Tuesday, June 26, 2012

Regulating Oligopoly and Oligopsony

Regulating Oligopoly and Oligopsony

Having concluded there was a need to regulate oligopoly and oligopsony, ( http://anamecon.blogspot.com/2012/03/on-need-for-regulation-of-oligopoly-and.html ) we discuss some ways how it might be done. Other suggestions are welcome.

The problem is the oligopolist produces less than the competitive equilibrium, and at a higher price, while the oligopsonist buys less than the competitive equilibrium, and at a lower price.
In dealing with oligopy we wish to decide which oligopies are most damaging.  Those in elastic markets, for instance, would be naturally limited in their ability to extract rents, while those in inelastic markets would have greater opportunity, and given the situation, inclination, to do so.  Similarly, the costs of entry to a market would also set limits on how much extra normal profit could be collected. Low entry costs would limit the extra normal profits to low levels, since higher profits would encourage the entry of other firms into the market.

With damaging oligopy, one way is simply to tax the results. A problem here is getting the receipts back to the damaged parties.  Another problem with this solution is that it would not affect the oligopist’s equilibrium, to produce at higher prices and lower quantity produced than at competitive equilibrium for oligopoly, and to buy at lower prices paid for and a lower quantity than at competitive equilibrium for oligopsony. That is, it would not eliminate bottlenecks in an economy. As may be, this approach would be to tax extra normal profits at a punitive rate, say, 90% of profits over 6% (allowing for a 3% inflation rate.)  The point is, by the time oligopy is manifest, the market is relatively fixed in proportion to the economy as a whole. Yet because of the price scheme of the oligopy, the market is defective in size to the economy, and the rent collected goes into the bank, ie taken out of the economy at large, or goes into buying up assets in the economy at large, increasing the proportion of ownership of the oligop, at the expense of the other members of the economy.  So one would wish to force the oligopy to grow to proportion of and at the growth rate of the economy as a whole.  (This is a mature market problem, not a growing market one.  It is not a problem of a company expanding into an open market, such as Apple, with its product innovations.  Extra normal profits here can still be a problem to an economy, and lead to alterations in the distribution of wealth and power.  But the reinvestment of extra normal profits in plant is also necessary to expand production to meet the demand a smaller company cannot reasonably fulfill.) 

What is desired is that normal profits are allowed to be reinvested in the oligopy, while extra normal profits are returned to the economy at large.  In oligopoly, one might gear the tax to be scaled at 6% on profit per unit produced, (with a 3% nominal rate of inflation, and a 3% rate of growth.). This would be effectively a progressive VAT, or value added tax, on the ologopoly.  This would incentivize the oligopolist to produce to competitive equilibrium, since the maximum profit would then be proportional to quantity produced. (Actually this by itself wouldn’t quite work, as the oligopolist would just be encouraged to internalize costs, so as to reduce his ‘profit’ to the 6%.)   

Another is to institute price floors in the case of oligopsony, or price ceilings in the case of oligopoly, at what one would hope to be nearer the equilibrium price for a perfectly competitive market. One example of price floors, with oligopsonies, is with minimum wage laws.

A problem here seems to be that one loses the use of price signals, although this is actually not a problem with oligopy, since the quantity traded is no longer responsive to prices anyhow.  Or more correctly, the price becomes fixed, and unresponsive over a large variation of economic conditions. In any case, over a large variation, price and quantity do not respond to the demands of the economy. While these price levels could just be legislated, probably a more efficient method would be a competitive buyer, in the case of oligopsony, or a competitive producer, in the case of oligopoly.  In the case of oligopoly, another option might be to subsidize production.  This option, subsidizing production, would fail, however, in all cases but the mildest kinks, that is, where there were numerous competitors in the oligopoly, (or hardly like an oligopoly at all.)  This is because, with a severe kink, the vertical part of the Marginal Cost MC curve extends through the price axis, or at least very close, and thus all or most of the cost of production would have to be subsidized in order to encourage an increase in quantity produced.  Otherwise, the quantity for profit maximization would not change. This would still be useful, in cases like health care, where the goal was universal coverage.  See: http://anamecon.blogspot.com/2010/03/real-problem-with-health-care-in-us.html

Similarly, just buying up large quantities from the oligopoly would be very expensive, since you would be buying at the oligopolist’s price, and providing him his extra normal profit, as is in fact the current US government policy with respect to the health care industry.  Policy should be to force the oligopolist to sell at a price nearer the equilibrium price.  Again, the situation with health care is different, since if you want universal coverage, you want to drive the oligopolist’s price to near zero, and to do so must effectively subsidize the entire production.  That is, make health care a public good. 

