No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Thirteen: Market “Failure” and the Role of the Government 313 There is little doubt that the driving force of innovation in an economy is the pursuit of monopoly profits—however transitory they might be. Apple Computer receives monopoly profits from their latest product innovations, but regulation could kill the goose that keeps laying golden eggs. The pursuit of these monopoly profits is precisely what has made our economy grow and our standard of living increase tremendously over time. Apple can only maintain those profits over the long term by staying ahead of the competition—which requires them to relentlessly serve customers better. If they don’t serve consumers well, the consumer will quickly move to a better servant. Ask General Motors how loyal consumers are when GM does not serve customers as well as Toyota or Honda. Monopoly profits not only drive innovation, they provide an incentive for firms to experiment with multiple variations of a product. We gain tremendous product variety in the marketplace as price searchers compete by product differentiation. If we want status and environmental kudos, we might buy a Tesla; if we value reliability, we may purchase a Honda; if we want a supercar, we may purchase a Corvette; if we want to be boring, we’ll buy a Ford (sorry Ford and Ford fans—I couldn’t resist that one!). All joking aside, the market will provide tremendous product variety in pursuit of the monopoly profits. Once again, we must compare institutional arrangements when we consider how to address this “failure.” Would any alternative (such as markets with government as the price regulator) be able to produce not only the valued allocative efficiency, but also the innovation and product variety that markets are famous for? Even if so, would the benefits of the regulatatory approach exceed the costs? Nevertheless, however you judge the outcome of monopoly, lack of competition at least raises the possibility that markets could be improved by government action. REMEDIES FOR LACK OF COMPETITION Historically, monopolies were often created by a sovereign who would give a specific charter for exclusive commercial rights to one business venture (such as with the Dutch East India Company) . Without the exclusive government charter restricting competition, the lure of sharing in the higher-than-normal profits would always draw competitors. Nevertheless, when governments have tried to remedy lack of competition, they have offered two approaches to improve market outcomes. The first is through anti-trust legislation, which was in part a populist response to large business trusts that were thought to be anti-competitive. This type of legislation often restricts mergers of businesses to preserve competitive forces. For example, the companies providing Direct P ($) Q (#) Q * P * Q M P M Consumer Surplus Deadweight Loss Producer Surplus Profit D S=MC MR Monopolist Figure 13.8, Price Searcher (Monopoly) Equilibrium. As discussed in Chapter 8, a price searcher in pursuit of monopoly profits will produce an output of Q M and charge P M . The additional quantities above Q M but less than Q* are valued by consumers greater than the opportunity cost of the resources used to produce them, so the price searcher output is not allocatively efficient.