1 Andrew Doyle; DYLAND002 Tutorial Group: 8; Rudi Van Blerk ECO1010F Course Essay 02 May 2012

Word Count: 1167

Economic Opinions on Monopoly And of Their Local Relevance

The idea of a single producer or monopoly has held a controversial space in the study of economics from its outset. Adam Smith often referred to as the father of economics expressed his views on monopolies in 1776 in his book The Wealth of Nations (Library Economics Liberty, 2008). Smiths views speak of high levels of inefficiency and a loss in consumer benefit caused by this market structure. Two centuries later, the views of Joseph Schumpeter suggested that monopolies (despite their inefficiencies), play a necessary role in the economy, fueling creativity and product development (Nakamura, 2000). This essay will examine the economic opinions of Smith and Schumpeter on the monopoly market structure and the relevance of monopolies and their views on the South African Economy.

A monopoly is a market structure that has exclusive control of a commodity or service for a particular market. This control makes it possible for the single firm to manipulate prices and the quantity supplied (Investopedia, 2012). Monopolies can be formed by legal barriers that only allow one firm to produce a specific good, or through a natural monopoly where the market can only support one firm, where if another firm enters both will make losses (Philip Mohr, 2009). Through the manipulation of price and quantity, it is possible for a monopoly to make economic profit both in the short and long run, achieved by restricting quantity supplied and raising the price of each good sold (Nakamura, 2000). This behavior creates a loss in consumer welfare and is often viewed as inefficient in comparison to a more competitive market structure (Smith, 1776).

Adam Smith was a Scottish philosopher most famous for his writings compiled into a 5 book series, titled The Wealth of Nations. In this series he expressed his most coveted ideas on the invisible hand of market forces, the division of labor and rational self-interest leading to economic wellbeing (Library Economics Liberty, 2008). Throughout the book Smith also expressed his views on monopolies, arguing that they sell their commodities much above the natural price (Smith, 1776) through under stocking the market. Smith believed that this was a highly inefficient way of operating; disadvantaging the consumer greatly while offering the producer super-normal profits by engrossing the whole trade to themselves, (the producer) will be able to make very large profits. (Smith, 1776)

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Smith believed that the most effective way of operating for society would be through perfect competition, where producers would be forced to produce at the lowest price, which the sellers can commonly afford to take, and at the same time continue their business. (Smith, 1776) The market forces would then determine price and quantity of the good sold by these firms. Smith believed that because the invisible hand would regulate prices in the consumers interest, government regulation would not be necessary (Nakamura, 2000).

Although Smiths views were generally against a monopolistic market structure, he did concede that where a natural monopoly occurs, one producer would be most efficient. This is so provided that government regulated the monopolist to ensure they do not regulate supply and strip away consumer welfare (Nakamura, 2000).

Joseph Alois Schumpeter, born in 1883 was an Austrian-Hungarian-American economist and political scientist. Schumpeters most famous publication was arguably Capitalism, Socialism and Democracy (1943). Here Schumpeter spoke of what drove innovation by entrepreneurs, thus coining the term creative destruction (Library Economics Liberty, 2008). This term showed that, by opening up new markets and creating organizational development throughout the process, the economic structure would revolutionise from within thus destroying the old structure (Schumpeter, 1949, p. 83). In Capitalism, Socialism and Democracy, Schumpeter argued that economic change revolves around innovation and that an innovation-orientated market could provide better economic results than the invisible hand and perfect competition ideologies of Adam Smith (Eduardo Carroll Pol, 2006). Schumpeter is thus alluding to the fact that the greatest benefit of a capitalist system is that it rewards innovation by allowing the innovator to capture shortterm monopolistic profits. Schumpeter describes how innovation often creates temporary monopolies, allowing super-normal profits to be captured until they are competed away by rivals or imitators with a better product (Nakamura, 2000). Thus, where Adam Smith saw the monopoly profits as economic inefficiency and believed government should dismantle them in favor of perfect competition; Schumpeter argued that they were necessary to sustain a healthy dynamic economy (Carbaugh, 2006). Monopolies are prevalent in the South African Economy- some are formed by government

