Do monopolies cause price inflation?

By Dr Frank Shostak

The jump in the yearly growth rate of the consumer price index the CPI from 5.4% in June 2021 to 9.1% by June 2022 prompted some economists to attribute this increase to monopolies. According to The News Observer from May 26, 2022 economists at the Federal Reserve Bank of Boston are of the view that monopolies are an important factor in keeping the prices of goods and services elevated.

By the popular way of thinking, monopolies undermine the efficient functioning of the market economy by being able to influence the prices and the quantity of products. Consequently, this undermines the wellbeing of individuals in the economy. On this way of thinking, the inefficiency emerges because of the deviation from the ideal state of the market as depicted by the “perfect competition” framework.

The “Perfect Competition” framework

In the world of perfect competition a market is characterized by the following features:

  • There are many buyers and sellers in the market
  • Homogeneous products are traded
  • Buyers and sellers are perfectly informed
  • No obstacles or barriers to enter the market

In the world of perfect competition, buyers and sellers have no control over the price of the product. They are price takers. 

The assumption of perfect information and thus absolute certainty implies that there is no room left for entrepreneurial activity. For in the world of certainty there are no risks and therefore no need for entrepreneurs. If this is so, who then introduces new products and how? According to the proponents of the perfect competition model, any real situation in a market that deviates from this model is regarded as sub-optimal to consumers’ wellbeing. 

For instance, if a particular firm is seen as dominating the market place it is regarded as bad news. It is then recommended that the government intervene whenever such deviation occurs. We hold that competition emerges not because of a large number of participants as such, but as a result of a large variety of products.

Competition in Products, Not Firms

The greater the variety is, the greater the competition will be and therefore more benefits for the consumer. Once an entrepreneur introduces a product — the outcome of his intellectual effort — he acquires 100 per cent of the newly-established market.

Following the logic of the popular way of thinking, however, this situation must not be allowed for it will undermine consumers’ wellbeing. If this way of thinking (i.e., the perfect competition model) were to be strictly adhered to, no new products would ever emerge. In such an environment, people would struggle to stay alive.

Once an entrepreneur successfully introduces a product and makes a profit, he attracts competition. Notice that what gives rise to competition is that consumers have endorsed the new product. The producers of older products must come with new ideas and new products to catch the attention of consumers.

The popular view that a producer that dominates a market could exploit his position by raising the price above the truly competitive level is erroneous. The goal of every business is to make profits. This, however, cannot be achieved without offering consumers a suitable price.

It is in the interest of every businessman to secure a price where the quantity that is produced can be sold at a profit. In setting this price, the producer-entrepreneur will have to consider how much money consumers are likely to spend on the product. He will have to consider the prices of various competitive products. He will also have to consider his production costs.

Any attempt on behalf of the alleged dominant producer to disregard these facts will cause him to suffer losses. Further to this, how can government officials establish whether the price of a product charged by a dominant producer is above the so-called competitive price level? How can they know what the competitive price is supposed to be? (see on this Murray Rothbard in Man, Economy and State p 661).

If government officials attempt to enforce a lower price this price could wipe out the incentive to produce the product. So rather than improving consumers’ well-being, government policies will only make things much worse. 

Again, contrary to the perfect competition model, what gives rise to a greater competitive environment is not a large number of participants in a particular market but rather a large variety of competitive products.  Government policies, in the spirit of the perfect competition model, however, are destroying product differentiation and therefore competition.

Products are Heterogeneous 

The whole idea that various suppliers can offer a homogeneous product is not tenable. For if this was the case why would a buyer prefer one seller to another. (The whole idea to enforce product homogeneity in order to emulate the perfect competition model will lead to no competition at all.)

Since product differentiation is what free market competition is all about, it means that every supplier of a product has 100 percent control as far as his product is concerned. In other words, he is a monopolist.

What gives rise to the product differentiation is that every entrepreneur has different ideas and talents. This is manifested in the way the product is made, the way it is packaged, the place in which it is sold, the way it is offered to the client, etc.

For instance, a hamburger that is sold in a beautiful restaurant is a different product from a hamburger sold in a takeaway shop. So, if the owner of a restaurant gains dominance in the sales of hamburgers should he then be restrained for this? Should he then alter his mode of operation and convert his restaurant into a takeaway shop in order to comply with the perfect competition model?

All that has happened here is that consumers have expressed a greater preference to dine in the restaurant rather than buying from the takeaway shop. So what is wrong with this?

Let us now assume that consumers have completely abandoned takeaway shops and buying hamburgers only from the restaurants, does this mean that the government must step in and intervene?

The whole issue of a harmful monopoly has no relevancy in the free-market environment. A harmful monopolist is likely to emerge when the government, by means of licenses, restricts the variety of products by limiting the number of firms in a particular market. By imposing restrictions on the number of firms and thus limiting the variety of goods and services offered to consumers, government curtails consumers’ choices thereby lowering their well-being.

Increases in money supply and price inflation 

Now, a price of a good is the amount of dollars paid per unit of a good. Hence, we suggest that for a given quantity of goods, if the stock of money remains unchanged the amount of dollars spent per unit of a good will also remain unchanged, all other things being equal.   

Let us say that an increase in the prices of goods allegedly raised by monopolists has taken place. If the money stock remains unchanged, then no general increase in the prices of goods and services is going to take place, all other things being equal.  

If more money is spent on products of monopolists, obviously then less money will be left for other goods, and services – note again a price is the amount of money per unit of a good. (All that we will have here is a situation where the prices of goods produced by monopolists will go up whilst the prices of other goods and services will go down – the average price will remain unchanged).  

Hence, increases in the money supply underpin the underlying rises in prices, and not monopolies. Without the support from money supply, all other things being equal, no general increase in prices can take place notwithstanding monopolies.    

Summary and conclusion 

We suggest that the whole idea of government regulating so-called monopolies in order to promote competition and prevent the acceleration in price inflation is a fallacy. What causes price inflation is monetary policy of the central bank. Furthermore, harmful monopolies without government issuing licenses cannot emerge as such. 

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