If someone is selling a shirt for 15 dollars, and the person next door is selling the same shirt for 10 dollars, why would you buy the more expensive shirt? When there are a large number of sellers for one product, the vendors that are cost effective enough to sell at the lowest price do the best in business. Competition among sellers ensures that market price is determined by costs (of capital and labor), and nothing more than that.
But competition, for various reasons, doesn’t always exist.
Say you concocted a soup that tastes good and has the daily recommended dose of every vital nutrient. You get it patented so that you’re the only person who can sell this soup.
When potential customers hear about you, they get excited. Knowing they can’t find your soup anywhere else, they’re willing to pay more than they would if you had competition. So their demand curve looks like this:
The soup is a beautiful invention that can make the world a better place. The only issue is: you’re a dick. And without anybody to undersell you, you’re a dick with pricing power. You have the freedom to produce a smaller quantity and charge a higher price.
Instead of picking a quantity where supply meets demand, you’ll pick a quantity where the revenue/price for each unit exceeds the (labor and capital) costs for each unit, i.e. a quantity where you make profit. At this quantity under a monopoly, consumers have to pay a higher price, and they don’t get more value out of paying this higher price; so in most cases: monopolies hurt consumers.
Note: As a society, we allow innovators to have some monopolistic power, because we want to encourage other people to innovate. So you and your dumb soup are safe.
A situation where there are a low number of buyers is called a monopsony. It’s less common than a monopoly, but it does happen. One good example is Wal-Mart, a company that often goes to small towns and run the local shops out of business, until most people have no choice but to sell their labor to Wal-Mart. (When you get employed, you’re selling your labor. Your employer is buying it).
The result is like that of a monopoly’s. People are willing to give their labor for a lower price (than they would under competition) because they know they can’t find employment elsewhere. So their labor supply curve looks like this:
Wal-Mart, being the greedy dick that it is, is aware of its pricing power. And Wal-Mart takes full advantage of it.
This leads to significantly lower pay (than there has to be and than there would be if there was competition). Monopsonies hurt producers.
Note: I give a simple model for monopoly/monopsony here because I feel it makes more intuitive sense for beginners. The actual orthodox model is a bit more complicated (but also more informative), and you’ll learn about that when you take the microeconomics course. On the graph titles here, I tell you what price and quantity the firms chose without actual explanation, but it’s a favor. The method is similar to how price and quantity will be chosen in the more orthodox model.
Say you want to buy a used book. If the book is in perfect condition, you’re willing to pay 15 dollars for it. But if the book has pages that were sneezed on, you’re willing to pay only 5 dollars. The problem is: you don’t know whether or not a book has been sneezed on. To handle this, you decide you’d be willing to pay somewhere between 15 and 5 dollars for a used book.
This is the effect of information asymmetry: Instead of having different markets for good and bad quality products, we have one market for both. You are therefore forced to take a risk of getting a book that’s been sneezed on every time you buy a used book.
Also, think of it from the viewpoint of the sellers: why would someone sell a perfect-condition book if they knew they would be underpaid for it? And why wouldn’t someone sell an awful-condition book if they knew they would be overpaid for it? This is known as adverse selection: in the presence of information asymmetry regarding good and bad quality products, there is often a preponderance of bad quality products.
When a supplier has to pay a 20 percent tax for each sale, the price he’s willing to sell his product at goes up 20 percent (to compensate for the tax). This is represented by an upward shift in supply.
When a consumer has to pay a 20 percent tax on his income, his purchasing power drops by 20 percent. This is represented by a downward shift in demand.
In either case: quantity produced decreases, and both parties get hurt. The government benefits from the tax revenue though.
Earlier, I spoke about how the demand and supply curve determine an equilibrium price, i.e. the price where producers supply just as much as consumers demand. When price is above this equilibrium price, then supply exceeds demand, leading to a surplus of the product. When price is below this equilibrium price, then demand exceeds supply, leading to a shortage of the product. Because producers want to avoid surpluses and shortages when selling, price naturally tends toward equilibrium.
For social or political reasons, a government might want to keep prices down to “protect” consumers. They do this by introducing a price maximum. When a price ceiling is below equilibrium, it results in a shortage of the product.
Sometimes the government wants to keep prices high to “protect” producers. They do this by introducing a price minimum. When a price floor is above equilibrium, it results in a surplus of the product.
Even the government doesn’t monetarily benefit from this; so who knows why they do it (other than to appease non-economic minded constituents).
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