Principles of Economics — The Theories of Exchange and Price
This is the third part of the series in which I summarize Carl Menger's 'Principles of Economics'. It captures the fourth and fifth chapter of the book, and builds the theoretical framework around the exchange of goods and the price of goods. For a summary of chapter one, two and three, see here and here.
Chapter IV - The Theory of Exchange
1. The Foundations of Economic Exchange
Menger starts out by establishing that exchange for economizing individuals is not an end in itself. There are obviously not many occurrences of trade where producers of the same good exchange units of that good with each other, just for the sake of it. Exchange is therefor nothing pleasurable, but a means to the satisfaction of other needs.
With a simple case, Menger clearly portrays the advantages of exchange: Suppose that two farmers, A and B, have both previously been carrying on isolated household economies. But now, after an unusually good harvest, farmer A has so much grain that he is unable to utilize a portion of it for himself and his household. Farmer B, on the other hand, a neighbor of farmer A, is assumed to have had an excellent vintage in the same year. But his cellar is still filled from previous years, and because he lacks additional containers he is considering pouring out a part of the older wine in storage which dates from an inferior vintage year. In other words, each farmer has a surplus of one good and a serious deficiency of the other.
The farmer with a surplus of grain must forgo consumption of wine since he has no vineyards at all, and the farmer with a surplus of wine is in want of foodstuffs. Farmer A can permit many bushels of grain to spoil on his fields when a keg of wine would afford him considerable pleasure. Farmer B is about to destroy several kegs of wine when he could very well use a few bushels of grain in his household. The first farmer thirsts and the second starves when both could be relieved by the grain A is permitting to spoil on his fields and by the wine B has resolved to pour out. Farmer A could still satisfy his and his family's need for food as completely as before and also indulge in the enjoyment of drinking wine, and farmer B could continue to enjoy as much wine as he pleases but would not need to starve. It is therefore evident that we have encountered a case in which, if command of a certain amount of A's goods were transferred to B and if command of a certain amount of B's goods were transferred to A, the needs of both economizing individuals could be better satisfied than would be the case in the absence of this reciprocal transfer.
To make the situation more realistic, Menger, in a second example, assumes less abundance for both farmers. The grain farmer now has plenty of grain, but not enough to satisfy all, albeit less important, needs. His cattle may be partially fattened by the last of the grain, for example. In other words, his grain will now at least not go to total waste should no exchange occur. The wine farmer still has plenty of excellent wine, but still not enough so that he must pour some of it out. He and his family may still have enough to satisfy all their drinking needs for the coming year, and the rest could be given to the servants in order to boost morale. This situation is interesting, because it begs the question: If no grain or wine now will spoil in the fields, or get poured out, is there an advantage at all that any exchange between the two farmers were to occur? The answer is almost always: yes. The least important bushel of wheat (cattle fattener) may have a low enough importance to the grain farmer, and the least important keg of wine (servant drink) may have low enough importance to the wine farmer, that an exchange of said quantities may causally lead to a more important need being satisfied for the grain farmer, and a more important need being satisfied for the wine farmer. In an exchange situation, they both increase their wealth.
The benefits of a mutual transfer of goods depend, therefor, on three conditions: (1) one economizing individual must have command of quantities of goods which have a smaller value to him than other quantities of goods at the disposal of another economizing individual who evaluates the goods in reverse fashion, (2) the two economizing individuals must have recognized this relationship, and (3) they must have the power to perform the exchange of goods.
2. The Limits of Economic Exchange
Menger starts of with an example here as well: Suppose that A, an American frontiersman, owns several horses but no cow, while B, his neighbor, has a number of cows but no horses. Provided that A has requirements for milk and milk products and B for draft animals, it is easy to see that a basis for exchange is present. At the same time, the exchange of one of A's horses, for example, for one of B's cows would not necessarily exhaust the basis for economic exchange operations between A and B with respect to these goods. It is also clear that a basis need not necessarily exist for exchange of the total quantities they possess. A who owns, for example, six horses may be able to satisfy his needs better if he exchanges one, or two, or perhaps even three, of his horses for B's cows. But from this it does not necessarily follow that he would derive an economic gain from the exchange transaction if he were to barter all his horses for all of B's cows. Although the initial economic situation provides a basis for economic exchange operations between A and B, the consequence of carrying the exchange too far might be that the needs of the two contracting parties would be less well provided for than before the exchange. This should be a rather obvious dynamic.
