Session 5
The Theory of Production [II]. Oligopoly and Monopoly.
Effects of oligopoly and monopoly on levels of employment,
price and output. Contradiction between maximization of
profits and maximization of employment. Globalization and
oligopolies: transnational corporations.
Comparing perfect competition and monopoly competition. The
case of environmental damage.
CONCEPTS FOR REVIEW:
Economies and dis-economies of scale. Efficiency
of production. The role of abnormal profits in
research and development. The role of abnormal
profits in patterns of consumption. The role of
abnormal profits in distribution of income.
Firm "B" will have the same costs than firm "A" but it will be a
"price maker". Its environment will be an imperfect market.
A real life market, that is.
SHORT-RUN PROFIT MAXIMIZATION SCHEDULE FOR FIRM 'B' IN AN IMPERFECT
COMPETITION SITUATION
(1) (2) (3) (4) (5) (6)
Output Total Total Profit Average Marginal Marginal Price
(Units Revenue Cost (2)-(3) Cost Cost Revenue Unit
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0 0 100 -100
1 150 150 0 150 50 150 150
2 280 184 96 92 34 130 140
3 390 208 182 69 24 110 130
4 480 227 253 57 19 90 120
5 550 250 300 50 23 70 110
6 600 280 320 47 30 50 100<----
7 630 318 312 45 38 30 90
8 640 366 274 46 48 10 80
9 630 425 205 47 59 -10 70
10 600 500 100 50 75 -30 60
11 550 595 - 45 54 95 -50 50
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IMPERFECT MARKET PERFECT MARKET
Output range: 1-2 to 10-11 2-3 to 13-14
Maximization of profits: 6-7 9-10
Price per unit: $100 $70
Both markets show a contradiction between ECONOMIC EFFICIENCY and
SOCIAL EFFICIENCY. But real markets maximize profits at a higher
price per unit and at a lower level of output. Real markets make
even more antagonistic the contradiction between maximization of
profits and full employment/maximum output.
In both cases profits are maximized before output/employment.
One conclusion is that there is no possibility of reaching the
level of full employment in a capitalist economy, UNLESS owners of
mean of production are forced to make NORMAL PROFITS only and
resign to the possibility of making ABNORMAL PROFITS.
The second conclusion, which is generally referred as THE EXCESS
CAPACITY THEOREM, is that in equilibrium, a monopolistic competitor
will produce an output smaller than the one that would minimize its
costs of production.
The above theorem demonstrates that the capitalist system IS NOT
EFFICIENT ECONOMICALLY. That is, its efficiency is not at a maximum.
The latter, because the point of maximum efficiency in an average
cost curve is where the average cost is minimum.
. .------> average cost curve
. .
. .
firm wil . .
produce here--->. .
. .
. <------lowest average cost = max. efficiency
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From the above shortcomings of the free-market system, the following
is true:
--the system waste resources (capital and labour) because maximize
profits at less than maximum output.
--the system is socially imperfect because does not maximize
employment.
--the system is economically inefficient because will not produce
when the average cost is at a minimum.
Summarizing the effects of imperfect markets (which are the only
possible markets in a market system):
-distort resource allocation -allocation of raw materials, capital
and labour
-deficient output -less than maximum capacity
-deficient employment -less than full employment
-deficient level of prices -prices are above costs, therefore there
is always an inflationary pressure
From the above features of imperfect markets (real markets in a
capitalist system) it follows that the labour market and the capital
market will distort distribution of income.
P. Samuelson and W. D. Nordhaus ("Economics", McGraw-Hill, 1992) warn
their readers at the beginning of the chapter "Wages, rent, and profits:
the distribution of income" with the following statement:
"For most of this century, the fruits of economic growth were shared
broadly among all gropus in American society. Suddenly, in the 1980s,
a new pattern emerged as upper-income groups enjoyed rising real
incomes while the poor suffered from increased homelessness and
deprivation. The next four chapters analyze the basic determinants of
factor earnings and incomes: the wages of labor, the rents of land,
and the profits earned by capital. Once the fundamentals of factor
incomes are mastered, we can begin to understand the divergent fortunes
of rich and poor."
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Samuelson and Nordhaus (1992) described the real features of the
capitalist market as follows:
"Although the market mechanism is an admirable way of producing and
allocating goods, sometimes market failures lead to deficiencies in
the economic outcomes"..."Markets fail to provide an efficient
allocation of resources in the presence of imperfect competition or
externalities. Imperfect competition, such as monopoly, produces high
prices and low levels of output."..."Externalities arise when business
actions impose costs or bestow benefits on others outside the
marketplace without compensation"..."air pollution"..."public goods"...
