Wednesday, September 18, 2013

The "Coase Theorem" and Big Business

Copyright, The New York Times Company

Big businesses, especially those with large shares of the markets in which they sell, are sometimes thought to harm the economy because they sell to customers with little fear of competition from other sellers. Big businesses charge too much, the argument goes, and all customers can do in response is to purchase less. (The seller understands that customers respond to high prices by purchasing less, but the high profit margins are thought to more than compensate for the lower volume.)

If the industry had more sellers, or the customers themselves were in charge of production, prices would be lower, consumers would buy more and in aggregate the industry’s sellers would produce more and need more employees.

This “monopoly view” is that dominant businesses result in less industry production and employment than would emerge in a competitive marketplace.

Consistent with the monopoly theory of big business, the federal government, especially the antitrust division of the Department of Justice, is authorized to punish businesses that are thought to be too large for the efficient operation of their marketplace, and in some instances to break them apart.

In the labor market, unions can sometimes be a dominant seller, and on that front there are opposing “monopoly” and “bargaining” theories, as I noted in last week’s post. The bargaining theory of labor unions suggests that they limit the economic damage that they do.

The same sort of bargaining theory is present in the antitrust field. A big business should not be satisfied with a high-price/low-volume outcome, even if it yields more profits than a low-price/high-volume outcome, because a price above marginal cost of production is inefficient: there may be ways that the buyer can be given a better deal and enhance the seller’s profits.

Profs. Kevin Murphy, Edward Snyder and Robert Topel of the University of Chicago have written about some of the results of bargaining between big businesses and their customers. Big businesses often offer volume discounts, quote nonlinear prices and give loyalty incentives to customers. All these policies can encourage customers to purchase more, perhaps in a quantity similar to what they would buy in a many-seller market with lower prices. If the bargaining view of monopolies is correct, then the monopoly view of big business has exaggerated the degree to which dominant sellers harm the economy.

While one point of view is that federal antitrust policy is not vigorous enough, Professor Coase reminds us that it is easy to exaggerate the economic problems created by dominant sellers.

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