Tài liệu Microeconomics for MBAs 38 docx

Chapter 11 Firm Production under Idealized Competitive Conditions Contestable Markets One of the most important developments in the study of markets is the theory of contestable markets. 2 The contestable market model stresses the importance of potential rather than actual competitors in a market. A market is deemed to be contestable if entry and exit are relatively easy. A market is perfectly contestable if entry is absolutely free and exit is costless. Free entry has a particular meaning in the theory of contestable markets; it means that new firms entering an industry are not at any cost disadvantage compared to existing firms in the industry. In other words, latecomers suffer no cost handicaps. Costless exit means that firms can leave the industry at any time and can recoup all costs incurred by entry. A contestable market, then, is marked by ease of entry and exit and in that respect is similar to a perfectly competitive market. Like a perfectly competitive market, a contestable market will be characterized by zero economic profits in the long run. For a contestable market, however, we do not need a large number of firms and a homogeneous product. Indeed, multiproduct firms are possible in contestable markets. A contestable market may have only two or three firms operating in it. Moreover, those firms produce at rates of output where price is equal to marginal cost. What brings about this result? Why do firms in contestable markets not produce and price at the monopoly equilibrium? The reason is entry and exit. If price is not equal to marginal cost, profit opportunities exist and new firms will quickly enter the market, causing existing firms to make losses. The potential competitors force the existing firms to produce where price equals marginal cost. A firm in a contestable market is always open to hit and run attacks from its potential competitors. They will therefore be forced to produce and sell at an output where price equals marginal cost and economic profits are zero. Any attempt to exploit market power will bring about entry into the market and the dissipation of all profits. The firms in the contestable market will be forced to operate as it they were in perfectly competitive markets. A contestable market is depicted in Figure 11.14. Note that although only three firms are in the industry, they all produce where price equals marginal and average cost. For the industry as a whole, price is equal to the minimum on the long-run average total cost curve. Each firm produces one-third (q) of total industry output (3q). Production at an efficient rate of output and marginal cost pricing, then, do not require the atomistic markets of the perfectly competitive model. A perfectly contestable market will do. What industries might this model fit? The air travel industry is one candidate. Many major markets are served by only two or three airlines. Yet if an airline with a dominant position in a particular regional market attempted to set price well above costs, entry would quickly follow. Airplanes can be shifted from one market or use to another with ease. New 2 The basic model of a contestable market is presented in William J. Baumol, “Contestable Markets: An Uprising in the Theory of Industry Structure,” American Economic Review, 72 (March 1982), 1-15. For a critical analysis of the model, see William G. Shepherd, “‘Contestability’ vs. Competition,” American Economic Review 74 (September 1984), pp. 572-587. Chapter 11 Firm Production under Idealized Competitive Conditions entrants do not appear to be at a cost disadvantage relative to existing firms. If the conditions for a contestable market were indeed met, then we would expect the air travel industry to be characterized by marginal cost pricing and zero economic profits. It is always difficult to determine whether or not price is equal to marginal cost; one indication that contestability characterizes the air travel industry is that prices do not appear to be higher in markets with fewer actual competitors. The zero-profit outcome also describes the air travel industry reasonable well. _________________________________________ FIGURE 11.14 A Contestable Market The market is composed of three firms, each producing output q*, which minimizes average costs. Total industry output is Q* = 3q*. Any attempt by the three firms to reduce output and increase market price will lead to entry by new firms and the dissipation of profits. MANAGER’S CORNER: When Workers Would Want Their Bosses to Cut Their Pay In trying to manage a firm’s production and cost properly, managers want to cater to many (not all) of their workers’ wishes. What is more obvious than the desire of workers for higher salaries and wages? Certainly no sane person would deny that all workers would rather be paid more money rather than less, everything else equal. But everything else is seldom equal. For example, while workers may rather take home bigger paychecks with the work being held equal, they do not necessarily want a higher wage if it requires less pleasant or more difficult responsibilities. 