So how can we know exactly how much ought to be exchanged? Menger has an example here as well. Suppose that in a virgin forest, far away from other economizing individuals, there live two frontiersmen. It is assumed that their needs are exactly the same. Each of them requires several horses to work his land. One horse is absolutely necessary if he is to be able to produce the food required for the maintenance of his and his family's lives. A second horse is required to produce the somewhat greater amount of food needed for an adequate diet for himself and his family. Each of the farmers could use a third horse to transport the timber and firewood he finds necessary from the forest to his log cabin, to draw loads of sand, stones, etc., and to work a field on which he will raise some luxury foods for his and his family's enjoyment. A fourth would be used solely for pleasure, and a fifth horse would have only the importance resulting from its availability as a substitute in case one of the other horses should become incapacitated. But neither of the frontiersmen could use a sixth horse. It is assumed also that each of them would need five cows to meet his full requirements for milk and milk products, that there is the same gradation in the importance of their needs for these products, and that a sixth cow could not be used by either of them.
The above example can be described in numerical form. We can represent the importance of the satisfactions that are provided for by the possessions of the two frontiersmen with a set of numbers that decrease in arithmetic series, with the series 50, 40, 30, 20, 10, 0, for example. Assuming that A, the first frontiersman, has 6 horses and only one cow, while B, the other frontiersman, has one horse and 6 cows, the successive degrees of importance of the satisfactions provided for by the possessions of the two persons can be represented by the following table:
From what was said earlier, it is easily seen that the basis for economic exchange operations is here present. The importance a single horse has to A is equal to 0, and the importance a second cow would have to him is equal to 40. On the other hand, a single cow has a value of 0 to B, while a second horse would have a value of 40 . Thus A and B could both provide considerably better for the satisfaction of their needs if A were to give B a horse and if B were to give A a cow in exchange. There is no doubt that they would actually undertake this exchange if they are economizing individuals. The importance of the satisfactions that are provided for by the possessions of the two persons after this first exchange will be as follows:
It is easily seen that each of the two traders obtained an economic gain from this first exchange equivalent to the gain that would accrue to him if his wealth had been increased by a good whose value to him is equal to 40. But it is just as certain that the basis for economic exchange operations has not been exhausted by this first exchange. For a horse still has much less value to A than an additional cow would have (10 as compared with 30), whereas a cow has a value of only 10 to B while an additional horse would have a value of 30. It is therefore in the economic interest of both economizing individuals to undertake a second exchange operation. The situation after the second exchange can be represented as follows:
From this point, it is easy to see how no more exchange is the probable outcome. A horse has a value of 20 for A, but should he exchange it for a cow, that cow would also have a value of 20. The opposite relationship holds true for B. There are in other words no reason that the two should conduct an exchange, especially when considering costs related to that transaction. The situation after the third exchange, should it anyway occur, can be represented as follows:
Should the exchange continue, where A exchange a horse for one more cow, and B exchanges a cow for one more horse, it is evident that both parties would suffer economic losses. A would gain 10 in value from his new cow but would have to give up a horse worth 30 to him. B would gain 10 in value from his new horse but would have to give up a cow worth 30 to him. Menger summarizes the situation: Above all we would find, in each instance and at any given point in time, a limit up to which two persons can exchange their goods to their mutual economic advantage. But we would find that they cannot overstep this limit without placing themselves in a less favorable economic position. In short, we would everywhere observe a limit at which the total economic gains to be derived from an exchange relationship are exhausted, and beyond which these gains would be diminished by further exchange operations, making the exchange of any further portions uneconomic. This limit is reached when one of the two bargainers has no further quantity of goods which is of less value to him than a quantity of another good at the disposal of the second bargainer who, at the same time, evaluates the two quantities of goods inversely.
