Essay Instructions: This research paper should be constructed into 5 parts. First, there should be an introduction to the nature of the policy issue being discussed and a very CLEAR THESIS position taken (approximately 1-2 pages). Second, the relevant PHILOSOPHICAL-CONSTITUTIONAL ISSUES that surround the issue should be outlined (approximately 2-3 pages). Third, the ECONOMIC LOGIC of your case should be presented concisely (approximately 2-3 pages) Fourth, a LITERATURE REVIEW of the economic studies that relate to your policy issue should be examined for their empirical findings (at least 3-4 studies reviewed, and at least 6-7 pages of analysis). Finally, a CONCLUSION summarizing your suggestions for policy improvement is needed (approximately 1-2 pages).
Please use this following paper for an example/revision:
Capitalism is the economic system that has dominated the United States since the break-up of feudalism. It is the social system based on the recognition of individual rights, including property rights, in which all is privately owned. In capitalism the purpose of government is to protect individual rights, to make sure that no one or group may initiate physical or coercive force upon anybody else. The success of capitalism is individual surplus that has been produced by individuals who decided to use their creative minds and energy to create a product. The private surplus they use to trade in the free market where they compete with other buyers and sellers. Competition is the efforts of two or more parties acting independently to secure the business of a third party by offering the most favorable term. When competition exists in the market place we see rivalry between sellers for the future business of consumers. Competition has improved our economy as a whole and has brought us to a higher standard of living. It has allowed us to learn how to allocate resources more efficiently, engage in innovation, technological advancement, and better response to the consumer. With so many benefits we would fear to risk the destruction of competition.
A monopoly is a threat to competition and in its market structure, it is a single seller of a product that has no substitutes in its entire market. Monopolies in the free market has been banned in the United States because it is believed to deprive consumers from technological innovation and has introduced us to high prices above the market equilibrium. There are different public policies to handle monopolies however, in the past; government has felt that antitrust laws are the best approach. Government has created antitrust laws such as the Sherman Act, the Clayton Act, and the Federal Trade Commission Act, all to prevent monopolies. We have seen through history cases where antitrust has been exercised such as the railroads, the Standard Oil Case, and the Alcoa case. There are those who believe that these antitrust laws have saved competition and that government should continue to intervene in the free market place. Yet there are others who opposed and say that government is the soul source of monopoly power. That these antitrust laws ironically support, create, and protect monopolies instead of preventing or disengaging them. We will review these classical cases to see if antitrust laws were properly executed or if they should not of been prosecuted in the first place. Both sides of the spectrum will be viewed to the best of my abilities. I do not believe that forcing these antitrust laws is the best solution to prevent and control monopolies. I believe that there are other alternatives besides antitrust laws.
Philosophical constitutional issues.
Prior to the Civil War, Americans feared of allowing government a vast amount of arbitrary power. It was viewed that government was the only institution that can compel anyone to obedience and the use of physical force while the businessman had none. This belief of government only having arbitrary power changed immediately after the Civil War during the coming age of the railroad industry. In reality railroads did not have the backing of legal force. However, to the farmers of the West, the railroads appeared to have arbitrary power that was only trusted in government. To the farmers the railroads seemed to tamper the laws of competition. They seem to be able to charge just high enough of a rate to keep farmers in the seed grain. The Western railroads were monopolies however, their arbitrary power arose not from the free market but from governmental subsidies and restrictions. So the farmers protested and took form of the National Grange movement and passed the Interstate Commerce Act of 1887. Soon after that the Sherman Act arose in 1890. It is claimed then and still stands today that firms, if left free, would develop arbitrary power.
These antitrust laws were passed to halt the spread of business monopoly and to restore competition in the market economy. Many supported and many were against antitrust laws. Legislators claim and exercised that they do have power, which is stated in Article one Section eight, ?The Congress shall have the power to . . . regulate commerce with foreign nations and among several states . . ..? (Constitution) We have seen legislative exercised this right in the Munn vs. Illinois case in 1877. Munn and Scott were business partners that privately owned a grain-storage. They argued to the Supreme Court that they do not have the right to force them to make their rates public, get a license through the state, or comply with price limits. The majority of the Supreme Court disagreed and declared that private property, which is involved with the public. Chief Justice Waite explains, ?must submit to be controlled by the public for the common good.? (Armentano) Those who supported antitrust laws believed that if left alone natural monopolies will occur in a free market and slow down the process of innovation. They believe that monopolies would charge high prices, misallocate resources, take away jobs from the people and give them low wages. Hilaire Belloc once said, ?the control of the production of wealth is the control of human life itself.?(Armentano) The Sherman Act of 1890 was the first of the antitrust laws. Its sole philosophical purpose is to prevent monopolies and free up competition.
