The Brand — The Surplus, Plate v

The terms of an exchange, the last plate showed, turn against whoever wants it more, so that the surplus flows to the party who can most easily walk away; and a seller who can make his product one of a kind, leaving his buyers nowhere else to go, has manufactured for himself exactly that advantage. This is no rare trick of the monopolist but the ordinary condition of nearly every seller in a modern economy, and the man who saw it whole was Edward Chamberlin. His subject was the great middle country of markets, neither the perfect competition where no seller has any power over his price nor the pure monopoly where one seller faces no rival at all, but the crowded terrain in between, where each seller differs a little from the rest and so commands a little power — power to capture a slice of the surplus, but power that the open door of entry turns, in the end, not into profit but into waste.

Set the two textbook extremes side by side, for the middle is defined against them. In perfect competition many sellers offer an identical product, and no one of them has the smallest sway over the price: a farmer who asks a penny more than the going rate for wheat that is indistinguishable from his neighbors' sells nothing, for every buyer simply turns to the next stall. Such a seller faces a price he cannot move, sells all he wishes at that price and nothing above it, and is driven by competition to price at the cost of one more unit — the outcome, the first plate showed, that wrings the greatest possible surplus from the market and leaves the seller no more than a normal return. At the other pole stands the pure monopolist, the sole source of a thing with no near substitute, who faces the whole market's demand himself and may hold back output to lift his price well above his cost, capturing for himself a swath of what would have been the buyers' surplus and destroying another swath in the trades his high price chokes off. The textbooks dwelt on these two cases. Chamberlin's insight was that almost no real seller lives at either pole.¹

1. The two textbook extremes define the middle. In perfect competition many sellers offer an identical product and none sways the price: a farmer asking a penny above the going rate for indistinguishable wheat sells nothing, every buyer turning to the next stall. He faces a price he cannot move, sells all he wishes at it and nothing above, and is driven to price at the cost of one more — the outcome that wrings the greatest surplus and leaves him a normal return. At the other pole the pure monopolist, sole source of a thing with no substitute, holds back output to lift price above cost, capturing a swath of buyers' surplus and destroying another in the trades he chokes off. Chamberlin saw that almost no real seller lives at either pole.

The reason is that real products are not identical. One baker's bread is crustier, another's is nearer the station, a third's comes wrapped in a name the customers trust; one barber is gentler, one cafe has the better light, one brand of soap has been pressed into the public mind by a decade of advertising. Each seller's wares differ from his rivals' — in substance, in location, in packaging, in reputation, in the mere familiarity of a name — and this DIFFERENTIATION, real or imagined, is the hinge of the whole analysis. Because his product is a little unlike the others, each seller has a body of buyers who PREFER it, who will not desert him for a rival the instant he raises his price by a penny, as they would if the goods were identical. He faces, in consequence, not the flat horizontal demand of the perfect competitor but a demand curve that slopes downward, gently, as his own: he can raise his price and lose only some of his custom, not all of it. That downward slope is a sliver of monopoly power — a small private domain, carved out of the larger market by the difference of his product, over which he alone presides. Chamberlin called the resulting world MONOPOLISTIC COMPETITION, and the name holds both truths at once: many sellers competing, yet each a little monopolist of his own brand.²

2. Real products are not identical. One baker's bread is crustier, another's nearer the station, a third's wrapped in a trusted name; one cafe has the better light, one soap a decade of advertising behind it. Each seller's wares differ — in substance, location, packaging, reputation, the familiarity of a name — and this DIFFERENTIATION is the hinge. Because his product is a little unlike the others, each seller has buyers who PREFER it and will not desert him the instant he raises his price a penny. He faces not the flat demand of the perfect competitor but a gently downward-sloping one: he can raise price and lose only some custom, not all. That slope is a sliver of monopoly power, a small private domain over which he alone presides. Chamberlin's name for the world: MONOPOLISTIC COMPETITION — many sellers competing, each a little monopolist of his own brand.

⁂

What does the seller do with his sliver of power? Exactly what the larger monopolist does, in smaller measure: he sets his price above the cost of one more unit. The downward slope of his private demand curve means that holding back a little output raises the price on all he sells, and the calculation that maximizes his profit lands, as it does for any firm with the least power over price, at an output where the price he charges exceeds the marginal cost of supplying it. The gap between the two is the mark of his market power and the measure of the surplus he captures — value that, in perfect competition, would have stayed with his buyers, now diverted into his own pocket by the simple fact that his product has no perfect substitute. This is the manufactured bargaining power of the previous plate made concrete: the differentiation, the brand, the loyal custom, are the devices by which the seller makes his buyers a little dependent, narrows their alternatives, and so turns the terms of every sale a little in his favor. Were the story to end here, monopolistic competition would be merely a diluted monopoly, the surplus quietly transferred from many buyers to many sellers. But the story does not end here, because the door stands open.³

3. What does the seller do with his sliver of power? What the larger monopolist does, in smaller measure: he sets price above the cost of one more unit. The downward slope means holding back a little output raises the price on all he sells, and profit-maximizing lands at an output where price exceeds marginal cost. The gap marks his market power and measures the surplus he captures — value that in perfect competition would have stayed with buyers, now diverted to him because his product has no perfect substitute. This is manufactured bargaining power made concrete: differentiation, the brand, loyal custom are the devices that make buyers a little dependent and turn the terms in his favor. Were that the end, this would be diluted monopoly. But the door stands open.

