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A Very Useful Introduction to the Wonderful World of Monopolies
Including Most Illustrative Examples and Pootie Pictures
by D.B.H., Dauphin
Anno MMX

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.

Example:

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).

2. Oligopolies

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.

 

Originally posted to Dauphin on Sun Jan 17, 2010 at 11:19 AM PST.

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Comment Preferences

  •  Tip Jar (21+ / 0-)

    Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

    by Dauphin on Sun Jan 17, 2010 at 11:19:48 AM PST

  •  Very good diary (12+ / 0-)

    Recommended reading.

    There's an important point that often takes a back seat in the HCR discussion to things like the public option, and that's the fact that the health insurance companies are engaged in a complex yet naked and entirely legal form of price fixing.  Since the passage of the McCarran-Ferguson Act of 1945, the insurance industry has been exempt from price-fixing and anti-trust law.  A repeal of MFA was on the table, then off the table, then on the table, and last I heard is back off the table.  But any serious reform bill whose stated purpose is to subject insurance companies to true competition for the purposes of containing cost must address this.

    Rush Limbaugh: Opiated Sack of Porkfarts

    by The Termite on Sun Jan 17, 2010 at 11:31:31 AM PST

    •  Yep. (3+ / 0-)
      Recommended by:
      The Termite, ubertar, scotths

      But if you set the maximum price and the product that has to be provided, there's not much even a monopolist can do. I'd say that maximum premiums and uniform standards for minimal insurance should be sufficient.

      Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

      by Dauphin on Sun Jan 17, 2010 at 11:33:18 AM PST

      [ Parent ]

      •  Some problems.. (1+ / 0-)
        Recommended by:
        shaharazade

        Demand is ineleastic.. your money or your life..

        95% of consumers are not technically literate enough to know the difference between excellent, good, fair, poor, or abysmal care, although they do know the difference between no care and care. This tempts the vendors to conspire to lower the standard of care, which is what they are doing.

        To do this, they need isolation from the outside world and isolation between the various functional castes.

        Separate but unequal.

        The Democrats clearly don't want to give up the health care issue by actually solving it. Single Payer is the only way.

        by Andiamo on Sun Jan 17, 2010 at 12:57:49 PM PST

        [ Parent ]

        •  Yes, demand is inelastic. But (0+ / 0-)

          if you fix the supply side of the equation through mandatory minimum coverage and maximum expenditure, you've just removed price-gouging from the equation.

          And you'll notice that minimal standards for exchanges also take the onus from customers.

          Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

          by Dauphin on Sun Jan 17, 2010 at 02:38:41 PM PST

          [ Parent ]

  •  Going to dinner, will respond to comments (2+ / 0-)
    Recommended by:
    edrie, shaharazade

    afterwards.

    Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

    by Dauphin on Sun Jan 17, 2010 at 11:34:05 AM PST

  •  The cap on premiums does not address (1+ / 0-)
    Recommended by:
    shaharazade

    the problems of the additional costs of co-pays etc. for those who actually want to use the system. On paper this might work, but the imposition of fees across the board which do not take into account the actual disposable income of those paying them, conjoined with the rapid cost increases which this bill does nothing to control, does little to actually provide the health care that this Bill ostensibly sought to provide. As a result this makes it little more than a regressive tax which provides very little for those in the middle that need the most help providing health care for their families.

    This may be great for the truly poor who receive the expanded subsidies, but it will be at the expense of the middle that the Bill was supposed to be aimed at; the top being able to do whatever it wants anyway. All this really seems to do is impose a mandate to extend the viability of an industry which is rapidly pricing itself out of the market.

    Am I wrong?

    A Republican is someone who can't enjoy his privileged position unless he is certain that somewhere, someone is in excruciating agony. I Love OCD

    by nippersdad on Sun Jan 17, 2010 at 11:43:06 AM PST

  •  The problem is middlemen which, in some (2+ / 0-)
    Recommended by:
    TiaRachel, shaharazade

    circumstances actually add value by transporting goods and services from where they aren't needed to where they are.  In the case of health care, the middlemen provide NO ADDED VALUE at all.  Moreover, IMHO, a service that's not wanted but needed falls into another category entirely and is not amenable to being appropriately managed by the market.  Indeed, for the majority of services that aren't wanted or valued by the recipients we rely on government to deal with them:

    inundation
    incineration
    invasion
    insult
    ignorance
    injury
    infestation

    Finally, there's the reality that in these areas success is measured as a reduction of need and/or use--i.e. the opposite of what the market for goods and services expects.

    How do you tell a predator from a protector? The predator will eat you sooner rather than later.

    by hannah on Sun Jan 17, 2010 at 11:58:37 AM PST

    •  They do provide great value to the politicians- (1+ / 0-)
      Recommended by:
      shaharazade

      The intentional withholding of adequate medical care especially when people are paying for it is clearly a crime.

      Politicians are paying a lot of our money for that extra layer of insulation from the legal implications of their actions.

