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Wednesday, June 27, 2012

Can Mutually Beneficial Exchanges Be Exploitative?

When two people not under duress enter into an exchange for goods or labor services, both must be expecting to benefit or the exchange would not occur. In any such exchange there necessarily exists a double inequality of value. Each trader gives up something to obtain what he or she prefers. Moreover, we have at least prima facie grounds for pronouncing the exchange legitimate since no compulsion is apparent.

This principle of sound economics (and moral theory) is unexceptionable. Indeed, we couldn’t make sense of buying and selling were this not the case. We must take care, however, in applying the free-exchange principle. Knowing that parties enter into an exchange freely may be a necessary condition for our pronouncing it legitimate, but it is not a sufficient condition.

For example if you enter a post office and buy a first-class stamp for 45 cents, may we conclude that you prefer the services the stamp will buy to whatever else you might have spent the 45 cents on? If you were not ordered into the post office at gunpoint, I should think so.

Is the transaction therefore legitimate? I should think not—not entirely. Why not? Because a system supported by violence constricted your alternatives. The post office of course is a protected government monopoly. No one may compete with the State in the delivery of first-class mail.

Apparently it isn’t enough to know that parties to a transaction entered it without duress. There are other criteria that a transaction must satisfy for it to be pronounced entirely legitimate.

Extending this analysis to private companies with monopolistic government privileges should incite no controversy. If the U.S. government outlawed competition with Federal Express for overnight delivery, the situation would be essentially the same as with the post office. No one would be forced to do business with FedEx. Likewise if government erects explicit or implicit barriers to entry in an industry. Transactions with the protected oligopolistic firms would still be mutually beneficial or they would not occur.

Exchanges therefore with a coercive monopoly are mutually beneficial, though we should be reluctant to call them legitimate. Any coercive monopoly will set its price low enough to produce the desired revenue. No sane monopolist would set a price so high that it would exceed consumers’ subjective estimate of the utility of the product. What would be the point? But that means every sale entails a buyer who believes he or she is better off engaging in the transaction despite the lack of alternative sellers.

Thus even with a monopoly, subjective marginal utility plays a role in governing price. As Kevin Carson notes, “[M]onopoly pricing targets the price to the highest amount the consumer is able to pay and still get enough utility to make the exchange worthwhile.”

And yet we libertarians don’t want to declare the exchanges fully legitimate, do we? The seller is a coercive monopoly or protected firm, after all. (This does not necessarily mean the seller is culpable for the situation.)

The great thing about competitive markets is not that marginal utility sets prices but that rivalry among sellers sets prices at a point where more people can gain utility by buying the good than could do so at the higher monopoly price. We all have bought things at a price below that which we were prepared to pay. The difference is called the “consumer surplus.” Ralph Hood put it nicely in The Freeman when discussing the falling price of electronic calculators: “[T]echnology allowed the price to drop. Competition made it drop.” In a manner of speaking, competition socializes consumer surplus.

On the other hand, in the absence of competition a coercive monopoly is able to charge more than in a freed market, capturing some of the surplus that would have gone to consumers. That’s exploitation through government privilege.


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JPMorgan Chase’s big loss again shows that government-induced moral hazard still lives. Gerald O’Driscoll has the scoop.

The genocide Rwanda endured in the early 1990s is well known in the West. Far less well known is the economic liberalization and growth the country has experienced since the healing began. Ángel Martín Oro and Marc Bisbal Arias describe the remarkable progress.

You’ve got to hand it to the early classical liberals and libertarians. From the get-go they correctly foresaw the horror of state socialism. Philip Vander Elst surveys the record.

Elia Kazan directed such critically acclaimed movies as On the Waterfront, A Streetcar Named Desire, and Gentleman’s Agreement. But his appearance before the House Un-American Activities Committee, which investigated Hollywood for communist connections in the 1950s, dogged his career to the end of his life. Bruce Edward Walker tells the story.

Here’s what our columnists have set forth on the table: Lawrence Reed lauds Grover Cleveland for his character and statesmanship. Burton Folsom compares Woodrow Wilson to George Washington. John Stossel explains that an economy needs no conductor. Walter Williams counsels: Beware politicians’ dreams. And Tyler Watts, hearing a Nobel Prize-winning economist say more inflation would be a good thing, responds, “It Just Ain’t So!”

Books on freedom of contract, Iceland’s financial collapse, adaptation to failure, and American militarism have occupied our reviewers.

—Sheldon Richman

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  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.