The Trump Administration is following the playbook of Reaganomics. As part of its Reaganomics program, the Reagan Administration cut back sharply on the regulation of everything from monopoly and oligopoly to pollution and product safety, important elements that likewise effect the aggregate supply curve. Continue reading “Oligopolies and Monopolies”
Of course Democrats want huge tax increases. Tax increases cause expanding deadweight loss and ultimately contract economic growth. Democrats clearly want to crash the economy while President Trump is in office to make sure that he’s a one-term President only.
Hillary Clinton and Democrats promised to wage war on pharmaceutical companies and do things like price controls on drugs and products of the biotechnology industry.
In California, there was a ballot measure to impose price controls on the sale of pharmaceutical drugs in the state.
Both Hillary Clinton’s probability of winning, and California’s ballot measure to impose price controls on the sale of drugs, weighed on pharmaceutical and biotechnology stocks leading up to the election.
Donald Trump did not promise a war on pharma. Trump promised increased funding for research and development and modernizing the FDA to ease the development, commercialization, and costs of bringing life-saving drugs to market.
Donald Trump won, and biotech stocks have been rallying ever since.
Democrats created shortages in the health care industry with ObamaCare, and they almost created the same shortages in pharmaceutical drugs. Let’s look at why price controls create market shortages.
A price control (or a price ceiling) occurs when the government puts a legal limit on how high the price of a product can be. For a price control to be effective, it must be set below the natural market equilibrium.
Using a hypothetical perfectly competitive market called pharmaceutical drugs, let’s examine the microeconomics of price control.
When a price control or price ceiling is set, a shortage occurs. The red horizontal line markets the price ceiling that is set by the government.
The price control forces the price down from P to P2. At the lower price, more people can afford the drug and so the quantity of the drug demanded goes up from Q to Q2 (point A).
The suppliers of the drug (pharmaceutical company) immediately cut back on supply (point B) as they are now paid below what the equilibrium market price established. Instead, these suppliers focus on supplying most of their drugs to other consumers, perhaps in other states that pay the full market price for the drugs they make. A shortage is created by the difference in the quantities of drugs demanded, versus the quantities of drugs supplied as illustrated by the shaded area. Shortages within the pharmaceutical industry would likely result in deaths, depending on the drugs needed.
The government set a price ceiling of P2 and so quantity supplied contracted to point B. However, at that supply level, consumers would be willing to pay a price of P3. Since P3 is greater than P2, deadweight loss occurs. The deadweight loss is the elimination of trading between both suppliers and consumers.
Price controls are a bad idea. If the government sets a price ceiling, there will be a shortage.
Donald Trump said he would block the AT&T and Time Warner merger if he becomes president, arguing that such media combinations leave too much power concentrated among too few companies. What Trump is describing is monopolistic behavior. As Bloomberg writes…
Trump also suggested he would favor a breakup of NBC and Comcast Corp., a merger completed in 2013. Such deals, he said, are “poison” to democracy and result in companies “telling the voters what to think and what to do.”
The problem of monopolies is growing beyond just the media industry.
30.3 percent of the market capitalization of the Nasdaq is now accounted for by just five companies — Apple Inc., Alphabet Inc. (Google’s parent), Microsoft Corp., Amazon.com Inc. and Facebook Inc.
Let’s examine what a monopoly is from a microeconomics perspective using a hypothetical Lemonade market.
Here’s the market for Lemonade in a perfectly competitive equilibrium at a price of Pe and the quantity of Qe. Now, because there are numerous buyers and sellers in this perfectly competitive industry, what do you suppose will happen if any one firm tries to raise its price above Pe?
In a perfectly competitive market, any Lemonade vendor that attempts to raise his price above the equilibrium established by supply and demand would see his quantity demanded quickly fall to zero. Such a vendor would rapidly lose market share as his customers would go to the cheaper priced competition.
The consumer surplus is the triangle C, and the producer surplus is the triangle E. Consumer surplus measures the difference between what consumers would have been willing to pay and what they actually pay. The producer surplus is the difference between the price at which producers would have been willing to supply a good and the price they actually receive.
Now suppose a monopolist corners the Lemonade market and raises the price to Pm. In this case, quantity falls to Qm.
Consumers have to pay more for less quantity, and the rectangle B is transferred to the monopolist. That means consumers are poorer and the monopolist is richer.
What portions of consumer and producer surplus represent the loss of allocative efficiency from monopoly pricing?
The efficiency loss on the consumer side comes from the consumption of lemonade that is forgone under monopoly pricing. The loss of efficiency on the producer’s side comes about by a reduction in output and an undersupply. The loss of consumer surplus is measured by the triangle C while the loss of producer surplus is measured by the triangle E. Together, the triangles C and E measure the loss in allocative efficiency from the monopoly pricing. The loss in allocative efficiency from the monopoly pricing is called the deadweight loss.
A monopoly exists when there is only one seller in the market selling a product for which there are no close substitutes.
In such a case, the monopolist is not a price taker as was our perfectly competitive Lemonade firm. Instead, it is a price maker which means that it exerts considerable control over what the market price will be. The monopolist has this power because it controls quantity supplied in the market.
The market structures of most industries in the US fall somewhere in between a monopoly and pure competition as illustrated below.
From this example, you can see why relatively free, democratic governments do not like monopolies. Monopolies not only transfer income from the many to the few, monopolies also create an efficiency loss in the process.
Through microeconomics and supply and demand graphs, we have proven that a perfectly competitive market yields the most efficient use and allocation of resources, as embodied in productive and allocative efficiency. For further reading, I did another lesson on monopolies here.
Do you remember when the WSJ, CNN, CNBC, NBC, ABC, CBS, Bloomberg, Forbes, and Reuters ran stories at the start of the year about how no one even knows who was advising Trump on economic matters? They even went as far to say that Trump had no support of any economists. Continue reading “Guess Who Is On Trump’s Economic Team, SWEET!”
California, New Jersey, and New York have the most cities with rent control. Sanctuary cities in California like San Francisco and Los Angeles have some of the toughest rent controls. Rent controls hurt the local economy and make rental unit availability worse. Aggregate deadweight loss from rent controls across the country negatively impacts the US economy and hence stock market. Let’s examine what happens with rent control from a macroeconomics perspective.
Most government revenue comes from the taxation of transactions and labor. Taxes impact both the supply and demand curves. Taxes cause a buyer to pay more for something and suppliers to receive less. The loss of value for both buyers and sellers is called the deadweight loss of taxation. Taxation has an enormous impact on the economy and thus stock market. Traders and investors need to understand the effects that taxation has on the economy and thus stock market. We will examine deadweight loss from a microeconomics perspective, ending with a macroeconomics viewpoint.