3 But even for the same work, workers may prefer to be paid less money. Indeed, workers are better off because employers are constantly looking for, and succeeding in finding, ways to pay them less. This is a point you very likely haven’t seen covered in your human resource studies. 3 As explained in an earlier chapter, despite what they may say, most young and inexperienced MBA graduates would not want a job paying $200,000 immediately upon graduation. Such an employee would have to contribute at least $200,000 to firm revenues, which he or she, without experience, is not likely to be able to do. The expected value of a job with a much lower salary is likely to be higher, given the much higher probability of the new graduate keeping it. Chapter 11 Firm Behavior under Idealized 22 Competitive Conditions In the analysis that follows, always keep in mind a key point in our above examples: workers can be better off even when they experience a cut in their monetary pay. Workers are better off with the lower pay than they were before because the only way the employer could reduce their pay (without reducing their ability to hire competent workers) is by substituting a fringe benefit that is worth even more than the lost pay. Even though monetary pay has been cut, total compensation has been increased. We advance the argument by showing that workers benefit more from a fringe the larger the reduction in their wage. Our demonstration in this section is, admittedly, subject to one qualification. That qualification is that all workers have much the same preferences for fringe benefits. Even if workers in general are made better off when a fringe benefit is substituted for monetary compensation, it is possible that the fringe benefit is one that some workers do not value at all, or do not value as much as they do the loss of money income. This is a problem, however, that both workers and employers have a strong motivation to overcome. Workers will be more attracted to firms that offer the combination of fringe benefits and money wages that best conforms to their preferences. For example, we have noted many young workers seeking part-time employment to help pay for college will want most of their compensation in money wages with little in the way of fringe benefits. They need cash and most face low (or no) tax rates. In general, older workers in higher income tax brackets and with greater demand for medical care will want more of their compensation in the form of untaxed fringe benefits such as health insurance. Therefore we can expect employers who hire a lot of young part-time workers to offer fewer fringe benefits than employers who hire mostly adult full-time workers. Also, employers will find it to their advantage in competing for workers to offer a menu of fringe benefits from which workers can choose. The closer an employer can adjust the fringe benefit package to the preferences of the workers, the more the employer can save by paying lower money wages. 4 But even if we assume that all workers benefit equally from the fringe benefits provided, can we really show that workers receive the greatest benefit when their wages are cut the most? What is to keep the employer from receiving all the advantage from fringe benefits that are worth more than they cost? Sure, an employer will provide fringe benefits that cost only $50 per worker if they are worth $100 to each worker. But if the employer then reduces each worker’s money income by the full $100, which she could presumably do without losing any workers, where is the gain to workers? The answer is that if some way is found to save on the cost of hiring workers, competition will force employers to share some – but not all of those savings with workers. For example, if one firm discovers a fringe benefit that lowers the cost of workers, other firms will find advantage in providing that benefit also. With workers becoming less costly to firms in general, they will be more aggressively sought out, and the competition between firms will prevent any one firm from lowering the wages of workers by the full value of the new fringe benefit. Also, even if the fringe benefit could only be provided by the one firm, so workers did not become more valuable to other firms, competition would 4 Over half of big American companies with 100 or more workers give those workers a chance to tailor their benefits. This means that a worker covered by a spouse’s health insurance can opt out of health insurance and have the savings applied to, say, dental insurance or car insurance. The purpose of giving workers the option is, naturally, cost control (The Economist, December 21, 1996, p. 91). Chapter 11 Firm Behavior under Idealized 23 Competitive Conditions still prevent the one firm providing the benefit from cutting the money wage by the full value of the benefit. Assume that the firm did initially attempt to capture all the value of a fringe benefit by lowering the wage by its full value. The result would be that workers now cost the firm a lot less than before, and this cost advantage would make it profitable to hire more workers. But the only way to hire more workers is to bid them away from other activities, which means bidding at