Economic Reasoning, Lecture 2 with David Gordon - Mises Academy
Economic Reasoning, Lecture
The Austrian Method and How It
Applies to Competition and
Monopoly, Part 2
●Judged by the quiz, I didn’t succeed fully in
showing how easy the Austrian view of utility
●When you have money, you have to decide
which products you want to buy.
●When you buy something, you will buy a
particular amount of it. You will buy a pound
of apples or one car, not “apples” or “cars”.
●How do you decide what to buy? You rank
the different products available to you. The
rank depends on how you value what you can
do with the products. Then, you will spend
money on your list, until your money runs out.
You will pick your highest ranked product first,
then go down the list.
●This ranking is what we mean by “utility”. Its
ranking on your list is a good’s utility to you.
Units of a Good
●There is one more thing we need to know to
●If you keep buying more of the same product,
the new units will rank lower on your list.
Why? Because you will use each unit you buy
for the highest valued goal then available on
your list. As you buy more units, you will
reach a lower-ranking goal.
●This principle is called the law of diminishing
marginal utility. It applies to money too.
The Basic Mistake
●We can determine how much pain we are
feeling, at least roughly. E.g., a doctor can
ask you to estimate how much pain you feel
on a 1 to 10 scale.
●We might construct a scale like that for how
happy we feel, going from, e.g., being mildly
in a good mood to being ecstatically happy.
●Jeremy Bentham used the word “utility” to
mean scales of pleasure and pain.
The Mistake Continued
●This is not what we mean by utility in
●All we mean by utility is how you rank
your goals, or the products that enable
you to reach these goals.
●Your goals can include getting pleasant
feelings and avoiding pain, but they
don’t have to.
The Mistake Concluded
●When people say you can’t measure
utility, this is often misunderstood. You
should not think that means there is
something there to measure, but we just
can’t do it.
●There is nothing to measure. It’s not
that we can’t find the right unit of
measurement---there is no unit. All that
●It’s important to understand the Austrian
view of utility because the neoclassicals
take a different view. This is one reason
their view of competition differs from the
●First we have to look at prices. Suppose
you are trying to sell something, e.g., a
bucket of golf balls. What price should
●Suppose you select a price. If you lower your
price, you will sell either the same amount or
more. You won’t sell less.
●Why? People can use money to buy other
things. At a higher price, they have to give up
more other goods.
●Some goods are more responsive to price
changes than others. Goods that are very
responsive to price changes have an elastic
demand curve. Those that aren’t have an
inelastic demand curve. The demand for salt
Prices and Monopoly
●Suppose there is only one seller of a good. I
own all the golf balls. When I set a price for
them, I estimate how much people will buy at
each price. I compare my estimate of what I
will make with the costs of selling the golf
balls at that price.
●If the demand curve is inelastic in some
range, I can raise the price and make more
Prices and Monopoly
●If I do that, then the price I am charging will
be above my costs. If there were other firms
competing with me, then I couldn’t raise the
price. If it tried to do it, the other firms would
take my customers away.
●Is monopoly bad? Neoclassical economists
say it is. They say that when prices are above
costs, you can increase utility by lowering the
The Neoclassical Argument
●You might think that the neoclassical
argument is obviously wrong. If you can’t
measure utility, how can you say that utility
has gone up?
●But the neoclassicals have an answer to this.
They say that without measuring utility, they
can still show that the monopoly price has
lower utility than the competitive price. This is
called the “deadweight loss” from monopoly.
The Austrian Response
●The neoclassical arguments depend on
knowing how much of a good would be
demanded at various prices, and what the
cost of supplying the good at that price would
●In my example, we would have to know how
many golf balls I would sell at my price when I
am the only seller. We would have to know
how many golf balls would be sold at the
lower, competitive price. We would also have
to know the costs of supplying the golf balls at
The Austrian Response
●How could we find out these things? All we
know is the actual price and cost, and how
much is bought at that price. Estimates of
other prices are at best speculative. Also,
even though the neoclassicals say they aren’t
trying to measure utility, they seem to be
taking utility to be more than just ranking of
●Suppose the neoclassical argument is
correct. So what? Why should we demand
that the market meet the ideal of increasing
Ethics and Economics
●It’s extremely important to keep ethical
judgments, views about what should be the
case, apart from judgments of what is the
●In the Austrian view, competition exists so
long as there is free entry and exit into an
industry. We don’t impose requirements on
the market. George Reisman calls the
neoclassical position “Platonic competition”.
●But isn’t it obvious that an increase in total
utility is a good thing? Even if it is an ethical
judgment, isn’t it a non-controversial one?
●Is the view that we should always act to
increase utility really non-controversial? We
can say that if people give each other
presents, there is a deadweight loss from
presents that people don’t like. We could
eliminate this deadweight loss if people just
gave instead of a present the cash they
intended to spend. It isn’t obvious this would
An Important Distinction
●If something has good consequences,
that gives you a reason to do it; and if it
has bad consequences, you have a
reason to avoid it.
●But these are not conclusive reasons.
Other reasons can override them, e.g.,
people’s rights. Neoclassical
economists often take for granted the
The Neoclassicals and
●There are not many cases of monopolies.
Most products have more than one seller. But
the neoclassicals have extended their
concept of deadweight loss far beyond
●They say that in order to eliminate
deadweight loss, there must be an extremely
large numbers of firms that sell the identical
Pure and Perfect Competition
●In this situation, the seller can sell any
amount he wants at the market price. He is a
price taker, i.e., he has no influence at all on
the price. The demand curve facing each
seller is perfectly elastic, i.e., it is a horizontal
line. If he raises his price, he will lose all his
business. His price isn’t above his costs, so
he won’t lower it.
●This is called pure competition. If we add that
all the people in the market have complete
knowledge of prices and quantites, then we
Problems with Perfect
●Almost nothing qualifies as perfectly
competitive. Agriculture is probably the
●The perfect competition model has
major problems. If everyone is a price
taker, where does the price come from?
It must be set by someone.
●Also, demand for the whole industry
can’t be perfectly elastic. Some people
would want the product, even if the
price were to rise. But you get the
industry demand curve by adding up the
demand curve for each firm, which is
●This is a contradiction.
●Since almost nothing qualifies as perfectly
competitive, neoclassicals need to have an
account of the rest of the economy. Some
members of the Chicago School, such as
Milton Friedman, think that the actual
economy isn’t too far away from perfect
competition. (Remember, Friedman doesn’t
think a model must have completely true
●Aside from monopolies, the structure of the
market is either monopolistic competition or
●In monopolistic competition, there are many
firms, but each has a slight influence on price.
The firms aren’t price takers.
●The products are slightly different, e.g.,
brands of toothpaste.
●In the neoclassical view, each firm has a
slight degree of monopoly power, because it
isn’t a price taker. Monopolistic competition
theorists often criticize advertising as a
wasteful effort to show that a product is
different from what close competitors offer.
●An oligopoly has a few very large firms
that compete with each other.
●Each firm has a great deal of influence
●Each firm must try to estimate what its
rivals will do when it decides on prices
The Austrian View
●Once again, the Austrian view of
competition is much simpler than the
●We don’t have to worry about market
structure at all. Whatever people freely
decide to do counts as competitive.