Thursday, October 6, 2011

Austrian Economics Forum Fall '11 #3--Competition and Monopoly

This week’s forum focused on the third chapter “Competition and Monopoly” in Kirzner’s book.  Much of the chapter was not controversial to an Austrian audience and so there wasn’t the sort of discussion surrounding it as one might expect with a larger mix of mainstream economists.

In traditional theory, economists envision a continuum in which we place “perfect competition” on one end and “monopoly” on the other.  This method of organizing our thoughts says that the most important aspect of markets is the number of firms.  On the monopoly end, there is one firm, while on the other end there are so many firms that they all face horizontal demand curves.  (As an aside, we really need to get rid of the term “perfect competition” and replace it with “perfect equilibrium,” because there is no competition in that model. It’s an equilibrium-only model.)

Kirzner completely rejects this approach to defining competitive markets.  He wants to use “competition” in the same manner that the average person uses it: as a rivalrous process.  Competition describes actions.  It is a verb.  The mainstream uses competition to describe states of markets.  It is a noun.  The result is that the mainstream cannot communicate to laymen, which Kirzner says has been a “disservice.”

With competition defined as a process, we can then apply it to the entrepreneur.  When the entrepreneur recognizes a market opportunity, he is able to act.  He applies means to achieve ends.  If others wish to use those same means, a rivalry emerges.  In a market, a bidding process arises and the one who outbids the marginal rival is able to employ those means.  It is this process that coordinates the economy.  The move toward equilibrium is an unintended consequence.  The mainstream lacks this function in that the Robbinsian maximizer does not compete.  Kirzner states

Purely Robbinsian economizing activity is never competitive; purely entrepreneurial activity always is.  In other words, I am asserting, that entrepreneurship and competitiveness are two sides of the same coin: that entrepreneurial activity is always competitive and that competitive activity is always entrepreneurial (rather than Robbinsian). (p 94)

The Robbinsian maximizer merely chooses the course according to a given framework and a given set of economic relationships.  In contrast the Kirznerian entrepreneur looks at the unseen and chooses based upon some factors that may be hidden or absent.  The entrepreneur strives for profits and does so by out-competing his rivals.  The “pure Robbinsian decision-maker is not seeking to outdistance his rivals—he is not intent on learning what opportunities they are about to available to the market in order to attempt to make available still more attractive opportunities.” (p 95)

Later (p 108) Kirzner states, “As soon as we draw the cost and revenue curves facing the firm, no matter what their shape, we have created a theoretical case in which all competitive behavior has by definition been ruled out.  What is left is neither competitive nor monopolistic (in the process sense), but a problem in allocation.”  This means that as soon as we assume the structure of the cost curves or the type of demand curves, we have transitioned away from anything competitive and entered into the world of the Robbinsian maximizer.  I think that this analysis goes too far.  In one sense I see exactly what Kirzner is attempting to draw attention to, however I do not see why a sufficiently generic supply and demand graph has to be that way.  If we follow Kirzner, then even imagining curves sends us into the maximizing world.  I think that an economist can look at a static graph and recognize that it is an imperfect representation of a dynamic process.

Kirzner then examines how competition can be limited.  “[F]or us to speak freely of a lack of competitiveness in a market process, we must be able to point to something which prevents market participants from competing. … What is it, …, which might halt the competitive process? … Competition, …, is at least potentially present so long as there exist no arbitrary impediments to entry.” (p 97)  As we can tell, there are several reservations and qualifications in his definition.  Furthermore, we doesn’t define the areas of monopoly in a positive sense, e.g., “you’ll know monopoly when….”  Instead, he defines a potential absence of competition in a negative sense and assumes that the result is monopoly.  Personally, I do not like this approach.  It seems that there is too much hedging.  Is there a reason to be overly cautious?  I do not know.

Later on (p 99), Kirzner gives us a better definition: “When we assert that purely entrepreneurial activity is always competitive, we are then asserting that with respect to purely entrepreneurial activity no possible obstacles to freedom of entry can exist.  We can see this by recalling that purely entrepreneurial activity involves no element of resource ownership. … [B]lockage of entry into a particular activity must arise from restricted access to the resources needed for that activity. … All imaginable obstacles to entry can be reduced, in basic terms, to restricted access to resources.”

To summarize Kirzner’s position, the pure entrepreneur is a metaphysical concept.  It is simply the recognition of a profit opportunity.  There is no way that we can stop a person from recognizing an opportunity.  As a result, all entrepreneurship is competitive and short of direct brain control, it is impossible to curtail this recognition.  Thus, all anti-competitive restrictions have to occur on the level of access to resources.  The restriction of access to resources is a decrease in competition.  A complete restriction is a monopoly.

