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February 19, 2006

Monopolies, Markets and Microsoft

by Eric

Okay, we’ve had an ongoing discussion here at the Liberty Papers about monopolies, markets and Microsoft. The position presented on one side, a position taken by many libertarians and libertarian-conservatives, is that monopolies that are not directly created by government fiat are okay and we shouldn’t see them as bad. They are, in this line of thinking, natural and arise out of very good business practices and market forces. I’m going to argue that this is not the case and that all monopolies, of whatever origin, should be viewed with suspicion and distrust by those who describe themselves as libertarians, classic liberals, anarcho-capitalists, etc. There are, essentially, five types of monopolies.

  1. The government created, or legal monopoly. AT&T was a legal monopoly, as are the police and fire departments in most cities. When the government directly intervenes and legally creates a market where only one competitor is allowed, that is a legal monopoly.
  2. Natural monopolies are ones that arise because economies of scale, economic efficiencies and capital costs for competitors are such that one one competitor is able to satisfy the demands of the market. In a perfect free market this is impossible.
  3. Monopolistic competition occurs when a single competitor in the market is powerful enough to act as a de facto monopoly. For example, at its height, Standard Oil controlled 64% of the oil market although there were more than 100 competitors in the market. Microsoft, today, is a monopolistic competition with control of 90% of the PC operating system market and more than 90% of the desktop office suite market. Companies in this position are able to take actions to maintain their position that a non-monopolistic competitor could not.
  4. Coercive monopolies occur when competitors use activities that violate the principles of free market. Coercion is aimed at hiding information from the market or influencing consumers and competitors in order to maintain a dominant position in the market. It is often difficult to distinguish between good business practices and coercive practices.
  5. Local monopolies exist when only one resource for a specific product exists in a given area, but not within the market as a whole. For example (and I’ll discuss it further down), Starbucks is a local monopoly at the Sacramento International Airport.


One of the questions that is important to answer, before we go further, is why monopolies are bad. Let’s start with this idea: free markets are about efficient allocation of scarce resources. The price you pay for a given product, let’s say a cup of coffee, in a free market reflects the value of that product to you, not the cost to produce the cup of coffee. If you had perfect information about the market for a cup of coffee, you would be able to purchase the coffee for its marginal cost. Marginal cost is the cost to produce one more unit of a given product. Since you don’t have perfect information, you will, instead, pay the lowest price that reflects the value of the coffee for you. Someone else may disagree with you about the value of the coffee and be unwilling to pay the price that you were willing to pay, feeling that they have a better use for the money than to buy a cup of coffee at the price you paid for it. This enables efficient allocation of resources, ensuring that you get your cup of coffee and I get my hamburger. Since there are, generally, never as many units of a given resource as there are people who want the resource, it is necessary to find a means to efficiently allocate resources. This is the goal of all economic systems. The great virtue of free markets is not that they are the best theoretical system, they aren’t. Their virtue is that, in practice, they work better to efficiently allocate resources than anything else we have tried.

The next idea we need to include, to understand monopolies, is something I talked about briefly already. Scarcity is the factor that drives markets. In any given market one of two things is true. There are more resources than consumers, or there are more consumers than resources. If there are more resources than consumers, then the resource cannot cost more than the marginal cost. Going back to our cup of coffee example, clearly there isn’t a scarcity of coffee shops (it seems like there’s one on every corner) so why can Starbucks charge more than $3.00 for a cup of specialty coffee that probably cost them no more $1.00 to produce? Because there is local scarcity, combined with your value for the product, to create a situation where Starbucks can sell the large iced mocha to you for more than its marginal cost. At Sacramento International Airport there is only one coffee shop in the concourse after the security checkpoints, a Starbucks. If you don’t like their prices, you either don’t buy their product or exit the concourse, go somewhere else, purchase your coffee and come back through security. This creates resource scarcity. Travellers typically place a higher value on coffee and Starbucks can charge $3.00 for that cup of coffee. If they didn’t have enough demand, they would lower the price until enough people valued the coffee at that price to sell enough units to produce a profit. It’s important to note that Starbucks had to compete with other coffee companies to acquire that location in the airport concourse. The company that owns the space found out, through the price that Starbucks was willing to pay, what the value of the location was to a coffee company.