From a Natural Rights perspective they believe that the antitrust law movements are seen to be more conservative than progressive. They view these antitrust laws as an outrage and that it stripped away private property rights. They hold that individuals have inalienable rights to life, liberty, and property. That anyone can enter into any non-coercive trading agreement on any terms, to produce and trade any good or service that they own. Anybody has the right to use his or her property in any way he or she pleases as long as it does not infringe on anybody else?s property. Adam Smith one of our Founding Fathers wrote the Wealth of Nations, and here he opposed government restrictions on production and trade, because he viewed it to hold down capital gains, and the expansion of national wealth and welfare. Jeremy Bentham and the Philosophic Radicals believed ?that interests reflected in the private, selfish economic activities of individuals were harmonious, and created a stable economic system . . ..? They support the free market capitalism because it served the greatest good to the greatest number.? The Philosophic Radicals rejected government intervention because it has shown through experience that its benefits rarely exceeded its costs.
According to Robert H. Frank in his text book Microeconomics and Behavior 5th Edition there are five sources of monopoly. The first is exclusive control over important inputs or when a seller has complete control over the supply of a product such as deBeers? control over the supply of mined diamonds. Economies of Scale are another source of monopoly. Economies of Scale is when given fixed input prices, the long-run average cost curve is downward sloping. In this case it is always cheaper to serve the market by having one firm producing the product. Patents are issued by governments and its sole purpose is to protect inventions and confers the right to exclusive benefits from all exchange involving the inventions to which it applies. There are both costs and benefits from all exchange involving the inventions to which it applies. There are both costs and benefits to patents. On one side the cost creates a monopoly and usually leads to higher prices for the consumer. However, with out patents we would not see many of the great invention that has occurred through history. Patents increase prices above marginal cost and speeds up the pace of innovation. Protection from competition by patents allows firms to recover costs of research and development of innovation. Network Economies are when a product becomes more valuable as greater number of consumers uses it. One great example is Microsoft?s Windows operating system that has a dominant market position. The last source of monopoly power is government licenses of franchises are when in a market, the law prevents anyone but a government-licensed firm from doing business. Strict regulations and high fee to attain a license accompany government licenses. These high fees and obtaining to strict regulations cost a lot and are usually transferred to the consumer as premium prices.
In a monopoly there is no supply curve because monopolies are the price maker not the price take that are found in a competitive markets. The demand is still downward sloping and the monopoly price is above the equilibrium price. High prices will distract consumers from buying more products. For monopolist to continue to sell larger amount of output they must cut prices back down. Monopolist who continues to sell above the price equilibrium will experience a dead weight loss as well as a loss in potential profit. In the long run if monopolies stay at the same monopoly price they will lose consumer surplus and lose potential revenues. What monopolies would do is use price discrimination. Price discrimination is when monopolists charge different prices to different buyers to maximize profits. Under price discrimination monopolist would be able to go down the demand curve and make profit. However, it is very difficult to practice perfect price discrimination because sellers lack the information to read individuals demand curve. No matter what in the long run monopolies would have a loss in consumer surplus. Prices will eventually go down to market price equilibrium. The difference is that there will be a deadweight loss that is not found in the competitive market.
P P
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Profit \
Pm \\ \\ Loss
Pe \\ Dead Weight Loss \\
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Q \\\\ Q
Monopoly Staying at monopoly prices Price Discrimination
The petroleum industry began in 1846 when Dr. Abraham Gener discovered how to distilled oil from coal and that kerosene could be drawn off and used as an illuminant. From the midst of all the entrepreneurs arose John D. Rockefeller who was just twenty-three and already a success. By 1868 Rockefeller?s attention into ?penny-pinching? techniques. Instead of buying oil from jobbers they hired them to get oil for them. They started to build storage facilities, coaxed more kerosene from a barrels of crude than others. They made money out of most of the disposable residue such as lubricating oils and Vaseline. They also invented gasoline, tar and paint. They became more innovative and began to build their own oil tankers that connected to trains to save money from putting them in barrels and then shipping them off in trains. After awhile they decided to dig their own pipeline in order to speed up transportation and cut costs on using trains. By 1870 the company became the biggest refiner in Cleveland. Rockefeller?s share of total refined outputs was no more than four percent, with as many as two hundred fifty other independent refiners and put out an average price to twenty-two cents a gallon. As 1890 approached, the market price of oil per gallon dropped to about eight cents. Independent refiners fell to one hundred four and Rockefellers market share was at eighty-eight percent. During the period of 1880-1895 Standard Oil resurrected an old common law known as the trust. A trust is when individuals pool their property and agree to have a trustee or a trustee group to manage that property in the interest of all owners.
