Chapter Seven

Under New Management

The Second Industrial Revolution

The Visible Hand

The Industrial Revolution was a period of transition, and a long one at that. Prior to this time, almost everyone worked from their home, and their pay was subject to the whims of the market. But by 1840, a new kind of economy had emerged. One with large corporations, wage labor, and career paths. This structure was both a source of stability and disruption, and has changed the fabric of economic life.

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The First Industrial Revolution saw a major switch from production by hand to production by machine. These changes were most pronounced in textiles (which is the production of cloth and woven fabric), the use of coal as a new source of energy, and the advent of steam engines. But after these transitions occurred, advancement continued, and spilled into other industries where innovation started to find even greater opportunities for growth. The period from 1870 until the beginning of World War I in 1914 was a time of unprecedented new marvels. While the first industrial revolution saw inventions that were not particularly advanced, the second industrial revolution was propelled by scientific advancements. Bessemer refined a better process for making steel. There were discoveries of cheap artificial dyes, sulfuric acid used in steelmaking, and the conversion of ammonia into nitrates which is used as a fertilizer. Alfred Nobel found a way to produce nitroglycerine on an industrial scale, which he turned into a paste called dynamite. Dynamite proved useful for a variety of projects from civil engineering to the quarrying of stone. Of course, dynamite was also a powerful weapon, and when Alfred Nobel read an erroneous obituary for himself which called him a war profiteer, Nobel decided to bequeath his fortune to create the Nobel Peace Prize. There was also the widespread adoption of electricity after the Jewish engineer Moritz van Jacobi invented a rotating electric motor with enough power to actually run machines, and Thomas Edison – taking the work of Nikola Tesla – developed a way to transmit electricity across long distances. Many of these inventions further combined into rapid advancements in transportation – railroads by land and large coal-powered ships by sea. --This wasn’t just an economic change, but a change in the very structure of the family. Throughout most of history, the working-class family was a unit of production and the cornerstone of a society’s output. The early inventions of the industrial revolution, like the spinning jenny, didn’t change this. The jenny was simply brought into the home. But eventually, the full mechanization of weaving led to work moving from the home into a larger factory. The workers in the family were now employed outside of the household, which disrupted the family structure. In England, this shift began in the mid-1820s, leading to a lot of social discontent. Wages were not much higher for these factory workers for a long while until home production had essentially been completely liquidated and subsumed by factory production in the late 1830s, and then wages did start to rise. But in those early years, scholars agree, this transition worked against labor. As the inventions of the industrial revolution began to revolutionize other sectors of the economy, the same story played out there too. People were no longer in business for themselves, producing their own wares and selling them to merchants. For better or worse, most people were now employees working for someone else and being paid wages for their services. --The increased scale of production that was made possible by industrialization radically transformed the structure of the economy. In 1840, it is estimated that the total U.S. workforce probably numbered almost 5.5 million people. But only about 3,000 of them were managers that supervised 50 or more employees. The large corporation, with its divisions and departments just didn’t exist, and had never existed before this time. Every business was small, consisting of families or perhaps partnerships between two or three entrepreneurs and a handful of employees. But