Summers stumbles

There’s been a lot of debate lately about whether tightening of anti-trust legislation might be a useful response to inflation. Underlying this question is that of the relationship between monopoly and inflation more generally. The dominant view among mainstream/neoclassical economists seems to be that there is no such relationship. That view is stated by one of the most prominent mainstream theorist, Larry Summers as follows

There is no basis in economics for expecting increases in demand to systematically larger price increases for monopolies or oligopolies than competitive industries.

Summers goes on to describe the opposite view as ‘anti-science’.

Readers of this blog will be devastated to learn that Summers is dead wrong. It’s quite straightforward to show, in a simple neoclassical model, that imperfect competition amplifies the inflationary effects of demand shocks. Here’s a paper I’ve just written with my colleague Flavio Menezes https://t.co/9FIactnJo7 which makes this point using the concept of the strategic industry supply curve. The same result can be presented, less elegantly in our view, using the standard tools of comparative statics to be found in any intermediate microeconomics test.

We also show that, contrary to a suggestion by Elizabeth Warren, imperfect competition is likely to dampen the impact of cost shocks. There isn’t, however, any equivalence here. Warren’s background is in law, and she isn’t making a claim just observing that monopoly power might be a problem. The distinction between cost shocks and demand shocks is unlikely to have been relevant to her, whereas it should have occurred immediately to a leading theorist like Summers.

I’m not sure about the lessons from all this. For me, it’s to think carefully before making dogmatic statements from authority. If all experts agree on something, we should say so, but be careful to make sure we are right.

17 thoughts on “Summers stumbles

  1. There seems to be a lack of research into true market power. My market theory tells me that when buyers and sellers meet one side has the upper hand. Over time it may not be the same side. Price gouging occurs when the seller perceives that it has the upper hand. But price discounting is founded on the perception that the market power lies elsewhere. Economics involves other people’s perceptions of market conditions. If the majority of participants, with effective demand, perceive that prices are likely to rise then they will expect price rises. On the other hand is the majority of participants, with effective supply, perceives that prices are likely to fall they will accept lower prices. Ceteris paribus it is these perceptions that matter to outcomes in most markets. Over time supply can change but demand may not change in certain markets. In times of extreme market conditions – panic buying, dumping, supply chain failures- laws of supply and demand may be overturned. Anti-trust regulators must take this all into account when trying to contain inflation. The black market is often overlooked. It is hard to apply economic dogma to any real market situation. John Maynard Keynes was always keen on doing empirical research before making any dogmatic statements.

  2. Sounds right. If a monopolist is exposed to a larger market then she has more monopoly power and will charge a higher price. A price increase will then have a smaller effect in reducing quantities demanded so demand is more inelastic. Not quite sure how you get from a once-and-for-all demand increase to an ongoing inflationary process but a step increase in demand will cause a step increase in price under monopoly.

  3. My market theory tells me that when buyers and sellers meet one side has the upper hand.

    I remember reading about ‘price makers’ and ‘price takers’. Supermarkets, for example, if I’m remembering this correctly, are ‘price makers’ both as sellers (dealing with customers) and as buyers (dealing with suppliers). The supermarket sets a price at which it will buy and a price at which it will sell and the choice for the ‘price takers’ (suppliers and customers, respectively) is to make the transaction at the price set by the supermarket or not to make it at all (that is, with that supermarket).

    But I’m not an economist, my recollection of what I read may well be muddled.

  4. ” ..contrary to a suggestion by Elizabeth Warren, imperfect competition is likely to dampen the impact of cost shocks.”
    Hmm, this is not intuitive. How can you disentangle the effect of imperfect competition per se and the technical conditions that often give rise to it? Not always of course: there is the real-world example of electricity, supplied in different places by markets gong all the way from total integrated monopoly to pretty atomistic competition, using the same physical infrastructure. We can also readily imagine an online retail market not dominated by Amazon. But at least one important recent example of an inflationary supply shock tells a different story; integrated circuits for embedding in consumer products. The extraordinarily high concentration of production in the hands of half-a-dozen chipmakers, led by the Taiwanese giant TSMC, comes from the extremely challenging technology and massive scale of investment (human as well as physical capital) in a state-of-the-art chip foundry. If Australia decided to build a domestic chip supplier, could this be done in under a decade? The vulnerability to a supply chain shock here really comes from the technology. not market design.