Menger ends this section by emphasizing that exchange almost always incur costs that subtracts from the total economic advantages of the action itself. There are freight costs, loading charges, tolls, excise taxes, premiums for marine and other insurance, costs of correspondence, commissions and other sales costs, brokerage charges, packaging costs, storage charges, the entire cost of the commercial banking system, even the expenses of traders and all their employees, etc. Implicit in this, Menger argues, a number of people have wrongly attributed traders' absence from the physical production of the goods to mean they are unproductive. This is of course not true, because in the case of no exchange, needs of individuals would be left unsatisfied as the command over needed goods were never properly facilitated.
Chapter V - The Theory of Price
Prices, according to Menger, are only incidental manifestations of trade, symptoms of an economic equilibrium between the economies of individuals. Menger also notes that it was easy to commit the error of regarding the magnitude of price as the essential feature of an exchange, and as a result of this mistake, to commit the further error of regarding the quantities of goods in an exchange as equivalents. Writers in the field of price theory, according to Menger, lost themselves in attempts to solve the problem of discovering the causes of an alleged equality between two quantities of goods. Some found the cause in equal quantities of labor expended on the goods. Others found it in equal costs of production.
As there are always transaction costs in trading, Menger thinks it is futile to look to any alleged equality of value between goods as an explanation of trade and prices. Instead, a correct theory of price must be directed to show how economizing men, in their endeavor to satisfy their needs as fully as possible, are led to give goods (that is, definite quantities of goods) for other goods.
1. Price Formation in an Isolated Exchange
In the previous chapter, we saw that the possibility of an economic exchange of goods is dependent on an economizing individual having command of goods that have a smaller value to him than other goods at the command of another economizing individual who values the two goods in reverse fashion. Let's go back to Menger's example of the grain farmer and the wine farmer:
Suppose that 100 units of A's grain have the same value to him as 40 units of wine. In other words, he will be willing to exchange his grain for wine only if he has to give less than 100 units of grain for 40 units of wine. If A can find no other economizing individual to whom a smaller quantity than 100 units of grain has a greater importance than 40 units of wine, he will never be in a position to exchange his grain for wine. In this event, the foundations for an economic exchange of the two goods would not be present so far as A is concerned. But if A does find a second economizing individual, B, to whom only 80 units of grain, for example, have a value equal to 40 units of wine, the prerequisites for an economic exchange between A and B are there, and at the same time a second limit is set to price formation. If it follows from the economic situation of A that the price of 40 units of wine must be below 100 units of grain (since he would otherwise derive no economic gain from the transaction), it follows from the economic situation of B that a greater quantity than 80 units of grain must be offered for his 40 units of wine. Hence, whatever the price that is finally established for 40 units of wine in an economic exchange between A and B, it must be formed between the limits of 80 and 100 units of grain, above 80 and below 100 units.
It is easily seen that A could provide better for the satisfaction of his needs even if he should have to give 99 units of grain for the 40 units of wine, and that B would be acting economically on the other side if he were to accept as little as 81 units of grain in exchange for his 40 units of wine. Since there is an opportunity for both economizing individuals to exploit a much larger economic advantage, each of them will direct his efforts to turning as large a share as possible of the economic gain to himself. The result is the phenomenon we call bargaining. Menger states that, as a general rule, the efforts of the two bargainers to obtain the maximum possible gain will be mutually paralyzing, and the price will therefore be equally far from the two extremes between which it can be established. In the above example, that would represent an exchange of 40 units of wine for 90 units of grain.
2. Price Formation Under Monopoly
A. Price formation and the distribution of goods when there is competition between several persons for a single indivisible monopolized good.
If an economizing individual, A, has a horse that has a value to him no higher than 10 bushels of grain if he were to acquire them, while to B, who has had a rich harvest of grain, 80 bushels have a value equal to a horse if he were to acquire one, it is clear that the foundations for an economic exchange of A's horse for B's grain are present. It is equally certain that the price of the horse can be formed between the wide limits of 10 and 80 bushels of grain. It is also clear that the transaction can take place naturally only between A and B only as long as B finds no competitor in his endeavor to acquire A's horse by trade.
