for kerosene fell from 30 cents a gallon in 1869 to 9 cents in 1880, 7.4 cents in 1890, and 5.9 cents in 1897. Most important, this feat was accomplished in a market open to competitors, the number and organizational size of which increased greatly after 1890. Indeed, competitors grew so quickly in the years preceding the federal antitrust case that Standard’s market share in petroleum refining declined from roughly 85 percent in 1890 to 64 percent in 1911. In 1911, at least 147 refining companies were competing with Standard, including such large firms as Gulf, Texaco, Union, Pure, Associated Oil and Gas, and Shell.

This rivalrous development is not surprising, given the enormous changes in the petroleum industry that took place after 1890. Standard Oil, which had dominated the Pennsylvania-crude oil markets and the national manufacture of kerosene, had its market position challenged by the development of crude oil production in the southwestern United States and by a product demand shift away from kerosene. The increasing popularity of fuel oil, and eventually gasoline, and Standard’s inability to control the market availability of crude (Standard Oil itself produced only 9 percent of the nation’s supply in 1907) practically guaranteed that the petroleum industry would not be monopolized by any one business organization.

Conventional wisdom holds that the government antitrust suit against Standard Oil proved that the firm had reduced outputs and increased prices and employed ruthless business practices toward its suppliers and competitors. But the facts are otherwise. The lower-court judges who convicted Standard Oil in 1909 found only that the formation of its holding company, Standard Oil of New Jersey in 1899, was a “contract or combination in restraint of traded,” forbidden explicitly by the Sherman Antitrust Act.⁸ Dissolution of that company was held to be the appropriate—and sufficient—judicial remedy to restore competition.

This fact is extremely important. The lower court did not find that prices for kerosene were higher because Standard Oil had reduced outputs or that the rebates it had secured from the railroads were unfair. The lower court did not rule on any of the substantive economic issues; although it had, of course, heard the government’s argument and Standard’s defense on various charges.

It is also generally assumed that, since the famous Standard Oil decision of 1911 established the “rule of reason” principle, the Supreme Court must have applied it to Standard’s business practices and determined that it had indeed restrained market output and raised market price. It is true that Justice White, writing for a unanimous court, argued that the rule of reason had existed under the common law and ought to be employed in antitrust cases. And it is true that White wrote that “no reasonable mind” could but conclude that Standard had, indeed, acted unreasonably under this legal principle.

But it is emphatically not true that the High Court presented any specific finding of guilt with respect to the charges of misconduct and monopolistic performance brought against them by the government. That sort of determination is the job of a lower or trial court anyway, and, as already noted, the trial court had found Standard Oil guilty of no specific illegality with respect to the important substantive issues. All that the Supreme Court did—contrary to overwhelming conventional wisdom—was conclude that some of Standard’s practices, such as merger, evidenced an unmistakable intent to monopolize and that these practices were unreasonable. Why were they unreasonable? Because the Court said that it was obvious that they were. Certainly no detailed analysis of Standard Oil’s market performance—as would be common practice in subsequent rule-of-reason monopoly cases—was ever conducted by either the trial court or the Supreme Court.

Since subsequent research has shown that petroleum outputs expanded and prices declined throughout the nineteenth century and that Standard had not engaged in ruthless business practices, like predatory price cutting, the Standard Oil case can hardly be cited by antitrust enthusiasts as evidence that monopoly is a free-market problem or that antitrust is necessary to protect the consuming public from private economic power.

Empirical Studies

The second kind of evidence concerning monopoly consists of empirical studies of market concentration, profitability, and the welfare losses associated with monopoly power. In these studies, profitability often serves as the measure of monopoly power and resource misallocation.