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legislation such as Eskom or Transnet, and others such as SAB (South African Breweries), manage to control almost the entire market despite competition. SAB dominates the South African beer market without any legal barriers to entry, and supplies 98% of the South African beer market each year. It thus operates as an almost uncontested monopoly. Despite being a monopoly, SAB is one of the toughest competitors around shrugging off the stereotype of inefficiency and wastage that are often associated with a monopoly structure. The firm is often considered one of the best-managed companies in South Africa. SAB has managed to keep the increase in the price of beer below the inflation rate, thus over the last 20 years halving the real price of beer. At the same time the company boasted a 740 million Rand pre-tax profit figure in the last fiscal year, a fair reward for innovation in Schumpeters views. One of the few complaints about the company is that despite their price rises being below the CPI, they could be considerably lower (McNeil, 1997). For many years Eskom has been a monopoly in the electricity sector due to government legislation. Eskom was granted the sole ownership of all power lines throughout the country and has had the choice of which independent power producers may enter the market and use their lines. Only in recent years has this been broken with independent power suppliers entering the market at will (Styan, 2007). Despite this Eskom still supplies 95% of South Africas power. In recent times Eskom has been under severe criticism. This criticism comes from the power shortages that have been occurring since 2007, but were most severe during the 2007/2008 period (City Press, 2011). During this period, companies in most sectors posted losses due to the power outages and South Africas GDP forecast was downgraded 20 points, from the government estimated 6%, to 4% growth (Bruggemans, 2008). These power outages clearly show Adam Smiths belief in monopolies being inefficient. In conclusion, Schumpeters and Smiths views, although somewhat conflicting, both have relevance within different sectors of the South African economy. In the case of SAB, due to innovation and efficiency, they have been able to keep their monopoly status and gained the rewards of supernormal profit. On the other hand Smiths views apply more to Eskom where the monopoly status is allowing the firm to operate inefficiently, and still make supernormal profits, while consumer welfare is lost in the process. Therefore, the consumer would be better off in a competitive market for electricity.

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Reference List
Nakamura, L. I. 2000, 06. Economics and the New Economy: The Invisible Hand Meets Creative Destruction. Retrieved 05 2012, from FEDERAL RESERVE BANK OF PHILADELPHIA: http://www.philadelphiafed.org/research-anddata/publications/business-review/2000/july-august/brja00ln.pdf Schumpeter, J. A. 1949. Capitalism, Scoialism & Democracy. In J. A. Schumpeter, Capitalism, Scoialism & Democracy (pp. 87-106). Routledge. Smith, A. 1776. AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF NATIONS. Investopedia. 2012. Monoploy Definition. Retrieved 05 2012, from Investopedia: http://www.investopedia.com/terms/m/monopoly.asp#axzz1tYwbGzT3 Eduardo Carroll Pol, E. P. 2006. An Introduction to Economics with Emphasis on Innovation. Innovation Planet. Philip Mohr, L. F. 2009. Economics for South African Students (Vol. 4). (D. Venter, Ed.) Pietermaritzburg, South Africa: Van Schaik Publishers. Library Economics Liberty. 2008. The Concise Encyclopedia of Economics: Joseph Alois Schumpeter. (D. R. Henderson, Ed.) Retrieved 05 2012, from Library Economics Liberty: http://www.econlib.org/library/Enc/bios/Schumpeter.html Library Economics Liberty. 2008. The Concise Encyclopedia of Economics: Adam Smith. (D. R. Henderson, Ed.) Retrieved 05 2012, from Library Economics Liberty: http://www.econlib.org/library/Enc/bios/Smith.html Styan, J.-B. 2007, 12 04. Eskom loses power monopoly. Retrieved 05 01, 2012, from Mining MX Higher Grade: http://www.miningmx.com/news/energy/Eskom-losespower-monopoly.htm Bruggemans, C. 2008, 01 28. The Column: 3 phase electricity. Retrieved 05 01, 2012, from FNB: https://www.fnb.co.za/economics/servlet/Economics?ID=3350 City Press. 2011, 05 29. Load shedding only as a last resort. Retrieved 05 01, 2012, from City Press: http://www.citypress.co.za/SouthAfrica/News/Load-shedding-only-as-alast-resort-20110528 Carbaugh, R. J. 2006. Contemporary Economics: An Applications Approach (Vol. 4). Cengage Learning. McNeil, D. G. 1997, 07 27. A 14-Brand Monopoly Takes 98% of Sales. Retrieved 05 2012, from New York Times: http://www.nytimes.com/1997/08/27/business/a-14-brandmonopoly-takes-98-of-sales.html?pagewanted=all&src=pm