Now, suppose that B1 does have a competitor, B2, who either does not have as great an abundance of grain as B1 or requires a horse less urgently. Still, B2 values a horse as highly as 30 bushels of grain, and could thus provide better for the satisfaction of his needs if he were to give 29 bushels of grain for A's horse. It is clear that the foundations for an economic exchange of a horse for some quantity of grain exist between B2 and A as well as between B1 and A. But since only one of the two competitors for A's horse can actually acquire it, two questions arise: (a) With which of the two competitors will the monopolist A conclude the exchange transaction? and (b) What will be the limits within which price formation will take place?
The answer to the first question arises from the following considerations. The value of A's horse to B2 is equal to 30 bushels of his grain. He would thus provide better for the satisfaction of his needs if he were to give as much as 29 bushels of his grain to A for his horse. On the other hand, B1 would obviously be acting uneconomically if, in the competition for A's horse, he were to permit B2 to acquire it for the price of 29 bushels of grain, since the economic gain of B1 would still be considerable if he were to give 30 bushels of grain or more for the horse and thereby economically exclude B2 from the exchange transaction. Thus the fact that there is a price range within which an exchange transaction would have become uneconomic for B2 but still be economic for B1 places B1 in a position to obtain for himself the gains resulting from the exchange by making the transaction economically impossible for his competitor. Since A would be acting uneconomically if he did not transfer his monopolized good to the competitor who is in a position to offer him the highest price for it, nothing is more certain than that the exchange transaction will take place between A and B1.
As concerns the second question (the limits within which price formation will take place), it is certain that the price that B1 will give A cannot reach 80 bushels of grain since at this price the transaction would lose its economic character for B1. Nor can the price fall below 30 bushels of grain. For price formation would then fall within the limits where the exchange transaction would still be advantageous for B2, who would therefore have an economic interest in competing until the price should again reach the limit of 30 bushels. In our case therefore, the price must, of necessity, be formed between the limits of 30 and 80 bushels of grain.
The effect of the competition of B2 is that price formation, in the exchange of goods between A and B1, will no longer take place between the wide limits of 10 and 80 bushels of grain, but between the narrower limits of 30 and 80 bushels of grain. For only if the price is fixed between these limits does an economic gain from the transaction accrue to A and B1 simultaneously with an economic exclusion of the competition of B2. The simple relationship of the isolated exchange thus reappears, the only difference being that the limits between which price formation takes place have become narrower.
Suppose now that the two previous competitors for A's horse, B1 and B2, are joined by a third competitor, B3. If the value of the horse to this third individual would be equal to 50 bushels of grain, it is clear from what has just been said that the transaction again will take place between A and B1, but the price will be formed between the limits of 50 and 80 bushels. If a fourth competitor, B4, appears, to whom A's horse would hate a value equal to 70 bushels of grain, the transaction will still take place between A and B1, but the price will be formed between the limits of 70 and 80 bushels.
Summarizing, we obtain the following principles: (1) When several economizing individuals, for each of whom the foundations for an economic exchange are present, compete for a single indivisible monopolized good, the competitor who will obtain the good will be the one for whom it is the equivalent of the largest quantity of the good offered for it in exchange. (2) Price formation takes place between limits that are set by the equivalents of the monopolized good in question for the two competitors who are most eager, or who are in the strongest competitive position, to perform the exchange. (3) Within these limits, the price is fixed according to the principles of price formation already demonstrated for isolated exchange.
B. Price formation and the distribution of goods when there is competition for several units of a monopolized good.
Suppose that a newly acquired horse would have a value to farmer B1, who has a large quantity of grain but no horses, equal to 80 bushels of his grain. To farmer B2 a newly acquired horse would have a value equal to 70 bushels of grain, to B3 60, to B4 50, to B5 40, to B6 30, to B7 20, and to B8 only 10 bushels of grain. A second horse would have a value, to each of these farmers of 10 bushels less than the value of the first, a third a value of 10 bushels less than the second, and so on, each additional horse having a value of 10 bushels less than the preceding one (provided in each case that an additional horse is needed at all). The essential features of this economic situation can be presented in a table.