that started to change. In factories, people were hired to supervise the workers on the floor across different shifts. And eventually, the structure of firms had to grow beyond even that as their operations expanded beyond just production. Railroads provide a good case study for the development of the modern firm. When railroads become larger and longer – say, 100 miles or more, broken into multiple sections – managers were required. That’s when the railroad tycoons began to face the challenge of figuring out how to effectively and efficiently operate a small business with large numbers of employees and equipment spread across large areas. After 1850, large American railroads started to operate through multiple units called divisions. Each division operated independently, with a central office overseeing systemwide functions, such as track maintenance and machinery repair. Eventually, other industries outside of transportation and communication, which both had a geographic motivation for this structure, started to adopt it in order to expand their reach. Manufacturers established distribution centers, sales offices, purchasing offices, and other mechanisms to allow for increased production and sales. In the United States, large, multi-unit enterprises like this followed what is known as a line-and-staff management structure. Line managers were directly responsible for the core functions of an enterprise. And in contrast, staff managers had responsibility for the materials required to run the company. Soon, management became a science all its own, and virtually every large firm has adopted this sort of management structure. --This radical new structure of separate business divisions each independently run by a manager, who was themselves under a manager of several divisions, who themselves worked under more managers or the chief executive, was able to capitalize on increased productivity and lowered costs. Prior to this structure, market mechanisms and Adam Smith’s invisible hand coordinated the efforts of different business operations. Farmers would grow the cotton and sell it to people who would weave it into yarn who would then sell the yarn to textile producers, who sold their work to merchants who then brought it to customers. The price system coordinated these activities and guided resources and work to their most valued and profitable uses. But now huge chunks of that production process were under the umbrella of one company, and managers would coordinate that production process. This meant there would be some losses in efficiency, as these managers would lose the power of the price system in guiding actions internally, resulting in occasional misallocations of resources. But those inefficiencies, were outweighed by the gains in productivity and lower costs. A multi-unit firm made transactions between units routine and less costly. Information flowed better when production was linked to buying, distribution, and sales. And the central organization made more efficient use of facilities and personnel.It’s unlikely management structures like this would have worked before the industrial revolution. Market activity needed to hit a critical mass first where production could reach a large enough scale to make these gains from coordination outweigh the losses in efficiency. But that high volume of production also provided a more reliable cash flow that gave birth to a new form of employment: the salaried manager. From this came standard career paths. A typical career path with a railroad company would see a young man hired at age 18 as a shop laborer, be promoted to skilled mechanic at age 24, brakemen at 25, freight conductor at 27, and passenger conductor at age 57. Educated young men started in clerical or statistical work and moved up to station agents or bureaucrats at the divisional or central headquarters.The modern idea of a company and of a career were born in this time and have largely persisted to this day. They were only possible once economic growth had gotten started, but they have themselves been a source of continued growth as gains from better management and skills increased productivity gains and cost reductions even more.