We talked about the implications of these concepts.  There arise two types of monopolies: one created by a government action and one created through the sole ownership of a resource. While we agreed with the first, the group debated the second concept.

As an aside, it arose that private property is a legal restriction to the access of resources.  I therefore have a monopoly over my car.  While Kirzner does argue that monopoly “diverts the entrepreneurial-competitive process into” other markets, I know that he would not argue that we should abolish private property. (p 107)  Kirzner states, “For us monopoly means the position of a producer who is immune from the threat of other entrepreneurs’ doing what he does.” (p 106)  However, it seems that for Kirzner, monopoly is not necessarily a bad thing.  I suspect that he will cover this in more detail later in the book.

Mises argues that intervention in the market distorts the market.  When the government buys pencils, it is not disrupting the normal market process and thus this is merely a shifting in supply and demand curves.  When the government imposes rules that prevent the market from doing its job, we have permanent discoordination.  For example, a maximum price set below the market price will create a permanent shortage.  I see Kirzner using the same logic in the background of his analysis.  When a monopoly exists due to legal barriers, we see the market unable to perform its job and this is bad.  If there is a monopoly that arises from ownership, then the market curves shift and the market adjusts.

The next item that we discussed was the idea of monopoly rent.  This is the return that a monopolist gains because he is a monopolist.  It is an addition to the return on the other factors of production, in which we are including entrepreneurial profit.  We found it difficult to separate these rents from the concept of entrepreneurial profit.  Luckily, Kirzner does not use it in his welfare appraisal of the monopoly.  Instead, he uses “the speed and smoothness with which misallocations can be discovered and corrected” (p 112) as his basis of comparison.  This definition directly parallels Mises’ definition on interventionism, where the focus (for monopoly) is directed to the obstacle to entry.

We then touched on some relatively random points.  We found them thought provoking and interesting enough to comment on.

Kirzner states, “for our notion of monopoly the shape of the demand curve facing the firm is of little significance. … [T]he significance of monopoly does not relate to the theory of the firm at all. (It is because of this that the shape of the demand curve is irrelevant.)” (p 108)  The importance of this comment is that the mainstream focuses on the firm (and the industry) and the consequent shape of the curves that the firms face.  Austrians have long rejected this static view of Industrial Organization.  Instead, we focus on the competitive process, on the action, on the verb.

Kirzner has a discussion on Monopolistic Competition, in which we basically throw the concept out.  In characteristic Kirzner fashion he cannot make a strong, direct statement and instead says, “The position developed thus far in this book makes it impossible for me to accept this approving judgment on the theory of monopolistic competition.” (p 113)  More directly he states, “the theory of monopolistic competition was on balance a decidedly unfortunate episode in the history of modern economic thought.” (p 114)  The problem was, of course, the fact that when it threw out the old perfect competition model, it left out the competition (in the Austrian sense).

Kirzner then has a nice discussion (pp 115-117) on how only in disequilibrium does product differentiation exists.  There is no reason to change product quality in a world of equilibrium.

Kirzner then delivers the one-two punch to monopolistic competition:

Thus far my criticism of the monopolistic competition view of the market has charged it (a) with overlooking the simplest available explanation of such phenomena as product differentiation …, and (b) with gratuitously advancing an alternative explanation ascribing these phenomena to the presence of monopolistic elements. … The explanation provided by the theory of monopolistic competition not only fails to recognize the disequilibrium character of the phenomena it seeks to explain, it fails even as an equilibrium theory. (p 117)


Finally Kirzner compares his concept of the entrepreneur with that of Schumpeter’s concept. They both reject the model of perfect competition.  Schumpeter does so on the grounds that entrepreneurs are disruptive to all equilibria.  They create something new which then explodes all the old economic relationships.  Kirzner does not deny that this occurs, but is merely a subset of his “alertness to hitherto unnoticed opportunities.”  The difference then rests on Kirzner’s emphasis.  He says that the primary function of the entrepreneur is to coordinate resources, the result of which is the movement towards equilibrium.  For Schumpeter, the coordination process is secondary and mundane.

The next meeting has been changed. Instead of meeting in 2 weeks (October 14th), it will convene in 3 (October 21st).  This development is unfortunate for me since that is the day that we have scheduled the trip to the hospital for the new (girl) baby’s arrival.  Since the surgery is scheduled for the morning, in theory I could make it to the afternoon meeting. (Yeah, right!)  So I will try to recruit someone to write up a summary for that session.  We’ll see.


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