Monopolies and Morals

Can any moral implications be derived from the existence of a natural or hypothetical monopoly? Can such a firm be considered evil merely for being a monopoly? The answer is no!   

According to the standard neoclassical interpretation, a monopoly is a firm that is the sole producer of a good or service. This firm has the ability to restrict its supply given some level of demand and thereby raises the final price of that product. The profit maximizing formula for this particular kind of firm, the optimum output so to say, can be found for any such firm by equating its marginal production with the marginal cost of producing its product.

What makes a monopoly unique then is its ability to restrict output to increase profits. There is certainly nothing morally repugnant about profit seeking behavior. If this particular firm’s structure of production was not acquired by the aid of theft, fraud or political privilege, then its owners should be free to dispose of their property as they see fit.

At best, such a scenario may be considered undesirable for some number of consumers. When the market for such a product is compared with the hypothetical case of the same market for the product under perfect competition, a neat geometric proof shows that a large portion of consumers are excluded from access to the product due to a higher price.

However, this hypothetical comparison of a monopolistically determined output and price to that of a “perfectly competitive” one is an atrociously misguided framework for an understanding of reality and hence, history. The comparison between two polar opposite industry concentrations and cetaris paribus assumptions make the implications worthless. Nonetheless, these abstractions are often the basis on which well-intentioned economists condemn the existence or even idea of monopolies.   

The Diminishing Marginal Utility of “Money”

The first issue I wish to take up in this blog is that of diminishing marginal utility and its application to money. At a glance, it is a simple, almost trivial exercise in microeconomic theory. In fact, I just explained the connection to my grandmother and she was fascinated by its simplicity. So lets jump right in!

The concept of diminishing marginal utility, that the utility gained from acquiring one additional unit of an economic good is less than the utility gained from the same economic good that was acquired prior, is a wonderful tool for understanding the limits of human desire for a number of homogenous commodities. To put it simply, it explains why most people do not want an endless amount of the same stuff.

Let us take delicious Bavarian beer as our example. It is a warm, sunny day and you decide to go out to the Biergarten with your friends. According to the law of diminishing marginal utility, you will enjoy the first beer the most. With each successive beer that you drink, the pleasure you derive from consuming another beer will diminish. That is, you will enjoy the first beer more than the second, the second more than the third and the third more than the fourth.

Take any economic good you can think of and apply this thought experiment. Couches, TVs, bacon, pants, houses, ovens, glasses and even drinking water are all subject to the law of diminishing marginal utility – and don’t forget to assume ceteris paribus!

Now, what is unique about the application of this theorem to money? According to Professor Fekete, the acknowledged father of what is now termed the “New Austrian School of Economics,” money has the “slowest rate of declining marginal utility.” This means that in comparison to any other economic good, you will get sick of or satiated by accumulating more money more slowly than any other good.

Why? The answer is simple. Money has the unique quality of being desired by all participants in a given market economy for the same reason – it can be used to buy other things. Thus, the rate at which the utility of each additional monetary unit will decline is less than the rate at which the marginal utility any other good will decline.

While this explanation is simple, it leads to far more interesting historically based question. Is a given item classified as money because it has the “slowest rate of declining marginal utility” or vice versa? At present, the most informed answer I can offer to this question is the case of the latter – that an item has the slowest rate of declining marginal utility and therefore becomes money.