The Market for Labor

Why do some jobs pay more than others? Just like the paradox that mostly-useless diamonds are worth more than life-giving water, the answer is supply and demand. Wages are set by the market for labor and the interaction of the supply of labor and the demand for labor. Each of us, for our own reasons, are willing to work a job if the pay is right. And firms are willing to hire us if the work we do increases the bottom line by more than our salary.

Open Video Transcript

The inventions of the industrial revolution shifted labor away from the home and into factories. Most people of the past were (as we would say today) self-employed. In a sense, they were thrown out of their jobs by the onset of these new manufacturing processes which they couldn’t compete with working by hand. And so, they had to get jobs working in one of these factories and being paid a wage. At first, these wages were about the same as what they were earning while self-employed, but eventually wages started to rise, and they kept on rising to this day. To understand why, we need to understand the market for labor. --First, let’s construct the supply of labor. Our regular supply curve relates the price earned to the quantity supplied. So, on our graph we have price on the vertical axis, which represents how much consumers pay for something, and quantity on the horizontal axis, which represents how much of that something is produced. Labor markets operate on the same principle, but with some different terminology. The price paid to workers for their labor is the wage, and the quantity of labor supplied is the number of hours people agree to work for. The supply of labor is the relationship between the wage paid for a job, and the number of hours people are willing to work. A key word there is ‘willing’. When wages are low, not many people are willing to work that job for long, and so the number of hours supplied is also low. But when wages are high, they attract many more people who are willing to do that work. And so, the number of hours of work supplied is higher. This positive relationship between wages and hours worked is what forms the labor supply curve. There are many factors which determine whether or not a person is willing to work for a certain wage. One of them is the availability of alternative jobs. A person with many high paying opportunities will have a lower willingness to work at low paying jobs. Whereas someone with fewer opportunities – whether that’s just or unjust – might be willing to work at lower pay. Working conditions are another important factor. Some people might need very high wages to be willing to work a high-pressure sales job, while others might thrive under those circumstances. Differences in preferences also influence our willingness to work riskier jobs, or job with certain demands. And then there is also the work/life balance. People might not be willing to give up too much of their time, even at high wages, because they are prioritizing family at home or more leisure time. And while it could be the case that offering an individual more money might lead them to choose to work less instead of more at that higher wage, collectively the market will attract more workers to a particular job when wages for that job are higher. --The demand for labor is a bit different than the demand for goods and services. Your demand for sandwiches is based on the subjective value you place on sandwiches. How much you are willing to pay for a sandwich is a matter of preference. But the demand for labor is what we call a derived demand, because how much employers are willing to pay is set by other market conditions, namely the marginal product of labor. The most that a firm would be willing to pay to get one more worker would be the amount by which that worker increases the firm’s revenue. For example, let’s imagine that we just opened up a new neighborhood grocery store. We operate one of the registers at the store, and after a while, business starts to pick up. Operating just one register ourselves, we are able to bring in $500 in store revenue every hour. But our long line is leading some customers to abandon their efforts and leave in frustration. We would benefit by hiring someone to operate a second register. If we do, our hourly revenue might rise to $615, which means we are now making $115 more than before. $115 is the most I would be willing to pay to hire one worker. If we hire a second, revenue might rise to $700, an $85 hike in revenue. Less than before, but still good for business if I can hire someone for less than $85 an hour. A third cashier might raise revenue to $760. A fourth to $800. A fifth to $825. A sixth to $840, and a seventh to $850. Each time, hiring someone is good for business, revenue goes up, but by less and less each time. We would only want to hire this seventh person if the going wage for cashiers is $10 an hour or less. --I can put the marginal product of labor into a chart like this one, and we can see how much each person we hire raises revenues. This right here is a relationship between the wage we have to pay, and the number of workers we hire. If the going wage is $25 per hour, we would only want to hire 5 cashiers. If the wage is $15 per hour, we would hire six cashiers. And we won’t hire a seventh until wages fall to $10 an hour or less. --When we chart this out on a graph, we get the demand for cashiers at our store. As you can see, it is downward-sloping just like any ol’ demand curve. And that is really all that matters. In this example, the demand curve is an actual curve, not a straight line. But just like all squares are rectangles but not all rectangles are squares, all lines are curves. And so, it doesn’t make any practical difference if we draw supply or demand curvy or as straight lines. --So, alas, we have our labor market, with both the supply of labor and the demand. The forces of competition will drive this market to an equilibrium found where supply and demand cross, setting the market wage paid by firms to workers, and also the total hours worked by those workers and hired by those firms. When labor productivity increases, that is, when the amount of revenue each worker generates for a firm increases, the demand for labor increases and shifts to the right. This leads to higher wages, and more work. But when the supply of labor increases, which might be due to more people, worse opportunities elsewhere, or better working conditions offered, the supply of labor shifts right. That pushes wages back down. --To tie this back to our understanding of economic history, prior to the industrial revolution, the supply of labor led the demand. We were stuck in that Malthusian trap, where growth in the population split up any gains in productivity, and wages stayed steady. But the Industrial Revolution made workers more productive by pairing them with machines. The demand for labor increased by more than the supply, and wages rose a bit. But creative destruction threw a lot of people out of work that they did from home, and they entered these labor markets looking for jobs at these factories. The supply of labor due to the transition in production kept pace with demand for a bit. But once the transition was done, and machines continued to improve, they raised labor productivity much faster than labor supply. And wages for ordinary people – the formally poor – started to rise more rapidly than ever before.

Unemployment

The big transition from household-based production to firm-based production meant that ordinary people relied on wage labor for their livelihoods. And since more jobs required specific knowledge and skills, transitions became harder. And so a greater focus was put on the concept of unemployment, or the number of workers currently out of work.

