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BOHANON & STYRING: What Alcoa can teach us about economics

July 16, 2016

Economic AnalysisEvery Independence Day evening, PBS airs “A Capitol Fourth.” Fireworks bloom over the Washington Monument. Had the fireworks been a bit brighter, viewers could have seen the 6.27 pounds of aluminum atop the monument. That aluminum teaches a lot about how capitalism really works.

What does aluminum on the Washington Monument have to do with the economy?

When the monument was completed in 1884, aluminum was a very expensive commodity suited for only the most luxurious and elevated uses. A few years earlier, French Emperor Napoleon III ordered a set of aluminum dinner plates for state occasions: for himself and his guest of honor. Guests of lesser rank had to make do with ordinary 99-percent-pure gold plates.

Aluminum is common in the Earth’s crust, but getting it into pure form at low cost had proved elusive. Alcoa commercialized a process to make aluminum cheaply from bauxite. From 1890 to 1929, Alcoa increased its aluminum output from 60,000 pounds a year to over 206 million pounds a year and cut the price from around $8 a pound to 25 cents a pound.

Alcoa and others made tons of money by finding mass-market uses for cheap aluminum, such as tea kettles. Napoleon III flaunted his pricey aluminum. It took capitalism to put it on the household stove.

Alcoa was so good that it had an effective monopoly. Now, anyone who has taken first-year economics knows a profit-maximizing monopolist is supposed to restrict output to raise prices. But here’s Alcoa The Monopolist vastly increasing output and cutting price to 1/30th of what it had been. Were stupid people running Alcoa?

Not at all. The raise price/restrict output directive assumes a world where costs are constant. However, new processes inevitably lower the costs of production, and this is exactly what happened in aluminum. The monopoly found it in its own best interests to pass on these cost reductions to consumers.

Why? Well, not because Alcoa loved its customers, but because the company was a greedy profit-maximizing capitalist. You see, making pennies per pound on many millions of pounds of aluminum is much more profitable than making dollars per pounds on a few thousand pounds. The only way to induce consumers to buy that much aluminum is to lower the price.

So next July 4, let’s have the producers of “A Capitol Fourth” spotlight the top of the Washington Monument. We’ll supply the economics lesson.•

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Bohanon is a professor of economics at Ball State University. Styring is an economist and independent researcher. Both also blog at INforefront.com. Send comments to ibjedit@ibj.com.

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