If the monopolist A brings only one horse to market, it is certain that B1 will acquire it at a price somewhere between 70 and 80 bushels of grain.
But suppose that the monopolist brings not merely one but three horses to market. Which one (or which ones) of the eight farmers will acquire the horses brought to market by the monopolist and what price will be charged? It appears in the table that that a first horse acquired by B1 would have a value to him equal to 80 bushels, a second a value equal to 70 bushels, and a third a value equal to only 60 bushels of grain. In this situation, B1 would be acting economically if he were to acquire one horse at a price between 70 and 80 bushels, thereby economically excluding all his competitors from the exchange. But he would act uneconomically with respect to the second horse if he were to offer 70 bushels or more for it, since by such an exchange the satisfaction of his needs would not be better provided for than before. The economic situation in this case is therefore such that, on the one hand, B1 can exclude all his competitors from acquiring any of the three horses only by conceding for each of them a price of 70 bushels of grain or more, while, on the other hand, he can purchase only one horse economically at this price and would worsen his economic position if he were also to buy the other two at the same price.
Since we are assuming that B1 is an individual behaving economically, he will not exclude his competitors from the exchange purposelessly or to his own detriment. He will exclude them from acquiring quantities of the monopolized good only if he can obtain for himself an economic advantage that he would have to forgo if he were to permit the other competitors to purchase quantities of the monopolized good. In our case, therefore, where an exclusion of all competitors for the monopolized good is rendered economically impossible for B1 by the economic situation, he will find himself in the position of being obliged to let B2 participate in the purchase of quantities of the monopolized good. B1 as well as B2 will have an interest in seeing that the price is fixed as much below 70 bushels of grain as is possible in the given economic situation.
In these efforts, B1 and B2 will be limited by the competition of the other competitors, above all by that of B3. They will have to agree to a price at which the other competitors for the monopolized good will be economically excluded from the transaction. Thus, in the case of three horses, the price will be formed between 60 and 70 bushels of grain. At a price fixed between these limits, B1 could acquire two horses and B2 could acquire one, in each case economically, while all other competitors would, at the same time, be excluded from acquiring quantities of the monopolized good.
If A were to bring 6 horses to market, we could show by similar reasoning that B1 would acquire 3 horses, that B2 would acquire 2 horses, that B3 would acquire one horse, and that the price of a horse would be formed between 50 and 60 bushels of grain. If A were to bring 10 horses to market, B1 would acquire 4 horses, B2 3 horses, B3 2 horses, B4 one horse, and the price would be formed between 40 and 50 bushels of grain. If the monopolist A should offer still larger quantities of the monopolized good for sale, there is no doubt, on the one hand, that an ever smaller number of farmers would be economically excluded from purchasing quantities of the monopolized good, and on the other hand, that the price of a given quantity of the monopolized good would be pressed down to successively lower levels.
Summarizing what has been said, we obtain the following principles:
(1) The quantity of a monopolized good offered for sale by a monopolist is acquired by those competitors for it to whom the largest quantities of the good offered in exchange for it are the equivalents of the units of the monopolized good. The monopolized good is distributed in such a way that the quantity of the good given in exchange that is the equivalent of one unit of the monopolized good is equal for each of the purchasers of portions of the monopolized good (50 bushels of grain equal to one horse, for example).
(2) Price formation takes place between limits that are set by the equivalent of one unit of the monopolized good to the individual least eager and least able to compete who still participates in the exchange and the equivalent of one unit of the monopolized good to the individual most eager and best able to compete of the competitors who are economically excluded from the exchange.
(3) The larger the quantity of the monopolized good offered for sale by the monopolist, the fewer will be the competitors for it who will be economically excluded from acquiring portions of it, and the more completely will those economizing individuals be provided with it who would have been in a position to acquire portions even if smaller quantities of it had been offered for sale.
(4) The larger the quantity of a monopolized good offered for sale by the monopolists the lower in terms of purchasing power and eagerness to trade will he have to descend among the classes of competitors for the monopolized good in order to sell the whole quantity, and hence the lower also will be the price of one unit of the monopolized good.
