I explained how monopolies and cartels maximise their incomes a couple of days ago. Only Deniro had a stab at answering them, so for the benefit of everybody else...
Question 1: In the absence of government imposed price caps, a monopoly such as a water company would set its price so as to maximise its profits, which in the instant case is £3.75 per m3, giving it a gross profit of £585 per household.
Question 2: If the water company's input costs increase from 50p to 75p per m3, the profit maximising price is still £3.75 per m3. The water company's gross profits would fall to £540 per household, but any attempt to 'pass on' the increased costs in higher prices would lead to a fall in quantity consumed and hence a marginal loss of revenue and profits.
Question 3: Members of a cartel maximise their profits by restricting their own output, which has the effect of pushing up prices. Thus at the reduced level of output, they charge the highest price which the market will bear. An increase in their input costs has no impact on the price that they charge, for similar reasons to those outlined in the answer to Question 2.
Bonus Question 1: Owners of land and buildings are a mixture of monopolists and a cartel.
At a local level, and especially in town centres, they are monopolists - if you happen to own such land and buildings then they offer a unique combination of access to hundreds of thousands of potential customers or employees (for commercial premises) and a unique combination of job and shopping opportunities, museums, pubs, theatres, parks etc (for residential). And like all monopolies, they are massively subsidised by the government, which ensures that parks are kept green, that roads and railways are built and maintained etc.
On the outskirts of towns, and in smaller towns or villages, they are a cartel. Their main concern is preventing any increase in the supply of buildings. The members of any trade or professional body insist that the government allow them to impose strict conditions on membership, in order to ensure that their members 'meet the highest standards and provide the best service to consumers'. In the same way, the NIMBYs insist that they oppose new development for loftier aims, such as 'protecting our heritage and way of life for future generations'.
Then there are owners of land without planning permission (e.g. regular commentator Sobers) who want these barriers to new development so that they can share in the spoils enjoyed by the current members of the cartel.
And paying for all this are the potential consumers of land and buildings, who have to pay vastly over the odds to break into the hallowed ranks of landowners; not only are they forced to pay extra for the scarcity value, it is their taxpayer's money which pays for the parks and the roads; they are the ones paying for the railway tickets and working in and visiting the pubs, theatres etc.
Bonus Question 2: The supply of buildings is restricted either for limitations of space (in town centres, although they could always build upwards) or because of politically motivated restrictions (everywhere else), so owners of land and buildings collect quasi-monopoly profits when they rent out or sell their buildings. With competing businesses, such profits are competed away by new entrants, so we observe that the prices for cars, TVs or clothes are such that the customer pays for cost + a profit margin (of 10% or 20% - if demand for something falls to a level where the industry cannot make these margins, the industry disappears), the quasi-monopoly profit element of rents and prices in the land market is between 50% and 90% of the rent or selling price.
Therefore, any increase in costs faced by owners of land and buildings would be borne entirely by those owners; all that would happen is that the profit element would fall to a range of (say) 40% to 80% of the rents and prices charged. The only way to pass on the burden of the higher costs would be to sell the land and buildings to somebody else (but accepting a correspondingly lower price - so the new owner gets a discount up front to compensate him). This is a very similar answer to Question 2 or Question 3.
Bonus Question 3: We can measure the super-profits accruing to the water company by looking at its costs (50p per m3) and assuming a reasonable mark-up of 20% for normal profit and overheads. The balance of £3.15 in this example would be 'super-profits' or 'economic rents'.
The same arithmetic applies to members of the land-and-building-owning-cartel. Any rental income which exceeds the cost of maintaining and insuring the bricks and mortar is 'super-profits' or 'monopoly profits' or 'economic rent'.
As to selling prices, let's assume that the government scrapped the cap on water prices: the company's profits would more than double, so it's fair to assume that the companies' share prices would also more than double. So the difference between the company's value as a monopoly and its current value (when their prices are restricted to those they would be able to charge in a truly free market) is a measure of the value of that monopoly.
Remember: even though the water company is a monopoly in itself, there would still be a free market in shares in that monopoly.
The same applies to land (i.e. the price of land and building minus the cost/value of the buildings). As the production cost of land (to the owner) is precisely £nil (unless he has to pay for flood defences on his own land etc), the entire selling price of that land can be seen as the value of the monopoly. This is at its most extreme at the margins of towns and cities, where farmland without planning permission is worth £5,000 per acre, but once it has planning permission, it is worth at least £500,000 per acre.
