One of the worst offenses of neoclassical economics against common sense and sound policy is its identification of monopoly power with the ability of a seller to raise the price of its product without losing all demand for its product. Put in econ-talk terms, when an individual seller faces a downward-sloping demand curve (rather than a horizontal demand curve) that seller is said to have some quantum of monopoly power.Professor Boudreaux puts the warning label "wonkish" on his post, and I'm probably going to be even more so.
The standard monopoly model, and the Cournot mineral spring duopoly model both require the strong premise that the firm or firms profit-maximizing against the demand curve face no threat of entry. The professor recognizes this point, although I fear he has crossed into libertarian political economy in proposing a strong association between government power and textbook exercises of market power.
To the extent that the downward slope of a seller’s demand curve exists because of a grant of special privilege by government – say, protection from the competition of foreign rivals – the resulting higher prices and reduced output are legitimately described as the results of monopoly power. And the corresponding deadweight welfare loss is indeed a loss; the world is poorer than it could have been and would have been without the grant of special privilege to the favored seller(s).Where the post becomes less clear is in its treatment of the pricing of an improved product that was previously not available at any price.
In contrast, if a seller gains more ability to raise its price – that is, if the demand curve facing the seller becomes less elastic – as a result of actions taken by that seller to make its product more attractive to consumers, then the higher price is no loss at all. And, importantly, there is no artificial restriction of output, properly reckoned. The seller might for a long length of time succeed in selling its output at prices well above marginal cost, but the proper point of reference is not the price and the rate of output that would prevail if this successfully innovating seller sold its product at a price equal to marginal cost. Indeed, the proper point of reference isn’t simply some other price and rate of output.Teaching point: prices exist precisely to enable people to make comparisons and substitutions. On occasion a student will suggest that Apple are capable of extracting whatever price they'd like for their latest iToy. My response: do you thank me that it's not even more expensive? The sharper interlocutors might suggest that I'm unlikely to buy it even if it is somewhat cheaper, which is a good way to get everybody focused on the marginal consumer. That leaves us in a world, however, in which the developer of a sufficiently superior product is able, profitably, to raise prices above competitive levels.
In my abstract hypothetical here, the seller’s innovation entices consumers voluntarily to regard the seller’s output as being more desirable than was the seller’s output before the innovation. The market itself has been changed; the product itself is new and not easily comparable through price and rates of output to the pre-innovation product.
The tougher policy point is monopolization, in which the company offers an improved product at a lower price than the existing product commands. Further development of that point is way too wonky for a sunny Friday morning.