      The Democrats clearly don't want to give up the health care issue by actually solving it. Single Payer is the only way.

      by Andiamo on Sun Jan 17, 2010 at 01:04:17 PM PST

      [ Parent ]

  •  Do you think it will take us down to 9% of GDP? (1+ / 0-)
    Recommended by:
    Dauphin

    caps on premiums and mandated care this system sets the insurance companies income and expenses, determining profts. Quite close to single-payer.

    In what sense is this close to single-payer? Simply from a coverage metric?

    In the UK, Australia, Norway, Japan, and Sweden they spend about 9% of GDP on health care, cover everyone, and have higher average life expectancies than we do. They're not the only ones, either. Current US expenditure is 16%. The economic superiority of single-payer is empirically obvious, and I'm sure you don't disagree.

    Do you think that this HCR bill will reduce health care expenditures as a % of GDP, keep it about the same, or increase it? Do you believe that there is any way to sub-10% without single-payer?

    It seems to me like the % of GDP will necessarily rise under the HCR bill, due to the mandate. I don't think the cost-controls will ameliorate the additional cost implicit in increased participation.

    "Any plan I sign must include an insurance exchange...including a public option." President Obama, 7-18-09

    by efraker on Sun Jan 17, 2010 at 12:03:53 PM PST

    •  They keep trying to associate (0+ / 0-)

      every bad idea they come up with that preserves their monopoly with single payer?

      The Democrats clearly don't want to give up the health care issue by actually solving it. Single Payer is the only way.

      by Andiamo on Sun Jan 17, 2010 at 01:07:26 PM PST

      [ Parent ]

      •  Had you read the diary you would've seen (0+ / 0-)

        it's not a monopoly at all. And thanks for implying "we" are a monolithic conspiracy.

        Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

        by Dauphin on Sun Jan 17, 2010 at 02:41:37 PM PST

        [ Parent ]

        •  Don't think Andiamo meant you when he said 'they' (0+ / 0-)

          Dauphin - I don't think Andiamo was talking about you when he said 'they' keep trying to associate. I think he was talking about the health care lobby. Er, unless you're part of the health care lobby?

          I agree with you that it isn't a monopoly; though I think the system must be insufficiently competitive. Else, how can care be provided so much more efficiently by single-payer systems in other nations?

          "Any plan I sign must include an insurance exchange...including a public option." President Obama, 7-18-09

          by efraker on Sun Jan 17, 2010 at 03:04:00 PM PST

          [ Parent ]

  •  for a little light reading... (0+ / 0-)

    try "here""here"

    ...and it's time we brought it back into play!

    we are the future. no one else. WE are the ones who make change happen in every little detail we do. make it count. we only get one go-round.

    by edrie on Sun Jan 17, 2010 at 12:06:33 PM PST

  •  can you explain (2+ / 0-)
    Recommended by:
    Dauphin, shaharazade

    why Hansen is wrong about cap and trade? I don't understand your point.

    •  Yes do (2+ / 0-)
      Recommended by:
      Dauphin, shaharazade

      I think I know the answer but I cannot fit it into the context at which the diary makes its parenthetical comment.

      50 states, 210 media market, 435 Congressional Districts, 3080 counties, 192,480 precincts

      by TarheelDem on Sun Jan 17, 2010 at 12:37:26 PM PST

      [ Parent ]

    •  Sure. (0+ / 0-)

      Hansen claims that cap-and-trade cannot work, but taxation can. In reality, both achieve the same effect. By setting price at x, I reduce the quantity by y, and if I set quantity at y, the price will stabilise at x, ceteris paribus. Now, Hansen blames cap-and-trade's carbon offsets, completely missing the fact that tax breaks play exactly the same role with taxation.

      Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

      by Dauphin on Sun Jan 17, 2010 at 02:35:18 PM PST

      [ Parent ]

      •  I see what you're saying (1+ / 0-)
        Recommended by:
        Dauphin

        changing the quantity has the same effect as changing the price. Got it.

        Are you worried about the possibility of speculation and derivatives in the carbon market? I am.

        •  I'm not. (0+ / 0-)

          Two reasons. The first is that there is no "fractional reserve carboning" which could be used for an expansion of credit. The second is that speculation which serves to drive the price up (and who'd short-sell a tightening supply?) only increades the cost of emissions, which is a good thing.

          In that way you pit interests of two spheres of capital against one another. Quite a feat.

          Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

          by Dauphin on Sun Jan 17, 2010 at 03:03:15 PM PST

          [ Parent ]

          •  I see your point about (1+ / 0-)
            Recommended by:
            Dauphin

            "fractional reserve carboning." Makes sense. And also your point about not wanting to short sell a dwindling supply of emissions allowances.

            But offsets are theoretically and practically unlimited. Seems like there's much more room for speculation (and bubbles) there.

            •  That depends on how (0+ / 0-)

              they are defined. From what I've read, most offsets are real investments: In planting a forest, for example. Those are easily checkable.

              Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

              by Dauphin on Sun Jan 17, 2010 at 03:37:52 PM PST

              [ Parent ]

              •  hmm... (1+ / 0-)
                Recommended by:
                Dauphin

                I actually own, as part of a collective, 120 acres of woodland in the Cumberland Plateau region of Tennessee. About 75% of it is wooded, though the stand is not very old, maybe just a few decades. We have a community compact not to cut down any trees, which we view as valuable in their own right.