The argument that "land is not a monopoly because anybody can buy it" simply does not hold. Land is by definition a monopoly as no new land can be created (land reclamation aside - and even reclaimed land needs a sea bed and access from existing land), so profits cannot be competed away. The fact that anybody can buy land is much like the fact that anybody can buy shares in a water company: you are buying into membership of a cartel or monopoly and not diluting it - you can only buy in if somebody else sells out.
It's a crowded field
3 hours ago
13 comments:
Your answer to question 2 is right, but only based on the artificial restriction to only five possible price levels.
In fact, the revenue maximising price would increase slightly if the costs increased.
If you take a more extreme case, with the costs going up to £2 per M3, you can see this clearly by redoing the maths in your table - in this case, the best of your five prices would be the £5 price.
AC, that's a fair point, but that wasn't the question I asked*. In any event, this observation does apply to members of a cartel, where output is fixed.
* If we assume that demand falls in a straight line between the figures given for price £3.75 and price £5, then the GP maximising price is actually £4 (not £3.75) at unit cost 50p. If unit cost increases by 25p, then the GP maximising price increases to £4.12.
But from the limited range of prices given, £3.75 is the best one for them to choose.
@MW Spot-on definition of cartel behaviour "Members of cartels maximize their profits by restricting their output".
This is the obvious explanantion about why the property bubble burst in the US,Spain and Ireland and did n't over here.As "good" capitalists the abroadsters responded to the availability of cheap credit and some kind of demand (probably whipped up by themselves) by chucking up houses.
Here the seen-it-all-before "bad" capitalists kept supply to the usual trickle and maximised profits by shoving the prices up for them ,according to the formula : two houses sold with £50,000 mark-ups is better business (less trouble) than one hundred with £1,000 mark-ups.Only building two also preserves the vital land bank.
Some libertarians and laissez -faire revivalists deny that capitalists ever restrict supply.Michael Gove, as an oppostion spokesman, expressed total incredulity that commercial landlords would ever mothball some properties in oder to put up rents in the rest.
DBC, thanks, more good examples.
But factually you are wrong - Spain & Ireland increased construction enormously, but the USA did not. At the peak in 2006 they allowed 1 million homes to be built, if you scale that down for UK smaller population, that's only 200,000 per year, much the same as here in the NIMBY heartlands.
Although I'm a dyed in the wool capitalist, I've developed sympathy for the idea of public ownership over services that present a natural monopoly. If the state owned the water distribution infrastructure for example, we could ask companies to compete for the right run those services thus introducing a form of laissez-faire.
If this worked -by removing the super-profits and handing them back to consumers as lower water prices- under current conditions it would almost certainly capitalise into higher land prices, (so landowners now scoop up the net gain). But this could be offset with lvt and a citizens dividend, so we have a mechanism for transfering water rents back into the pockets of every citizens, equally. For those that say this won't work I present the state of Alaska, who paid out $1500 in 2009 as an oil dividend.
CD, with things like water companies, landing slots at airports etc, the capitalist/'free market' way forward is indeed to allow them to charge any old prices they like, tax the monopoly element of profits at a very high rate (i.e. by using LVT or similar) and dish it out as a CD.
So people might end up paying more £ for less water (let's say £675 instead of £400), but most of that £585 super-profit gets taxed away and dished out as CD of (up to) £585 per household, so consumers end up better off AND they use water more sparingly. Or they might spend more of that £585 CD on water, who knows?
Talking of monopolies and economic rent, it's interesting that the public are instinctively against the privatisation of the forrests, but they're also against lvt as it's presented as a form of neo-communism.
How are we to square this circle? It's quite simply naked self interest, individuals like monopolistic practices when they're they're the beneficiary (i.e rising "house" prices), but recognise the stitch up when they're on the receiving end.
I don't think there's any way out of this conundrum.
CD, forests are a tricky one, but the numbers are so tiny (Forestry Commission owns about 5% of the UK by surface area, and the lowest value bits at that, that whether it makes a small loss or profit on its activities is neither here nor there (the value to the public of having somewhere to go for a walk is difficult to measure). So I'm with the Luddites on this one.
As to people's hypocrisy, my favourite bit is when the NIMBYs start wailing about "our greenbelt". It's not "their" greenbelt, it clearly belongs to somebody else.
