What Milton Freidman Gets Wrong About Monopolies
In his excellent book Capitalism and Freedom, Freidman writes (Pg. 28):
Exchange is truly voluntary only when nearly equivalent alternatives exist. Monopoly implies the absence of alternatives and thereby inhibits effective freedom of exchange.
I disagree with the first sentence. The second sentence is flat-out wrong.
Monopolies do not imply the absence of alternatives. There is no economic problem without alternatives. If monopoly implies the absence of alternatives, then that means there are no costs interacting to the monopoly, something we know is incorrect. It also implies there are no substitutes for the monopoly’s good, something we also know isn’t correct. After all, demand curves (even for a monopolist) slope downward.
Perhaps an example will help. Say there are two competitors, one who offers green shirts for sale and one who offers blue shirts for sale. The one who offers blue shirts closes down, so all that is left is the one who offers green shirts. In Freidman's description, the alternatives have fallen from green shirt-blue shirt to just green shirt. But this is incorrect. There is another alternative. The relevant choice is not between green shirt, blue shirt. It is between green shirt, blue shirt and going naked (ie, no consumption). Thus, the next scenario comes down between green shirt and being naked as the day you were born. There is always an alternative. Just because the alternative is undesirable does not mean the alternative does not exist.*
Furthermore, there is always the alternative, that Friedman himself notes earlier in the book (Pg. 13), of producing for one’s self (emphasis added):
The incentive for adopting this indirect route [of producing some goods and exchanging them for other goods voluntarily] is, of course, the increased product made possible by the division of labor and specialization of function. Since the household always has the alternative of producing directly for itself, it need not enter into any exchange unless it benefits from it.
Returning to our example above, we have another always-present alternative: green shirt, nothing, self-production. Like with the “nothing” alternative, the cost of self-production may be extremely high and undesirable, but that does not mean the alternative does not exist.
In regard to substitutes, substitutes always exist. The Law of Demand teaches us that, as prices for one good rise, the demand for substitute goods increases. People seek out alternatives. As prices get higher, the intensity of their search increases. People may develop new alternatives, or they may use things in different manners. For example, if the price of firewood gets high enough, people may start burning phone books. The mere presence of these alternatives help define the shape of the demand curve the monopoly faces.
Along this same point, firms are petrified of competition, either real or shadow competition. A monopoly, by definition, does not face any other direct competitors in their industry (however defined), but that does not mean competition does not exist. As just mentioned, as prices rise, people seek alternatives (substitutes). The longer prices stay relatively high, the greater that search becomes and the more elastic the demand curve becomes. As such, monopolies tend not to capitalize on their positions and capture all the rents they could (for more on this, see this 1999 article by Don Boudreaux and Burt Folsom).
Monopolies can be problematic from an economic perspective, but their existence does not imply the absence of alternatives.
*We could go even farther here and point out that other alternatives are represented by the opportunity cost. I could buy the green shirt, or a pair of pants.