The thinking behind profitability as the measure of monopoly power is that economic profits would tend to be dispersed under competitive conditions; hence, the existence of economic profits in the long run could be an indication that the competitive process has been restricted. Some empirical studies argue that certain business expenses, such as advertising and even product differentiation, should be included with profits in any measurement of the overall social costs associated with monopoly power.⁹

There are, however, some very serious methodological difficulties associated with these studies, including the concentration-profit studies discussed earlier.¹⁰ In the first place, most empirical studies use accounting profit data to draw conclusions about economic profit, a debatable procedure at best. Second, legal monopoly and free-market monopoly might well be inexorably intertwined in the actual business world: tariffs, quotas, licensing, and other legal restrictions always tend to generate economic rents in markets that are otherwise openly competitive. Third, empirical studies almost always take the atomistically competitive equilibrium condition as a welfare benchmark. While economic profits might well be dispersed in some imaginary equilibrium world, that is irrelevant in any actual resource allocation problem. Profits (and losses) are always essential in providing the information and incentives required to ensure that resources are being allocated from less valuable uses to more valuable uses. Long-run profits may imply that some organizations are relatively more efficient than others over long periods of time and that the competitive process has not yet reached any final equilibrium.

Such economic factors as uncertainty, risk, price expectations, and innovation are not short-run market disturbances that disappear if only we wait long enough. They are a continuous part of the competitive market process. Moreover, advertising and product differentiation in a disequilibrium world cannot simply be treated as some unwelcome welfare burden or social cost. (See chapter 4.) In short, profits need not evidence any extraordinary social inefficiency or burden; nor can empirical regression studies of profit and concentration ever serve as a reliable guide for rational antitrust regulation.

Legal Monopoly and Consumer Welfare

While free-market monopoly theory is seriously flawed, it is true that legal barriers to competition can create resource-misallocating monopoly power. Government, usually at the behest of some business interest, may decide to legally restrict entry into certain markets. Government licensing, certificates of public convenience, legal franchise, and quotas both foreign and domestic—each can tend to restrict entry, reduce the supply of available output, or raise the market price of a product to consumers. Firms and suppliers that would have voluntarily entered into trade and exchange with willing consumer-buyers are legally prevented from doing so; consumers who would have willingly purchased additional output at lower prices cannot; and innovations that would have been introduced by new suppliers are delayed or lost altogether. The competitive market process has been undercut and artificially shortcircuited—by law.

The government power of monopoly—of legally restraining trade—can have the effect of reducing market supply and raising market price. This restriction of output is not voluntary; nor is it due to disequilibrium. There has been no voluntary refusal to deal or trade; prospective buyers and sellers are, presumably, anxious to trade and thereby to improve their relative welfare, but they are prevented from doing so by law. Potential suppliers are not excluded because they are less efficient users of capital or cannot realize economies of scale; they are excluded arbitrarily by government power. Indeed, a reasonable guess is that some of the potential entrants are more efficient than existing producers—else why the necessity of legal restrictions?

Moreover, there are no economic incentives that tend to offset legal output reductions. The economic incentives for protected business organizations are, as explained earlier, to maintain or expand existing monopoly restrictions that legally exclude potential competitors. Firms will waste additional resources to retain legal privileges and their monopoly rents. Indeed, all of the conventional criticisms of monopoly actually do apply to legal monopoly and rationalize the repeal of such restrictions.

Conclusions

This chapter has argued that the theory of free-market monopoly is flawed. Neither theory nor evidence can rationalize antitrust policy. But if legal barriers restrain trade, can antitrust regulation be justifiably used against them?

Employing antitrust against legal barriers to entry enacted by state and local governments may create incentives to dismantle those barriers. In fact, some antitrust critics are sympathetic to using antitrust in an already regulated society solely to remove legal restrictions on competition or cooperation.¹¹ Some important caveats are in order, however. First, employing antitrust against legal barriers to entry is the only application of antitrust that can be rationalized. Second, the possible dangers from antitrust misuse—prosecuting cooperative agreements between suppliers instead of strictly legal barriers to trade, for example, and the continuation of private antitrust—are likely to be so great as to overwhelm the marginal benefits that could arise from prosecuting legal monopoly. If the political choice were to retain antitrust regulation or abolish it completely, total abolition would still be the better course. Finally, should Congress or the courts move to block further the application of antitrust to legal monopolies, there would again be no rationalization for any antitrust policy.¹²

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¹The standard theoretical analysis of competition, monopoly, and resource misallocation can be found in any microeconomics text and in most texts on antitrust policy. See, for instance, William F. Shughart II, The Organization of Industry, 2nd ed. (Houston, Texas: Dame Publications, 1997).

