A Very Useful Introduction to the Wonderful World of Monopolies
Including Most Illustrative Examples and Pootie Pictures
by D.B.H., Dauphin
Well, balls. All the wailing and gnashing of teeth regarding healthcare reform, and not one single diary which explains monopolies. Oh, well... (sharpens pen and wit), as a friend, Nathan Wallace, is fond of saying, "it's a thankless job, but somebody's got to do it."
1. An Example of a Monopoly
Imagine a village full of refugees. They're desperate, and they all have basic needs which have to be fulfilled. Food, water, shelther, clothing, medicine.
Now imaginea trader coming into town, laden with supplies of all kinds (for the purpose of this example, let's assume he has enough to fulfil every refuge's needs indefinitely). People will happily flock to his truck, and he will, with a smile, distribute supplies for a pittance. Then everyone will sing, dance, and act in a musical.
"If men were angels, there would be no need for laws." - Alexander Hamilton
Let children watch children's films. Newsflash: People tend to be complete and utter bastards who'll stab you in the back, douse you with gasoline, light you up, and then act all teary-eyed at your funeral and leave a bouquet of flowers they know you loved because "that's what you'd have wanted," if they thought it would bring them the slightest advantage. It is a fact of life that often, far too often, that merchant will be a complete and utter bastard who'll squeeze the refugees dry.
That trader will likely set the prices for supplies high. He can do it by limiting supply ("Oops, I forgot a truck back in Chicago") or by setting a price ("200 dollars for a sandwich"). The end result of both approaches is identical (which is why Hansen is wrong about cap-and-trade). This is a "who you gonna call" situation. You can't buy those supplies anywhere else.
However, there is a natural limit to this squeezing of refugees. The monopolist wants to make as much money as possible. His profit (ignoring costs) is equal to price times quantity).
Pr = P x Q
This leads us to a very important fact: For a monopolist, there can be found an optimal level of price gouging: There is a price where the profit is maximal. Above it, so few people can afford to buy the product that the profit is lower, and below it the price is so low that, despite more people buying the product, the profit is lower. That optimum, when shown on a graph, is called the Cournot point.
P(1) x Q(1) = 20 x 100 = 2000
P(2) x Q(2) = 25 x 90 = 2450
P(3) x Q(3) = 30 x 60 = 1800
Of the three choices, the second price generates the most profit and is optimal for the monopolist. People can stop buying a product because of substitutes (which is why a monopoly on teddy bears is worth precisely a rat's tonker), or because they won't be able to afford it (which is bad).
The solution to the merchant problem seems simple: Let the authorities entice more merchants. That might work, but, then again, it might not.
If the number of merchants were sufficient that none of them would have the ability to influence price by himself and if there were enough of them that they could not form a cartel to influence price collectively then we would (under the assumption of atomised demand) have a market of pure competition (that takes some other assumptions, such as zero transaction costs, perfect information, substantive rationality, and so on) where price would be determined by the invisible hand of the market instead of the monopolist's very visible hand.
Such markets are few and far between. Most markets are naturally oligopolic to a greater or lesser extent. The participants may be of equal economic power or of differing economic clout (one, for example, is a price setter, and they can only adapt with quantity they can produce at such a price - they are quantity adaptors). A good example of a market where competition is sometimes pure are your local farmer's markets (Not mine, though. The vendors seem to have a cartel agreement).
What are the implications of an oligopoly? It's essentially a weaker monopoly. That, however, is insufficient. What will actually happen is a question of non-economic factors.
The first possibility is that oligopolists don't want to risk a trade war. Sure, you may gain a lot, but you can also lose. In that case, the oligopolists may form a cartel to set price and quantity that individual members may sell. A similar state of affairs may result from conscious parallelism (which is illegal) or through a silent cartel (which isn't illegal), when oligopolists simply won't compete. Older management tends to favour these routes.
Another possibility is a trade war: Oligopolists will fight it out. In the short term, that is an advantage to the customers. A textbook example is that of two boating companies on the Volga who got into a trade war. By its end they were both ferrying passengers for free, and one was distributing free bread to them.
Unfortunately, this is only useful when a participant can't win. If an oligopolist beats his competitors, he will probably recoup his loses just like a monopolist would. And then you're living in Lower Shithole instead of Upper Shithole. You should never rely on unregulated oligopolistic competition.
Young, dynamic, or cocaine-addled management tends to choose the trade war route.
3. What to do?
Since oligopolies are naturally occurring, pursuing optimal markets is a pipe dream. What most states strive for is functional competition: A constant simmering competition where no one wins. That can be done via regulation and/or through state intervention. Institutions which protect competition, such as the German Bundeskartellamt, are common in developed capitalistic societies.
Regulation provides information and safety to customers. Competitionkeeping institutions, on the other hand, ex officio sanction certain actions, such as founding cartels or engaging in conscious parallelism. They also have to approve certain actions in advance (sanctioning if permission is not requested) and break trusts up, if needed (those roles may be divided between several institutions).
There are several ways of dealing with a monopoly. One is nationalisation. Generally, this is not practiced today. Instead, it's held that a monopoly (or a dominant position) is permissible, but the actor who finds him- or herself in such a position is severly limited in actions: Abusing the dominant position is illegal. That is why Intel and Microsoft had to pay heavy fines in Europe. Oh, well, live and hopefully learn.
4. A Comment Regarding Healthcare
Bearing this in mind, we can see the logic behing healthcare reform. We've got an oligopoly which has a pretty good gig. They don't compete much since they all have similar interests and are trying to find their Cournot points by raising premiums (effectively prices) and lowering the quality of the product (health insurance).
Healthcare reform bends over backwards to ensure the customers won't get overly screwed over by this state of affairs without going to single-payer or a two-tiered mandatory public and optional private insurance. Medical loss ratio fixes the amount of money that has to go to care instead of administration, marketing, and profits. A cap on premiums as a percentage of income sets a maximum amount on the healthcare industry's income and, by proxy, profits. Requirements for a plan to participate in an exchange set the minimal quality of the product, while ending rescissions and discrimination based upon pre-existing conditions mean the healthcare industry cannot shirk its obligations and discriminate against the needy. Subsidies aim to ensure that the poor won't pay the maximal % of their income themselves, and the modified excise tax aims to ensure the wealthy are penalised (and money can be redistributed).
Will it work? I have no idea. But as a way of addressing the problem of oligopoly, there is no economic reason this approach shiuldn't work. Sure, single payer would be more elegant and probably more efficient, but with caps on premiums and mandated care this system sets the insurance companies income and expenses, determining profts. Quite close to single-payer. The minimal product and maximum price are set. If there's no competition, we get something. If the insurance companies begin to compete, so much the better.