least some away from other firms. This can only be done by increasing the wage back up not to the point where it was before the fringe benefit was added, but high enough so that the total compensation is higher with the fringe benefit than it was before, even though the money wage is lower than before. You are excused, however, if you are not yet convinced that when a fringe benefit is provided the gain to workers is greater the larger the reduction in their money wage. Our verbal discussion of the effect of fringe benefits is not sufficiently precise to convincingly establish the connections between those benefits, the money wage, and the gain to workers. The best way to get at these connections is by returning to the demand and supply curves used earlier. With those curves we have already seen that if the fringe benefit is worth providing (its value is greater than its cost), then the wages of workers will fall by more than the cost of the fringe benefit (the employer gains) but by less than its value to workers (the workers gain). Illustrating this important point again will set the stage for understanding why the bigger the wage cut the better for workers. In Figure 11.15 the initial demand curve for workers (without the fringe) is given by D 1 and the initial supply curve for workers (without the fringe) is given by S 1 . 5 Given these curves the market-clearing wage is given by W 1 and the number of workers hired is given by Q 1 . Now assume that the employer adds a fringe benefit (say another week of paid vacation each year) that costs exactly the same amount per worker as it is worth to each worker. The demand curve for workers will shift down by an amount equal to the cost per worker of the fringe benefit, or to D2. And the workers supply curve will shift down by the same amount to S2. _________________________________________ FIGURE 11.15. Fringes and the Labor Market An Increase in fringes can increase the cost of doing business, causing the demand curve for labor to decrease from D1 to D2. However, it can also cause the supply curve of labor to increase from S1 to S3. The wage rate might fall from W 1 to W 3 , but workers are better off because the get the added value of the fringes. __________________________________ 5 The remaining discussion draws heavily on an article by one of the authors: Dwight R. Lee, “Why Workers Should Want Mandated Benefits to Lower Their Wages,” Economic Inquiry (April 1996), pp. 401-407. Chapter 11 Firm Behavior under Idealized 24 Competitive Conditions These shifts reflect the fact that (assuming workers are worth the same as before and are just as willing to work as before) once the additional vacation is provided: 1) the employer is willing to hire the same number of workers as before if the cost for each remains the same, that is if the wage drops by the same amount as the additional vacation cost per worker; and 2) the same number of workers are willing to work if the value of their compensation remains the same, that is if the money wage drops by the same amount as the value each worker receives from the additional vacation. With both the demand and supply curves shifting down by the same amount, they obviously intersect (as shown in Figure 11.15) at the same number of workers, Q 1 , but at a wage, W 2 , that is less than W 1 by exactly the cost (and value) of the fringe benefit. In essence, nothing has really changed. Workers are receiving compensation that is worth exactly the same as before (W 2 +ac = W 1 ), and the cost of that compensation to the employer is exactly the same. In the case just examined, it really makes no difference to the workers or to the employer whether the additional vacation is provided or not. So let’s forget about additional vacation time and consider a different fringe benefit, say membership in the neighborhood health club, one that cost the employer the same amount to provide, but which is more valuable to the workers. In this case the employer’s demand curve for labor remains at D 2 . But because of the greater value the workers receive from the health club membership, the supply curve shifts down below S 2 , say to S 3 , indicating that now people can be enticed into working for the firm at a lower money wage. As seen in Figure 11.15, with the new supply and demand curves, the money wage will decline to W 3 from W 2 and the number of workers hired will increase to Q 2 from Q 1 . But the most important thing to notice is that the workers have gained as the money wage is cut. The Q 1 workers who were employed by the firm before receiving the health club membership, value that membership enough that they would continue working even if the money wage fell to W 3 ’. Even though the money wage is reduced because of the health club membership, each worker is better off by an amount equal to the difference between W 3 and W 3 ’, which we can think of as a bonus. And obviously the Q 2 - Q1 newly hired workers are better off since the wage of W 3 and the health club membership are enough for them to voluntarily leave their previous activities. (You can also see that workers are better off by noting that the wage rate of W 3 plus the value