One of the main criticisms of capitalism is that it leads to the formation of monopolies. Besides the fact that socialism is far worse because it consists of a single monopoly – the government – are monopolies really that common in a free market?
Are monopolies bad?
A monopoly is when a company has full control over the production and distribution of a particular good or service. The reason monopolies can be harmful to the economy is that they can prevent innovation and drive up prices for consumers. But this only occurs if a monopoly prevents the entry of competitors into the given field. In the history of capitalism, this has never happened under a free market. The only instances where this can ever occur is when there is government intervention.
If I own a company that has a monopoly in the oranges market, I will have to keep innovating and provide the lowest prices for consumers. If I start charging prices much higher than the cost of production, a competitor will just come in and sell oranges cheaper. Socialists will state that my monopoly can just buy out the competitor and go back to charging exorbitant prices. However, if I do that, another company will just come in and sell oranges cheaper again. Due to this, a monopoly will always have to charge the cheapest possible price for their product.
An example of a monopoly is John D. Rockefeller’s Standard Oil Company, which was founded in 1870, and had a monopoly on the oil industry for about 20 years. Standard Oil was able to massively reduce the cost of producing oil, allowing customers to buy at the lowest possible price. While Standard Oil had a monopoly on the oil industry, if it raised the price of oil much higher than the cost of production, a competitor would come onto the playing field and sell it cheaper. Due to this, Standard Oil had to keep innovating and trying to push down oil prices to maintain its monopoly. However, this didn’t stop the U.S. government from unjustly breaking up Standard Oil in 1911.
People also underestimate the number of competitors a company really has. If my orange company controlled 100% of the orange market, this doesn’t mean I have no competitors. I will be competing with potential alternatives to the product, such as companies selling apples or companies selling pears. Even if I was able to bar the competition from selling oranges, which I cannot do in a free market, I would not be able to raise prices that high because customers would just start buying alternatives instead, such as apples and pears.
Economies of scale
Economies of scale allow a monopoly to spread costs over a large volume of production, reducing the average cost per unit. This will then allow the monopoly to sell the product cheaper. As newer companies will be unable to spread costs over a large volume of production, economies of scale will bar entry of competitors into the field unless the competitor can decrease costs enough to sell the product even cheaper than the monopoly’s or innovate to make their product better than the monopoly’s.
Let’s say my orange monopoly business sells oranges for 25p each and due to economies of scale, it costs me 20p per orange. Let’s also say it costs 25p per orange for a company without economies of scale. If a new company is started and is able to produce oranges 2p cheaper (for 23p each), the company will now be able to sell oranges for 24p each, which is cheaper than I’m selling them for. As it costs me 20p per orange (if I adopt the new company’s practice, it will now be 18p), I can just lower the price I sell oranges for to 23p and the new company will be out of business. The entrepreneur’s idea that reduces orange production by 2p per would’ve increased the overall efficiency of the economy. However, the entrepreneur will be deterred from starting the business as he knows that, due to economies of scale, I can reduce costs further.
While economies of scale will deter some competition, it is unlikely to decrease overall innovation. This is because the monopolistic company will most likely reinvest the extra profits into research and development to further improve their product. The monopoly is also unable to raise the prices of their products to be much higher than their cost of production without economies of scale. Having monopolies reduce the costs of production of their products due to economies of scale is better for the economy as a whole. The alternative, where companies are not allowed to be big enough to have cost reductions due to economies of scale, would be economically inefficient.
Predatory Pricing
Predatory pricing is a very simple theory. A predatory business lowers its price until it is below the cost of production to drive its competitors out of business. During this period of time, the predatory business makes a loss. However, once all the competitors have been driven out of business, the predatory business can now raise its price far above the cost of production. Predatory pricing is one of the main fears against monopolies. However, this fear is slightly irrational. Once bankrupting the competition, the predatory business would not be able to raise its price far above the cost of production because another competitor would likely just enter the market and sell the product for a lower price. Engaging in predatory pricing is extremely risky for a business as the business would be taking on a massive loss to bankrupt another business and will be unlikely to recoup this loss.
While predatory pricing is unlikely, it has occurred. An example would be the tragic downfall of diapers.com at the hands of Jeff Bezos. Amazon tried to purchase diapers.com but failed. In response, Amazon decided to sell diapers cheaper than diapers.com, operating at a loss. When diapers.com eventually ran out of money, they eventually had to sell to Amazon.
The case above rarely occurs, but it should certainly be illegal. If a company bankrupts another company by predatory pricing, it will most likely deter any potential competitors from entering the industry, having a negative impact on economic growth. It should also be discouraged as it would severely harm the livelihood of the business owner whose company has gone bankrupt. However, just because a monopoly can carry out predatory pricing doesn’t mean that monopolies are intrinsically bad and the power that monopolies have should be limited.
Mergers and Acquisitions
In 2019, the UK’s Competition and Markets Authority (CMA) blocked the merger between Sainsbury’s and Asda on the grounds that it would ‘reduce competition’. Apparently, this would lead to increased prices for consumers. I do not see how this would be the case. If the merged Sainsbury’s/Asda company decided to sell any product far above the cost of production, a competitor would just be able to sell it cheaper.
Monopolies themselves do not harm competition within a free market. A monopoly is unable to increase the price of its products far above the cost of production because if they do, a competitor will just sell it cheaper. For this reason, there is no reason why a merger or an acquisition should ever be blocked to prevent ‘reduced competition’.
Patents
90% of the EpiPen market is controlled by Mylan. This has allowed them to increase the price of EpiPens dramatically. The EpiPens are also not as good quality as they could be. While most label Mylan’s coercive monopoly as a symptom of capitalism, their government-granted monopoly is actually due to their patent on EpiPens, which is due to expire in 2025.
While the above example is from the US, both the UK and the US patent systems cause massive issues to the economy. Patents in these countries last 20 years. That prevents any competitors from entering the marketplace, allowing the company with the patent to raise prices drastically. For 20 whole years.
There definitely needs to be some patent system to incentivize innovation. Without any sort of patent system, individuals will not be motivated to create new products as an existing large company will just come in, take the idea, and sell the product. That said, 20 years is far too long. A better system would be a patent that runs out when one of the following two conditions are met: the first sale is made or it has been a certain amount of time. The time for the second condition can depend on how complex the product is. This would allow the individuals with the patent to get a head start but they will not be able to increase the price of the product dramatically as there will be competitors just around the corner.
Conclusion
One of the biggest lies that socialists tell you is that monopolies are inherent to free market capitalism. In a free market, there cannot be a coercive monopoly. Monopolies can exist in a free market, but they cannot be coercive. They cannot raise prices far above the cost of production because there will always be potential competitors that could sell it cheaper. To retain their monopoly, they would have to constantly be innovating and sell the product at the cheapest possible price. The only reason coercive monopolies can ever arise is because they are a government-granted monopoly. Do you know what economic system is full of government-granted monopolies? Socialism.