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As economies undergo change due to growth, unemployment tends to fluctuate. To start to get a handle on this, let’s first talk about the labor force. The labor force is the group of people in a country ready and willing to work. But to properly measure such a thing, we need a more exact definition. We start with the civilian noninstitutional population age 16 and older. Yikes, that is a mouthful. Civilian means not an active-duty member of the military. Noninstitutional means not in prison or in a residential care facility like a nursing home. That is our starting group. Among them, some people are currently working, and some people are not working. The sizes of these boxes are not meant to be proportional, but rather to leave room for some detail. There are many reasons a person might not be working. They might be absent from their job because they are on vacation or out sick or on paternity leave or something like that. They might be on layoff but expect to be recalled back into their job. We saw quite a bit of that during the Covid-19 pandemic, where people were furloughed, as it is sometimes called, meaning they were temporarily laid off. Then there are those who are not working, but they are actively looking for a job. Specifically, someone is considered to be *actively* looking for a job if they have applied to jobs within the last four weeks. And then there are those who are not working but who do not fit any of those criteria. These would be people without a job, but who are not actively looking for one. It could be that they were looking but gave up - or so-called discouraged workers – but most commonly they are people who are retired, or stay-at-home parents, or full-time students, or something like that. Those who are currently working or just temporarily absent from their job are considered employed. Those who are temporarily laid off or actively looking for a job but without one are considered unemployed. If a person is employed or unemployed, then they are part of the labor force. If you do not have a job and are not actively looking for one, then you are not in the labor force. The big thing to note here is that, while in the normal parlance of life we might say anyone without a job is “unemployed”, by the strict definition of unemployment, you have to be actively looking for a job or awaiting to return to one you already have. --With this information, we can calculate the unemployment rate, which is by far the most popular statistic reported to describe the health of an economy. The unemployment rate is calculated by taking the number of unemployed persons and dividing by the labor force. Again – these values are determined by our strict definitions for being unemployed and being in the labor force. Here is an example with some real data from 2020. In March of 2020, just over 7 million people were unemployed – meaning they were all actively looking for a job. And those 7 million were joined by many more with a job to give us a labor force of well over 162 million. Remember, the labor force includes both the employed and the unemployed. With these numbers, we can calculate the unemployment rate for March of 2020 by taking 7,185,000 and dividing by 162,721,000. If you turn to your trusty calculator, you’ll find this is equal to about 0.0442, which is 4.42% when put into percentage form. Note that for percentage form, we move that decimal place over to the right by two spots. Of course, March of 2020 saw enormous disruption to the economy as health officials across the world issued guidance about Covid-19. In April of 2020, the number of unemployed rose to a staggering 23 million people, while the labor force fell to 156 million. That big jump in unemployment was the result of many people being laid off and starting to look for a new job. Meanwhile, the big drop in the size of the labor force came from many people losing work but choosing not to begin to look for a new job. Remember, to be in the labor force you need to have a job or be actively looking for one. Those who chose to stay home and wait out the pandemic fell out of the labor force. With these numbers, we can calculate the new unemployment rate, which is 23,109,000 divided by 156,478,000, which is 0.1477 or 14.77%. This sudden rise of over 10 percentage points led to a lot of government action, though that is a subject for a later chapter. --There are many reasons a person might be unemployed. We typically categorize reasons into one of three types. First is Frictional Unemployment. This is unemployment that arises because workers have imperfect information about available jobs and need to engage in a time-consuming process of job search. In any given month, a lot of people will just be going through the normal process of finding a job, and that process takes time and effort both for the jobseeker and those trying to fill an open position. For this reason, we expect to see some unemployment every month without cause for concern. This sort of unemployment isn’t desirable, and lots of innovations like indeed.com or resume workshops are aimed at reducing the length of time someone is in this situation, but it isn’t a major problem either. A bigger problem is structural unemployment, or the unemployment that arises when certain jobs are replaced by new methods, and those job skills are no longer needed. This is the unemployment due to the process of creative destruction. When someone loses their job because the product they were making is now obsolete, or the process to make it changed and eliminated their position, or if the job just moved to a different town or country for economic reasons, then they would be structurally unemployed. If a computer programmer loses their job, they will probably just apply for another computer programming job. But when someone loses their job due to creative destruction, there are no more help wanted ads for that kind of work. The person has to develop new skills or turn to a different profession. This is the kind of unemployment that people tried to stop for so long and with it they stopped innovation, but after the Industrial Revolution societies have mostly turned a blind eye to it, reminding themselves that economic growth which causes this kind of unemployment means better jobs that will eventually replace the ones lost. And indeed, they do. Eventually. Then there is the new villain on the scene: cyclical unemployment. This type of unemployment is the result of an economic downturn and a deviation from what we call the natural rate of unemployment, consisting of frictional and structural unemployment. This kind of unemployment is the central focus of part two of this course, but for now we can understand it as the unemployment that arises because the economy is lousy sometimes. The upside of frictional unemployment is that we end up with better matches between employer and employee. You don’t have to take the first job offered to you; you can wait for the job you really want. The upside of structural unemployment is that we have improved on the use of our resources, and this economic growth will bring us better and higher paying jobs. There is no upside for cyclical unemployment. Which is why we expend so much effort trying to minimize it.