  5. I’ve read the linked paper by Menezes and Quiggin, “Monopolies amplify demand shocks”, Feb 2022.

    IMHO, the paper deals with one specific technical question within one specific theoretical framework, namely marginal analysis. The authors indicate it is motivated by a statement by Summers, which they aim to disprove.

    I don’t know the theoretical framework on which Summers bases his statement. This is relevant in so far as marginal analysis is not suitable whenever new and lumpy physical investment is required to meet a positive demand shock. (Only a positive demand shock is of interest in the context of inflation.)

    If new and lumpy physical investment is required to meet a positive demand shock, then it is conceivable that Summers argument is valid, whereby in practice (or in theoretical work that is not limited to comparative static) one would need to take into account the time profile of the demand shock relative to the time profile of the physical investment.

  6. James Wimberley, neo-classical cross-diagrams, obtained from so-called marginal analysis, cannot deal with reality, an example of which you have given.

    If one takes out the jump to conclusion of the methodology in the said cross diagrams, then one observes the diagrams represent 8 different situations (without any empirical basis for any one of them). This is the original sin of comparative static analysis.

    So, the purpose of the article, I assume, is to challenge Summers regarding ‘neo-classical’ wisdom.

  7. Ernestine, Is this suitable our homework? Introducing neo’-classical looks like a rabbit hole.
    *

    “The Keynesian cross
    The expenditure-output, or Keynesian cross, model

    “Use a diagram to analyze the relationship between aggregate expenditure and economic output in the Keynesian model.

    “The Keynesian cross
    Keynesian cross
    > Details on shifting aggregate planned expenditures
    > Keynesian cross and the multiplier
    > The expenditure-output, or Keynesian cross, model

    “Next lesson
    IS-LM”
    https://www.khanacademy.org/economics-finance-domain/macroeconomics/income-and-expenditure-topic/macroeconomics-the-keynesian-cross/a/the-expenditure-output-or-keynesian-cross-model-cnx
    *

    And high praise for Ikon… and above I assume will assist Ikon more rapidly than I.

    Ernestine said;
    “The supply and demand cross diagrams of Econ 101 are diagrammatic characterisation of an individual agent’s choice ‘in equilibrium’ (ie existence is presupposed.

    “To be frank, IMHO Ikonoclast is considering a dynamic disequilibrium situation, which takes into account the extreme income inequality and the flow-on affects for ‘aggregate demand’ for goods and services. Ikonoclast keeps on saying he is not an economist. I belief he should be given credit for his analytical skills. He should be assisted, IMHO.”
    https://johnquiggin.com/2020/09/07/monday-message-board-477/comment-page-1/#comment-227696

    Ernestine again:
    https://johnquiggin.com/2020/03/18/how-to-stop-the-toilet-paper-panic/comment-page-1/

    I’ll get through, with a better understanding of JQ’s linked note, when I’ve completed above! .

    Your comments are most appreciated Ernestine..

  8. James Wimberley, neo-classical cross-diagrams, obtained from so-called marginal analysis, cannot deal with reality, an example of which you have given.

    If one takes out the jump to conclusion of the methodology in the said cross diagrams, then one observes the diagrams represent 8 different situations (without an empirical basis for any one of them). This is the original sin of comparative static analysis.

    So, the purpose of the article, I assume, is to challenge Summers regarding ‘neo-classical’ wisdom.

  9. The cost result is clear for a monopoly. With a flat marginal cost curve and a linear demand MR=MC before and after the cost increase, price rises and the gap between P and MC diminishes with a cost increase. Easy to see using the geometry of MR, MC and demand in the monopoly model. Demand doesn’t change so the same market but MR=MC at lower output.

  10. Some useful anecdata on chipmaking costs. TSMC plans to invest over $40bn in 2022 in expanded capacity; https://www.reuters.com/technology/tsmc-q4-profit-rises-164-record-beats-market-forecasts-2022-01-13/ Intel plans two new fabs in Ohio, announced cost $20bn. https://spectrum.ieee.org/intel-ohio-fab These price tags rule out startups, and the big companies that can afford to risk $10bn in table stakes (Apple, Amazon….) are sensibly too cautious to try. For any new entrant, the technical and commercial risks of failure are very high: even mighty Intel stumbled in the transition to 10 nanometers. Oligopoly will continue.

