Monopolies and cartels

Wikipedia does excellent crash courses in monopolies and cartels. Read up if you have quarter of an hour to spare, but most of this will be obvious to those who did a couple of units of economics and mainly it's just applying commonsense.

Assuming that the demand for their output is price elastic and all producers are profit maximisers, there is a subtle difference in how they go about things. The questions for you, dear readers, are at the end of each section.

Monopolies

1. The closest thing we can imagine to a complete monopoly is e.g. a water company. It would be more or less impossible for a competitor to nudge his way into the market, as he would have to spend billions on his own reservoirs, digging up the pavements and installing pipes to each house. Thus the water company need have no fear of competition, there is no way that a competitor can under cut his prices and compete away his profits.

2. In round figures, a typical annual domestic water bill is 320 cubic metres at £1.25 per m3, the price being capped by the government so an average household pays £400 a year. The marginal cost to the water company is 50p per m3, so it has £240 a year gross profit for fixed costs, inflated directors' salaries (which is profit share rather than payment for work done) and dividends.

3. What the water companies would like to do is to offer members of the government some tasty directorships (in practice, most politicians can be bought off for one or two hundred thousand pounds a year, as they have no other marketable skills) and scrap the £1.25 cap. Let's assume that they then nudge the prices up in their area and quantity used, being price elastic, goes down. The following table (completely made up figures for illustration purposes only) shows how this affects their gross profits ('GP'):

Price £1.25, usage 320 m3 = £400, less £160 costs = GP £240
Price £2.50, usage 240 m3 = £600, less £120 costs = GP £480
Price £3.75, usage 180 m3 = £675, less £90 costs = GP £585
Price £5.00, usage 120 m3 = £600, less £60 costs = GP £540
Price £6.25, usage 80 m3 = £500, less £40 costs = GP £460

Question 1: which price would the water company charge?

Question 2: if the marginal cost of treating and delivering 1 m3 went up to 75p, would the water company increase or reduce the price from the previous answer, or would it continue charging the same price?

Cartels

4. Here we have lots of competing/co-operating suppliers, who could either agree a fixed minimum price OR a fixed maximum quantity (but not both).

5. The most famous cartels are de Beers and OPEC, both of whom agree to restrict quantity in order to push up price. This is clearly collusion, but as they operate across borders and the members of these cartels are usually governments, there is little that other countries can do to stop them. Members of cartels always cheat and supply more than their allotted quota, but by and large, they seem to function quite well (from the point of view of the members!)

6. Smaller cartels operate on a national or local level. These are subject to national (or EU) legislation, so they can't be so blatant as to set maximum output (i.e. to voluntarily restrict their own output) so they are more likely to agree set a minimum price, which is an offence if done by express agreement, but in the absence of proof thereof, it is difficult for legislators to prove that there is active collusion.

7. Unfortunately for the cartel members, boosting their profits by agreeing a minimum price is only half the battle, as new entrants could still move in to the market and under cut them. So what these smaller or local cartels are more likely to focus on is raising barriers to entry to restrict supply. This is not collusion between the members as such, because they dress it up with guff like 'Ensuring that our members meet the highest standards' so in theory anybody can join that industry, but in practice they can't. Plus, politicians just love imposing regulations on industries, which just happen to also act as barriers to entry.

Question 3: Assuming that members of a cartel have achieved its goal of setting a profit maximising price/output level, what impact would an increase in their input costs have? Would they increase or reduce their prices, or would they keep them the same?

And returning to my favourite 'industry'...

Bonus question 1: Do owners of land and buildings in any location act more like a monopoly or like a cartel?

Bonus question 2: Assuming that owners of land and buildings have restricted output to a level which gives them a large element of super-profits, what impact would an increase in their input costs* have on the rents or price they charge - would they increase them, reduce them or keep them the same?

Bonus question 3: How do we measure in £'s the amount of super-profits accruing to the owner of any particular land and buildings?

* Remember that interest is not an input cost, it is a cost of ownership or a way of splitting up the total income between owner and bank, ditto the tax that the owner pays on his rent or capital gains, which is a way of splitting up the total income between owner and government. Their real input costs are things like repairs, insurance, letting and estate fees and so on. But for the purposes of this discussion it is not necessary to make this distinction.