Richard McKenzie - In Defense of Monopoly: How Market Power Fosters Creative Production

Richard B. McKenzie and Dwight R. Lee

The University of Michigan Press

Ann Arbor

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Library of Congress Cataloging-in-Publication Data

McKenzie, Richard B.

In defense of monopoly : how market power fosters creative production / Richard B. McKenzie and Dwight R. Lee.

p. cm.

Includes bibliographical references and index.

ISBN-13: 978-0-472-11615-7 (cloth : alk. paper)

ISBN-10: 0-472-11615-0 (cloth : alk. paper)

1. Monopolies. 2. Production (Economic theory) I. Lee, Dwight R.II. Title.

HD2757.2.M34 2007

338.8'2dc22 2007035404

ISBN 978-0-472-90114-2 (OA ebook)

Page v for

Charlie

Page vi Page vii A systemany system, economic or otherthat at every given point of time fully utilizes its possibilities to the best advantage may yet in the long run be inferior to a system that does so at no given point of time, because the latters failure to do so may be a condition for the level or speed of long-run performance.

Joseph A. Schumpeter

Capitalism, Socialism, and Democracy (1942, 83; emphasis in the original)

Most adults in the United States and much of the industrialized world today can vividly remember as children playing their way through marathon Monopoly games. Few have come close, however, to challenging the length of the longest Monopoly game in history (which dragged on for 1,680 hours, or seventy straight days).

Although the board game involves key market institutionsmoney, a bank and banker, deeds, trades, and wealth accumulationonly a modicum of business savvy is required to win. Accordingly, ten-year-old kids can beat their parents, who may be astute, seasoned business people, mainly because the competition among the players is highly constrained by detailed rules, the layout of the board, and elements of luck that are introduced through required tosses of the dice and draws of the cards of chance. The games popularity is probably attributable in no small way to the fact that it taps into twin passions: to win and to acquire wealth (even play wealth).

Each players best strategy for winning is often to buy up all properties of given colorsfor example, all the green properties of Pennsylvania, North Carolina, and Pacific Avenuesand then add (plastic) houses or hotels to them. We can only surmise that the game is called Monopoly because the rent that property owners can charge when another player lands on any particular property escalates both with the number of properties of a given color owned and with the number of houses and hotels that owners buy for each property. Market dominance translates into a form of monopoly rents, loosely defined.

The player who is able to buy both Boardwalk and Park Place (the only two blue properties) and put the maximum of four hotels on each has a good chance of winning, given that the rents on those properties are then the highest on the board. Of course, the owner of those two properties can be assured of their monopoly in the game because the players are trapped: They each in turn must throw the die and must follow in lockstep the route, square by square, around the board, which means that players must run the risk of landing on the monopolized properties. However, winning by developing monopolies on properties of given colors is never assured, mainly because of the properties costs and the several elements of chance.

Economists play another monopoly game in their textbooks (and classroom Page xiv lectures) that is not totally unlike the board game. Like the board game, the economists textbook monopoly game is also highly constrainednot, of course, by the printed surface of a piece of cardboard, but by an underlying, explicitly stated set of assumptions. Economists start by loosely attributing the status of monopoly to any firm that has market power, that is, the firm is sufficiently dominant in its market and sufficiently protected by barriers to the entry of potential rivals that the monopoly can raise its prices and capture economic rents or monopoly profits by restricting output below the idealized competitive output level. The assumption underlying the economists monopoly game that lines up best with the Monopoly board game is that the more control a firm has over a carefully defined, given market (or the greater the firms market dominance, often defined as percentage of all market sales) and the more the firm is protected from market entry of rivals, the more economic rents the monopolist can earn.

But there is another way the two games align: The prospects for creativity and improvement in both games are nil. In the case of the board game, the board and the properties on the board are given. That is to say, they are not created by the players in the course of the play. Their market values are also predetermined and fixed. The rent to be made on each property is also given and fixed, which is to say that the rent is merely extracted by the property owners, as opposed to being created by them. No new properties can be added, and neither can the existing properties be subdivided and reconfigured to enhance the value of all properties. It follows that a players rent from becoming a monopolist over Boardwalk and Park Place will never affect the creation of new properties by others, which, of course, means that players have every reason to charge what the game (and market) will bear at the time of play. Because nothing is created or destroyed by the play of the Monopoly, the game can always be used again, with everything (rules, property values, and rents) remaining exactly the same.

In the case of the economists monopoly game, the monopolized good is also given to the textbook (and blackboard) analytics. That is, by assumption, the monopolist has nothing to do with its own emergence as a monopoly or the creation of its good and its market. The monopoly and its good and market are simply assumed into existence. With the shapes and locations of the monopolists demand and cost functions also given, again by assumption, there is not much more for economists to do in playing their model-building games other than move around their boards and deduce the monopolys output and price levels that maximize economic profits (or rents).

In the narrow context of the model, because the monopolist necessarily restricts output below the (idealized) competitive level, a self-evident ineffi-ciency Page xv exists in the allocation of resources mandated by the underlying assumptions and the rules of the monopoly model. The monopoly rent is merely extracted from the consumer surplus that is presumed to exist independent of whatever the monopolist may have done in the past or proposes to do in the future. Under such conditions, the fairness of the rent extraction is, at best, suspect. Again, this is because the monopolist, by assumption, had absolutely nothing to do with the creation of the monopolized good, the goods market, the protective entry barriers (which, under the model, serve only a negative economic function, that of permitting a curb in output), and the resulting consumer surplus and (hence) the monopoly rent that is extracted. Prices above marginal cost of production, of course, serve no value-creating function.