For unlike the pure monopolist, who is protected by some barrier — a patent, a unique resource, a franchise — the monopolistic competitor has no wall around his little domain. If his differentiated product earns him a profit above the normal return, that profit is a signal, and others answer it: new sellers enter with brands of their own, each carving out its own slice of preferring buyers, each drawing custom away from those already there. As entry proceeds, every incumbent's private demand curve shrinks inward — his share of the market thins, his loyal buyers grow fewer, the profit he was earning erodes. And entry does not stop until the profit is gone: in the long-run equilibrium of monopolistic competition, so many sellers crowd the market that each one's demand has shrunk just to the point where his price barely covers his average cost, and his profit above the normal return has vanished. The surplus he captured with his sliver of power, which looked like it would be his to keep, has been competed away by the press of newcomers attracted by the very profit it represented. He still prices above marginal cost; he still has his sliver of power; but he no longer earns anything for it.⁴

4. Unlike the pure monopolist, protected by a patent or franchise, the monopolistic competitor has no wall around his domain. If his product earns profit above the normal return, that profit is a signal: new sellers enter with their own brands, each carving out preferring buyers, each drawing custom away. Every incumbent's private demand shrinks inward — his share thins, his loyal buyers grow fewer, his profit erodes. Entry stops only when profit is gone: so many sellers crowd the market that each one's demand has shrunk to where price barely covers average cost, and profit above the normal return has vanished. The surplus his sliver of power captured, seemingly his to keep, is competed away by the newcomers the profit itself attracted. He still prices above marginal cost, still has his sliver of power — but earns nothing for it.

If the captured surplus is not kept as profit, where does it go? Into waste. Picture the firm at its long-run rest: its downward-sloping demand curve just touches its average-cost curve, price equal to average cost, profit nil. But a downward-sloping line can touch a U-shaped cost curve only along the curve's falling stretch, never at its lowest point — which means the firm produces at an output BELOW the scale at which its average cost would be least. Every firm in monopolistic competition runs, in equilibrium, with idle capacity it could profitably use if only it had the customers; there are too many sellers, each too small, each producing less than it efficiently could, each carrying the overhead of a scale it never reaches. This is Chamberlin's EXCESS CAPACITY: the standing waste of the differentiated market, the surplus that market power captured turning out to be neither pocketed by sellers nor enjoyed by buyers but simply dissipated in the inefficiency of a crowd of half-idle firms. Whether the waste is pure loss is the one question Chamberlin left honestly open, for the excess capacity is the price of VARIETY — the many brands, the choice, the differentiation buyers seem to want — and a world of fewer, fuller firms making fewer, plainer goods would run at lower cost but offer less to choose among. The surplus lost to too many sellers may be, in part, the surplus buyers gain from having so many to choose from.⁵

5. If the captured surplus is not kept as profit, where does it go? Into waste. At long-run rest the firm's downward-sloping demand just touches its average-cost curve, price equal to average cost, profit nil. But a sloping line can touch a U-shaped curve only along its falling stretch, never at the lowest point — so the firm produces BELOW least-cost scale. Every firm runs with idle capacity it could profitably use if it had the customers: too many sellers, each too small, each below efficient scale. This is Chamberlin's EXCESS CAPACITY — the surplus that market power captured dissipated in the inefficiency of half-idle firms. Whether it is pure loss Chamberlin left open, for the waste is the price of VARIETY: a world of fewer, fuller firms would cost less but offer less to choose among.

Edward Chamberlin charted the market as it actually is, between the poles of perfect competition and pure monopoly, and in doing so traced a third fate for the surplus. Because real products are differentiated, nearly every seller commands a sliver of monopoly power — a downward-sloping demand for his own brand, a body of buyers who prefer it — and uses that power, as any monopolist does, to price above the cost of one more unit and capture a slice of what would have been his buyers' surplus. But the open door of entry undoes him: drawn by the profit, newcomers crowd in with brands of their own until each seller's share has shrunk to where his price merely covers his average cost and his profit is gone. The captured surplus is not kept; it is competed away into EXCESS CAPACITY, the waste of too many firms each producing below its efficient scale — though that waste is also the cost of the variety buyers enjoy. So in the real economy market power is everywhere, the surplus is everywhere being captured and everywhere being dissipated, and pure profit is rarer than the textbook monopolist suggests. What remains is to measure how much power a seller has, to state the rule that would restore the lost surplus, and to ask how the surplus ought to be divided. The next plate is the control.