The Irvine Company needs some serious antitrust enforcement

Dec 17, JDN 2458105

I probably wouldn’t even have known about this issue if I hadn’t ended up living in Irvine.

The wealthiest real estate magnate in the United States is Donald Bren, sole owner of the Irvine Company. His net wealth is estimated at $15 billion, which puts him behind the likes of Jeff Bezos or Bill Gates, but well above Donald Trump even at his most optimistic estimates.

Where did he get all this wealth?

The Irvine Company isn’t even particularly shy about its history, though of course they put a positive spin on it. Right there on their own website they talk about how it used to be a series of ranches farmed by immigrants. Look a bit deeper into their complaints about “squatters” and it becomes apparent that the main reason they were able to get so rich is that the immigrant tenant farmers whose land they owned were disallowed by law from owning real estate. (Not to mention how it was originally taken from Native American tribes, as most of the land in the US was.) Then of course the land has increased in price and been passed down from generation to generation.

This isn’t capitalism. Capitalism requires a competitive market with low barriers of entry and trade in real physical capital—machines, vehicles, factories. The ownership of land by a single family that passes down its title through generations while extracting wealth from tenant farmers who aren’t allowed to own anything has another name. We call it feudalism.

The Irvine Company is privately-held, and thus not required to publish its finances the way a publicly-traded company would be, so I can’t tell you exactly what assets its owns or how much profit it makes. But I can tell you that it owns over 57,000 housing units—and there are only 96,000 housing units in the city of Irvine, so that means they literally own 60% of the city. They don’t just own houses either; they also own most of the commercial districts, parks, and streets.

As a proportion of all the housing in the United States, that isn’t so much. Even compared to Southern California (the most densely populated region in North America), it may not seem all that extravagant. But within the city of Irvine itself, this is getting dangerously close to a monopoly. Housing is expensive all over California, so they can’t be entirely blamed—but is it really that hard to believe that letting one company own 60% of your city is going to increase rents?

This is sort of thing that calls for a bold and unequivocal policy response. The Irvine Company should be forced to subdivide itself into multiple companies—perhaps Irvine Residential, Irvine Commercial, and Irvine Civic—and then those companies should be made publicly-traded, and a majority of their shares immediately distributed to the residents of the city. Unlike most land reform proposals, selecting who gets shares is actually quite straightforward: Anyone who pays rent on an Irvine Company property receives a share.

Land reform has a checkered history to say the least, which is probably why policymakers are reluctant to take this sort of approach. But this is a land reform that could be handled swiftly, by a very simple mechanism, with very clear rules. Moreover, it is entirely within the rule of law, as the Irvine Company is obviously at this point an illegitimate monopoly in violation of the Sherman Antitrust Act, Clayton Antitrust Act, and Federal Trade Commission Act. The Herfindahl-Hirschman Index for real estate in the city of Irvine would be at least 3600, well over the standard threshold of 2500 that FTC guidelines consider prima facie evidence of an antitrust violation in the market. Formally, the land reform could be accomplished by collecting damages in an amount necessary to purchase the shares at the (mandatory) IPO, then the beneficiaries of the damages paid in shares would be the residents of Irvine. The FTC is also empowered to bring criminal charges if necessary.

Oddly, most of the talk about the Irvine Company among residents of Irvine centers around their detailed policy decisions, whether expanding road X was a good idea, how you feel about the fact that they built complex Y. (There’s also a bizarre reverence for the Irvine Master Plan; people speak of it as if it were the US Constitution, when it’s actually more like’s five-year revenue targets. This is a for-profit company. Their plan is about taking your money.) This is rather like debating whether or not you have a good king; even if you do, you’re still a feudal subject. No single individual or corporation should have that kind of power over the population of an entire city. This is not a small city, either; Irvine has about three-quarters of the population of Iceland, or a third the population of Boston. Take half of Donald Bren’s $15 billion, divide it evenly over the 250,000 people of the city, and each one gets $30,000. That’s a conservative estimate of how much monopolistic rent the Irvine Company has extracted from the people of Irvine.

By itself, redistributing the assets of the Irvine Company wouldn’t solve the problem of high rents in Southern California. But I think it would help, and I’m honestly having trouble seeing the downsides. The only people who seem to be harmed are billionaires who inherited wealth that was originally extracted from serfs. Like I said, this is within the law, and wouldn’t require new legislation. We would only need to aggressively enforce laws that have been on the books for a century. It doesn’t even seem like it should be politically unpopular, as you’re basically giving a check for tens of thousands of dollars to each voting resident in the city.

