AM03 Monopolies

Building on the analysis of Supply and Demand in Chapter 3 of Hill and Myatt’s Anti-Textbook, this lecture constructs a very simple model of monopoly and duopoly, to show that policy implications in these cases differ dramatically from what conventional textbooks teach. The higher level goal is to teach students Meta-Theoretical thinking. This goes beyond the binary logic which lies behind conventional textbooks, which teach student to think in terms of whether theories are true or false, or even instrumental – enabling you to formulate policy and welfare questions. In Meta-Theory, we try to step back and ask questions about who created this theory, in what historical context, which groups did it help, and which did it hurt, and what will the effects be upon us and upon the world, if we decide to affirm these theories for use in our personal lives, and to shape our societies?
The Hill and Myatt Anti-Text is ideally suited to this goal, since it is directly a meta-analysis of the message contained in conventional textbooks, and brings out the implications hidden beneath the surface of the analysis. In particular, the Anti-Text helps us to understand the rhetorical strategy used by conventional textbooks to convince students of theories which are overwhelmingly contradicted by empirical evidence.
BTW, it is worth pausing here to admire the efficiency with which economists succeed in creating such deep brainwashing that mountains of empirical evidence fail to move the faith of the true believers. For Real-World economists, it is very important to study these rhetorical strategies, as exposing this framework is an important component of the De-Programming techniques which are required to reverse the effects of this brainwashing.
Getting back to AM03, the two central META-Questions that we focus on are the following:
1. What are the rhetorical strategies used by conventional textbooks to create the dramatically false and misleading belief that Supply and Demand framework is universally applicable in terms of understanding how markets work?
2. WHY do textbooks want students to believe in Supply and Demand, when this theory is easily proven false?
The methodology used in the lecture is to create a VERY SIMPLE model of a monopoly, one which can be easily understood directly and intuitively by students. We talk about an ice-cream seller in a Public Park, who is the sole vendor of ice-cream. He purchases his ice-cream wholesale at PKR 25, and can sell it for various prices, but the demand will be reduced if he charges higher prices. The rhetorical point in using such models is that conventional textbooks, of necessity, work in IMAGINARY worlds, which cannot be understood intuitively – this is because the theories that they are trying to sell to the students are patently false in any real world context and scenario. That is why, we build on strengths by using REAL WORLD examples to oppose the IMAGINARY scenarios of conventional textbooks. Setting up and examining this example leads to the easy realization of the following key points which we try to convey to the students in this lecture:
1. The main issues facing the monopolist is a large amount of uncertainty and random fluctuations in the demand for ice-cream. The idea of MAXIMIZATION, which requires a KNOWN demand function, simply is not possible for the ice cream vendor. How can he possibly know or learn the demand function, which is dependent on vagaries of the weather, and people? INSTEAD, rule and heuristic based behavior is the only realistic possibility; this possibility is what Agent Based Models implement. (Striking a blow against the MAXIMIZATION idea).
2. Nonetheless, we play along with the conventional textbooks and pretend that somehow the demand function is fixed and known. Then it is clear that the monopolist has the power to set prices, and hence does not have a SUPPLY function. Furthermore, the profit maximization equilibrium does not maximize social welfare. It is clear that REGULATING prices, setting a ceiling price that he can charge, will actually improve social welfare, making more ice-cream available to larger number of customers at cheaper prices, while still allowing fair profits to the monopolist.
The above lessons emerge in an example that is easily understood directly and intuitively by students. Next we focus on the rhetorical aspects.
1. Given that S&D does not hold in monopolies, and more generally in any markets where firm set prices, why is the model given such prominence in textbooks? Before proceeding to apply S&D analysis, should we not ask the question as to whether or not firms have market power, so that we can be sure that there is a supply curve to analyze?
2. The policy implication that setting a price ceiling below observed market equilibrium will lead to shortages is based on S&D and exactly the opposite is true in monopolistic markets. Before dogmatically opposing prices ceilings, should we not try to find out the extent to which perfect competition applies in these markets?
Hill and Myatt also examine the rhetorical strategy used by textbooks to convince students of universal applicability of Supply and Demand. The S&D model is introduced very early, and used throughout the textbook. Problems with and exceptions are mentioned very late in the textbook, and the qualifications required to use S&D never mentioned. Thus the students get the impression that S&D is universally applicable, even though the model works only under conditions of perfect competition. The next lecture AM04 examines a duopoly model in detail and shows that the assumption of full information and zero transactions costs are ESSENTIAL to supply and demand – slight violations, with less than full information, and more than zero transaction costs – lead to complete breakdown of supply and demand. Thus a very fragile special case is presented as the central model for analysis of markets. WHY? Because this is the ONLY case in which markets work well without regulation. IN ALL OTHER CASES, markets require regulation and government interventions improve social welfare. Since the GOAL of textbooks is to prove efficiency of markets and to prove that government interventions are always harmful, they have no choice but to present S&D as the sole model with universal applicability.

For the 90 minute Video-Lecture, together with a 2500 outline and summary, see:

AM03: Monopoly

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