of the fringe, the vertical distance between S 1 and S 3 , adds to more than W 1 .) It should be clear that the workers would be even better off if instead of a health club membership, the firm found another fringe benefit that would drive their wages down even more. It can be easily shown that if another fringe benefit (for example, flexible scheduling) is more valuable to the workers than the health club membership and that benefit can be provided at the same cost, the money wage will be driven down below W 3 . However, again, the workers will be better off (simply because the sum of the lower wage plus the value of the benefit will lead to higher total compensation). The working rule employers should keep in mind: The more valuable the fringe benefit provided for a given cost, the lower the wage but the better off the workers. It should be clear that employers have a strong motivation to provide fringe benefits that cost less than they are worth to workers. Both employers and employees win when such benefits are provided. Yet many people believe that private businesses are not sufficiently motivated to provide fringe benefits to their workers and that the government should mandate Chapter 11 Firm Behavior under Idealized 25 Competitive Conditions certain employment-related benefits. An explanation for this belief may be the widespread view discussed, which is that workers earn their wages but are given fringe benefits by their employers. This perspective is reflected in the common assumption by advocates of mandated benefits that the cost of those benefits will not result in lower wages for workers. 6 If this were true, then employers would have little motivation to provide fringe benefits even if they were worth more than they cost. But clearly employers do provide fringe benefits without being required for reasons that should be obvious by now. It pays employers to provide fringe benefits that are worth more than they cost because workers are willing to pay for more than the costs of those benefits in lower wages. If it were true that a fringe benefit, if provided, would not be paid for partly by workers, then it is a fringe benefit that would make both employers and employees worse off. To see the problem with a fringe benefit that doesn’t reduce wages, consider Figure 11.16. Again we start off with a demand and supply curve for labor given by D 1 and S 1 respectively. As before, the initial market-clearing wage is W 1 and Q 1 workers are hired. Now assume that the government mandates a benefit that costs the employer something to provide but which has no value at all to the workers. Such a mandate would shift the demand curve for labor down to D 2 , where the vertical distance between D 1 and D 2 is the cost per worker of the benefit, while leaving the supply curve unaffected. As seen in Figure 11.16, the result is a decline in the market-clearing wage to W 2 from W 1 and the layoff of Q 1 - Q 2 workers. Even the workers who keep their jobs are clearly worse off since they end up paying for part of a worthless benefit with lower wages. _________________________________ FIGURE 11.16 Mandated Benefits and the Labor Market A mandated benefit that has no value to workers, but imposes a cost of employers, will cause the demand curve to fall from D 1 to D 2 . However, the supply curve will not move. A mandated benefit that costs employers but has no impact on wages must be a benefit that his negative value for workers, otherwise, the wage would fall. _________________________________ 6 This assumption is often made explicit. It is commonly argued, for example, that the one-half of the Social Security tax employers are required by law to pay is really paid by the employer and does not come out of the pocket of the workers. Chapter 11 Firm Behavior under Idealized 26 Competitive Conditions But what about a mandated benefit that has no effect on wages, one that is paid for entirely by the employer? Such a benefit would be one that had a negative value to workers; it is one that they would be willing to pay to keep from being provided. For example, assume the government mandated that all employers provide a smoke-free work environment. For some employers a smoke-free environment makes sense, and many firms had such a policy before they were required. But consider an employer whose workers all smoke. Providing a smoke-free work place would shift the demand curve down from D 1 to D 2 to reflect the employer cost from workers spending less time working and more time outside smoking. Also, the employer would see the firm’s labor supply curve shift back since the workers would find the new working conditions less pleasant than before. If the supply curve shifts back from S 1 to S 2 , which is the same amount the demand curve shifts down, then the market- clearing wage remains at W 1 but now Q 1 – Q 3 workers are laid off. Even though the wage doesn’t fall, the workers are worse off in this case than in any of the previous cases considered all of which saw the wage fall. Indeed, the workers are obviously worse off in terms of total compensation: they receive a wage of W 1 , but they have to endure the cost of ac