Of course, it won’t happen. As usual, I’m imagining more justice in the world than there actually has ever been.

Why are movies so expensive? Did they used to be? Do they need to be?

August 10, JDN 2457611

One of the better arguments in favor of copyright involves film production. Films are extraordinarily expensive to produce; without copyright, how would they recover their costs? $100 million is a common budget these days.

It is commonly thought that film budgets used to be much smaller, so I looked at some data from The Numbers on over 5,000 films going back to 1915, and inflation-adjusted the budgets using the CPI. (I learned some interesting LibreOffice Calc functions in the process of merging the data; also LibreOffice crashed a few times trying to make the graphs, so that’s fun. I finally realized it had copied over all the 10,000 hyperlinks from the HTML data set.)

If you just look at the nominal figures, there does seem to be some sort of upward trend:


But once you do the proper inflation adjustment, this trend basically disappears:


In real terms, the grosses of some early movies are quite large. Adjusted to 2015 dollars, Gone with the Wind grossed $6.659 billion—still the highest ever. In 1937, Snow White and the Seven Dwarfs grossed over $3.043 billion in 2015 dollars. In 1950, Cinderella made it to $2.592 billion in today’s money. (Horrifyingly, The Birth of a Nation grossed $258 million in today’s money.)

Nor is there any evidence that movie production has gotten more expensive. The linear trend is actually negative, though with a very small slope that is not statistically significant. On average, the real budget of a movie falls by $1752 per year.


While the two most expensive movies came out recently (Pirates of the Caribbean: At World’s End and Avatar), the third most expensive was released in 1963 (Cleopatra). The really hugely expensive movies do seem to cluster relatively recently—but then so do the really cheap films, some of which have budgets under $10,000. It may just be that more movies are produced in general, and overall the cost of producing a film doesn’t seem to have changed in real terms. The best return on investment is My Date with Drew, released in 2005, which had a budget of $1,100 but grossed $181,000, giving it an ROI of 16,358%. The highest real profit was of course Gone with the Wind, which made an astonishing $6.592 billion, though Titanic, Avatar, Aliens and Terminator 2 combined actually beat it with a total profit of $6.651 billion, which may explain why James Cameron can now basically make any movie he wants and already has four sequels lined up for Avatar.

The biggest real loss was 1970’s Waterloo, which made back only $18 million of its $153 million budget, losing $135 million and having an ROI of -87.7%. This was not quite as bad an ROI as 2002’s The Adventures of Pluto Nash, which had an ROI of -92.91%.

But making movies has always been expensive, at least for big blockbusters. (The $8,900 budget of Primer is something I could probably put on credit cards if I had to.) It’s nothing new to spend $100 million in today’s money.

When considering the ethics and economics of copyright, it’s useful to think about what Michele Boldrin calls “pizzaright”: you can’t copy my pizza, or you are guilty of pizzaright infringement. Many of the arguments for copyright are so general—this is a valuable service, it carries some risk of failure, it wouldn’t be as profitable without the monopoly, so fewer companies might enter the business—that they would also apply to pizza. Yet somehow nobody thinks that pizzaright should be a thing. If there is a justification for copyrights, it must come from the special circumstances of works of art (broadly conceived, including writing, film, music, etc.), and the only one that really seems strong enough is the high upfront cost of certain types of art—and indeed, the only ones that really seem to fit that are films and video games.

Painting, writing, and music just aren’t that expensive. People are willing to create these things for very little money, and can do so more or less on their own, especially nowadays. If the prices are reasonable, people will still want to buy from the creators directly—and sure enough, widespread music piracy hasn’t killed music, it has only killed the corporate record industry. But movies and video games really can easily cost $100 million to make, so there’s a serious concern of what might happen if they couldn’t use copyright to recover their costs.

The question for me is, did we really need copyright to fund these budgets?

Let’s take a look at how Star Wars made its money. $6.249 billion came from box office revenue, while $873 million came from VHS and DVD sales; those would probably be substantially reduced if not for copyright. But even before The Force Awakens was released, the Star Wars franchise had already made some $12 billion in toy sales alone. “Merchandizing, merchandizing, where the real money from the movie is made!”