I apologize for the couple of paragraphs on economics, but I think they were necessary to introduce the next idea. A monopoly is the ability to artificially manipulate scarcity and create inefficiency. In an inefficient market, fewer people are able to acquire a resource than would be able to without the monopoly existing. In a perfectly inefficient market, one person gains and everyone else loses. Bear in mind that a market only exists if the resources are needed and the resource consumer cannot acquire the resource for no cost. So, for example, there is no market for air. While air is certainly a resource that is needed, there is no cost to me to acquire air. If we lived on the moon, where oxygen would be difficult to produce, there would be a cost to me to acquire air. My option would be to produce it myself or purchase it from someone else. It is likely, with massive amounts of energy freely available on the moon, that the economy of the moon would be based on oxygen production rather than fossil fuels or other energy sources. But, that’s just speculation. The fact is, there is no market on earth for air because there is no cost to me to acquire more of the resource. In other words, the marginal cost is zero. If a market exists, the marginal cost is higher than zero. And this means that one, or more, consumers need the product and must pay for it. Otherwise a market cannot exist. This need (as opposed to want) may be the result of a localized situation, or a temporary issue, leading to the need. After all, when we look at coffee cup purchasers, we can say, in the long term, that they do not need that coffee. But in a localized, short term situation there is at least one consumer who needs it, whether that is due to being tired or having an addiction to caffeine, or because my boss told me to go buy coffee, or some other reason. I am now in a position where I must acquire the product, it is not a choice.

Let’s quickly distinguish between what a group of people, whether company or labor union or other organization, does and what a monopoly does. For ease, let’s call this a company, knowing the other groupings apply as well. In a free market you can increase the number of widgets you sell by increasing demand or decreasing price (see the value discussion to understand why). A company is formed to do this. This is not the same thing as creating artificial scarcity through violation of the free market, which is what a monopoly does.

The bottom line? A monopoly is bad, economically, because it creates inefficiency in the market. In fact, a monopoly represents a failure of the market. In an efficient market (remember efficiency is about allocation of scarce resources) a monopoly should not occur. When resources are not allocated efficiently, it means that everytime someone “wins”, everyone else is impacted negatively.

From a political perspective, monopolies are bad because they represent concentrations of power. Concentrations of power are threats to individual liberties. The basic idea of the US Constitution was to create competing concentrations of power to minimize those problems. Anarcho-capitalism views everything as a market. There is good reason to see the world this way since governments are another means of allocating resources. What has happened is that rather than treating old age retirement as a competitive market, we have given a legal monopoly to the government, and now the competitive market is for the political ideas that will lead to the most efficient allocation of taxation and tax distribution to provide for pensions to retirees. In other words, sometimes the resources in the market are ideas and people, rather than physical products or money. Because we place value on the end result, which is the collection and distribution of taxes, money enters politics, just as it does any other arena. Anarcho-capitalists suggest that a competitive market for politics would lead to a more efficient allocation of resources. That said, tehre is no reason to view a concentration of power differently based on whether it is “public” or “private”.

This discussion is meant to illustrate why concentrations of power and monopolies should be viewed as bad by free market proponents. It is not because we don’t like free markets that we oppose monopolies, it is precisely because we do like free markets. And monopolies mean the market is no longer free, it is no longer capable of the most efficient allocation of resources. Whether Microsoft, for example, did anything wrong in achieving its current monopoly, or not, is really, in many ways, beside the point. The situation now is that someone must acquire resources in a market where Microsoft artificially controls, and manipulates, scarcity. This means that it is possible for Microsoft to gain while everyone else in the market loses. The outcome of a free market is that everyone wins. I gain a resource for the value I place on it. The supplier makes a profit. That’s good for both of us. If, however, I must acquire the resource and the market is not competitive, I will end up paying more for the product than the value it has for me. While it is easy to argue that the average home computer user does not have to have a computer, and they are making a statement about the value of a Windows operating system when they do buy a computer, it is not so easy to argue that the average business user does not have to have a computer. In fact, most businesses find themselves, as consumers, in the position of being required to purchase a product from a sole supplier who is artificially manipulating resource scarcity in the operating system and desktop office suite market.

