Happy holidays! Thanks for reading and from me to you I hope you enjoy some time off with friends, family, and loved ones, and do things that make you happy outside of work whatever that may be. I appreciate you all taking time to comment, share, and speak to me about these posts, as although I write sometimes to collect my own thoughts and sometimes to inform or persuade, it makes me super happy that this can be useful or insightful to others. So thank you! And I hope to continue to write and create more content in the coming year.
There are two basic ideas around regulation of markets. Some on the economic right want the government out of the marketplace, such that the invisible hand and free market will correct for bad actors and create the most efficient and lowest cost allocation of goods. On the other hand, some say that without government regulation then monopolies will naturally occur, and consumers will end up paying more for goods than if the regulations had gone into place. Such is the incentive for antitrust, and organizations such as the FTC, FCC, SEC, and others to investigate potentially harmful business practices, especially mergers and acquisitions.
The idea being that dangerous behavior in price setting, information asymmetries, and market consolidation occurs, and since losses are distributed amongst the masses and gains are centralized to only a few players, there is clear incentive for concentration and favorable regulation.
Lina Khan, chairwoman of the FTC, seems to be focused on this through attempting to prevent consolidation in the tech industry, with the most recent example being the blocking of Microsoft’s acquisition of Activision. Historically the former ideology of free markets became popular under Reagan in the 80s, while there seems to be a shift towards prevention of firms becoming too big now, especially in tech.
It’s important to not only consider the demand side of the economy. After all consumers are also workers and owners of businesses in the economy, so what’s good for business could translate to profits for consumers if it were true that wealth was more equally distributed, but only 56% of American adults own a stock and the top 10% of earners own 89% of stocks so at this point what is good for business and good for workers seems to be decoupled.
But regardless, I’ll consider the supply side for a moment. From my education in microeconomic theory1 there are two types of competition among firms. Bertrand competition, where firms set a price and then the quantity supplied depends on the demand for that good at that price, and Cournot competition, where firms set a quantity they want to produce, and then the price level is set from there. Bertrand competition seems intuitive, but you can think of Cournot competition as something like a contract in place for a fixed quantity of goods, and then the price is negotiated.
Whether the firm operates in Bertrand or Cournot competition might be interesting, as its strategy against other firms in the market might change. For example using a principle from game theory from a previous post
a Nash Equilibrium might occur between three identical firms with two firms competing fiercely against each other by lowering the price in an attempt to capture the entire market to the point where marginal cost = marginal benefit, resulting in 0 profit for two of the firms. Then the third chooses either a price higher than the competitive equilibrium (resulting in making 0 goods and 0 profit) or at the competitive price and again making 0 profit.
This would be a Nash Equilibrium if there is not a strategy which any of the firms can improve their outcome given the other firms strategies. And it is since if the competing firms lowered their prices any more they would make negative profits, and if they raised prices they would be out-competed by the other firm so they would produce no goods. And similar for the other two firms. They cannot improve their outcome, resulting in a Nash Equilibrium.
The conclusion you might draw here if you are Lina Khan, is that as long as there are two firms competing in the economy then prices will be as low as possible, to the point where firms aren’t making any profits.
However, this may not be the case under Cournot competition, even if the firms aren’t identical, where a Nash Equilibrium exists where both firms make positive profit.
But does Bertrand or Cournot competition even accurately describe what firms choose to do in the economy? The assumptions here are pretty strong after all. Both forms of competition assume that firms know exactly what their demand and cost functions would be, as well as frictionless execution with complete certainty.
So in my opinion, likely neither is realistic for modeling firms. Firms are run by human beings who make mistakes, have a difficult time measuring the present, and simply cannot predict the future. At the very best firms may just be an attempt at a coordination game to try to fill contracts for the lowest cost, with constantly undersupplied staffing at the lowest cost since there is a large disincentive to fire employees (which no one wants to do) but also a disincentive to hire (since training and hiring is costly!) paired with the information asymmetry of market value of the employees labor. That is, unless you are in the cyclical oil industry which is accustomed to lavish spending when the price of oil is high, and large cutbacks when oil is low.
The most profitable companies then might be the ones that happen to strike gold on their products and happen to generate more revenue than last quarter, or continually find ways to skirt regulations, or a combination of both.
Now, I suspect not all companies are like this. Some likely attempt to be honest, and treat their employees with dignity and care about their communities. But I also suspect those companies either have a cap on their growth or don’t survive before being out priced (Bertrand) or out produced (Cournot) by other firms.
It is eat or be eaten as they say, and although in the long run maybe consumers wise up to ill behavior in business practices, there are high search costs associated with obtaining this information. The invisible hand may be too slow to react before its too late for consumers.
Most of my micro theory is based on the holy text of Mas Colell https://www.amazon.com/Microeconomic-Theory-Andreu-Mas-Colell/dp/0195073401