Did they need intellectual property to do that? Well, yes—but all they needed was trademark. Defenders of “intellectual property” like to use that term because it elides fundamental distinctions between the three types: trademark, copyright, and patent.
Trademark is unproblematic. You can’t lie about who you are or where you products came from when you’re selling something. So if you are claiming to sell official Star Wars merchandise, you’d better be selling official Star Wars merchandise, and trademark protects that.

Copyright is problematic, but may be necessary in some cases. Copyright protects the content of the movies from being copied or modified without Lucasfilm’s permission. So now rather than simply protecting against the claim that you represent Lucasfilm, we are protecting against people buying the movie, copying it, and reselling the copies—even though that is a real economic service they are providing, and is in no way fraudulent as long as they are clear about the fact that they made the copies.

Patent is, frankly, ridiculous. The concept of “owning” ideas is absurd. You came up with a good way to do something? Great! Go do it then. But don’t expect other people to pay you simply for the privilege of hearing your good idea. Of course I want to financially support researchers, but there are much, much better ways of doing that, like government grants and universities. Patents only raise revenue for research that sells, first of all—so vaccines and basic research can’t be funded that way, even though they are the most important research by far. Furthermore, there’s nothing to guarantee that the person who actually invented the idea is the one who makes the profit from it—and in our current system where corporations can own patents (and do own almost 90% of patents), it typically isn’t. Even if it were, the whole concept of owning ideas is nonsensical, and it has driven us to the insane extremes of corporations owning patents on human DNA. The best argument I’ve heard for patents is that they are a second-best solution that incentivizes transparency and avoids trade secrets from becoming commonplace; but in that case they should definitely be short, and we should never extend them. Companies should not be able to make basically cosmetic modifications and renew the patent, and expiring patents should be a cause for celebration.

Hollywood actually formed in Los Angeles precisely to escape patents, but of course they love copyright and trademark. So do they like “intellectual property”?

Could blockbuster films be produced profitably using only trademark, in the absence of copyright?

Clearly Star Wars would have still turned a profit. But not every movie can do such merchandizing, and when movies start getting written purely for merchandizing it can be painful to watch.

The real question is whether a film like Gone with the Wind or Avatar could still be made, and make a reasonable profit (if a much smaller one).

Well, there’s always porn. Porn raises over $400 million per year in revenue, despite having essentially unenforceable copyright. They too are outraged over piracy, yet somehow I don’t think porn will ever cease to exist. A top porn star can make over $200,000 per year.Then there are of course independent films that never turn a profit at all, yet people keep making them.

So clearly it is possible to make some films without copyright protection, and something like Gone with the Wind needn’t cost $100 million to make. The only reason it cost as much as it did (about $66 million in today’s money) was that movie stars could command huge winner-takes-all salaries, which would no longer be true if copyright went away. And don’t tell me people wouldn’t be willing to be movie stars for $200,000 a year instead of $1.8 million (what Clark Gable made for Gone with the Wind, adjusted for inflation).

Yet some Hollywood blockbuster budgets are genuinely necessary. The real question is whether we could have Avatar without copyright. Not having films like Avatar is something I would count as a substantial loss to our society; we would lose important pieces of our art and culture.

So, where did all that money go? I don’t have a breakdown for Avatar in particular, but I do have a full budget breakdown for The Village. Of its $71.7 million, $33.5 million was “above the line”, which basically means the winner-takes-all superstar salaries for the director, producer, and cast. That amount could be dramatically reduced with no real cost to society—let’s drop it to say $3 million. Shooting costs were $28.8 million, post-production was $8.4 million, and miscellaneous expenses added about $1 million; all of those would be much harder to reduce (they mainly go to technical staff who make reasonable salaries, not to superstars), so let’s assume the full amount is necessary. That’s about $38 million in real cost to produce. Avatar had a lot more (and better) post-production, so let’s go ahead and multiply the post-production budget by an order of magnitude to $84 million. Our new total budget is $113.8 million.
That sounds like a lot, and it is; but this could be made back without copyright. Avatar sold over 14.5 million DVDs and over 8 million Blu-Rays. Conservatively assuming that the price elasticity of demand is zero (which is ridiculous—assuming the monopoly pricing is optimal it should be -1), if those DVDs were sold for $2 each and the Blu-Rays were sold for $5 each, with 50% of those prices being profit, this would yield a total profit of $14.5 million from DVDs and $20 million from Blu-Rays. That’s already $34.5 million. With realistic assumptions about elasticity of demand, cutting the prices this much (DVDs down from an average of $16, Blu-Rays down from an average of $20) would multiply the number of DVDs sold by at least 5 and the number of Blu-Rays sold by at least 3, which would get us all the way up to $132 million—enough to cover our new budget. (Of course this is much less than they actually made, which is why they set the prices they did—but that doesn’t mean it’s optimal from society’s perspective.)

