Additionally, “natural” monopolies (as opposed to government-instituted monopolies such as Bell) such as Standard Oil -didn’t- underproduce. They can’t afford to.
I find this difficult to believe. Consider the most extreme example of a natural monopoly: a software company. The marginal cost is $0. This isn’t quite realistic, but let’s assume for the sake of argument that everyone wants what they produce at least a little. In order to not underproduce, they’d have to give everyone their product. Unless they have some way of distinguishing people who are willing to pay $10 from people who are only willing to pay 1¢, they can’t charge more than 1¢ without underproducing, but this won’t give them enough money to offset the cost of producing the product.
Underproduce: A potential customer is willing to buy something for more than the cost to produce it, yet the thing isn’t produced.
A monopoly gets to choose what price it offers to sell its goods at. If it raises its price, it gets fewer buyers but makes more money per buyer. The profit-maximizing price point is usually not equal to marginal cost, which means that the price will be too high for some people that could have been profitable customers (if not for the fact that selling to them would require the monopolist to make less money from everyone else).
That definition, if minimized, leads to economic waste, because it fails to reflect opportunity costs.
To illustrate with an example, my absolute favorite soda of all time is Mountain Dew Pitch Black II. It is also one of the most hated flavors among most people I’ve met who tried it.
There exist sufficient customers who like Mountain Dew Pitch Black II for Pepsi to make a profit producing it. Are they losing money by not producing it?
As it transpires, no. There exist -many more- customers for -other- flavours of soft drink Pepsi could be producing. Pepsi doesn’t have unlimited manufacturing capacity; they use the same equipment to produce a wide range of drinks. The opportunity cost of producing Mountain Dew Pitch Black II is that they -aren’t- using that equipment to produce a more popular flavor. So I’m out of luck, and the limited run is all they produced. (There was a Pitch Black I and a Pitch Black III, neither of which I had opportunity to try; Pitch Black III had an even more limited run than Pitch Black II.)
Producing Pitch Black II would be a -waste of resources-, in spite of the fact that it could be profitably manufactured. In terms of utility, it is a suboptimal utility-maximizing strategy.
So if we’re using underproduction as some kind of moral yardstick, I think it’s rather flawed, on account that we wouldn’t actually prefer the universe in which underproduction didn’t happen.
That definition, if minimized, leads to economic waste, because it fails to reflect opportunity costs.
Sorry. In the context of microeconomics, “cost” usually means “opportunity cost” and I didn’t realize I needed to say this explicitly. Dollar costs are usually a pretty good proxy for opportunity costs in many cases, though...
If cost includes opportunity cost, your entire second paragraph ceases to be meaningful, because the cost would necessarily include the opportunity cost of not having priced the good higher and made higher profits. Using opportunity cost as your cost means this kind of underproduction is impossible; your marginal cost is whatever cost would result in the maximum profits.
Your entire post consists of explaining the meaning of an assertion, rather than explaining its basis. Why would you think that “cost” does not include opportunity cost?
And I don’t see why it’s accurate to say the Pepsi doesn’t have unlimited manufacturing capacity. Yes, their current manufacturing capacity is limited, but you didn’t give any explanation for why they can’t build more equipment. Without such an explanation, this makes as much sense as saying that it wouldn’t be profitable for me to run a home bakery business because there amount of flour in my house is finite.
The cost to build special equipment for this Pitch Black might be covered the absolute sales of Pitch Black, but it is doubtful that it would cover the slight increase in sales vs standard Mountain Dew—I imagine that Pitch Black drinkers would buy less standard Mountain Dew (or, failing that, other Pepsi products) if Pitch Black were available.
I find this difficult to believe. Consider the most extreme example of a natural monopoly: a software company. The marginal cost is $0. This isn’t quite realistic, but let’s assume for the sake of argument that everyone wants what they produce at least a little. In order to not underproduce, they’d have to give everyone their product. Unless they have some way of distinguishing people who are willing to pay $10 from people who are only willing to pay 1¢, they can’t charge more than 1¢ without underproducing, but this won’t give them enough money to offset the cost of producing the product.
There’s something slippery going on in the word “underproduce.” Would you mind tabooing it?
Underproduce: A potential customer is willing to buy something for more than the cost to produce it, yet the thing isn’t produced.
A monopoly gets to choose what price it offers to sell its goods at. If it raises its price, it gets fewer buyers but makes more money per buyer. The profit-maximizing price point is usually not equal to marginal cost, which means that the price will be too high for some people that could have been profitable customers (if not for the fact that selling to them would require the monopolist to make less money from everyone else).
That definition, if minimized, leads to economic waste, because it fails to reflect opportunity costs.
To illustrate with an example, my absolute favorite soda of all time is Mountain Dew Pitch Black II. It is also one of the most hated flavors among most people I’ve met who tried it.
There exist sufficient customers who like Mountain Dew Pitch Black II for Pepsi to make a profit producing it. Are they losing money by not producing it?
As it transpires, no. There exist -many more- customers for -other- flavours of soft drink Pepsi could be producing. Pepsi doesn’t have unlimited manufacturing capacity; they use the same equipment to produce a wide range of drinks. The opportunity cost of producing Mountain Dew Pitch Black II is that they -aren’t- using that equipment to produce a more popular flavor. So I’m out of luck, and the limited run is all they produced. (There was a Pitch Black I and a Pitch Black III, neither of which I had opportunity to try; Pitch Black III had an even more limited run than Pitch Black II.)
Producing Pitch Black II would be a -waste of resources-, in spite of the fact that it could be profitably manufactured. In terms of utility, it is a suboptimal utility-maximizing strategy.
So if we’re using underproduction as some kind of moral yardstick, I think it’s rather flawed, on account that we wouldn’t actually prefer the universe in which underproduction didn’t happen.
Sorry. In the context of microeconomics, “cost” usually means “opportunity cost” and I didn’t realize I needed to say this explicitly. Dollar costs are usually a pretty good proxy for opportunity costs in many cases, though...
If cost includes opportunity cost, your entire second paragraph ceases to be meaningful, because the cost would necessarily include the opportunity cost of not having priced the good higher and made higher profits. Using opportunity cost as your cost means this kind of underproduction is impossible; your marginal cost is whatever cost would result in the maximum profits.
Your entire post consists of explaining the meaning of an assertion, rather than explaining its basis. Why would you think that “cost” does not include opportunity cost?
And I don’t see why it’s accurate to say the Pepsi doesn’t have unlimited manufacturing capacity. Yes, their current manufacturing capacity is limited, but you didn’t give any explanation for why they can’t build more equipment. Without such an explanation, this makes as much sense as saying that it wouldn’t be profitable for me to run a home bakery business because there amount of flour in my house is finite.
The cost to build special equipment for this Pitch Black might be covered the absolute sales of Pitch Black, but it is doubtful that it would cover the slight increase in sales vs standard Mountain Dew—I imagine that Pitch Black drinkers would buy less standard Mountain Dew (or, failing that, other Pepsi products) if Pitch Black were available.