In the case of oligopsony, by competitive, we mean a buyer who buys sufficient goods to drive the price up to what it would be under competitive equilibrium.  This buyer would constitute a regulator.  And what would the signals be, that this regulator would look for?  He would seek a normal profit for suppliers. (This assumes that for firms facing the oligopsony, there is no barrier to entry.  If there were such a barrier, we would expect the situation to evolve into one of oligopoly facing oligopsony. Does such a market exist at a competitive equilibrium?  It would seem to depend on the relative elasticities of the supply and demand.)

One way this might be shown would be an equilibrium in firms entering and leaving the market.  This shows how the quantity of suppliers might also be regulated. By increasing the price and quantity bought, firms would be encouraged to enter the market.  By reducing the price and quantity bought, firms would be encouraged to exit the market.

The idea of government being a last resort buyer of labor suggests an alternative to minimum wage laws.  The government would enter the labor market and act as a monopsonist, and bid up wages until the unemployment rate was down to desired levels.  Private industries would have to pay this rate also, or lose employees to the government.

The situation would seem to be more difficult with oligopoly.  The problem with the government producing to competitive equilibrium is that governments are notorious for producing inferior products.  Another problem, as in agriculture and education, is what the government actually does.  That is the government subsidizes production into the face of oligopsonies.   This results in producing a surplus of goods into a buyers market, driving down the prices.  (Indeed, the prices have been driven down so low, in the case of education, that buyers, the institutions of higher education, must be paid to accept most of the production of public education. The prices are negative.  This is an alternative way of looking at the distribution of pricings and cost burdens in education.  On the other end, businesses refuse to pay the universities for the production of the universities, their graduates.  They do not send clear signals as to what they want, except in a few career specific employment and unemployment rates. 

One way to rein in oligopoly is to promote the production of substitute goods.  The development and subsidy of alternative energy sources, for instance, would moderate the action of oil and coal oligopolists, which is one of the reasons they oppose alternative energy sources so fiercely.
As another alternative, the government could employ the aggressive use of anti-trust legislation, to prevent the formation of oligopoly. Probably a figure of providing 20% of the market would constitute a member of an oligopoly.  Thus, keeping firms below that size would prevent the kink from becoming too pronounced.  A problem arises, when the oligopoly faces oligopsony, or monopsony, as in retail supermarket chains, with their limited shelf space.   By hindering one, one encourages the other, and oligopsony can be as socially destructive as oligopoly.   

Another possible solution is to separate the functions of the oligopy, making one part into a quasi-utility, and eliminating costs of entry to the other function.  Thus, for instance, (as was done with British rail) providers of cable TVcould be separated into parts, one which merely operated and maintained the cable, and the other which provided the content, paying the operators of the cable a fee.  The operator would be a regulated monopoly, and the content providers would be competitive, the costs of entry, one of the prerequisites for oligopoly, minimized.  The same could be done with cell phones, the towers being regulated, and selling their bandwidth, which they would seek to maximize, for a fee.

Health care in the US is an instance of oligopoly. Actually it is an instance of several different oligopolies.  One is medical equipment supply.  Another is pharmaceutical supply.  Locally hospitals form oligopolies.  (Hospitals are an obvious choice for regulated utility.)  Finally, a limited supply of doctors and other medical personnel creates an effective oligopoly to health care consumers.   Production of health care is restricted, driving up prices. Buying from the oligopoly will not change this, and indeed can be expected to further drive up prices. 

For industries requiring a high level of maintenance of resources, such as farming, further regulation might be required of producers, to prevent depletion of assets in efforts to temporarily acquire extra normal profits.  Progressive taxation would be helpful here, since it increases the present value of future returns, rather than exploitation of the resource for immediate returns.

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