C. The influence of the price fixed by a monopolist on the quantity of a monopolized good that can be sold and on the distribution of the good among the competitors for it.
(1) When a monopolist sets the price of a unit of a monopolized good, the competitors for the monopolized good who are excluded from acquiring quantities of it are those for whom one unit of the monopolized good is the equivalent of a quantity of the good offered in exchange that is equal to or less than the price of the monopolized good.
(2) Competitors for quantities of a monopolized good for whom one unit of it is the equivalent of a quantity of the good offered in exchange that is larger than the price fixed by the monopolist will supply themselves with quantities of the monopolized good up to the limit at which one unit of it becomes for them the equivalent of an amount of the good offered in exchange that is equal to the monopoly price. The quantity of the monopolized good that will be acquired by each of these competitors at each price set by the monopolist is determined by the foundations for economic exchange operations existing for each individual at that price.
(3) The higher a monopolist sets the price of a unit of a monopolized good, the larger will be the class of competitors for the monopolized good who are excluded from acquiring it, the less completely will the other classes of the population be provided with it, and the smaller will be the sales of the monopolist. Opposite relationships hold in the reverse case.
D. The principles of monopoly trading (the policy of a monopolist).
What does give a monopolist an exceptional position in economic life is the fact that he has a choice between determining the quantity of a monopolized good to be traded or its price. He makes this choice by himself and without regard to other economizing individuals, considering only his economic advantage. It is thus in his power to regulate price by offering smaller or larger quantities of the monopolized good for sale, or to regulate the quantity of the monopolized good traded by raising or lowering the price, always in accordance with his economic interest.
A monopolist will therefore raise his price, within the limits between which exchange operations have economic character, if he anticipates a greater economic gain from selling small quantities of the monopolized good for a high price. He will lower his price if he finds it more to his advantage to market larger quantities of the monopolized good at a lower price. He will also attempt to regulate quantities, which as an extreme example Menger takes the Dutch East India Company's custom of burning spice stockpiles instead of selling them. It was in that company's economic interest to restrict the total quantities in order to fetch a high price on the quantities headed for the market.
Menger summarizes: [...] we find that, for each quantity of a good that a monopolist decides to sell, the price is determined independently of his will; that, at each price that he decides to set for a unit of the monopolized good, the quantity is determined independently; that the distribution of goods is governed, in either case, in accordance with exact laws; and that the entire course of economic events is throughout not fortuitous but capable of being reduced to definite principles.
3. Price Formation and the Distribution of Goods Under Bilateral Competition
A. The origin of competition.
We would interpret the concept of the monopolist too narrowly if we limited it to persons who are protected from the competition by the state or by some other organ of society. There are persons who, as a result of their property holdings, or due to special talents or circumstances, can market goods that it is physically or economically impossible for other economizing persons to supply competitively.
The manner in which competition develops from monopoly is closely connected with the economic progress of civilization. The increase of population, the increased needs of the various economizing individuals, and their growing wealth, drive the monopolist to exclude progressively larger classes of the population from consuming the monopolized good, and permit him at the same time to drive his prices higher and higher. This economic situation is usually such that the need for competition itself calls forth competition, provided there are no social or other barriers in the way.
B. The effect of the quantities of a commodity supplied by competitors on price formation; the effect of given prices set by them on sales; and in both cases the effect on the distribution of the commodity among the competing buyers.
What will be the influence of larger or smaller quantities of a commodity offered for sale by several competing sellers on the price and on the distribution of the commodity among the competitors for it? Menger derives a new scenario from the earlier discussed horse monopolist and grain farmers.
Assume that there now are two competitors in supply, A1 and A2, and that together they have 3 horses for sale, A1 having two horses and A2 one. From what was said earlier, it is clear that in this case farmer B1 will buy 2 horses and farmer B2 one horse. The price will be between 60 and 70 bushels of grain, a higher price being impossible because of the economic interest of the two farmers B1 and B2, and a lower price because of the competition of B3. If A1 and A2 have six horses for sale, B1 will purchase three of them, B2 two, and B3 one, and the price will be between 50 and 60 bushels of grain, etc.
