Tài liệu Microeconomics for MBAs 38 docx

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 su

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

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)

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 D 1 to D 2 However, it

can also cause the supply curve of labor to

increase from S 1 to S 3 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 D2 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

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 D1 to D2 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 W1 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

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

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