Monopolies: Are they good for us?

The Interview: Economic Theory Part 2

W: So even though a company isn’t a monopoly, can it still wield monopolistic power and is that why we look at these extreme scenarios to identify these things?

JI: Yes of course. In a sense, business loves monopolies, they always try to differentiate and say “oh, nobody is supplying the goods or services that we’re providing” so they always try to create a niche where they have some degree of monopolistic power.

W: So are there industries/businesses where there is some degree of competition, but the leader in that industry is so widely demanded for whatever reason that they have some degree of monopolistic power even though it’s not an actual monopoly?

JI: That’s definitely the case, you need some other competitor. Look at Intel and AMD for example, but for AMD to do their job, they need to be at least getting close to Intel’s level of performance. You can look at aerospace, Boeing was quite dominant until Airbus. Boeing would claim Airbus is a government supported entity, but the existence of Airbus ensures that Boeing stays sharp and on their toes. Even though there isn’t perfect competition in the case of aircraft it’s kind of a duopoly but that is ok, it’s not bad because you have competitors that keep each other on their toes. As long as they don’t collude, they will keep on innovating. Competition in duopolies can be pretty savage, every bit as savage as perfect competition.

W: The other thing that I think about when I think of monopolistic enterprises is that innovation can suffer, is that normal and why would you say that is if so?

JI: Yes, basically because you sit on your laurels. It’s about incentive isn’t it? If you’re profitable and no one is anywhere close to you, yeah, you sit on your laurels, you just milk the consumer for money because at the end of the day they are not building GPUs or whatever just for the sake of it, they’re there to make money and if they’re making money and no one is coming close, what’s the point of spending money on research and technology. Even if they spend money in these areas, there’s none of the urgency that comes with the knowledge that if you don’t innovate you’re not going to survive.

W: If you measure under normal circumstances over time from point A to point B, in a market where there was competition. Over that fixed period of time you would expect to see a higher degree of innovation in a competitive market over that period of time vs. a monopolistic scenario?

JI: Yes, definitely. In fact, one of the key reasons why Europe became so dominant in world affairs up to the 19^th/20^th century is because of competition in military technology and it advanced faster in Europe than elsewhere because there were all these nation states competing with each other so they kept innovating. This enabled them to go and colonize places all around the world simply because of superior military technology and that technology was a result of competition within Europe. Elsewhere for example, in China you had a large dominant country so when the European powers went to China, it was no match for the Europeans militarily. The same is true in industry, competition sharpens your innovation and as a result enables you to dominate.

W: Now to another point of economic theory, for the benefit of our readers, what does “Economies of Scale” mean?

JI: Economies of scale means a lot of things but the effect is that it’s cheaper to make more stuff. Take the car industry, if you need to setup machinery to stamp your panels etc, investing in this sort of machinery to stamp panels is spread over the production run of 100,000 instead of 1,000 then of course, it’s cheaper. Basically, it’s cheaper to produce more stuff than to have a limited production run. The unit cost of production is lower when you have a larger production run and generally economies of scale come with larger companies, but it also depends on the industry because of course the holy grail of industry is to create a low cost way for producing a limited run. 3D printing is an obvious example of this.

W: But surely that would mean that monopolies are more efficient because they would have vast economies of scale. Or is there such a thing as diseconomies of scale?

JI: Yes, there are diseconomies of scale too. We talked about the car industry as an example of where a production run is helped by economies of scale, but General Motors is a case which was so huge at one point that they ran into a diseconomies of scale scenario with bureaucracy etc limiting their ability to be nimble.

Coordination, communication, systems to manage information, processes and infrastructure etc, the cost of this coordination starts to rise again.

W: So economies of scale benefits as an argument for being a good reason for monopolies (interrupted vehemently!)

JI: NO! It’s not so much just about the cost of production, it’s about how much of this lower cost of production is passed onto the consumer. At the end of the day, monopolists do not have any incentive to pass on these lower costs of production to the consumer.

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