But okay, suppose I’m wrong about the elasticity, and dropping the price from $16 to $2 for a DVD somehow wouldn’t actually increase the number purchased. What other sources of revenue would they have? Well, box office tickets would still be a thing. They’d have to come down in price, but given the high-quality high-fidelity versions that cinemas require—making them quite hard to pirate—they would still get decent money from each cinema. Let’s say the price drops by 90%—all cinemas are now $1 cinemas!—and the sales again somehow remain exactly the same (rather than dramatically increasing as they actually would). What would Avatar’s worldwide box office gross be then? $278 million. They could give the DVDs away for free and still turn a profit.

And that’s Avatar, one of the most expensive movies ever made. By cutting out the winner-takes-all salaries and huge corporate profits, the budget can be substantially reduced, and then what real costs remain can be quite well covered by box office and DVD sales at reasonable prices. If you imagine that piracy somehow undercuts everything until you have to give away things for free, you might think this is impossible; but in reality pirated versions are of unreliable quality, people do want to support artists and they are willing to pay something for their entertainment. They’re just tired of paying monopoly prices to benefit the shareholders of Viacom.

Would this end the era of the multi-millionaire movie star? Yes, I suppose it might. But it would also put about $10 billion per year back in the pockets of American consumers—and there’s little reason to think it would take away future Avatars, much less future Gone with the Winds.

Is Equal Unfair?

JDN 2457492

Much as you are officially a professional when people start paying you for what you do, I think you are officially a book reviewer when people start sending you books for free asking you to review them for publicity. This has now happened to me, with the book Equal Is Unfair by Don Watkins and Yaron Brook. This post is longer than usual, but in order to be fair to the book’s virtues as well as its flaws, I felt a need to explain quite thoroughly.

It’s a very frustrating book, because at times I find myself agreeing quite strongly with the first part of a paragraph, and then reaching the end of that same paragraph and wanting to press my forehead firmly into the desk in front of me. It makes some really good points, and for the most part uses economic statistics reasonably accurately—but then it rides gleefully down a slippery slope fallacy like a waterslide. But I guess that’s what I should have expected; it’s by leaders of the Ayn Rand Institute, and my experience with reading Ayn Rand is similar to that of Randall Monroe (I’m mainly referring to the alt-text, which uses slightly foul language).

As I kept being jostled between “That’s a very good point.”, “Hmm, that’s an interesting perspective.”, and “How can anyone as educated as you believe anything that stupid!?” I realized that there are actually three books here, interleaved:

1. A decent economics text on the downsides of taxation and regulation and the great success of technology and capitalism at raising the standard of living in the United States, which could have been written by just about any mainstream centrist neoclassical economist—I’d say it reads most like John Taylor or Ken Galbraith. My reactions to this book were things like “That’s a very good point.”, and “Sure, but any economist would agree with that.”

2. An interesting philosophical treatise on the meanings of “equality” and “opportunity” and their application to normative economic policy, as well as about the limitations of statistical data in making political and ethical judgments. It could have been written by Robert Nozick (actually I think much of it was based on Robert Nozick). Some of the arguments are convincing, others are not, and many of the conclusions are taken too far; but it’s well within the space of reasonable philosophical arguments. My reactions to this book were things like “Hmm, that’s an interesting perspective.” and “Your argument is valid, but I think I reject the second premise.”

3. A delusional rant of the sort that could only be penned by a True Believer in the One True Gospel of Ayn Rand, about how poor people are lazy moochers, billionaires are world-changing geniuses whose superior talent and great generosity we should all bow down before, and anyone who would dare suggest that perhaps Steve Jobs got lucky or owes something to the rest of society is an authoritarian Communist who hates all achievement and wants to destroy the American Dream. It was this book that gave me reactions like “How can anyone as educated as you believe anything that stupid!?” and “You clearly have no idea what poverty is like, do you?” and “[expletive] you, you narcissistic ingrate!”

Given that the two co-authors are Executive Director and a fellow of the Ayn Rand Institute, I suppose I should really be pleasantly surprised that books 1 and 2 exist, rather than disappointed by book 3.