Many grew hatred toward Rockefeller and blamed him for being unfair and driving their firms out of business. Ida Tarbell sister of William Tarbell and Treasurer of Pure Oil Company, theorized that Rockefeller used predatory pricing. Predatory pricing is a technique when a firm deliberately undersells their rival competitors to drive them out the business and then rise prices back to monopoly prices. In 1909 Standard Oil was convicted in violations of the Sherman Act. Judge Hook explained that ?A holding company owning the stocks of other concerns whose commercial activities, if free and independent of common control, would naturally bring them into competition with each other is a form of trust or combination prohibited by section one of the Sherman Act. The Standard Oil Company of New Jersey is such a holding company.? (Armentano) The Standard Oil Company appealed to the Supreme Court. To their disappointment Judge White reaffirmed the lower courts decision. Judge White found them guilty beyond dispute were one ?the creation of the Standard Oil Company of Ohio. Second, ?the organization of the Standard Oil Trust in 1882,? and three ?the increase of the capital of the Standard Oil Company of New Jersey and the acquisition by that company of the shares of the stock of the other corporations in exchange for its certificates.? (Armentano)
Humphrey Davy discovered the element aluminum in 1807. It was Charles Hall discovered and patented the first commercially successful way for making aluminum by using the electrolysis of molten alumina solution dissolved in cyolite. With the help of Captain Alfred E. Hunt and Arthur V. Davis they created the company call Alcoa. At first they were only able to make two thousand pounds a year of aluminum ingot and were sold for between five and eight dollars per pound in 1887. They knew that in order to become commercially successful they must find a cheaper way to obtain the raw material so it could compete with its other substitute materials. Through time Alcoa expanded on innovation and technology which was beginning to drive the prices down for aluminum. By 1889 they were producing fifteen thousand pounds of aluminum a year and by 1897 three million. In 1937, Alcoa was producing about five hundred million pounds a year and selling it for only twenty-two cents per pound. They were able to obtain 99.9% of pure aluminum from low-grade ores using the electrolysis process. Alcoa found ways to strengthen the element and the anti corrosiveness of the metal, and many alloys for several useful purposes.
In 1929 the Federal Trade Commission finally brought Alcoa to court. They found in favor of Alcoa for not being a monopoly in eight counts. Alcoa was innocent from monopolizing the scrap market, on bauxite other ore of aluminum, waterpower, sand casting, and virgin aluminum ingots. They were found not to have control in the policy of Aluminum Goods Manufacturing Co., and the market of foreign aluminum. They were found not to have any arbitrary power on prices and that it was controlled from the economic law of supply and demand. In the district court Judge also found in favor of Alcoa. Judge Caffey concluded: ?In consequence, I concluded that the government has failed to establish the charge of conspiracy between Alcoa and European producers of aluminum.? (Armentano) The losing party filed an appeal and won there. Judge Hand argued instead that Alcoa?s fabrication ?pro tanto reduces the demand for ingot itself? and affects the primary ingot market and ingot price. Judge Hand reduce the relevant market under consideration to virgin ingot aluminum and Alcoa?s market share jumped from ten percent to ninety percent thus making Alcoa a monopoly.
Cigarettes were unpopular in the early 1850?s and all firms were using Turkish tobaccos and were hand-rolling cigarettes making only two thousand a day. By the 1880?s there was a rapid shift in public taste to Virginia tobacco blends. Larger firms began to become more innovative and adopted new technology such as machines and were now able to produce one hundred thousand a day. James B. Duke quickly stood out by posting large newspaper ads and renting billboards. He started placing coupons on cigarette boxes and gave incentives to retailers to sell his products. By January 1890 the five leading cigarette firms merged together to form the American Tobacco Company and placed J.B. Duke as its president. By 1910 there was no doubt that it was the largest firm in the country but there were still at least three hundred independent cigarette firms and twenty thousand independent cigar firms. The company took a bigger step and decided to cut the middleman out and opened its own store to cut costs. The American Tobacco Company was finally charged in violation of the Sherman Act and Justice White lead the hearing. It was found guilty in violation of the Sherman Act because its acts, contracts, and agreements, and combinations were ?unusual and wrongful character as to bring them within the prohibitions of the law.? (Armentano)
In the cases that have been mentioned there were many things that were over looked. For instance the courts did not pay attention to the things that Rockefeller and his company were doing. Standard Oil had the highest paid employees in the industry. Most of the time when Standard Oil bought other firms, he would buy the firm above its value. Rockefeller employed thousands of people and they all praised him. He donated thousands of dollars to charity and built many public libraries. The price drop in refining oil did not just come from Rockefeller?s ?penny-pinching? innovation these drops mostly came from the United States Treasury?s deflationary policies and the declination in general demand and prices that hurt all business due to the post Civil War. Most firms entered the oil refining industry during the Civil War so when the war was over it was only natural to expect a general reduction in the number of refiners.