Microsoft is both a monopolistic competition and a coercive monopoly. They maintain, and indeed created, their monopoly through practices which violate free market principles, including collusion, theft, dumping and product tying, among other things. Because they are a monopolistic competition, they can artificially control resource scarcity over the entirety of the operating system and office suite markets, not just locally. In order to prevent the loss of their monopoly, they tie your office suite to other products, such as proprietary data formats and the operating system in order to make it as close to impossible as they can for you to not purchase their product. Dumping occurs when you sell a product below its marginal cost in order to put competitors out of a market. It is fairly clear that MS dumped IE by selling it at $0 in order to force Netscape out of the browser market. I could write for days about Microsoft’s business practices. I won’t, let’s just let it stand that just about everyone economist out there considers Microsoft a monopoly and considers a monopoly to be bad, not good. Since nearly all economists these days favor free markets, then I am hard pressed to wonder how you can be a free market proponent and yet find Microsoft’s business practice and monopoly to be “okay”, “acceptable” or “good”.

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19 Comments

  1. Eric, I can see and concede your point that monopolies are bad, no matter how they are created. But what is a company to do, when they actually have succeeded (through no coercion) and now have the corner on their particular market? (I’m leaving MS completely out of this theoretical question.) Obviously, while having little or no competition can mean that they do control prices through scarcity – what should they do at that point? This is what I have difficulty with – we can’t just earmark every business which has achieved a monopoly through simple good business practices as being bad – because in just about every instance I can think of, someone, somewhere could have started a competing business. The fact that they did not or have not is not the fault of the monopoly. Isn’t this about the time that government usually steps in to break up a monopoly through deregulation? And isn’t that something that we want to avoid? Knowing that competition is good for the free market and actually forcing the creation of competition to maintain a free market seems to me to be where the rub comes in.

    Comment by Kay — February 19, 2006 @ 1:14 pm
  2. “let’s just let it stand that just about everyone economist out there considers Microsoft a monopoly and considers a monopoly to be bad, not good.”

    You’ve mixed up two concepts. From a legal perspective, there is a difference between a monopoly and monopolistic behavior. Monopolies happen – companies that are very good at what they do tend to dominate the market.
    The “bad” part is what they do once they own the market – do they abuse their position, or do they continue to operate as a competitive organism? The classic monopolistic behavior is “once they own the market, they raise prices with impunity.” A more dire monopolistic behavior is doing something to ensure continued domination of the market. Standard Oil being able to charge what they like is bad enough, but it does subject them to competitive vulnerability. But if Standard Oil used their position to require a specific patented additive in gasoline, then required cars to need that additive to run, they would be locking themselves into the gasoline market for the foreseeable future.

    Microsoft’s massive misstep was requiring OEM hardware sellers to pay for a copy of Windows for every PC sold, whether Windows was installed or not. Since they were paying for it, OEM’s decided they might as well install it. This hamstrung competing OS’s beyond repair, and resulted in the settlement negotiated with DOJ.

    In any event, breaking up a monopoly just because it’s believed to be a monopoly requires massive governmental interference – how do you square that with a “libertarian” ideal?

    In addition, remember that IBM was sued by DOJ in the 70′s for antitrust, but the suit was dropped when Reagan was elected. Where’s the long-term damage suffered as a result of *that* monopoly?

    People complained about the telco monopoly, resulting in deregulation. Let’s face it – that didn’t accomplish much in terms of progress; the telco’s still thwarted broadband advances for almost a decade until they were forced to compete by cable broadband. Cable monopolies abuse pricing regularly, but are now facing issues as telco’s and broadband providers work to offer content.

    I’m not sure that any monopoly can really survive as a “complacent abusive monopoly” in the long term. Even IE is losing ground to Firefox and forced to compete.