As evidence of each of the three books interleaved, I offer the following quotations:

Book 1:

“All else being equal, taxes discourage production and prosperity.” (p. 30)

No reasonable economist would disagree. The key is all else being equal—it rarely is.

“For most of human history, our most pressing problem was getting enough food. Now food is abundant and affordable.” (p.84)

Correct! And worth pointing out, especially to anyone who thinks that economic progress is an illusion or we should go back to pre-industrial farming practices—and such people do exist.

“Wealth creation is first and foremost knowledge creation. And this is why you can add to the list of people who have created the modern world, great thinkers: people such as Euclid, Aristotle, Galileo, Newton, Darwin, Einstein, and a relative handful of others.” (p.90, emph. in orig.)

Absolutely right, though as I’ll get to below there’s something rather notable about that list.

“To be sure, there is competition in an economy, but it’s not a zero-sum game in which some have to lose so that others can win—not in the big picture.” (p. 97)

Yes! Precisely! I wish I could explain to more people—on both the Left and the Right, by the way—that economics is nonzero-sum, and that in the long run competitive markets improve the standard of living of society as a whole, not just the people who win that competition.

Book 2:

“Even opportunities that may come to us without effort on our part—affluent parents, valuable personal connections, a good education—require enormous effort to capitalize on.” (p. 66)

This is sometimes true, but clearly doesn’t apply to things like the Waltons’ inherited billions, for which all they had to do was be born in the right family and not waste their money too extravagantly.

“But life is not a game, and achieving equality of initial chances means forcing people to play by different rules.” (p. 79)

This is an interesting point, and one that I think we should acknowledge; we must treat those born rich differently from those born poor, because their unequal starting positions mean that treating them equally from this point forward would lead to a wildly unfair outcome. If my grandfather stole your grandfather’s wealth and passed it on to me, the fair thing to do is not to treat you and I equally from this point forward—it’s to force me to return what was stolen, insofar as that is possible. And even if we suppose that my grandfather earned far vaster wealth than yours, I think a more limited redistribution remains justified simply to put you and I on a level playing field and ensure fair competition and economic efficiency.

“The key error in this argument is that it totally mischaracterizes what it means to earn something. For the egalitarians, the results of our actions don’t merely have to be under our control, but entirely of our own making. […] But there is nothing like that in reality, and so what the egalitarians are ultimately doing is wiping out the very possibility of earning something.” (p. 193)

The way they use “egalitarian” as an insult is a bit grating, but there clearly are some actual egalitarian philosophers whose views are this extreme, such as G.A. Cohen, James Kwak and Peter Singer. I strongly agree that we need to make a principled distinction between gains that are earned and gains that are unearned, such that both sets are nonempty. Yet while Cohen would seem to make “earned” an empty set, Watkins and Brook very nearly make “unearned” empty—you get what you get, and you deserve it. The only exceptions they seem willing to make are outright theft and, what they consider equivalent, taxation. They have no concept of exploitation, excessive market power, or arbitrage—and while they claim they oppose fraud, they seem to think that only government is capable of it.

Book 3:

“What about government handouts (usually referred to as ‘transfer payments’)?” (p. 23)

Because Social Security is totally just a handout—it’s not like you pay into it your whole life or anything.

“No one cares whether the person who fixes his car or performs his brain surgery or applies for a job at his company is male or female, Indian or Pakistani—he wants to know whether they are competent.” (p.61)

Yes they do. We have direct experimental evidence of this.

“The notion that ‘spending drives the economy’ and that rich people spend less than others isn’t a view seriously entertained by economists,[…]” (p. 110)

The New Synthesis is Keynesian! This is what Milton Friedman was talking about when he said, “We’re all Keynesians now.”

“Because mobility statistics don’t distinguish between those who don’t rise and those who can’t, they are useless when it comes to assessing how healthy mobility is.” (p. 119)

So, if Black people have much lower odds of achieving high incomes even controlling for education, we can’t assume that they are disadvantaged or discriminated against; maybe Black people are just lazy or stupid? Is that what you’re saying here? (I think it might be.)

“Payroll taxes alone amount to 15.3 percent of your income; money that is taken from you and handed out to the elderly. This means that you have to spend more than a month and a half each year working without pay in order to fund other people’s retirement and medical care.” (p. 127)

That is not even close to how taxes work. Taxes are not “taken” from money you’d otherwise get—taxation changes prices and the monetary system depends upon taxation.

