Free Market Supporters Always Get This One Thing Wrong

When the Justice Department sued to prohibit the attempted merger of two of America's largest airlines, American Airlines and US Airways, the subject of antitrust laws again came into public view. Ever since Teddy Roosevelt's vigorous trust-busting, our government's actions against monopolies and anti-competitive collusion have ebbed and flowed. Conservatives and libertarians who advocate for a "free" market, however, generally condemn these laws and their enforcement. They argue that without government intervention, no company can block competition and if one company dominates the market it is because the company is the one that most efficiently serves its consumers. Yet that is simply not the case in the real world, where large firms can and have frequently priced goods and services higher than what is optimal for society.

We know that prices are determined by convergence of supply and demand. If a market's competition is perfect, with numerous sellers and buyers in it, each one seller would not be able to influence what price it can charge, as the interaction of so many buyers and sellers has already generated an efficient price. Such price is the highest that the buyers can offer and the lowest the sellers are willing to sell with. Therefore the largest number of goods end up getting sold at the lowest price possible, producing the most welfare for all. A monopolistic situation arises, however, when one seller is able to sell goods at a higher price than the efficient competitive price, while selling less of them. That happens, for example, when there is only one company around. Because monopolies can sell fewer goods with a higher price, and get more profits than by selling the most goods at the lowest price, it will just do that, at the consumers' expense. A business always tries to maximize its profits in whatever situation it finds itself in, so a firm could well have started to take over the market because it can deliver the best goods cheaply, yet once this firm assumes the monopolistic position it will act just like any other monopoly.

Despite what free market advocates believe, there are ways companies maintain their monopolies without governments' help. One of them is "economies of scale," where it is less costly to be big than to be small, as making a product on a massive scale is more efficient than producing just a few. This makes it almost impossible for new companies to challenge a monopoly. Those favoring the American Airlines-US Airways merger boast that airline mergers will increase economies of scale to make airfare cheaper. But if this trend continues, it is possible that we reach a point where this leads to only one remaining player in the game, having acquired all the rest. Another danger, which is not so theoretical, is that the presence of only a small number of companies would lead to price collusion, where large firms agree to maintain the price higher than the efficient price. In 1993, Kim and Singa, in a study in the American Economic Review, found that airline mergers caused prices to spike, likely due to collusion. Therefore, Assistant Attorney General Bill Baer had valid reasons for his comment, "We simply cannot approve a merger that would result in U.S. consumers paying higher fees, higher fares, and receiving less service."

This is where the government comes to step in and works to mitigate the effects of monopoly pricing by blocking mergers, breaking up companies, and prosecuting those who collude to fix prices. And those government actions can be effective. A study in 1981 conducted by Block, Nold, and Sidak found that penalties on collusion had driven prices of bread down for consumers by deterring such collusion. In 1997, the Federal Trade Commission halted the merger of Staples and Office Depot, and government calculations showed that prices would increase by 7-8% in cities where both stores were present had the merger taken place. In cases where antitrust enforcement against mergers was considered but did not happen, a study by Ashenfelter and Hosken indicated that price increases subsequently took place, in the merger of P&G and Tambrands in the female hygiene product industry, as well as the merger of Pennzoil and Quaker State in the motor oil market.

Some argue that natural monopolies cannot last forever. PolicyMic's Pierre-Guy Veer's excellently written story depicted how the previously unknown Idaho-based firm Winco is overcoming Walmart's monopoly in retail. However, that fact does not mean this situation should simply be tolerated. No human entities, even governmental ones, last forever. A company that has almost monopolistic control over a market can fall eventually due to its own mismanagement or technical innovations that render its products obsolete. But such events may not occur until several decades after the firm has used its power over prices to harm everyone else. If limited government intervention can somewhat restore the competitiveness of the marketplace, it would be a better choice than to just wait it out expecting everything will be all right eventually. Plus, in some industries monopolies do worse harm than price increases. One of them is the news media, where Rupert Murdoch's continuing success in monopolizing American media should be a cause of concern — and for reasons far beyond economic effects.