Practice Questions

1. The table below shows the number of hours workers are willing to work at each wage, as well as the marginal product of labor.

What will be the wage paid to workers? How many hours of work will be hired?

Reveal the Answer

In the first table, we see how many hours workers will supply at each wage. If the firm only pays $8 an hour, the few workers willing to accept the wage will only work a collective total of 100 hours.

In the second table, we see how much the firm is willing to pay for a certain number of hours of work. If the going wage is $20 an hour, they would be willing to hire up to 100 hours, but not more than that.

So, its obvious that the firm will at least hire 100 hours of work. They can get it for $8/hour, while it benefits their bottom line by $20/hour.

As you work down the chart, you will see that the firm is willing to pay more than what workers are willing to accept. Firms would pay up to $18/hour for 125 hours of work, but they can attract that many workers at only $9/ hour.

If the going wage is $12/hour, then workers will want to supply 200 hours of work to the firm, and the firm will want to hire 200 hours. This match is what sets our equilibrium. It is where supply and demand are crossing (graph it out to see!).

At 225 hours, workers need $13, but the firm will only pay $10, so it won't happen. It just isn't worth it to the workers or to the firm.

So, the wage paid to workers (all of them if the market is sufficiently competitive) is $12 per hour, and 200 hours of work will be hired at that wage.

2. Suppose a country has a civilian noninstitutional population age 16 and over of 35 million people. Of those 35 million people, 7 million do not have a job and are not looking for one, while 26,740,000 are currently employed. What is this country's unemployment rate?

Reveal the Answer

The unemployment rate is calculated as:

(# of Unemployed) / (Labor Force)

The question does not tell us either number, but gives us enough information to figure both of them out. Let's start with the number of unemployed. We know that the 26,740,000 people currently employed are part of the labor force. That leaves 8,260,000 people who are in the eligible population but without a job.

The question tells us that 7 million people don't have a job and are not looking for one. That means these 7 million people are not in the labor force (you must be actively looking for a job or have one to be in the labor force). So, the remaining 1,260,000 people don't have a job and are looking for one. That is our # of Unemployed.

The labor force consists of the employed (26,740,000) and the unemployed (1,260,000). Adding those together gives a labor force of 28,000,000 people.

With those two numbers, we can find the unemployment rate:

1,260,000 / 28,000,000 = 0.045 or 4.5%

The Rise of Unions

Trade Unions were common throughout human history, and largely protected the interests of powerful guilds. But as firms grew larger and larger after the Industrial Revolution, they started to exert a lot of power over the lives of their workers. Abuses of this power led to the formation of labor unions, which pushed back against the bosses and fought for better working conditions and better pay. While union membership has waned in the last half-century, they were an important political force in balancing the power in labor markets.

