Fritz Machlup, Competition, Pliopoly and Profit (February 1942)

This first installment of Machlup’s journal article develops a theory of competition through entry, distinguishing it from the conduct of sellers already in a market. Its twelve sections move from conceptual and methodological clarification to opportunity costs, normal profit, entrepreneurial ability, and the obstacles posed by uncertainty, indivisibility, and immobility. The central question is not how many firms exist, but whether additional firms will enter when economic profits appear—and what prevents their entry from eliminating those profits.

Machlup introduces “pliopoly” to distinguish the arrival of more sellers from “polypoly,” the situation conventionally associated with many sellers. Polypoly concerns sellers’ beliefs that their individual actions will not provoke competitors’ reactions. Large numbers commonly support this disposition, but do not define it:

Thus, a subjective habit or disposition of certain individuals is the essence of the concept of polypoly.

Pliopoly instead expresses the observing economist’s expectation that newcomers will respond to attractive profits. The distinction separates an existing pattern of conduct from a process unfolding over time, and beliefs attributed to identifiable market participants from a forecast concerning unspecified potential entrants. Polypoly might conceivably be investigated through sellers’ reports about their expectations; pliopoly cannot be established immediately, because the predicted entry and erosion of profits take time.

The conditions for entry include knowledge of profits, entrepreneurial initiative, access to equipment and skills, manageable investment requirements, available finance, and freedom from official restrictions or incumbent intimidation. None alone suffices. Moreover, calling entry “easy” requires a judgment about acceptable delay: a reasonable adjustment period for a hot-dog stand need not be reasonable for an airplane factory. Perfect competition therefore has no absolute temporal threshold. Machlup also rejects treating the “industry” as a naturally bounded entity. It is an analytical grouping of firms whose interdependencies matter for the problem; here, the relevant relationship is the adverse effect of additional output on other firms’ sales conditions.

Entry and withdrawal require separate treatment. New equipment may be built much faster than existing equipment wears out, allowing entrants to destroy supernormal profits while established firms continue operating with subnormal earnings. Replacement funds released across the economy can finance entry even when withdrawal from particular industries is slow. This asymmetry leads to the article’s central accounting distinction:

Unless the meaning of profit is made clear the concept of pliopoly cannot have any clear meaning.

Business profit is residual income shaped by ownership and financing arrangements. A firm owning its equipment reports income that another firm pays out as rent or interest. Economic profit, by contrast, exists only after covering the opportunity costs of every resource, owned as well as hired. These costs reflect the best alternative uses forgone. Positive economic profit thus indicates an opportunity for reallocating resources, rather than merely a favorable accounting result.

Fixed resources complicate this argument because their short-run alternatives may be severely limited. Their earnings above variable costs are quasi-rents; “normal profit” covers the opportunity costs of the resources needed to reproduce the enterprise:

On the other hand, normal profit, being equal to the opportunity cost of all the fixed resources that would be required to reproduce the enterprise, is equivalent to zero profit in the economic sense.

Machlup refuses to define normal profit by an industry’s failure to grow or contract: that would conceal barriers to entry inside the definition. Nor should the long run be defined so that completed adjustment automatically guarantees perfect competition. Withdrawal depends on salvage values, equipment life, and replacement schedules. Small successive repairs may remain worthwhile even for a loss-making firm, whereas a large simultaneous replacement can precipitate closure. Industry-wide contraction can nevertheless occur as particular establishments reach substantial replacement requirements.

The later sections distinguish managerial services, which have measurable units and opportunity costs, from entrepreneurial initiative under uncertainty. Explaining profit by an entrepreneurial ability itself measured through profit would be circular:

The entrepreneurial ability must not be defined and measured by the profit which it supposedly explains at the same time.

Uncertainty supplies a different explanation. Entrepreneurs discount anticipated receipts through safety margins, restraining their demand for resources and their willingness to enter. If receipts meet expectations, a surplus may remain after all costs. The most cautious do not necessarily earn the most: they may abstain, leaving opportunities to those prepared to venture.

Indivisibility independently prevents profit-eliminating adjustment. An additional efficient plant may be too large to pay, even when existing firms earn persistent profits under certainty. Large production units also magnify uncertainty and financing difficulties and may foster oligopolistic threats against entrants. Yet Machlup qualifies the argument: economic history shows that enormous investments can sometimes attract rapid entry.

The closing analysis distinguishes these mechanisms from immobility:

Immobility may create rents, not pure profit.

Scarcity earnings attributable to particular resources are rents, whether retained as business profit or paid to their owners. Licensing restrictions can create monopoly rents that subsequently appear as returns on capitalized assets. Conversely, cheap immobile factors cannot by themselves explain persistent pure profit: another obstacle must prevent competitors from locating nearby. Indivisible plants may provide that obstacle; patents, land ownership, or privileges may instead protect imputable rents. The installment’s enduring contribution is this separation of market conduct, entry processes, and income categories: neither numerous sellers nor modest accounting profit rates establish that competitive entry is effective.