"Markets do not necessarily produce a fair distribution of income; they
may spin off unacceptably high levels of inequality of income and
consumption"..."the business cycle's excesses of inflation and
unemployment."
From the table above, is clear that the owner of the firm will try to
make the difference between total revenue and total costs as large as
possible. Therefore, the system will work with two main pressures:
a) total revenue increasing, and
b) total costs decreasing.
Because increasing total revenue will be limited by levels of price,
the most obvious way to maximize profits (abnormal profits) is pushing
costs down. Two main ways of doing the latter:
1) rising productivity, and
2) decreasing levels of wages.
Thus, the capitalist system will growth with a driving force pushing
technology, science, inventions to increase productivity, and a
driving force to keep wages growing far behind abnormal profits, or,
even better, push wages down in relative terms or absolute terms.
(Average wages and average rates of profits in the U.S.A. in the last
twenty years illustrate this point).
The above dynamic forces will evolve into what is known as economies
of scale.
________________________________________________________________________
Economies and dis-economies of scale:
This notion is associated with production costs in the long run.
In the long run all desired resource adjustments can be negotiated
by an industry and the individual firms which it comprises. The firm
can alter its plant capacity, plant size, and new firms can enter and
old firms can leave and industry. There is no distinction between
fixed and variable costs for the obvious reason that all resources and
therefore all costs are variable in the long run.
The long-run Average Total Costs curve shows the least per unit cost
at which any output can be produced after the firm has had time to make
all appropriate adjustments in its plant size. The long-run Average
Total Costs is U-shaped. Why?
The law of diminishing returns is not applicable here, because the law
of diminishing returns presumes that one resource is fixed in supply,
and the long-run ATC assumes that all resources are available:
* * U-shaped average total cost curve
* * The vertical axis represent cost per unit,
* * the horizontal axis, output
* *
* *
The U-shaped long-run average cost curve is explainable in terms of
what capitalist economists call "economies and diseconomies" of
scale (or large-scale production).
ECONOMIES OF SCALE:
Economies of scale or economies of mass production, explain the
downsloping part of the long-run ATC curve:
a) labour specialization
increased specialization in the use of labour is feasible
as a plant increases in size. The worker may become highly
efficient.
b) managerial specialization
greater efficiency and lower unit costs are the net result.
c) efficient capital
only large-scale producers are able to afford and operate
efficiently the best available equipment
d) by-products
the large-scale producer is in better position to utilize
by-products than is a small firm. The large meat-packing
plant makes glue, fertilizer, pharmaceuticals, and a host
of other products from animal remnants which would be
discarded by smaller producers.
a), b), c) and d) will contribute to lower unit costs for the
business person/firm who is able to expand her/his scale of operations.
DISECONOMIES OF SCALE:
In time the expansion of a firm may give rise to diseconomies and
therefore higher per unit costs. The main factor has to do with certain
managerial problems involved in efficiently controlling and coordinating
a firm's operations as it becomes a large-scale producer. The result
is impaired efficiency and rising average costs. From here the rising
right-side section of the U-shaped average total costs curve.
ECONOMIES AND DIESCONOMIES OF SCALE ARE A FUNDAMENTAL DETERMINANT OF
THE STRUCTURE OF ANY INDUSTRY.
1.- Where economies of scale are many and diseconomies are remote, the
long-run average total cost curve will decline over a long range
of output. Automobile, steel, aluminium, heavy industries in
general, electronics -specially discrete components associated
with computers (microprocessors, memory, etc)- are this type of
economies/diseconomies of scale:
| .
unit costs | .--> long-run ATC declining over a long run of output
| . .
| . .
| . .
| . .
|__________________________________________________________
output
2.- Where economies of scale are few and diseconomies quickly
encountered, minimum unit costs will be achieved at a modest
level of production. This will support a large number of
relatively small producers. Examples: retail trades and some
type of farming, baking, clothing, shoe, etc.:
|
unit costs | . .
| . .
| . .
| . .
| .
|__________________________________________________________
output
3.- When we find a mixture of large and small producers operating
with roughly the same degree of efficiency, then there will be
a long range of output where unit costs will not vary, or
will change very little. Examples are meat-packing, furniture,
and house appliances, etc.:
| . .
unit costs | . .
| . .
| . .
| . . . . . . . . . . . . . . . .
|
|__________________________________________________________
output
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|