    Comment by Philo — February 19, 2006 @ 1:40 pm
  3. Empires come and go. History teaches that much. However, the cost of “letting the problem fix itself” is much higher then actively intervening and making a clear public statement as to what is allowed and what is not. Otherwise, you’ll find yourself trading one empire for another and gaining very little overall. Or said otherwise: anything you don’t punish significantly more then the possible profits gained by it is actually stimulating it. Be sure to understand the long term effects of what you stimulate. And most certainly that what you stimulate by inactivity, slow reaction and underpunishment.

    Comment by Arthur B. — February 19, 2006 @ 2:11 pm
  4. I don’t advocate government intervention to deal with a monopoly. What I advocate is ending government intervention which tends to create monopolies. We spent quite a while getting ourselves into this mess, it’s going to take time to get out of it.

    Philo, a monopoly practices monopolistic behavior. If I’m mixing up legal and practical definitions, then most economics texts are as well.

    Understanding something and viewing it as bad does not automatically infer that government action is the right solution. I realize, of course, that most people automatically assume that calling something bad means the person speaking is going to call for some sort of government activity. That is, of course, the accepted practice in our country today. It doesn’t mean that it is the practice I’m advocating.

    Comment by Eric — February 19, 2006 @ 5:51 pm
  5. ^^ This changed the whole read for me. ^^

    As of his 5:51 comment, Eric is absolutely right. Monopoly is the anathema of free markets, but government intervention not only shouldn’t be called for, not only shouldn’t be the means of rectification, but CAN’T be the means. MSFT is a great example of how government intervention has reinforced their monopoly.

    The concept came home to me two weeks ago, when my father’s wife and I were having a conversation about Windows and IE vs. linux and Mozilla. I made the comment that Firefox was much more suited to what her clients were trying to do; she let me know that her clients were sooooo tied to doing things the same way they did every day, she’s having trouble getting some to upgrade from Win95. There is no way those clients would change browsers!

    That got me thinking (and firmly believing) that the MSFT anti-trust suits reinforced the monopoly. After all, if the government goes after them, there can’t be any viable alternative, right? Competing products must be inferior, or else the government wouldn’t have wasted their time. Any competitive OS or office suite has to now overcome not just the “trial sub” to MS Office, but the government-reinforced idea that their product is inferior.

    Comment by Brock — February 19, 2006 @ 10:01 pm
  6. [...] Monopolies, Markets and Microsoft Liberty Papers, CA - 10 hours ago difficult to distinguish between good business practices and concentration of power differently based on whether argue that the average home computer user does [...]

    Pingback by dboweb » Blog Archive » — February 19, 2006 @ 10:13 pm
  7. By the way Kay, it is not possible, in a perfect market, for a natural monopoly to arise. Therefore, if a monopoly exists, it is because the market is distorted in some fashion. Local monopolies often occur, but don’t represent a significant negative because they are local. That is, if you don’t like the price of the coffee at the Starbucks in the airport concourse, it is not the only possible solution for you to get coffee. You could leave the concourse, wait until you arrive at your destination or even, *ugh*, buy a cup of coffee at Burger King.

    On the other hand, a monopoly like Microsoft cannot exist without a distorted market. The single most significant distortion of the market is the government. This is a long winded way, Kay, of saying that the solution to most of the monopolies we see around us to get rid of government intervention.

    Comment by Eric — February 19, 2006 @ 10:24 pm
  8. “This is a long winded way, Kay, of saying that the solution to most of the monopolies we see around us to get rid of government intervention.”
    Bingo. I agree completely – all I can see government doing is mucking things up – even when the intentions are the best.

    Comment by Kay — February 20, 2006 @ 3:56 am
  9. Eric,

    I agree that there is, unless you define it very narrowly, no such thing as a natural monopoly. That doesn’t mean, however, that even in a completely free market with no government intervention that dominant market players capable of created “artificial scarcity” might arise. This is especially true given the fact that its clear that its more than just price that influences supply and demand — which is the reason that Starbucks can still charge $ 3.00 for that cup of coffee when Joe’s Coffee Shop across the street only charges $ 1.50; whether its true or not, people perceive Starbucks as selling higher quality coffee and are therefore willing to pay the extra money for the better product.

