Re: Fear of Life (was Microsoft, Automation)

ChuckKuecker (
Mon, 4 May 1998 10:17:32 -0500 (CDT)

At 16:25 5/3/98 -0400, you wrote:
>We imagine that you make a variety of goods, and this demand curve
>represents the demand for all the different goods you might make in a
>competitive market. OK, now suppose you invent something new. The
>invention is a "sunk cost": it does not add to your marginal costs (see
>below) and so it does not change the shape of your supply curve. (This may
>not necessarily be true; making a sensor may be more costly the other goods
>which you make currently, or it may be cheaper. However, because the
>effect is ambiguous, we can presume that it doesn't change your supply
>curve. Even if it does, this doesn't affect my argument.) Nonetheless, it
>DOES increase the demand for your goods, since you now attract new buyers
>who want to buy your new product.

I agree that a 'sunk cost' does not add to production costs, but it sure
DOES affect my ultimate profits!

The 'sunk cost' needs to be covered BEFORE I can realize profits on my
invention. Otherwise, there is no point in the whole process - if I can
never recocver my R+D costs, why should I even think of creating something?

> |\_
> | \_
> | \_
> | \_
>Price |\_ \_ _/ <-- supply
> P**|--\_------\_/
> | \_ _/^\_
> P* |______\_/ | \_
> | _/^\_ | \_
> | _/ | \_ \_
> | _/ | |\_ \_
> |/ | | \ \ <--- new demand
> ---------------------------
> Q* Q**
> Quantity
>Where P** and Q** are the new price and quantity. As this graph shows, you
>reap increased revenues thanks to the invention, even under a market where
>you don't have copyright protection. To be specific, you reap extra
>revenues given by the trapezoid formed by the y-axis, the old price line,
>the supply curve and the new price line.

Only if the demand magically expands to suck up all I produce. Look at what
happened to DRAM makers recently due to huge increases in supply in a finite

>So what did I mean by externalities? Well, just as your firm will receive
>the money in that trapezoid, so will all other firms who produce
>"knock-offs." You will all EACH receive the quantity inside that
>trapezoid. Thus, invention has positive externalities on other suppliers.

How can all my 'knock off' competition also collect the SAME amount given a
fixed market? If there is the possibility of selling X products, and you
double the number of vendors, the profits available are X devided by each
competitor's market share. Anything else is a pyrimid scheme.

>Meanwhile, it IS worthwhile to pay for invention, even if the invention is
>not protected with a government monopoly, if the area inside your trapezoid
>is equal to or greater than the cost of invention. Indeed, the larger your
>stake in the market, the more worthwhile invention is.

That is true. As long as my profits exceed my costs, I will keep on
producing, regardless of competition.

>>If I set my prices arbitrarily high, I limit my sales to those for whom
>>money is no object. This is a very small market. If I charge a reasonable
>>price for my invention, based on its' costs and a fair payment to me for the
>>development, I should have more takers.
>Let's look at what you're saying economically.
>You correctly point out that if you set the price arbitrarily high, you
>won't have as many takers as if you set the price somewhat lower. I agree
>with this; monopolies do not get to set their own revenues, they only get
>to set the market price without worrying about competitors. So we imagine
>that you demand curve looks like this:
>Price |\__
> | \__
> | \__
> | \__
> | \__
> | \__
> | \__
> | \ <-- demand
> -----------------------------
> Quantity
>However, because you are the only source of this particular good, you
>represent the entire market for that good. This means that each time you
>want to increase quantity by one, you have to lower the price slightly. As
>a result, the marginal revenue (MR, or the revenue you get from selling one
>more of your product) for a monopoly is actually LOWER than the demand
>curve, and looks like this:

Why must I lower the price? Where is this rule posted? I don't see
Volkswagen, who has a 'monopoly' on their New Beetle, lowering the price
sequentially on each car they sell..

>The profit maximization rule for firms state that you should continue to
>produce goods until your marginal costs are equal to or greater than your
>marginal revenue; in order words, that you should make one more if the cost
>of one more is less than the revenues which it will make for you. A normal
>firm will find this point when the supply curve intersects the demand
>curve, because for most firms, the demand curve IS the marginal revenue
>curve. Monopolies, on the other hand, have a lower MR curve, and thus will
>set their quantity lower than a regular firm. Unfortunately for consumers,
>however, the PRICE a monopoly can charge for a given quantity is given by
>the demand curve, not by the marginal revenue curve. So what we see is
>that monopolies, when acting in such a way as to maximize their profits,
>will set prices higher than a competitive firm would, and produce a smaller
>quantity, thus:

I am going to excise the graphs in the interest of bandwidth. You know what
you drew..

