Mises Daily Articles
A Critique of Neoclassical and Austrian Monopoly Theory
One of the most controversial areas in Austrian economics, and one where even long-established Austrian theorists differ sharply, is monopoly theory. Indeed, as we shall see below, the differences are not merely semantic, nor are they confined to detail or some minor theoretical implication. Rather, there are major and fundamental disagreements between some of the leading Austrians, and these disagreements are created by wholly different theories concerning the definition of monopoly, the origins of monopoly, and the supposed effects of monopoly on consumer sovereignty and efficient resource allocation.
NEOCLASSICAL MONOPOLY THEORY
By way of contrast, and in order to place the Austrian theories of monopoly in perspective, it is perhaps necessary to review and criticize the traditional (neoclassical) theory of monopoly. 1
A monopolist in neoclassical analysis is a firm that faces the entire demand for the product under consideration. In order to maximize its profits, it produces an output where the marginal revenue associated with the last unit sold is just equal to the marginal costs associated with producing and selling that final unit. But since the demand function facing the monopolist is necessarily sloped downward (perhaps even steeply downward), the price charged for the output is greater than both marginal revenue and marginal cost.
This situation, it is argued, compares "unfavorably" with price and output (and cost) under competitive conditions. Under competitive conditions, since price and marginal revenue are equal, price is always identical with marginal cost when profits are maximized. Further, under competitive equilibrium conditions, price is always driven down to the minimum point of the average cost function, so that production tends to take place at its most "efficient" point. Therefore, monopoly prices are higher than competitive prices, outputs are less, and average costs greater than under comparable competitive (cost) conditions.
But, importantly, how is a firm able to obtain a monopoly position in the market and, thus, "misallocate" economic resources? In the first place the monopoly could simply be due to governmental prohibition of competitive entry, and there is certainly a recognition of this source of monopoly in the neoclassical literature. However, more recently it has been popular to stress certain non-legal "barriers to entry" that, allegedly, preserve monopoly and resource misallocation.2 These barriers would include any difficulty or impediment that a new firm might have to overcome in order to compete successfully with an existing firm (monopolist). Thus, scale economies enjoyed by an existing firm, or commercially successful product differentiation employed by such a firm, becomes, in the new jargon, a barrier to entry that limits competition and reduces society's "welfare."
CONTEMPORARY MONOPOLY THEORY: A CRITIQUE
There are two avenues of criticism that one might take with respect to neoclassical monopoly theory. In the first place, one might criticize the purely competitive model which is employed as a benchmark and as a basis of comparison with monopolistic situations. And secondly, one might criticize the whole concept of non-legal barriers to entry, arguing, instead, that it is simply consumer preference that "limits competition" and that, consequently no misallocation of resources occurs.
Most economists would agree that pure competition is not actually possible. Some would agree, perhaps reluctantly, that it might not even be desirable or optimal if it could exist. (If they agree to this, of course, then they must also agree that moving toward pure competition is not necessarily desirable, either.) But few economists have noticed or emphasized the fundamental flaw of the purely competitive model, namely, that it is not a description of competition at all.3 Pure competition is a static, equilibrium condition whose very assumptions are such that competitive process is ruled out by definition. Or to put the