Friday, May 06, 2005

There's no such thing as a free...market

I'm catching up on my e-mail after a long day, and the Foundation for Economic Education's daily "In Brief" newsletter alerted me to this in the Washington Post. Looks like Don Luskin (via Jill Olson) linked to this, and many others probably did too, but I'll offer my own thoughts.
A gasoline price war erupted in St. Mary's County last week after one station slashed its price for regular to $1.999 a gallon and spurred three others to follow suit, giving drivers some hope of relief at the pump.

But the price dip proved fleeting. Maryland regulators quickly stepped in and told the stations that their prices were too low. They needed to go up by 5 cents.

In as much time as it takes to fill the tank of an SUV, prices at BJ's Wholesale Club, Sheetz and two Wawa outlets bounced to $2.049 a gallon.

The sudden fluctuation in the Lexington Park area was the result of a little-noticed Maryland law that took effect in 2001. The General Assembly mandated that stations cannot charge less than what they pay for gas -- unless they're lowering prices to compete with a nearby station.

Independent service station owners pressed lawmakers for the measure as a way to protect themselves from big retailers selling gas below cost to drive them out of business and limit competition. Maryland is one of at least 13 states to adopt similar laws, which are not in effect in the District or Virginia.
Those business who cannot compete instead call upon the power of the state to make others uncompetitive.

Let a business sell below cost, if it wants to. I don't mind predatory pricing because it increases my personal consumer surplus, at least until the business has to raise prices so that it returns to profitability. Historical evidence shows that a big business, once it "prices out" its competitors and achieves monopoly power, cannot really increase its prices. Cannot, not just won't. Contrary to popular wisdom, Standard Oil established and maintained its monopoly not so much with predatory pricing as it did through corporate spies, bribery of popular officials, and outright fraud. Even so, Standard Oil couldn't charge whatever it wanted for petroleum.

Barring corporate espionage, bribery and fraud, higher prices will diminish sales. Higher prices also encourage the entry of new competitors (or old ones). Competitors know that the big business can't outprice them forever, and they can break the big business' back if they have enough financial backing to survive the price war. Also, higher prices encourage competitors to sell substitutes, particularly substitutes that previously were too expensive.

Let's say X's natural market price is $1 per unit. Y would sell for $1.10 per unit, so since it can't compete, nobody bothers to produce it. But if X's producer thinks, "Aha, we're a monopoly" and raises the price to $1.50, others will start producing Y to sell very competitively at $1.10. This is because a monopoly is not the same thing as market power, and indeed it's extremely difficult to attain real monopoly power without some sort of government-backed monopoly.

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