Okay, I'm having a discussion with a socialist/statist about the free market, monopoly, and anti-trust laws (repeal them!). I'm getting to the point where my austro-libertarian knowledge is incomplete. He says:
It is a major financial commitment for a startup to stock and staff a store. As soon as they do, bang! Down the prices go down the street! Is it "peaceful" to attack competitors with your superior economic strength? If you think it is, then you must agree with my contention that free markets will always end up with a very few dominant players is correct, because that is the inevitable result. Do you think that the best interests of society are served when a dominant business can dictate prices and drive out competitors?
How do I respond to this?
Matthew:How do I respond to this?
He's talking about "predatory pricing." It's true he has no understanding of business, entrepreneurship or economics. Send him a copy of the rest of this post:
People will say things like "once they've got a foothold in a community, what's to stop them from raising their prices, too? Absolutely nothing." That's why this old and popular myth of economics is known as "predatory pricing." Sounds scary right? You know this one. It's basically the idea that a big firm that can afford to sell products at a loss for a while (i.e. for less than they paid for them) will drop their prices so low that smaller firms will be driven out of business. After the competition has been forced out of the market, the predatory firm raises its price, compensating itself for the money it lost while it was engaged in predatory pricing, and earns monopoly profits forever after. Sounds logical right? The problem with this is, it doesn't work economically...and (therefore as you would expect) there are virtually no examples of this occurring. There has never been a single clear-cut example of a monopoly created by so-called predatory pricing, let alone one in which prices were raised drastically and customers were "gouged." Claims of predatory pricing are typically made by competitors who are either unwilling or unable to cut their own prices. And as I stated, this is not just a situation in which we have no examples...it economically doesn't work...and has been shown for decades to not work. Here's a short video that tells a really great story of when a big firm tried predatory pricing against a very smart fellow whose name you've probably heard of.
For anyone interested in the actual economics of the theory, I've provided several resources below, some of which actually contain references to dozens more. But for the Cliff's Notes kids, I'll just offer some highlights just for those interested (my comments are in italics in the brackets):
And he actually goes on and on. Another big one is the concept of brand reputation. If every time a new competitor pops up, you drop your prices to compete, and then the competitor disappears, and you jack up your prices, how long will it take before people just won't shop at your store? There is a lot to be said for reputation and brand loyalty. If the choice is between a new place that is giving good service and reasonable prices that stay reasonable, people will choose that over a quixotic price changer pretty darn quick. If you're interested in more reasons why it never works, I highly recommend following the links to sources #1 and #3. Reisman goes into great detail, but provides very simple, easy to understand examples. 1 - DiLorenzo, Thomas J. 1992. “The Myth of Predatory Pricing,” Policy Analysis No. 169. Cato Institute; http://mx.nthu.edu.tw/~cshwang/teach...03-06-monopoly and profit/DiLorenzo=THE MYTH OF PREDATORY PRICING.pdf 2 - Anderson, William L. 2003. "Pounding Square Pegs into Round Holes: Another Look at the Neo-Classical Theory of Predatory Pricing." The Quarterly Journal of Austrian Economics, Vol. 6, Spring; http://mises.org/journals/qjae/pdf/qjae6_1_2.pdf 3 - Reisman, George. 1998. Capitalism: A Treatise on Economics. Ottawa, IL: Jameson Books. pp. 399-407; http://www.capitalism.net/Capitalism...M_Internet.pdf 4 - http://mises.org/daily/226 5 - Isaac, R. Mark, and Vernon L. Smith. 1985. “In Search of Predatory Pricing.” Journal of Political Economy 93: 320–45.
He forgets one of the most elementary aspects of capitalism: credit! There's no such thing as superior economic strength. If there's money to be earned, a new competitor can borrow money.
This is the kind of thinking of one who:
A) Has never run a business
and
B) Thinks low price is the only way to compete
Unless you find a new way to create a good with less expense than a major corporation, you can't win on the front of low price.
The solution is to find a "niche" or specific way to sell to your market. Better marketing, different products, positioning, etc.
Frankly, the market doesn't care who is a big business or a small one. You either learn to channel and use the demand of consumers, or you flop. Pretty simple.
A big business may dominate a section of the market. Fortunately, there are many sections. Trying to dominate them all would be far and beyond the budget of any company. I actually suggest reading Positioning: The Battle For Your Mind by Al Ries and Jack Trout. Shows you how a business can enter the market strategically and even use the size of their competitor against them.
I would imagine if an entrepreneur sees that a market is there he'll start a business. If the evil big business lowers prices then consumers win. If the process repeats consumers win again. Even his straw man argument doesn't sound so bad to me.