  11. Perhaps I should or must substantiate my rather strong assertion in my post at 7.22pm that there is no empirical base for any of the 8 situations represented in the comparative static result in the paper in question. All 8 cases share one assumption, namely constant marginal costs. (I understand, I believe, why this assumption is convenient. It allows representing the mark-up in alternative economies, ie P-c). However, setting aside the implicit assumption about the production technology, a constant marginal cost implies unlimited (infinite) input resources. I cannot think of even a special case for which this assumption is empirically even approximately fulfilled. (Adding a restriction on the range of possible demand changes might be sufficient.) As for the role of technology, see James Wimberley’s examples.

    I don’t understand Larry Summers assertion: “There is no basis in economics for expecting increases in demand to systematically larger price increases for monopolies or oligopolies than competitive industries.” And ‘Summers goes on to describe the opposite view as ‘anti-science’.

    I know from observation that the increase in demand for OP masks in 2020 as well as hand sanitisers at the beginning of the pandemic resulted in sharp price increases in Australia and in some EU countries. I recall the then Federal Minister of Health in Germany revealed that prior to the pandemic the unit price of an OP mask was a few Euro cents but increased to a few Euros now (I don’t recall the exact numbers but the price increase was at least tenfold). In Australia hand sanitisers were sold out in supermarkets, such as Woolworths and Coles, but could be found in some ‘discount’ chemist shops for a multiple of the supermarket price. At that time, the Asian suppliers of these products had an effective monopoly position. It is not clear from these observations how much of the price hike was pocketed by the producers and how much by international traders. The fact is that as soon as local companies started to produce these products (there is no high tech production technology constraint), prices dropped a lot. These observations go toward the paper in question and against Summers’ assertion.

  12. As Ernestine says, this isn’t meant as a realistic and general model of monopoly. Just showing the Summers claim, which is supposed to apply universally, is invalid even in the simplest neoclassical model.

  13. I think Harry has pointed out that monopsony labour buyers can be forced to pay higher wages with greater employment … at the same time!!….. if you have strong labour unions to match the power of concentrated industries. But the labour movement is pretty weak. The Austrian economists make all these arguments as to why industry concentration isn’t the problem its sometimes made out to be. But I think these arguments are flawed, since they don’t talk about the dovetailing effects where industry concentration is coupled with a powerful financial cartel. I would say that anti-trust is not the best. Its not the ideal. But its all the Americans have to deal with the current catastrophe of runaway monopoly. The laws are already on the books. I would use these laws with extreme prejudice.

  14. The go-to-guy on the growth of monopoly right now is a history major called “Matt Stoller” Quite a young man. … He investigates how the focus was taken away from the idea of the citizen and a producer to being a “consumer.” This was kind of bipartisan intellectual crime, and championed both by people like Gailbraith as well as the Chicago school.Stoller also partly redeems for me the FDR regime. For all their faults and war crimes, they did set their hearts against monopoly. They were crap managers in their own time, but set us up beautifully for a productive, and actually comparitively fair Bretton Woods era. I hope to see a new era even more productive and even more egalitarian than Bretton Woods was. Its barely worth living unless we can get to this new era.

  15. I won’t say much. It sounds to me like Summers is putting forward another little apologetic for monopolies. We already have a pretty good idea that private monopolies are bad. The issues are much wider than just inflation, as we all know. It’s time to rein in the monopolies.

  16. The new classicals do this a lot — informing people that anything that surprises them is junk science.

    But I’m not surprised to see Summers do it.

    When I conversed with him I came to see that, though a great many persons, and most of all he himself, thought that he was wise, yet he was not wise. Then I tried to prove to him that he was not wise, though he fancied that he was. By so doing I made him indignant, and many of the bystanders.

    So when I went away, I thought to myself, “I am wiser than this man: neither of us knows anything that is really worth knowing, but he thinks that he has knowledge when he has not, while I, having no knowledge, do not think that I have. I seem, at any rate, to be a little wiser than he is on this point: I do not think that I know what I do not know.”

    Socrates

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