    If market dominance or significant control of a particular market, even if it isn’t “monopolistic” from an economic perspective, arises in the context of a free market, then I (1) what’s wrong with it ? and (2) what should be done about it ? In the end, if the dominant company doesn’t remain comeptative, they will lose their market share.

    You also state:

    “Microsoft is both a monopolistic competition and a coercive monopoly. They maintain, and indeed created, their monopoly through practices which violate free market principles, including collusion, theft, dumping and product tying, among other things.”

    In what sense do any of these actions violate free-market principles ? They don’t violate anyone’s rights, they don’t involve the use of government force, and they are perfectly permissible activities for an entity whose prime, and only, goal is to make a profit.

    Collusion is just another word for partnership. Its only a problem if the ends that the two parties are seeking to achieve are themselves illegitmiate. That’s not the case when we’re talking about making a profit.

    Theft ? Well, considering that there are signficant problems with intellectual property itself, I am reserving judgment on whether that’s really a problem from a libertarian point of view. Maybe it is.

    Dumping ? What’s wrong with dumping ? If someone wants to sell me something for less than its costing them, that’s of benefit to me as a consumer. If their competitors don’t like it, they need to act to respond.

    And product tying ? If Microsoft wants to give away Internet Explorer with every copy of Windows, then let them — even when they were doing that as part of their strategy against Netcape, people still had the choice to completely ignore that IE icon on their desktop and use another brother. The fact of the matter is that, starting with IE 4, Microsoft was putting out a better browser than Netscape.

    I guess I’m still confused. If a corporation in a truly free market with a government that adhered to libertarian principles engaged in any of the above actions, what would you propose be done ?

    Comment by Doug — February 20, 2006 @ 8:46 am
  10. You miss the point of what a free market means. It means that every player has perfect information. If you have perfect information then you wouldn’t buy a Starbucks coffee when you know that the coffee shop half a block away has the exact same coffee, skill sets, etc. for 20% less. A truly free market means that nothing can ever be sold for more than its marginal cost.

    Economists, even libertarian economists, don’t agree with you that collusion, dumping, tying and theft are not problems. Before we deal with our ideology, we need to deal with how the market actually works.

    Comment by Eric — February 20, 2006 @ 9:02 am
  11. Eric,

    I define a free market as one completely free of government intervention where buyers, sellers, and other market participants are free to engage each other on the terms that they agree to.

    Because we are all human, we are never going to have a situation where everyone has perfect information. There are always going to be people who know something, or think they know something, that other’s don’t. This is why the stock market works the way it does — some people think Home Depot is a worth buying at its current market price, others think its time to sell.

    And I don’t think you got the point of my Starbucks example. Joe’s Coffee Shop is never going to be selling the exact same coffee as Starbucks, most prominently because consumers have demonstrated repeatedly that they are willing to pay more for a name even it it means paying more than they “should”; the Starbucks name obviously has some value to them that they’re willing to pay for. How else can you explain the fact that people are willing to pay $ 3.00 for a bottle of Dasani water when they can get it for free out of the tap ?

    I’m not saying these consumer choices are right or wrong, they just are.

    Comment by Doug — February 20, 2006 @ 9:18 am
  12. I agree that a perfect free market cannot exist. But, it is the starting point for understanding free market economics. Just as a perfect managed economy cannot exist, but it is the starting point for understanding socialist economics. In a perfect free market, all players have perfect information and thus the consumer will find out that the only difference between Joe’s and Starbuck’s is the name brand. The reason we value name brands is that we don’t have the perfect information to tell us that Joe’s and Starbuck’s are actually exactly the same product.

    The point? To understand why consumers make the choice between Joe’s and Starbuck’s.

    I think, again, it is important to understand economics and markets independent of political ideology. Once I understand that, then I can start to think about how best to achieve my political goals, whatever they may be, within the context of how a market and economics really work. To argue, for example, that collusion is just a form of partnership that we don’t like politically is to ignore the economic underpinning of the difference between collusion and partnership.