There is a way out of this conundrum, and that's education! The place to start is young people with a job who are tenants - they are the ones who come out miles ahead if we replaced income tax with LVT, so they'd vote for it out of naked self-interest (most people would end up slightly better off, of course, they just don't know it yet).
Then it's just up to each subsequent generation to remind the older ones that they have already benefitted from it. It's getting the ball rolling that's the tricky bit.
As regards house building in the US during the boom ,your views are a little unorthodox,not that
there's anything wrong with that,of course.
Wikipedia on Subprime mortgage crisis
" This credit and house price explosion led to a building boom and eventually to a surplus of unsold homes which caused US house prices to begin declining in mid 2006".
A variety of sources say that by the end of May 2008 ,there was a US surplus which would account for 11.2 months of normal supply (circa 5 million houses), where at its optimum the US market was thought to run with a surplus of four months' supply .
Perhaps the US housing market wa saturated to begin with and any supply would push it over the edge.
WTF Lehman's were doing betting the lot on a speculative housing project, the Lord alone knows.
But enough of cavilling ,enjoy the witless Michael Gove making a fool of himself in the Commons in the debate on Rating (Empty Properties ) Bill 6 June 2007.
"The basic premise of this bill is that owners are deliberately keeping property empty and need to be taxed into putting it to good use" (blah di blah more of the same, then he essays some Oxford Union levity after changing tense.)"Where were these remarkable individuals who wanted to earn less than they could every year?What evidence was there for widespread economic masochism on the part of the commercial property sector?"
In response to the water company point, an ex post tax is a less than optimal solution imo. Companies can use various tricks to reduce paper profits, and I believe they can shift their headquarters offshore to reduce tax obligations (although as an accountant you'd know much more about these matters than me). A major advantage of the lvt is that it's an ex ante tax so it's a lot more transparent, this would help nullify accusations of cronyism in gov't contracts. I would be wary of upping water prices and promising consumers that the profits will all be taxed away, it's a political hurdle that would be difficult to overcome.
But to be fair, in comparison to the landowners water companies are relatively insignificant, so disagreement between Georgists on this issue isn't that big a deal (not for me anyway)
As for the forestry commission, I'm not sure what you mean by the term "luddite". On balance I'm in favour of keeping the status quo, but it's amusing to see "capitalists" keep their knickers in a twist on this because of their failure to understand rental economics. In their left/right world private = good and public: bad, but what they don't get is that private ownership doesn't always equate with the free market, as the housing market aptly demonstrates.
Anyway, sorry to bore you with my semi-coherent ramblings!
DBC, the huge number of empty homes in the USA is because mortgage finance dried up and because people just defaulted and abandoned them when their cut-price-introductory mortgage deals ended. My point was simply that there was no massive construction boom like in Ireland or Spain (where there clearly was).
CD: "In response to the water company point, an ex post tax is a less than optimal solution imo."
Yeah, but at present there are caps on water prices at (say) £1.25. The govt could quite easily tell them that the price cap is being lifted, and as a quid pro quo, corporation tax on their profits will be lifted from 28% to 70%. So the govt gives with one hand and takes with the other in equal measure.
The water companies' post-tax GP won't change (i.e. it will go from 72% of £240 = £173, to 30% of £585 = £176). And the govt gets an extra £342 in tax per household which it could (in fairness) pay back to each household as a CD, so the net cost of your water bill goes down from £400 (with no subsidy) to £333 (i.e. bill £675 less CD £342). And we waste less money purifying water to the highest standard just for flushing toilets and washing cars and other such fripperies.
Actually, there's no need for purist LVT on this (which could have been achieved by the state retaining the infrastructure and renting it out to water companies). The point is that the higher the price cap, the higher the rent they could have charged.
That's fair enough, but my concern is that water companies will simply use accounting trickery to hide their profits, thus upping consumer costs and minimising their tax liabilities, so the CD never gets returned.
Though as I say corporate taxation isn't my strong point so I have little way of knowing whether my concerns are justified. I guess I'll have to leave that to the experts, or do some more research.
CD, they would do their damnedest to apply 'accounting trickery', but all the government needs to do is to take their total income, deduct a [(fairly arbitrary) amount for unit costs x a known figure (volume)] and ask for (say) 70% of the resulting figure.
Then they wouldn't need to bother doing a full corporation tax return with all the stupid adjustments to all the figures in the accounts. Whether the water companies come out slightly ahead on the deal or slightly behind doesn't really matter.
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