Open Video Transcript

The transition to wage labor and large multi-unit corporations brought about by the Industrial Revolution also saw a great deal of change in working conditions. Where there had once been many different producers, organized around families, now there were just a few firms. Greater concentration of production into the hands of fewer firms gave those firms market power. That market power extended to the market for labor, where firms could be demanding of employees. Working conditions were, in many cases, quite brutal. Hours were long, and the work was backbreaking and repetitive. Employers also engaged in many abuses. There are stories of workers being barred from wearing wristwatches so that bosses could fiddle with the company clock and steal worker’s time. Some employers imposed moral sanctions on their employees, hiring officers to patrol the local bars and gathering places and punishing workers who stayed out late or were found wandering home drunk. In Europe, workers were in some respects used to this kind of authoritarian rule. But in the United States, where ordinary men had the power of the vote, workers started to join together to oppose the influence of their employers. --Labor Unions are an organization of workers who have come together to achieve common goals, such as protecting the integrity of their trade, improving safety standards, and obtaining better wages, benefits, and working conditions. Through solidarity, workers would act as one and insist that management meet their demands. Union member rose through the 19th century and really took off in the beginning of the 20th century. Through collective bargaining, workers secured shorter work weeks (the typical workweek in 1880 was around 60-70 hours, which was eventually shortened to our modern 40 hours). They also improved safety conditions and negotiated higher wages, though much of that success is also due to labor laws being passed at the urging of these unions. --It is important to understand that both excess power on the part of firms, and excess power on the part of workers, lead to poor economic outcomes. Labor demand is made up of firms who hire workers. When firms grow in size, and face less competition with other firms for workers, they gain what the economist Joan Robinson called monopsony power. You have almost certainly heard of a monopoly, which is the sole seller of product. A monopsony is the sole buyer of something, in this case, of labor. With monopsony power, firms are able to suppress wages. It means that fewer workers will want to work for the company, but essentially the firm is able to increase profits by lowering labor costs more than they lower revenue. We can see this by thinking about the surplus. They are capturing some of the workers’ surplus, but at the expense of some market inefficiency and deadweight loss in the form of lower employment. This is bad news for both workers and the economy, and just as they do with wages, firms can also suppress worker compensation via worse working conditions. Labor unions flip the script. If enough workers join the union, and agree to act in solidarity, they become a monopoly on the supply of labor. The union is then able to extract higher wages up to the maximum the firm is willing to pay, which would be based on the marginal product of labor. Unions take back that surplus and then some, transferring it to the workers. But notice that this too is inefficient with lower employment. In theory it is possible that the union and the firm will be able to negotiate themselves to the wage that would otherwise be set by the market, and with it the full employment we would hope to see. But in practice this is difficult, especially when market conditions change. In the end, both large firms and labor unions tend to keep things stuck in place. --The bargaining chip unions have is the ability to go on strike, which is when all the workers in the union stop working in protest. Perhaps the largest strike to ever happen was the Pullman Strike in 1894. It started in Pullman, near Chicago, a company town where the biggest employer was Pullman Company, owned by George Pullman. You can start to see the problem. The Pullman Company produced railroad cars, and by this time had a virtual monopoly on the production of “sleeper cars”, which allowed passengers to sleep when travelling across long distances. The company was so big they actually built the town of Pullman. But as you might imagine, workers who moved their lives and family there didn’t have many options. Pullman had a monopsony on their labor. Many of Pullman’s workers joined the American Railway Union, which was led by Eugene Debs. In 1893, there was a financial panic which led to many bankruptcies in the railroad industry. Business slowed down considerably, and George Pullman decided to cut the wages of his workers. Debs organized a strike, and the movement grew from there, eventually involving over 250,000 workers across 27 states, and shutting down a huge amount of railroad travel. Eventually, President Grover Cleveland stepped in and forced the workers to end the strike. Debs ended up in jail over the incident, but later joined the Socialist Party of America and was their nominee for president five times. Unions have waned since their heyday in the first half of the 20th century, largely because business has become more competitive. There are fewer company towns and more choice as to where one works. So long as workers have choice in their employment, and firms compete to attract them to the job, labor markets can take care of themselves. But in this Gilded Age of greater concentration of business into the hands of powerful bosses, unions proved to be an important part of the fabric of American life and won the American worker many important victories.