Why does a monopoly have a lower MR curve? Just because you are the only
supplier, this does not affect the DEMAND for your product. Demand is quite
different from sales. Many might like to purchase a product but refrain
because the cost is too high. The demand is there, but sales lag. Once the
artificailly high price is lowered (and this DOES NOT mean that you sell
below cost!) the sales will increase. If you cut costs even further, sales
will increase to the limit of the real demand. If this happens before you
run out of margin and production capacity, you make lots of money. If you
run out of supply before you can sell everything demanded, the demand does
not disappear, but raising your price will surely cause more customers to
back off and wait..

>Where P* and Q* are the price and quantity which would be reached by a free
>market, and P and Q are the price and quantity which a monopoly would
>choose to maximize profits. (I recognize that it's hard to read... Try
>drawing it on paper or something.) When we keep in mind that the
>consumers' surplus is the area under the demand curve and above the price
>line, whereas the monopoly's surplus is the area above the supply curve and
>below the price line, it is clear that by setting the prices this high, the
>firms are benefitting at the expense of the consumers. Worse, we also note
>that because this quantity is lower than it would be under a free market
>there is "deadweight loss" (the wealth which would have been created if the
>market were free), represented by the area inside the triangle bounded by
>the demand curve, the supply curve and the quantity line. The part of this
>triangle above the price line is that surplus which would have been earned
>by consumers; the part below this triangle is that which would have been
>earned by firms. Firms will happily sacrifice this triangle, however, if
>they can gain the rectangle formed by the y-axis, the monopoly price, the
>quantity line, and the competitive price. The revenues in that rectangle
>outweigh the revenues in the triangle.

In a free market, will goods magically appear to fill all the holes? There
are going to be second order effects - lags in development, tooling, etc.
that will prevent the market from being fully satisfied at least in the
beginning of sales of a new invention. Some 'profit' will always be
unreaped. This 'loss' is an imaginary quantity, since there is no way to
EVER recover it, unless you posit 'thought to production' technology..

>This is why monopolies are bad: they are REALLY bad for consumers, since
>they go from reaping the entire area under the demand curve and above the
>competitive price line to only getting the much smaller area below the
>demand curve and above the monopolistic price line. Moreover, they are
>also bad for the wealth of society as a whole, because the deadweight loss
>represents commerce which COULD have contributed to economic growth for
>everybody, but won't, because the monopolistic firm is profit maximizing.

The monopoly is only bad for consumers if it refuses to listen to the
customer's wants and needs. If the company cares about it's customers, they
will adjust their products to fit what the amrket wants. If this is the
case, other firms will find ways to produce equivalent product that
sidesteps the patent, and satisfy the true wants of the market.

>So, to answer your point directly: Yes, you won't set your price
>arbitrarily high; instead, you'll set your price just high enough to
>squeeze profits out of the consumers at the expense of everybody else,
>hurting everyone by hurting the consumers.

See above. Personally, I am not a robber baron. I just want to keep OTHER
robber barons from profiting from my work until I can recover my 'sunk costs'.

>>In the case of our products, the market is fairly small and specialized. One
>>competitior stealing our ideas and undercutting us would ruin the whole
>>works for us.
>If your product isn't worth making under a competitive price, but is only
>worthwhile under government protection, maybe you should rethink whether
>the product is worth making at all.

If the competitive price is arrived at by allowing anyone who happens along
to steal my idea, I might as well stay out of the market.

>>The rewards are for the initial creation of the information, not knowledge
>>of same. You seem to be saying that the creators deserve no rewards for
>>their thinking!
>I don't understand what you're saying here. As you surely know if you've
>read my other posts on this topic, I DO think that creaters deserve rewards
>for inventing, I just don't think they deserve monopoly status on the idea.

It's pretty hard to reap profits BEFORE you sell a product, unless there's
some fairy godmother of a government agency that pays me for the
development, then lets anyone who cares to make the gadget! We have enough
handouts now!

>>>You still benefit from the invention in the form of the new market you've
>>>just created or in the increased demand for your products. The fact that
>>>your competitor will also benefit does not detract from this. Thus, so
>>>long as you still make a profit from the invention, it's still worthwhile
>>>to pay for it.
>>I beg to differ. As I stated earlier, if the market is small, you are
>>seriously harmed by knock-off competetion.
>Again, if you need the coerced profits in the rectangle in order to stay
>afloat, then maybe you should be rethinking the value of your product in
>general. And as I think I have shown, you DO benefit from invention, even
>when other people are allowed to compete with you for your products.

Again, you are confusing a limited supply with infinity! If there is a
demand for X products, and the knock-off guy can make them for less than I
can, because I have 'sunk costs' to amortize, I am dead. The customers will
naturally buy his product and pass mine by - after all, there is no
difference if his quality matches mine! If he makes a cheap imitation, I
still may be dead if he succeeds in selling long enough for me to starve to
death, or if he poisons the market.

I get no benefit from a given market if my costs prevent me from selling at
a profit. Period.

Chuck Kuecker