¹F.A. Hayek, “The Meaning of Competition,” in Individualism and Economic Order (Chicago: Henry Regnery, 1972), pp. 92–106. On the historical development of the distinction between the competitive process and the competitive equilibrium, see Paul J. McNulty, “Economic Theory and the Meaning of Competition,” Quarterly Journal of Economics 82 (November 1968): 639–56. Ludwig von Mises termed the competitive process “catallactic competition.” Ludwig von Mises, Human Action: A Treatise on Economics (New Haven, Conn.: Yale University Press, 1963), pp. 274–94.

³See, for instance, Edwin Mansfield, Microeconomics: Theory and Applications, 5th ed. (New York: W.W. Norton, 1985), p. 294. The entire notion of a free-market monopoly price and output may be untenable. See Murray N. Rothbard, Man, Economy, and State (Princeton, N.J.: D. Van Nostrand, 1962), Vol. 2, pp. 586–615. Also see the Appendix in this chapter for an explanation of Rothbard’s monopoly theory.

⁴The difficulties of effective collusion are reviewed in Dominick T. Armentano. Antitrust and Monopoly: Anatomy of a Policy Failure, 2nd ed. (Oakland, Calif.: Independent Institute, 1990), pp. 133–37. See also George J. Stigler, “A Theory of Oligopoly,” Journal of Political Economy 72, no. 11 (February 1964): 44–61.

⁵A negative relationship between collusion and profitability is found by Peter Asch and Joseph J. Seneca in “Is Collusion Profitable?” Review of Economics and Statistics 58 (February 1976): 1–12. See also Howard Marvel, Jeffrey Netter, and Anthony Robinson, “Price Fixing and Civil Damages: An Economic Analysis,” Stanford Law Review 40 (1988): 561–78.

⁶Standard Oil Company of New Jersey v. United States, 221, US. 1 (1911).

⁷See Armentano, Antitrust and Monopoly, pp. 55–73. See also Ron Chernow, Titan: The Life of John D. Rockefeller, Sr. (New York: Random House, 1998).

⁸United States v. Standard Oil Company of New Jersey, 173, F. Rep. 179 (1909).

⁹There have been various attempts to measure the social cost of monopoly. See, for example, Keith Cowling and Dennis C Mueller, “The Social Cost of Monopoly Power,” Economic Journal 88 (December 1978): 727–48.

¹⁰For an excellent criticism of all such studies and measurements, see Stephen C. Littlechild, “Misleading Calculations of the Social Costs of Monopoly Power,” Economic Journal 91 (June 1983): 348–63. For a statistical criticism of concentration-profit studies see Eugene M. Singer, Antitrust Economics and Legal Analysis (Columbus, Ohio: Grid Publishing, 1981), pp. 31–33.

¹¹ See Dominick T. Armentano, “Towards a Rational Antitrust Policy,” hearings before the Joint Economic Committee, November 14, 1983, in Antitrust Policy and Competition (Washington, D.C.: U.S. Government Printing Office, 1984), pp. 23–33.

¹²The so-called Parker doctrine (Parker v. Brown, 317 U.S. 341 [1943]) already makes explicitly authorized state-government regulation exempt from antitrust law. The Local Government Antitrust Act of 1984 eliminates personal antitrust liability for municipal officials. See Antitrust and Trade Regulation Reporter 47, no. 1178 (August 16, 1984): 345–52.

Appendix

Rothbardian Monopoly Theory

Economist Murray N. Rothbard (1926–1995) made several important contributions to monopoly theory that have been ignored by mainstream industrial organization theorists. His views on monopoly and on the impossibility of “competitive prices” and “monopoly prices” (in a free market) challenge the mainstream neoclassical position and are at variance with those of his fellow Austrian economists as well.