from the smoking ban (which means that they receive net compensation of W 3 (W 1 – ac) There are at least three important points that follow from the discussion. First, workers benefit from the desire of their employers to cut their wages by providing fringe benefits in much the same way that consumers benefit from suppliers who desire to profit by selling them products. Second, employers have a strong motivation to provide fringe benefits only when those benefits are worth more to workers than they cost. And three, if those who advocate mandated government benefits are correct when they argue that the benefit will be paid for entirely by the employer (will not lower wages), then the benefit isn’t worth providing, and mandating it will make workers worse off. Concluding Comments Perfect competition is an idealized market structure that can never be fully attained in the real world. Nonetheless, the model helps to illuminate the influence of competition in the marketplace, just as the idealized concepts of the physical sciences help to illustrate the workings of the natural world. Physicists, for example, deal with the concept of gravity by talking of the acceleration of a falling body in a vacuum. Vacuums do not exist naturally in the world as we know it, but as theoretical constructs they are useful in isolating and emphasizing the directional power of gravitational pull. In a similar fashion, the theoretical construct of perfect competition helps to highlight the directional influence and consequences of competition. The model of perfect competition also provides a benchmark for comparing the relative efficiency of real-world markets. The perfectly competitive model clarifies the rules of efficient production and suggests that free movement of resources is essential to achieving efficient production levels. Without a free flow of resources, new firms cannot move into profitable production lines, increase market supply and push prices down, and force other firms to minimize their production costs. Competition requires mobility of resources. The model of perfect competition must ultimately be judged not so much by the realism of this underlying assumptions. No “model” is designed to be “real,” or fully Chapter 11 Firm Behavior under Idealized 27 Competitive Conditions descriptive. Rather, they must be judged by their usefulness in understanding behavior. In the manager’s corner, we once again used the model of perfect competition to understand why cutting the pay of workers, under some conditions, can be in the interest of workers. Review Questions 1. In a graph, draw in the short-run average and marginal cost curves, plus the demand curve for a perfect competitor. Give the firm’s demanded, identify the short-run production level for a profit-maximizing firm. Identify the profits. 2. On the graph for question 1, indicate with a Pm the minimum price the firm requires to continue short-run operations. 3. On the graph for question 1, darken the firm’s marginal cost curve above its intersection with the average variable supply cost curve. Explain why that portion of the marginal cost curve is the firm’s supply curve. 4. Why does a perfectly competitive firm seek to equate marginal cost with marginal revenue rather than to produce where average total cost is at a minimum? 5. If perfectly competitive firms are making a profit in the short run, what will happen to the industry’s equilibrium price and quantity in the long run? 6. Suppose the market demand for a product rises. In the short run, how will a perfect competitor react to the higher market price? Draw a graph to illustrate your answer. What will happen to the market price in the long run? Why? 7. Suppose that you know absolutely nothing about price and cost in a particular competitive industry. How could you nevertheless determine whether the typical firm in the industry was making economic profits or losses? 8. Suppose a manager were to refuse to provide a fringe benefit that could lower the wages of their workers, but were to the benefit of were, on balance. What would be that manager’s fate? 9. When should a firm eliminate fringe benefits? CHAPTER 12 Monopoly Power and Firm Pricing Decisions That competition is a virtue, at least as far as enterprises are concerned has been a basic article of faith in the American Tradition, and a vigorous antitrust policy has long been regarded as both beneficial and necessary, not only to extend competitive forces into new regions but also to preserve them where they may be flourishing at the moment. G. Warren Nutter Henry Alder Einhorn t the bottom of almost all arguments against the free market is a deep-seated concern about the distorting (some would say corrupting) influence of monopolies. People who are suspicious of the free market fear that too many producers are not controlled by the forces of competition, but instead hold considerable monopoly power. Unless government intervenes, these firms are likely to exploit their power for their own selfish benefit. This theme has been fundamental to the writings of John Kenneth Galbraith. The initiative in deciding what is produced comes not from the sovereign consumer who, through the market, issues instructions that bend the productive mechanism to his ultimate will. Rather it comes from the great producing organization which reaches forward to control the markets that it is presumed to serve and, beyond, to bend the customers to its needs. 