The Tycoons

One cannot stress enough that the real winners of the Industrial Revolution were the poor. Innovation has lifted the wages of typical workers 16-fold (60-fold in the U.S.!). But one also cannot ignore the incredible levels of wealth that have been achieved by a lucky few. Business Tycoons built industrial empires, shutting down their competition, and accumulating an unreasonable amount of influence over the economy. While the superrich are still with us, their ability to build monopolies has thankfully been stifled by regulations which promote competition.

Open Video Transcript

The word “Tycoon” comes from Japanese, where the word refers to an independent ruler who did not have an imperial lineage. Indeed, this is an apt name for the captains of industry during the Gilded Age of the late 1800s. Cornelius Vanderbilt’s great-great-great grandfather came to America from the Netherlands as an indentured servant. By the time he was around 50 years old, Cornelius was the richest man in America, having built a railroad and steamship empire. His company was critical to the Union’s naval effort during the Civil War. Then there is Andrew Carnegie. Born in a one-room cottage in Scotland, his family came to America looking for work. Carnegie became a business magnate, starting in telegraphs, and then railroads, eventually creating U.S. Steel in 1901 at the age of 66, which catapulted him to top of the list of wealthiest people in the world. And of course, there is John D. Rockefeller, who was born into a large and poor family in New York in 1839. By 1870, when he was 31, he founded the Standard Oil Company. Within 20 years he was the richest man in the world, a tenure interrupted by Carnegie for a bit, but historians agree that Rockefeller was likely the wealthiest person in the history of the world. --If we turn back to our Adam Smith, there is one thing we don’t want businesses to be and that’s “big”. Without significant competition to drive out inefficiency, resources are misused, and unfair practices go unabated. In America, many states began to introduce laws which restricted the size of businesses. Business tycoons like Rockefeller had to find ways around them to keep their companies together, so they started to form trusts. A trust is a legal arrangement in which a person gives someone else the right to hold assets on their behalf. In this context, the shareholders of different companies which would otherwise all compete with each other place their shares into a legal trust which is then governed by a board of trustees. In the case of Rockefeller’s Standard Oil, for example, 37 different shareholders placed their shares into the trust controlled by Rockefeller and 8 others. This allowed Rockefeller to control the companies owned by the others and operate them as one large monopoly. --Trusts quickly became a way for clever industrialists to consolidate their market power. One example is the American Tobacco Company. James Buchanan Duke had just entered the growing cigarette business in 1879 with W. Duke, Sons & Company. At the time, cigarettes had to be rolled by hand, and a skilled cigarette roller could produce about 200 cigarettes per hour. One major cigarette producer, Allen & Ginter, offered a reward to anyone who could invent a machine which would roll and cut cigarettes. An inventor named James Bonsack rose to the occasion and delivered his machine to Allen & Ginter, which produced 200 cigarettes per minute, and expected the $75,000 bounty in return. But the company rejected his machine, claiming it was unreliable, but really, they were worried about consumer focus groups which responded negatively to the uniformly cut cigarettes. James Duke, or Buck as his friends called him, saw an opportunity. He bought the exclusive rights to Bonsack’s machine and wagered that consumers would adjust to the new cigarettes when they saw the lower price. He was right, and within a decade his company was the biggest cigarette maker in the country. Duke went to his competitors with an idea. They would form a holding company which would operate all the cigarette companies jointly. He called it the American Tobacco Company, and he got other major manufacturers to join in, putting him in charge of them all. Duke’s company was joined by W.S. Kimball & Company, Kinney Tobacco, Goodwin & Company, and yep, you guessed it, Allen & Ginter. Together they controlled 90% of the cigarette market, and under Duke’s control the company grew 12 times as large. Buck Duke became one of the wealthiest men in the country, and in 1924 he gave $19 million to Trinity College in his home state of North Carolina, which is the equivalent of about $280 million in 2020. They were so thankful for the tremendous endowment, they renamed the whole school after him, and it is known today as Duke University. --In 1890, the U.S. passed the Sherman Antitrust Act, which prohibited anticompetitive agreements and conduct which attempts to monopolize a market. In 1911, the American Tobacco Company was broken up into four separate companies by the same court ruling