Rothbard argues that it may be confusing (and even absurd) to define monopoly as “the control over the entire supply of some commodity or resource,” a common definitional approach in neoclassical and Austrian circles. This definition is inappropriate since the slightest consumer-perceived difference between different units of some commodity or resource (with respect to location for example), would then mean that each seller is a “monopolist.”¹ But even if this were an appropriate definitional approach, the entire notion of monopoly price in a free market is untenable according to Rothbard. He argues that any acceptable theory of monopoly price is itself conditional on an independent determination of a competitive price against which the monopoly price might be compared. For Rothbard, however, any independent determination of a competitive price in a free market is impossible. Free markets contain only free-market prices.²

Competitive prices in the orthodox literature have usually been associated with marginal cost pricing, particularly under conditions of long-run equilibrium. For Rothbard, however, such prices are meaningless and irrelevant since they are associated with a static equilibrium condition that could never actually exist, and would not necessarily be optimal even if it did exist. In any actual market situation, all sellers have some influence over price, and market information is never perfect. In all real markets, sellers face a sloped demand curve, not the perfectly elastic demand curve associated with atomistic competition. Thus, all market pricing is free-market pricing whether it is accomplished by many small sellers or by a few firms with significant market share. Competitive prices are as fictitious as the medieval notion of the “just” price.

It has been common to define a monopoly price as that price accomplished when output is restricted under conditions of inelastic demand, thus increasing the net income of the supplier. Rothbard argues, however, that there is no objective way to determine that such a price is a monopoly price or that such a restriction is antisocial. All we can know is that all firms attempt to produce a stock of goods that maximizes their net income given their estimation of demand. They attempt to set the price (other things being equal) such that the range of demand above their asking price is elastic. If they discover that they can increase their monetary income by producing less in the next selling period, then they do so.

Rothbard maintains that to speak of the initial price as the competitive price, and the second-period price as the monopoly price makes no objective sense. How, he asks, is it to be objectively determined that the first price is actually a competitive price? Could it, in fact, have been a “sub-competitive” price? Presumably even atomistic firms can make mistakes and produce too much.³ If they do they must restrict production in the next period and market price may increase; but this does not mean that the second price is a monopoly price. Indeed, the entire discussion makes no rational sense since there are no independent criteria that would allow such determinations. All that can be known for sure, Rothbard argues, is that the prices both before and after any supply change are free-market prices.

In addition, the negative welfare implications concerning alleged monopoly prices would not follow even if such prices could exist. Since the inelasticity of demand for Rothbard is “purely the result of the voluntary demands” of the consumers, and since the exchange (at the higher price) is completely voluntary anyway, there is no unambiguous way to conclude that any supply restriction reduced social welfare.

Rothbard has been severely critical of orthodox utility and welfare analysis.⁴ The conventional wisdom in antitrust, among both reformers and traditionalists, has been to assert that business agreements such as price-fixing ought to be prohibited since they tend to reduce consumer welfare and lower social efficiency. For Rothbard, however, the costs and benefits associated with exchange are personal and subjective, and do not lend themselves to any cardinal measurement or aggregation. He holds that there is no unambiguous manner by which the costs for consumers and the benefits for producers (or vice versa) might be totaled up across various markets, and then compared to make a determination as to whether a business agreement is socially efficient or not. Indeed, the entire notion of social efficiency is a myth for Rothbard.⁵ Individual consumer and producer utility and surplus may exist, but these notions cannot be mathematically manipulated to allow any regulatory rule-of-reason judgments.

Rothbard’s criticism of conventional and Austrian monopoly theory allows him to conclude that monopoly can be best defined as a grant of special privilege from government that legally reserves “a certain area of production to one particular individual or group.”⁶ This definition of monopoly is historically relevant and unambiguous in Rothbard’s judgment. It is historically relevant since it is the original meaning of the term in English common law, and much of this sort of monopoly still survives today. It is unambiguous since such an approach allows a clear distinction to be made between free-market prices and monopoly prices. Free markets—that are either rivalrous or cooperative in varying degrees—can only give rise to free-market prices. On the other hand, monopoly prices can arise whenever government legally restrains trade. Presumably an unambiguous antimonopoly policy would conclude that all such privileges, including orthodox antitrust policy itself which restrains free trade, be abolished.

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¹Rothbard, Man, Economy, and State, pp. 590–91.

²Ibid., pp. 604–05.

³Ibid., p. 607.

⁴Murray N. Rothbard, Toward a Reconstruction of Utility and Welfare Economics (New York: Center for Libertarian Studies, 1977).

⁵Murray N. Rothbard, “The Myth of Efficiency,” in Mario Rizzo, ed., Time, Uncertainty, and Disequilibrium (Boston: D.C. Heath, 1979), pp. 90–95.

⁶Rothbard, Man, Economy, and State, p. 591.