Some Questions (Especially for Students of Formal Economics)

by Don Boudreaux on July 29, 2014

in Competition, Economics

Suppose that consumers throughout history have grown their own apples.  Apples were never produced for sale in markets by specialized apple growers; nor did any household that grew apples in its yard sell those apples to anyone.  All apples that were consumed were grown by the individuals or households that consumed them.

Suppose also that each household’s minimum cost today of growing apples, when reckoned accurately in dollars, is $15 per pound.

Now, there arrives on the scene today an apple entrepreneur (call him Johnny) who, using his own special skills that he honed, enters the business of growing and selling apples.  Johnny’s cost of growing and supplying apples is $1 per pound – and his apples are identical in quality to those grown throughout history, and still grown today, by households.  And the scale of Johnny’s operation allows him to profitably satisfy large numbers of customers.

Johnny charges (let us say) $5.00 per pound for his apples.  Other people are free – in the sense of not being prevented by coercion – to enter the apple-selling business in competition with Johnny.  But at least for the time being, no one else has the skills to produce apples at any per-pound cost lower than $15 per pound.  So at least for the time being, Johnny is the society’s only specialized apple producer and seller.  And he is, as a result, making handsome profits!

Economists call Johnny a “monopolist” because Johnny has the power to raise the price of his apples a bit without driving away all of his customers.  If Johnny, for example, hikes the price of his apples from $5.00 per pound to $5.50 per pound, he will almost surely still be able to sell some quantity of apples.

Questions:

(1) Is Johnny really a monopolist in the negative-connotation-laden sense of that term?

(2) Would consumers today be better off had Johnny never been born (or had Johnny never discovered or honed his special talent for growing apples)?

(3) Would a maximum-apple-price regulation that prohibits the sale of apples at any price higher than (say) $2.00 per pound benefit consumers?

Let’s travel forward a bit in time.

Assuming that the government never interfered in the apple market, other entrepreneurs eventually enter into competition with Johnny, pushing the per-pound price of apples down to $1.00.  If Johnny now raises his price above $1.00 per pound, he loses almost all of his customers.

Johnny is disappointed that he no longer earns profits as hefty as he earned earlier.  So Johnny experiments and devises a new’n'improved apple – one that tastes better than any apple ever before grown.  Ignoring whatever costs Johnny incurred to develop this tastier apple variety, the per-pound cost to Johnny of producing these new’n'improved apples is $1.10.  And consumers like them so much that many consumers are willing to buy Johnny’s apples at $1.10 per-pound.

At first, Johnny charges just $1.10 per pound for his new-fangled apples.  But soon he raises his price to $1.50 per pound and discovers that, although the quantity demanded of his apples is lower at $1.50 per pound than it was at $1.10, he still has plenty of customers at the higher price.

Questions:

(4) Does Johnny’s innovation – a new’n'improved apple variety – harm consumers?

(5) Compared to the earlier situation in which all apples are identical and sell for $1.00 per pound, do you see anything in this newer situation deserving the name “deadweight loss” – the newer situation being the one in which many people voluntarily pay $1.50 per pound for Johnny’s new’n'improved apples (that cost Johnny only $1.10 per pound to produce)?

(6) Does the fact that Johnny can raise the price of his new’n'improved apples without losing all of his customers mean that Johnny possesses something deserving the name “monopoly power”?

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