which broke up John D. Rockefeller’s Standard Oil. And you can see on this chart that the companies that Standard Oil was broken into are still around today under different names. In 1917 the law was used to break up Thomas Edison’s monopolistic control on the motion picture industry, and as recently as 1982 it was used to break up the monopoly AT&T had on telephones. In 2001 the law was used to bring a suit again Microsoft, but a settlement prevented the company from being broken up. In all history though, there is only one company that has survived an antitrust suit unscathed, and that is Major League Baseball. Certain they would get a favorable ruling, in 1915 the newly formed Federal League sued the National League, which along with the American League make up the MLB. Their case was pretty simple. The organization was a collection of separate companies that each controlled one team. And by prohibiting teams from playing other teams outside the league, they were engaged in anticompetitive behavior. They filed in the court of Judge Kennesaw Mountain Landis – yes, his real name was Kennesaw Mountain Landis – who had the reputation of being a trust-buster after he ordered John D. Rockefeller himself to testify in his courtroom. It was a slam dunk. But what the Federal League did not count on was the fact that Kennesaw Mountain Landis was a trust-buster second, and a baseball fan first. He ruled against them, and the case was appealed to the Supreme Court. The Supreme Court at the time was led by former president William H. Taft, whose tenure in the White House also earned him a reputation as a trust-buster. But Taft too was first and foremost a baseball fan. And he and the court ruled – absurdly I must say – that baseball did not constitute interstate commerce and thus was not subject to the Antitrust act. The ruling has stood unchallenged to this day, and if you know your baseball history you know that when Major League Baseball was caught in a scandal and needed a commissioner to bring them out of it, they made Kennesaw Mountain Landis the first commissioner of Major League Baseball. --Of course, we still have business tycoons today, like Elon Musk, Jeff Bezos, and Bill Gates. It might be worth noting though, that John D. Rockefeller’s net worth was the equivalent of about 2% of GDP, and all three of these men would need to combine their wealth to reach a similar level. The other thing worth mentioning is that at the time of this recording, only Elon Musk is still running the companies he started. In every other case, from Standard Oil to Amazon, the company has lived beyond their founder. Prior to the Gilded Age, that was extremely rare. Most companies dissolved when their founder died, or the business partnership dissolved because the founders wanted to move on to other things. These days, companies live on for years, even centuries now, continually seeking ways to improve their products and contribute to economic growth. Important too is that there are no Vanderbilts or Carnegies or Rockefellers or Dukes on the Forbes list of wealthiest people in the world. In fact, in-between Rockefeller and Bill Gates came people with names like H.L. Hunt and Daniel Ludwig, and John Kluge and I am willing to bet you’ve never heard of them. But they were once the richest men in the country. The Gilded Age did not do away with the rich aristocracy, but none of these people were born into royalty. Creative destruction disrupts that aristocracy as much as it disrupts industry, replacing it every generation with new innovators. The giant businesses these tycoons create might not be as efficient as Adam Smith envisioned, and regulations like the Sherman Antitrust Act have improved on that, but they do seem to be indispensable engines of progress.

Quick Quiz

Now is the time to test yourself on these concepts! This quick quiz is a great way to see what has clicked and what needs more attention. It is also a good time to reach out to your instructor with questions.

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Planned Obsolescence

I love this video from Veritasium, which explores the history of planned obsolescence and a true conspiracy on the part of light bulb manufacturers. This is a great example of Trusts, anti-competitive agreements, and the now 'visible hand' of corporate management trading economic efficiency for higher profits. You'll also hear stories about how technological anxiety continues to stifle innovation.

Dr. Goegan Explains...

Example Question
The marginal product of labor for a firm is given by: MPL = 128 - 2H, where H is the number of hours they hire workers to work. For example, the marginal product of the first hour of labor would be 128 - 2*1, and the marginal product of the second hour of labor would be 128 - 2*2, and so on.

The competitive market wage is $13 per hour, but a labor union has pushed those wages up by $5 per hour. How many fewer hours of labor will the firm hire due to the higher wages?

Round your final answer to two decimal places.

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