Monopolies v Cartels, with charts

The traditional Alfred Marshall supply-demand chart has quantity on the bottom axis and plots price as a function of quantity. Which way round is better depends on whether you are looking at the decision making process or a monopoly or of a cartel:

Monopoly

A true monopoly (i.e. a water company in the absence of a regulatory price-cap) doesn't really pick the profit-maximising quantity (and then charge the resulting price), he chooses the profit-maximising price (and then supplies the resulting quantity). Adam Collyer pointed out that when a monopolist's input costs increase, then its profit-maximising price (usually) also increases.

Here's a chart showing the water company's gross profits (right hand scale) with input costs of 50p and £2.00 per m3 at various different prices - the curve shifts to the right and downwards, so the profit-maximising price increases from £4.25 to just under £5 - the monopoly 'passes on' about half of the increase in input costs but only if he is prepared to accept that quantity consumed/supplied is reduced by a quarter.

The quantity now consumed by each household drops from 190 m3 to 140 m3 per year (although that is not immediately obvious from the chart). Click to enlarge:
Cartels

Cartels - such as OPEC, De Beers or the Home-Owner-Ists - work by restricting quantity supplied, and here it is helpful to have 'quantity' as the controlled variable, i.e. the horizontal axis.

This chart uses the same units as for the water example, so let's imagine that one 'unit' of housing per household is half a square yard and the 'price' is per unit per month (e.g. an average house is 95 sq yards internal area and an average rent is say £4 x 95 x 2 = £760 per month, a bit on the low side, but hey).

On average, there is one home per household and most people are owner-occupiers, so to all intents and purposes, anybody who owns a home is in the cartel. Each member's quota is fixed - he owns one house and can either live in it, rent it out or leave it empty (they can sell it, of course, but then the new cartel member has to make exactly the same choice).

Let's assume that

i) The actual cost of 50p relates to usual overheads (council tax, heating, repairs, insurance etc) of £95 per month (again, it's a little on the low side, but it will do for illustration purposes) and

ii) All members of the cartel have co-ordinated their efforts in the past to maximise the cash value of their rental income (actual or notional) by restricting supply to 190 units per household.

Each member thus occupies 190 units (95 sq yards internal area) and has net rental income of £665 per month (£760 gross minus £95 costs). So by and large, they are cutting off their noses to spite their faces - it is their own standard of living that they are reducing - but hey.

So what happens if input costs increase by £1.50 per unit per month (from £95 to £370 per household)? Each member of the cartel's net rental income now falls to £390 per month. What the cartel as a whole would like to do is to remove 50 units of housing per household from the market (i.e. demolish a quarter of all housing, in round terms), which would now by the new profit maximising point (just over £400 per household).

But no member of the cartel wants his own house to be demolished and forego the £370 just so that the surviving members of the cartel can increase their profits by £30 each (in the same way as no member of the OPEC cartel wants to reduce his own quota), so quantity supplied is not reduced.

Therefore the rental value of a home stays exactly the same: wherever the vertical line for quantity crosses the blue demand curve (left hand axis) i.e. at £760 gross per month and the entire increase in input costs is borne by the members of the cartel and not their customers (potential tenants or purchasers).

All in all, this is a roundabout way of dealing with the supposed Killer Argument Against LVT, that landlords would 'pass on' the tax to their tenants (a landlord can only act as a monopolist if he owns most of the available housing in an area, which apart from local councils or large shopping malls is usually not the case). Remember: landlords are only able to 'pass on' an increase in their input costs if all landlords and homeowners collectively agree to demolish a significant amount of housing, which is unlikely to happen (prisoner's dilemma)*. Click to enlarge:* For sure, if LVT were offset by reductions in income tax or VAT, then the LVT would be 'passed on', but this is only fair enough.