If we compare the price and the distribution of goods resulting from the sale of a given quantity of a commodity by several competing sellers with the situation observed under monopoly, we find a complete analogy. Whether a given quantity of a commodity is sold by a monopolist or by several competitors in supply, and independent of the way in which the commodity was originally distributed among the competing sellers, the effect on price formation and on the resultant distribution of the commodity among the competing buyers is exactly the same.
C. The effect of competition in the supply of a good on the quantity sold and on the price at which it is offered (the policies of competitors).
If competition in supply is to exercise any effect at all on price formation, total sales, and the distribution of a good among its competing purchasers, either different quantities of the good must be offered for sale or the competing sellers must find themselves obliged to set different prices under the regime of competition in supply than under monopoly.
Take Menger's example: A monopolist has died, and has left his holdings of the monopolized good and means of production to two heirs in equal shares. It is not impossible that the two heirs of the monopolist will, instead of competing with each other, operate as associates in a single firm and carry on a monopoly policy. If we suppose each of the two heirs to be determined to pursue the sale of the previously monopolized good independently, we have a case of real competition before us, and the questions to be considered are: what quantities of the previously monopolized good will now, in contrast to previously, be offered for sale, and what prices will be set by the two competitors? Let's turn to a new example.
Assume that a monopolist has 1,000 pounds of a monopolized commodity and that he can either sell 800 pounds at 9 ounces of silver per pound or dispose of the whole available quantity at 6 ounces of silver per pound. It is thus in his power to take 6,000 ounces of silver for the entire quantity of the monopolized commodity at his command, or to take 7,200 ounces of silver for 800 pounds of it. If the monopolist is an economizing individual pursuing his self-interest, the choice he will make is not subject to doubt. He will destroy 200 pounds of his monopolized commodity, permit them to spoil, or otherwise withdraw them from trade, and will offer only the remaining 800 pounds for sale - or, which amounts to the same thing, he will set his price at such a level that the same result will obtain. But if the 1,000 pounds of the previously monopolized commodity are divided between two competitors, this policy immediately becomes economically impossible for each of them. If one of the two were to destroy part of the quantity available to him, or if he were to withdraw it from trade in some other way, he would cause an increase in the price of a unit of his commodity. But never, or only in very rare instances, would he able to obtain a greater profit by doing so.
The first effect, therefore, of the appearance of competition in supply is that none of the competitors selling a commodity can derive an economic advantage from destroying or withdrawing from exchange a part of the available quantity of the commodity - or, which amounts to the same thing, from leaving the means of production available for its production unused. A second phenomenon of economic life that is peculiar to monopoly is also removed by competition: the successive exploitation of the various social classes that was mentioned in the previous section. We saw that it can often be to the advantage of a monopolist to market only small quantities of the monopolized good in the beginning at high prices and to sell to classes of people of successively lower purchasing power only by degrees, in order to exploit all classes of people in a stepwise fashion. This procedure is immediately rendered impossible by competition.
Whatever else may be the effect of competition on the distribution of goods and on price formation, it is certain that two of the socially most injurious out-growths of monopoly described earlier are removed by competition. Neither the destruction of part of the available quantity of a commodity subject to competition in supply, nor the destruction of a part of the factors serving for its production, is in the interest of separate competitors, and the successive exploitation of the various social classes becomes impossible.
But competition has still another, much more important, consequence. It is the increase of the quantities of a previously monopolized commodity that become available to economizing men. Monopoly usually causes only part of the quantity of the goods at the command of the monopolist to be offered for sale, or only some of the available means of production to be put to use. True competition always puts this malpractice to an end immediately. But competition usually has the further effect of increasing the available quantity of a previously monopolized commodity. Competition leads to large scale production with its tendency to make many small profits and with its high degree of economy, since the smaller the profit on each unit the more dangerous becomes every uneconomic waste, and the brisker the competition the less possible becomes an unthinking continuation of business according to old-established methods.