“People are poor, in the end, because they have not created enough wealth to make themselves prosperous.” (p. 144)

This sentence was so awful that when I showed it to my boyfriend, he assumed it must be out of context. When I showed him the context, he started swearing the most I’ve heard him swear in a long time, because the context was even worse than it sounds. Yes, this book is literally arguing that the reason people are poor is that they’re just too lazy and stupid to work their way out of poverty.

“No society has fully implemented the egalitarian doctrine, but one came as close as any society can come: Cambodia’s Khmer Rouge.” (p. 207)

Because obviously the problem with the Khmer Rouge was their capital gains taxes. They were just too darn fair, and if they’d been more selfish they would never have committed genocide. (The authors literally appear to believe this.)


So there are my extensive quotations, to show that this really is what the book is saying. Now, a little more summary of the good, the bad, and the ugly.

One good thing is that the authors really do seem to understand fairly well the arguments of their opponents. They quote their opponents extensively, and only a few times did it feel meaningfully out of context. Their use of economic statistics is also fairly good, though occasionally they present misleading numbers or compare two obviously incomparable measures.

One of the core points in Equal is Unfair is quite weak: They argue against the “shared-pie assumption”, which is that we create wealth as a society, and thus the rest of society is owed some portion of the fruits of our efforts. They maintain that this is fundamentally authoritarian and immoral; essentially they believe a totalizing false dichotomy between either absolute laissez-faire or Stalinist Communism.

But the “shared-pie assumption” is not false; we do create wealth as a society. Human cognition is fundamentally social cognition; they said themselves that we depend upon the discoveries of people like Newton and Einstein for our way of life. But it should be obvious we can never pay Einstein back; so instead we must pay forward, to help some child born in the ghetto to rise to become the next Einstein. I agree that we must build a society where opportunity is maximized—and that means, necessarily, redistributing wealth from its current state of absurd and immoral inequality.

I do however agree with another core point, which is that most discussions of inequality rely upon a tacit assumption which is false: They call it the “fixed-pie assumption”.

When you talk about the share of income going to different groups in a population, you have to be careful about the fact that there is not a fixed amount of wealth in a society to be distributed—not a “fixed pie” that we are cutting up and giving around. If it were really true that the rising income share of the top 1% were necessary to maximize the absolute benefits of the bottom 99%, we probably should tolerate that, because the alternative means harming everyone. (In arguing this they quote John Rawls several times with disapprobation, which is baffling because that is exactly what Rawls says.)

Even if that’s true, there is still a case to be made against inequality, because too much wealth in the hands of a few people will give them more power—and unequal power can be dangerous even if wealth is earned, exchanges are uncoerced, and the distribution is optimally efficient. (Watkins and Brook dismiss this contention out of hand, essentially defining beneficent exploitation out of existence.)

Of course, in the real world, there’s no reason to think that the ballooning income share of the top 0.01% in the US is actually associated with improved standard of living for everyone else.

I’ve shown these graphs before, but they bear repeating:

Income shares for the top 1% and especially the top 0.1% and 0.01% have risen dramatically in the last 30 years.


But real median income has only slightly increased during the same period.


Thus, mean income has risen much faster than median income.


While theoretically it could be that the nature of our productivity technology has shifted in such a way that it suddenly became necessary to heap more and more wealth on the top 1% in order to continue increasing national output, there is actually very little evidence of this. On the contrary, as Joseph Stiglitz (Nobel Laureate, you may recall) has documented, the leading cause of our rising inequality appears to be a dramatic increase in rent-seeking, which is to say corruption, exploitation, and monopoly power. (This probably has something to do with why I found in my master’s thesis that rising top income shares correlate quite strongly with rising levels of corruption.)

Now to be fair, the authors of Equal is Unfair do say that they are opposed to rent-seeking, and would like to see it removed. But they have a very odd concept of what rent-seeking entails, and it basically seems to amount to saying that whatever the government does is rent-seeking, whatever corporations do is fair free-market competition. On page 38 they warn us not to assume that government is good and corporations are bad—but actually it’s much more that they assume that government is bad and corporations are good. (The mainstream opinion appears to be actually that both are bad, and we should replace them both with… er… something.)