    Comment by Eric — February 20, 2006 @ 10:37 am
  13. Actually, I do believe that a free market can exist; whether we have the political will to allow that to happen is another question. As I said, when I think of a free market, I think of an economic system completely free of the distorting effects of government intervention.

    It is a mistake, I think, to define a free market by the existence of something — perfect information — that will never exist.

    Comment by Doug — February 20, 2006 @ 11:25 am
  14. The problem is that free market, in economic terms, means precisely that: a market where all players have perfect information. Clearly no one is ever going to have perfect information, except in limited and unique circumstances. If you state that a natural monopoly can exist in a free market, you are stating something that is impossible. If you say that a monopoly, or monopolistic competitor to be more precise, can exist in a market that doesn’t have government distortion, the economics answer would be that you are correct, although it is much less likely than it existing in a market distorted by the government.

    Finally, since monopolistic behavior and monopolies try to create artificial scarcity and prevent all players from having information, this is something that moves us away from a free market, not towards it. In other words, it is a market distortion. A free market, by virtue of being perfectly efficient, is the ideal good, and anything that moves away from that is bad.

    This is all economics. Political ideas cannot change this, anymore than they can change the value of PI. The trick is to have your political ideas reflect the reality of this. The problem with socialism is that it assumes you can remove market forces. The problem with capitalism is that it assumes you can eliminate externalities. It turns out, in practice, that externalities are much less distorting for a market than market forces are for a managed economy.

    Comment by Eric — February 20, 2006 @ 12:10 pm
  15. Standard Econ text notwithstanding, in an economic activity with high capital start up costs or other non-govt. barriers to entry, and significant economies of scale, a short term monopoly is certainly possible, especially if existing firms are permitted to merge to take advantage of the economies of scale. This is still typically a short term outcome.

    That said, I agree with Eric that nearly all monopolies happen because of earlier govt. interference in the market.

    And with that said, I happen to know that Joe pees in the pot each morning, so I’d stick with the Starbucks if I were you.

    Comment by KJ — February 20, 2006 @ 2:56 pm
  16. Ewwww! I knew there was some reason I only drink my own coffee, LOL!

    Comment by Kay — February 20, 2006 @ 3:21 pm
  17. There’s other things Joe could do in the pot that are worse. :-(

    Comment by Eric — February 20, 2006 @ 3:58 pm
  18. A Final Word On Monopolies

    About two weeks ago, we had quite a spirited debate here about the question of monopolies in a free market system, and specifically the question of whether Microsoft, or any other supposed monopoly was a problem that libertarians and classical libera…

    Trackback by The Liberty Papers — February 27, 2006 @ 4:55 pm
  19. [...] I think the last sentence is clearly how Libertarians are perceived. It is, in fact, one of my primary issues, as has been evident in the discussion between Doug Mataconis and I here on The Liberty Papers (see this, this and this for examples). Yes, I believe in individual rights and liberties and the power of markets, I detest the idea of “positive freedoms”, and agree with much else that libertarians believe in. But, I’m not a libertarian, and rarely describe myself as being one. Then it is usually because I’m closer to that position than anything else. The thing I think that libertarians and anarcho-capitalists basically lose sight of is that all concentrations of power are destructive to individual liberty, whether they are formal governments, or not. Speaking of collusion, this brings up another issue that keeps people on the socialist side of the fence: monopolies. We’re all taught in school that artificial monopolies (i.e. those that are created intentionally by monopolists) can be created and sustained, that they harm the consumer, and that they must be broken up or controlled by government. In school, these were simply called “monopolies” and natural or state monopolies simply weren’t addressed. In actuality, it’s not hard to show that historical monopolies have always failed except when the state has intervened to support them, and that even where natural monopolies persist, they do not harm the consumer (at least not more than a state monopoly) and advances in technology eventually make them competitive anyway. [...]

    Pingback by The Liberty Papers»Blog Archive » Thoughts Along The Same Lines — March 1, 2006 @ 10:10 am

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