“What happens then?”

A friend called me to catch up on stuff. He decided to play “Ask the Economist” and fired off a handful of questions. They started out with the typical finance related questions, where should I put my money etc. I had to go into the whole thing about not being an accountant or finance person, that I was studying economics. So he asks where the economy is going and I tell the only truthful answer, nobody knows. Think about it, how many of the talking heads on tv or the radio have their life savings into whatever they think is going to happen with the economy? Why aren’t all the people calling for economic ruin because of the falling dollar shorting the dollar in currency markets? They should make a fortune if they actually knew what was going on. They don’t really know they’re just taking their best guess, it’s all anyone can do.
My friend then went on to something a little more interesting. “There’s only 3 cell phone companies now, what happens when they get down to one, what then?” Like so much of economics, the answer is pretty straightforward with a little thought. If, through mergers and acquisitions there was a single cell pone service company left, what would happen to rates? What would happen to service? The conventional wisdom is that once there is no competition, the company would jack up its rates and really “take advantage” of consumers. Here’s the thing, companies have to compete with both actual and *potential* competitors. If people see that a company is really raking in the dough, you can be sure that another company will come along for a piece of the pie. The lone company has an incentive to keep rates low to prevent competitors from starting up. They will of course try to split the difference between what they would charge in a competitive market with what they can as a monopoly, but the rates shouldn’t go up as high as you’d think. If they do, it will only be temporarily, another competitor will take up the slack eventually.
What about monopolies, they’re bad right? Well, there are two different types of monopolies. The first one is a natural monopoly. this is one that has some sort of “natural” advantage over their competition such that no one else can compete with them. The second type is the one granted by governments. Natural monopolies are incredibly rare, I don’t think there can be one over the long haul. Competition always finds a way to eventually break into the market or to innovate a new product that will be a substitute for the monopolist’s product. Government granted monopolies are typically the poster children of wasteful, inefficient organizations. many argue that these are the only “true” monopolies that exist. The government will either charter a single company for some service, pass laws preventing entry into the sector, or a combination of the two. This looks pretty bad for consumers, and it is. There is a silver lining though, even if the law forbids direct competition, businesses have the incentive to pursue that potential profit. They do so by innovation, they create products that can be substituted for the monopolized product. A perfect example is cable TV. Local governments grant small scale monopolies in that area to particular cable companies. For the length of the contract, another cable company cannot compete for that market. Satellite dishes were created in order to get around the government granted monopolies. Now people have a choice, and it keeps both companies on their toes… The moral of the story is that profits are what cause companies to innovate, and it’s what, ironically, will cause companies to keep their prices in check.


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