Economics in Two Lessons, Chapter 9

Thanks to everyone who the first eight chapters of my book-in-progress, Economics in Two Lessons. I’ve found the comments on Chapter 8 valuable, but haven’t yet found time to edit in response to them. Soon, I hope!

In the meantime, I’ve posted a draft of Chapter 9: Market Failure. Comments, criticism and praise are welcome.

The book so far is available
Table of Contents
Chapter 1: What is opportunity cost?
Chapter 2: Markets, opportunity cost and equilibrium
Chapter 3:Time, information and uncertainty
Chapter 4:Lesson 1: Applications.
Chapter 5: Lesson 1 and economic policy.
Chapter 6: The opportunity cost of destruction
Chapter 7: Property rights, and income distribution
Chapter 8:Unemployment

8 thoughts on “Economics in Two Lessons, Chapter 9

  1. Citing a business magazine you say that Amazon is one of the world’s most profitable companies. That’s not true. Amazon has only recently become profitable and in the fourth quarter of 2017 made a profit of (from memory) US$1.7 billion, about the same on an annual basis as the ANZ bank.

    Amazon’s revenue is huge and its strategy is to monopolise the world with low prices and in the future make gargantuan profits. The stock market thinks this strategy will work which is why Jeff Bezos is the richest person in the world. But right now Amazon is not very profitable. And, you never know, another company might come along in the future that will eat Amazon’s lunch, just as happened to IBM and Microsoft.

  2. John

    it seems to me that a widespread trend over several decades, but maybe longer, is for firms to make more internal differentiation between management functions, and product- or service-specific functions, and to grow the number of the latter while extracting most of the operating profits from the production or service functions to the management function. Management functions seem more generic, and so there is a possibility for hidden levels of monopoly or oligopoly in an economy: a few conglomerates can control most of the economy even though in any particular product or service market there might appear to be a number of providers. For example, Virgin runs all sorts of businesses, linked I assume by some sort of core management services.

    I’m not sure whether this is really a market failure or potential for it, but it seems that the economy could in meaningful terms be much more concentrated than superficially appears to be the case – the meaningful referring to the capturing of excess shares of profits by the management “sector”.

    It also seems to me almost axiomatic if one believes that competition does truly operate (ie some go out of business or lose market share), that all markets must tend to oligopoly unless either firms lose their skills very rapidly (loss of competitive advantage through decay) and/or there is a very high rate of innovation and low enough costs of entry (loss of competitive advantage due to diversity in innovation).

    So, if market concentration is a form of market failure, and you outline that it is, it seems that market failure arising from effective competition is inevitable.

    Coupled with corrupted or incomplete pricing (ie non-inclusion of externalities), it reinforces the point you make throughout that the competitive market is a sort of autists’ fantasy.

    Do economists have theory or rules of thumb for how much market imperfection can be accepted or put up with, or that simply a political question?

  3. John – this extends what I was trying to say in the earlier post, but the network structure of economies (I can’t pinpoint any particular reference, and I am sure you will know the field) and concentration of ownership and cross-ownership exhibits power law distributions, which appropriately enough given the name, must have consequences for market power and hence market failures.

    This is not a new observation I think, but the model of perfect markets is completely analogous to the billiard ball model of particles interacting, and is built on complete absence of any coordinating mechanisms within either buyers or sellers. By analogy, pre-quantum physics, pre-ecosystems thinking.

  4. I wonder if some market failure is the result of people failure, i.e. folk not behaving as rationally as we would like them to. An example might be saving for retirement. If I understand correctly, a huge proportion of the public take next to no interest in their superannuation and can’t even name their fund. Not many folk put in the research needed to maximise their super and they end up in non performing funds with lots of fees. In cases like this, where folk are not maximising their own welfare, government regulation that could be considered patronising makes sense.

    Given that not-for-profit industry super funds have consistently outperformed the for-profit retail funds, and the latter charge higher fees, retirees might get more free lunches if the for-profit retail funds were axed.

  5. You associate monopsony with labor markets (9.4). I have just re-read those chapters in ‘The Economics of Imperfect Competition’, and Joan Robinson’s 1969 Preface to the Second Edition. The supply of armaments is a large component of national economies. It seems to me that it is a particular kind of monopsony; one that pays no attention to costs (marginal, opportunity or otherwise) utility, or any established measure of efficiency, satisfaction or performance. I can not offer you an answer (nor have I found one, at least since Edmund Burke) but, f you are writing a book with the scope you have outlined, I suggest you have to categorise ‘defence’ spending somewhere.

  6. Should have added – I see that as quite separate to your ‘Opportunity cost of destruction’, which is a particularly entertaining chapter.

  7. The comments on Crooked Timber are closed so I hope you don’t mind posting here instead.
    Here are a few thoughts on this chapter.

    This is the ending of the section on economies of size and I think it needs to be punchier and you don’t address why it is a problem until the discussion on natural monopolies.

    ‘Whatever their source, economies of size create a problem for One Lesson economics. When
    economies of size are present, the (marginal) opportunity cost of producing an additional unit of a good or service is less than the average cost of the total quantity produced. If prices are equal to the marginal opportunity cost of production, the revenue derived from sales will be less than the total cost.‘

    I’ve just been reading William Davies’ On the Limits of Neoliberalism and he writes a lot about Chicago and Law and Economics. He points to Coase’s theory of the firm as arguing that perfect competition would have inefficiencies so some level of level of imperfect competition is necessary which then comes down to ‘expert ‘analysis of economists. There is not just ‘government failure’ but the costs of regulation may be greater than the benefits of regulation. Also, he mentions Schumpeter and monopoly profits as the reward for the heroic entrepreneur. I think this is relevant to the defence of monopoly section. Even if it doesn’t apply to a pure monopoly there is rarely an example of a pure monopoly outside of nationalisation or state intervention e.g. you talk about Google but there are other search engines like Bing (lol) or duck duck go, the point is that Google has the market power to behave as a monopolist. I think you could make it clearer in what sense you are using ‘monopoly’.

    An issue with monopsony that I keep thinking about is social care in the UK. There has been a lot of moves to schemes like personal budgets and direct payments where the money which would have been used on public provision is given directly to service users or parents (customers) so that care can be personalised. The problem is that the state or local authority is in a monsoponist so can set the prices for their provision and also take advantage of economies of size then the people receiving direct payments don’t actually have enough to meet their needs and care providers aren’t paid enough to make a profit and deliver the necessary quality of service (go out of business or drop quality). There also the problems of bureaucracy and proving you meet thresholds to need funding. The problem is using market solutions to address market failures – social care has a positive externality so is undersupplied by the market.

  8. @Smith

    Coming back to this rather belatedly, the quoted article refers to “most valuable”, which I would take as referring to stock market valuation rather than current profitability. If you can think of a good shorthand rephrasing of “the five most valuable companies in the world”, making this a bit clearer, I’d be very grateful.

    @Robert Banks There’s a rule of thumb somewhere that five firms are enough for a workably competitive outcome, but I’m not sure if its valid.

    @Hugo Deviations from rational behavior can cause or amplify market failures, but they are not the only cause. There’s a section on bounded rationality coming up.

    @Ian Kirkegaard Thanks!

    @Philip I share the concern that the chapter isn’t punchy enough. Working on it now.

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