1 Currently, the Department of Justice and nineteen state attorneys general are suing Microsoft because of the concern that one firm has too much “market power.” Furthermore, the company, as a consequence, is harming consumers as well as its potential market rivals and may be doing other damage to the economy, for example, impairing competition. This chapter is really a continuation of our earlier discussion of “market failures,” for monopoly is often seen as one of the gravest of all forms of failure in markets. Accordingly, we will examine the dynamics of monopoly power and attempt to place their consequences in proper perspective. We will also consider the usefulness of antitrust laws in controlling monopoly and promoting competition. This chapter will elucidate the government’s concerns with Microsoft’s market position. It will also help us understand Microsoft’s court defense. In the next chapter, we will apply the model of monopoly developed here to two forms of partial monopoly, monopolistic competition and oligopoly. 1 John Kenneth Galbraith, The New Industrial State (Boston: Houghton Mifflin, 1967), p. 6. A Chapter 12 Monopoly Power and Firm Pricing Decisions The Origins of Monopoly We have defined the competitive market as the process by which market rivals, each pursuing its own private interests, strive to outdo one another. This competitive market process has many benefits. It enables producers to obtain information about what consumers and other producers are willing to do. It promotes higher production levels, lower prices, and a greater variety of goods and services than would be achieved otherwise. Monopoly power is the conceptual opposite of competition. Monopoly power is the ability of a firm to raise profitably the market price of its good or service by reducing production. Whereas the demand curve of the competitive firm is horizontal (see the previous chapter), a firm with monopoly power faces a downward-sloping demand curve. By restricting production the monopoly can raise its market price. To maximize its profits (or minimize its losses), such a firm need only search through the various price- quantity combinations. In very general terms, then, a firm with monopoly power is a price searcher. It can control price because other firms are to some extent unable or unwilling to compete. As a result, a monopolized market produces fewer benefits than perfect competition. Businesses vary considerably in the extent of their monopoly power. The postal service and your local telephone company both have significant monopoly power. They confront few competitors, and entry into their markets is barred by law. IBM has far less monopoly power. Although it can affect the price it charges for its computers by expanding or contracting its sales, IBM is restrained by the possibility that other firms will enter its market. On a smaller scale, grocery stores face the same threat. They may have many competitors already, and they must be concerned about additional stores entering the market. Nevertheless, grocery stores still retain some power to restrict sales and raise their prices. The exact opposite of perfect competition is pure monopoly. Since, by definition, the pure monopolist is the only producer of a product that has no close substitutes, the demand it confronts is the market demand for the product. Unlike the perfect competitor, who has no power over price, the pure monopolist can raise the price of its product without fear that customers will go elsewhere. With no other producers offering the same product, or even a close substitute, the consumer has nowhere to turn. As we will see, production levels are generally lower and prices higher under pure monopoly than under competition. How does monopoly arise? To answer that question clearly, we must reflect once again on the basis for competition. Competition occurs because market rivals want to exploit profitable opportunities and can enter markets where such opportunities exist. In the extreme case of perfect competition, there are no barriers to entry, and competitors are numerous. Entrepreneurs are always on the lookout for any opportunity to enter such a market in pursuit of profit. Individual competitors cannot raise their price, for if they do, their rivals may move in, cut prices, and take away all their customers. If a wheat farmer asks more than the market price, for example, customers can move to others who will sell wheat at market price. For this reason perfect competitors are called price takers. They have no real control over the price they charge. . wages that best conforms to their preferences. For example, we have noted many young workers seeking part-time employment to help pay for college will want. greater demand for medical care will want more of their compensation in the form of untaxed fringe benefits such as health insurance. Therefore we can expect