                Each acre probably sequesters about 1 ton of carbon every year, something like that. Which means the whole piece of land sequesters about 75 tons of carbon every year. I have my own carbon offset!

                Anyway, we don't cut down our trees because we like trees more than money. But if we wanted to make money off the land, we might clear-cut the land, which would likely produce about $1000 per acre, or $75,000 total.

                How much money could we make from selling avoided deforestation carbon offset credits?

                It seems like the cost of credit should be more than the $1000 per acre of forest we could make by cutting it all down.

                If we didn't love trees more than money, I imagine we would either demand $1000 per acre of forest that we didn't cut down (for fifty years?) or just cut it all down and sell offsets for reforesting the tract with quick growing pine. Rinse and repeat in 15 years.

                So, which is the most profitable approach?

                It seems like the most profitable approach for this piece of land is to cut it all, replant and collect carbon offsets for doing so, and then cut it all down again.

                It seems like the value of the offset would have to be tremendously high to match the value of timber. The price of carbon is around $20 per ton, right? The timber is worth 50 times more than that.

                Not sure I'm understanding.

                •  If I understand correctly, (0+ / 0-)

                  you must actually let the trees stand for a certain period of time.

                  Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

                  by Dauphin on Sun Jan 17, 2010 at 04:18:13 PM PST

                  [ Parent ]

                  •  ok (1+ / 0-)
                    Recommended by:
                    Dauphin

                    Let's say I clear-cut the land and pocket $75,000. It costs me $25,000 to replant, and 16.66 years later I cut again for another $75,000. I do it again. That's 50 years, and I have made $175,000 profit cutting and planting.

                    In order for avoided deforestation credits to be competitive, they would have to equal that number, $175,000 over 50 years.

                    Keeping it simple, that means the buyer would be paying $175,000 for 50 years X 75 acres X 1 ton of carbon per acre or 3750 tons of carbon, provided I didn't cut anything for 50 years.

                    $175,000/3750 is $46.66 per ton of carbon.

                    Current prices for forest carbon is around $10 or less.

                    http://www.environmentalleader.com/...

                    I think that price is going to have to come up a lot to have any real effect.

  •  A discussion of the buyer side of this (2+ / 0-)
    Recommended by:
    Dauphin, shaharazade

    Monopsony and oligopsony would also be helpful.

    To my mind, especially in relationship to the various labor "markets" for jobs and income.

    50 states, 210 media market, 435 Congressional Districts, 3080 counties, 192,480 precincts

    by TarheelDem on Sun Jan 17, 2010 at 12:39:29 PM PST

  •  This is an issue that needs more exposure. (0+ / 0-)

    I'm glad here is a forum we can uncover the grim facts of rampant capitalism.

    "Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all" Andrew Carnegie

    by pantherq on Sun Jan 17, 2010 at 02:00:37 PM PST

  •  This post changed my mind (2+ / 0-)
    Recommended by:
    sberel, Dauphin

    Or at least opened me up to maybe the current HCR bill not being a total, unmitigated disaster.  This directly addresses my problem with the lack of a public option in the bill.

    Without some limitation on monopolistic (or at least oligoplistic) pricing, all a mandate does, or a subsidy, is raise the Cournot point- the extra money pumped into the system ends up simply as greater profits for the insurance company.  The defenders of the bill (including Paul Krugman) have not discussed how the bill deals with this.

    Note, I still think the bill is highly likely to still be a failure- but there is a difference between "highly likely" and "guaranteed", and a difference between "a failure" and "an unmitigated disaster".  My previous position was that without at least a public option, the bill was nothing but a gift of free profits to the insurance companies.  And that the bill was also a gift to the Republican party which would then be able to claim (correctly, for a change) that every time the Democratic party took up health care reform, they made the situation worse.  And that since the government demonstrably can not make things better, the best thing it can do is get out of the way.  Unmitigated disaster- that not only do we not get health care reform, we get a resurgent Republican party.

    My position now is that I don't have a lot of confidence that even a Democratic administration will effectively enforce these new regulations, and I have every confidence that the next Republican administration (and there will be one) will not enforce them and will take every opportunity to repeal them.  A failure, in other words, and in another decade or two, we will have to go around the merry-go-round again.  The difference is that I now have a slim sliver of hope that the lesson learned from this failure is not going to be that the Republicans were right, and that government is the problem, but instead that the failure was too little and too ineffectual government intervention.

    "History does not always repeat itself. Sometimes it just yells, 'Can't you remember anything I told you?' and lets fly with a club." --John W. Campbell

    by bhurt on Sun Jan 17, 2010 at 03:30:17 PM PST

    •  Although we (1+ / 0-)
      Recommended by:
      sberel

      disagree, I'm glad I could help. :)

      Iuris praecepta sunt haec: Honeste vivere, alterum non laedere, suum cuique tribuere. - Ulpian, Digestae 1, 3

      by Dauphin on Sun Jan 17, 2010 at 03:34:41 PM PST

      [ Parent ]

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