Ask him to first summarize what Rothbard says here [in section (4) “Cutthroat” Competition] about why it is a non issue, then to explain why Rohbard is wrong.
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It's easy to refute an argument if you first misrepresent it. William Keizer
Ask him why this doesn't happen now. The regulators (FTC/DOJ) don't see a case for every new store that opens in a market, so "predatory pricing" if possible, is still profitable. Especially regarding smallish businesses, they never get accused/taken to court over monopolistic pricing--it just isn't profitable for the courts to do so.
Tell him to go read Kevin Carson.
Big businesses do dominate the market... with the help of the State. And it is no surprise that prices go down when a new competitor enters the market, elementary economic theory predicts that this should happen. Businessmen cannot blindly plan as if their entrance into the market will not affect the market. If burgers are selling for $5 you cannot build your business plan so that it will fail if you cannot sell your burgers for at least $5. You need to be able to survive even if burger prices fall to $4.50 or $4 and this is the role of capitalization and part and parcel of why capitalism is so important. The businessman with a good idea and a good reputation can seek to partner with venture capitalists with an appetite for risk in search of returns. If he's sufficiently capitalized, he will be able to withstand market downturns or even organized attacks.
The most important point is to remember that "attacking" competitors with low prices, in a free market, is a recipe for bankruptcy. Selling below the optimal price results in losses not greater profits. The established player already has the advantage against the newcomer by virtue of the fact that he is operating in the black where the newcomer is almost invariably operating in the red. The established player is giving up that advantage if he slashes prices to "attack" the newcomer. A properly capitalized newcomer will be able to leverage such suicidal behavior to gain market share that much faster.
But when big business is holding hands with the State it has a partner with unlimited funds. Competition against an opponent with unlimited funds determined to drive any newcomers to bankruptcy through price wars is impossible. Wal-Mart's market cap is just $187 billion. That's just 10 days of US Federal government spending. I would much rather compete against Wal-Mart without the Feds than against a much smaller company with the Feds on their side.
Clayton -
Is the expectation of a price war a barrier in the market that keeps competitors out? For example, a company is the only provider of electricity to a small rural town, and can therefore demand monopoly prices. What keeps competitors out is the cost of building another landline. But competitors want to get some of those high profits too, so the first company can never raise prices above where it would be worthwhile to build another landline. But...! if they actually do that there would be a price war and neither company would make a lot of profits. Which means that building another landline is unlikely to be worth the cost. But the first company knows that, so it is free to raise prices as much as it wants.
So you pay higher prices for the increased burden it takes to get electricity or phone or cable services out to your middle-of-nowhere area. So what?
Why in the world should someone who chooses to live somewhere that it is more difficult to get services to him not have to shoulder the cost of getting those services? If you don't want to pay more, go live somewhere closer to what you want to buy. You don't want to pay $5/gallon for gasoline? Then don't live in Hawaii.
By the same token, if you want the benefit of lower prices from competition, don't live in a small town where there's one grocery store, one repair shop, and one appliance store. Hell. You're lucky those services are even there at all. Plenty of people have to drive for an hour or more just to get to a store of any kind.
Lots of great replies here. Thanks to all for the information.
I don't think I'll ever convert this socialist, but maybe the next one...
BTW I am not familiar with the verify answer system. I picked the one with the most information, but the others were good too.
What about the example of an organisation producing chairs within a town and then a big importer business opens up in town and starts selling chairs. They are importing the chairs from china and selling them by the 1000s. The local chair seller struggles to compete and goes out of business.
Another example is where you have two shops right next to each other selling the same thing and due to one being a franchise they can sell beer and other products cheaper. The non franchised one goes out of business.
So not necessarily "big business" but just improved production, distribution and logistics, this can cause a reduction in cost without any loss in quality. For the consumer cheaper prices and better products is a good thing, but it does happen in today’s society and people do lose their businesses.
Why would he assume government beurocrats would do better than a private ubercompany? Had that been the case, we'd all be writing in French here, and New York would be Nouvelle Marseille.
John James:So you pay higher prices for the increased burden it takes to get electricity or phone or cable services out to your middle-of-nowhere area...
Yes, I know. You don't have to give me the rhetoric. I was asking whether this dilemma has a free market solution, like the predatory pricing one. Making it about rural electricity lines is just a way to easier illustrate the point. We can use any business instead. Say a cornflakes manufacturer has some natural advantage over it's competitors, so there is a slight barrier to entry and he has a large market share. In on itself that's nothing bad, people still get the best deal. If he tries to exploit his position beyond his natural advantage, others will compete with him because they want a piece of the pie. So the story goes. But, and here comes my question, competitors know that once they compete with him there will be a price war and not a lot of profit to be had, won't that act as a barrier to entry?