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Judge Jackson's Bad Economics

Mises Daily: Thursday, June 08, 2000 by

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In proscribing the biggest corporate breakup since AT&T--and the most significant goverment intervention in high-tech to date--US District Judge Thomas Penfield Jackson harshly rebuked the software giant for stifling computer-age competition.

This ruling seems to be heavily influenced by the meaning of what market competition is all about. According to the popular view a proper competitive environment must emulate the perfect competition model.

In the world of perfect competition a market is characterised by the following features:

  • There are many buyers and sellers on the market
  • Homogeneous products are traded
  • Buyers and sellers are perfectly informed
  • No obstacles or barriers to enter the market

In the world of perfect competition buyers and sellers have no control over the price of the product. They are price takers. The assumption of perfect information and thus perfect certainty implies that there is no room left for entrepreneurial activity. For in the world of certainty there are no risks and therefore no need for entrepreneurs.

However, if this is so, who then introduces new products and how? According to proponents of the perfect competition model any real situation in a market that deviates from this model is regarded as sub-optimal to consumers' well being. It is then recommended that the government intervene in order to improve consumers well being whenever such deviation occurs.

Contrary to this way of thinking, competition does not stem from having a large number of participants in a particular market, but from a large variety of products in a particular industry. The greater the variety is, the greater the competition will be and therefore more benefits for consumer.

Now, once an entrepreneur introduces a product—- the outcome of his intellectual effort--he acquires 100 per cent of the newly established market. Following, however, the logic of the accepted way of thinking, this situation must not be allowed for it will undermine consumers' well being.

However, if this way of thinking were to be strictly adhered to, no new products would ever emerge. In such an environment people would struggle to stay alive. Once an entrepreneur successfully introduces a product and makes a profit he attracts competition. Notice that what gives rise to the competition is that consumers have endorsed the new product. Now producers of older products must come with new ideas and new products to catch the attention of consumers.

The US Justice Department demand that Microsoft must separate its browser from Windows 98 is an attempt to destroy product differentiation and enforce homogeneity in accordance with the misguided world of the perfect competition model.

However, by forcing homogeneity, government officials are preventing the introduction of new products. This in turn means that instead of promoting competition, this is what is generally believed, the government will paralyse the computer industry and eliminate competition altogether.

By combining its browser with Windows 98 the Microsoft offers a new product to consumers. How then can this new product be bad for consumers? After all if a consumer becomes dissatisfied with Microsoft's browser he always has the option to use browsers offered by other suppliers. Consequently it is consumers that must be allowed to express their judgment and not government officials.

The popular view that a producer that dominates a market could exploit his position by raising the price above the truly competitive level is erroneous. The goal of every business is to make profits. This however, cannot be achieved without offering consumers a suitable price.

It is in the interest of every businessman to secure a price where the quantity that is produced could be sold at a profit. In setting this price the producer entrepreneur will have to consider how much money consumers are likely to spend on the product. He will have to consider prices of various competitive products. He will also have to consider his production costs.

Any attempt on behalf of the alleged dominant producer to disregard these facts will cause him to suffer losses. Further to this, how can government officials establish whether the price of a product charged by a dominant producer is above the so-called competitive level?

How can they know what the competitive price is supposed to be? If government officials attempt to enforce a lower price this price could wipe out the incentive to produce the product. So again rather then improving consumers well being government policies will make things much worse.

Contrary to the perfect competition model, what gives rise to a greater competitive environment is not a large number of participants in a particular market but rather a large variety of competitive products. Government policies, in the spirit of the perfect competition model, are however, destroying product differentiation and therefore competition.

The whole idea that various suppliers can offer a homogeneous product is not tenable. For if this was the case why would a buyer prefer one seller on the other? (The whole idea to enforce product homogeneity in order to emulate the perfect competition model will lead to no competition at all). Since product differentiation is what free market competition is all about it means that every supplier of a product has 100 per cent control as far as the product is concerned. In other words, he is a monopolist.

What gives rise to the product differentiation is that every entrepreneur has different ideas and talents. This difference in ideas and talents is manifested in the way the product is packaged, the place it is sold the way it is offered to the client etc.

For instance a hamburger that is sold in a beautiful restaurant is a different product from a hamburger sold in a take away shop. So if the owner of a restaurant gains dominance in sales of hamburgers should he then be restrained for this? Should he then alter his mode of operation and convert his restaurant into a take away shop in order to comply with the perfect competition model? All that has happened here is that consumers have expressed a greater preference to dine in the restaurant rather than buying from the take away shop. So what is wrong with this?

Let us now assume that consumers have completely abandoned take away shops and buying hamburgers only from the restaurant, does this mean that the government must step in and intervene?

Consequently the whole issue of a harmful monopoly has no relevancy in the free-market environment. A harmful monopolist can only emerge when the government by means of licenses restricts the number of suppliers in a particular industry. By imposing restrictions and thus limiting the variety of goods and services offered to consumers, government curtails consumers' choices thereby lowering their well being. At minimum, Judge Jackson's decision, if implemented, will do that, and worse.

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Frank Shostak is chief economist at Ord-Minnett, Australia. Send him MAIL.