The predatory pricing theory that Tarbell mentioned would be economically foolish according to John S. McGee. He argued that predatory pricing would be very costly to large firms and would not want to initiate a price war with each other. McGee explained how firms could just simply close down and wait for prices to return to profitable levels; or new owners could purchase bankrupt companies and get them ready to compete again. Finally McGee explained that firms could not initiate predatory pricing practice unless they are already in possession of monopoly power. If they are already a monopoly firms cannot gain initial monopoly position though predatory pricing.
By 1911 firms started to catch on to Rockefeller?s innovation and prices continue to drop to about five cents per gallon, the number of refiners started to increase and went up to one hundred forty-seven, and Rockefeller?s market share dropped to sixty-four percent. Between 1896 and 1911 the petroleum industry began to change and the markets became less and less secured. There was a new substitute that was beginning to arise in the markets and that was the disposable product of oil. Other petroleum products became more important in the form of, lighter fuel oils, lubricating oils, and gasoline. The kerosene age was coming to an end.
Before government intervene with Standard Oil Rockefeller?s market, the share was already dropping. New firms were already beginning to arise and if government would of left Standard Oil alone they would continue to see their market share drop and new firms being built. Standard Oil was not a monopoly but just going through natural stage of advance innovation due to competition. This decision should have not resulted this way because the Sherman Act was founded in 1890 and the Standard Oil Trust was formed in 1882. This means that Judge White used the ex-post facto clause, which is against the Constitution.
Alcoa was yet another company that was not monopolizing but being innovative and economically efficient which was the result of competition. Alcoa could not be a monopoly because it was competing with other substitutes such as scrap metals and plastics. They could have not block entry to the market because there was another firm, Southern Aluminum that tried to enter the market. It was near completion but World War I broke out and they could not secure domestic financing. Alcoa eventually bought them out. This company was started by Lloyd Emory who owed a brewing company and J.B. Duke a multimillionaire tobacco entrepreneur. These two had more than enough finance and knowledge to start the business however, their company just never left the planning stage. No one dared tried to enter the market during this period because they had economies of scale in the aluminum market. In the case of the American Tobacco Company, it should have never been charged in the first place because again it was going through its stage of being efficient and innovative due to competition. There was also hundreds of other independent firms in the market.
The antitrust laws were meant to prevent monopolies however, in the cases that we have discussed it has seemed to stop productive competitive firms. Even if these firms were monopolies, government would leave them alone and see their market share diminish over time. These antitrust laws attempted to prevent monopolies by stopping predatory pricing and buying up the competition. As we have discussed above predatory pricing does not make any economic sense and would instead ruin a firm who attempts to use it instead of giving it an advantage. Buying up the competition would make no difference either because all that is doing is just transferring funds and assets within the company. In Microeconomics and Behavior it mentions other public policy that can be use for natural monopolies one is the state ownership and management. This is when the state takes over the industry and charges price less than the average cost. Private businesses are not able to do this because they are not able to stay in business in the long run and government can soak up costs by raising taxes. However, this would be less beneficial to the private citizen because their taxes are already high as it is. Other alternatives include state regulation of private monopolies or when government steps in and set guidelines or regulations that limit pricing discretion. Some examples of this are electric, water, and telephone services. Exclusive contracting for natural monopolies is a system proposed by economist Harold Demsetz. This works by government allowing a private company to have rights to service the people in a particular industry such as, fire protection, garbage collection, postal delivery, and many others. The last one that would have worked best for these cases has been discussed is the laissez-faire policy toward natural monopolies or leave it alone. This policy is very simple and all that government has to do is nothing. Government would just allow the markets to handle natural monopolies and through time they would go away.
Bibliographies
1. Armentano, Dominick T. ?Antitrust and Monopoly Anatomy of a Policy Failure.? The Independent Institute. Oakland, California ?1990
2. Rand, Ayn. ?Capitalism: The Unknown Ideal.? Signet. ? 1967
3. Robert, Frank H. ?Microeconomics and Behavior.? 5th Edition. McGraw-Hill Irwin. ? 2002
4. Rustici, Thomas C. Lecture Notes. March 2004
5. Constitution of the United States of America, The