They do make some other good points I wish more leftists would appreciate, such as the point that while colonialism and imperialism can damage countries that suffer them and make them poorer, they generally do not benefit the countries that commit them and make them richer. The notion that Europe is rich because of imperialism is simply wrong; Europe is rich because of education, technology, and good governance. Indeed, the greatest surge in Europe’s economic growth occurred as the period of imperialism was winding down—when Europeans realized that they would be better off trying to actually invent and produce things rather than stealing them from others.

Likewise, they rightfully demolish notions of primitivism and anti-globalization that I often see bouncing around from folks like Naomi Klein. But these are book 1 messages; any economist would agree that primitivism is a terrible idea, and very few are opposed to globalization per se.

The end of Equal is Unfair gives a five-part plan for unleashing opportunity in America:

1. Abolish all forms of corporate welfare so that no business can gain unfair advantage.

2. Abolish government barriers to work so that every individual can enjoy the dignity of earned success.

3. Phase out the welfare state so that America can once again become the land of self-reliance.

4. Unleash the power of innovation in education by ending the government monopoly on schooling.

5. Liberate innovators from the regulatory shackles that are strangling them.

Number 1 is hard to disagree with, except that they include literally everything the government does that benefits a corporation as corporate welfare, including things like subsidies for solar power that the world desperately needs (or millions of people will die).

Number 2 sounds really great until you realize that they are including all labor standards, environmental standards and safety regulations as “barriers to work”; because it’s such a barrier for children to not be able to work in a factory where your arm can get cut off, and such a barrier that we’ve eliminated lead from gasoline emissions and thereby cut crime in half.

Number 3 could mean a lot of things; if it means replacing the existing system with a basic income I’m all for it. But in fact it seems to mean removing all social insurance whatsoever. Indeed, Watkins and Brook do not appear to believe in social insurance at all. The whole concept of “less fortunate”, “there but for the grace of God go I” seems to elude them. They have no sense that being fortunate in their own lives gives them some duty to help others who were not; they feel no pang of moral obligation whatsoever to help anyone else who needs help. Indeed, they literally mock the idea that human beings are “all in this together”.

They also don’t even seem to believe in public goods, or somehow imagine that rational self-interest could lead people to pay for public goods without any enforcement whatsoever despite the overwhelming incentives to free-ride. (What if you allow people to freely enter a contract that provides such enforcement mechanisms? Oh, you mean like social democracy?)

Regarding number 4, I’d first like to point out that private schools exist. Moreover, so do charter schools in most states, and in states without charter schools there are usually vouchers parents can use to offset the cost of private schools. So while the government has a monopoly in the market share sense—the vast majority of education in the US is public—it does not actually appear to be enforcing a monopoly in the anti-competitive sense—you can go to private school, it’s just too expensive or not as good. Why, it’s almost as if education is a public good or a natural monopoly.

Number 5 also sounds all right, until you see that they actually seem most opposed to antitrust laws of all things. Why would antitrust laws be the ones that bother you? They are designed to increase competition and lower barriers, and largely succeed in doing so (when they are actually enforced, which is rare of late). If you really want to end barriers to innovation and government-granted monopolies, why is it not patents that draw your ire?

They also seem to have trouble with the difference between handicapping and redistribution—they seem to think that the only way to make outcomes more equal is to bring the top down and leave the bottom where it is, and they often use ridiculous examples like “Should we ban reading to your children, because some people don’t?” But of course no serious egalitarian would suggest such a thing. Education isn’t fungible, so it can’t be redistributed. You can take it away (and sometimes you can add it, e.g. public education, which Watkins and Brooks adamantly oppose); but you can’t simply transfer it from one person to another. Money on the other hand, is by definition fungible—that’s kind of what makes it money, really. So when we take a dollar from a rich person and give it to a poor person, the poor person now has an extra dollar. We’ve not simply lowered; we’ve also raised. (In practice it’s a bit more complicated than that, as redistribution can introduce inefficiencies. So realistically maybe we take $1.00 and give $0.90; that’s still worth doing in a lot of cases.)

If attributes like intelligence were fungible, I think we’d have a very serious moral question on our hands! It is not obvious to me that the world is better off with its current range of intelligence, compared to a world where geniuses had their excess IQ somehow sucked out and transferred to mentally disabled people. Or if you think that the marginal utility of intelligence is increasing, then maybe we should redistribute IQ upward—take it from some mentally disabled children who aren’t really using it for much and add it onto some geniuses to make them super-geniuses. Of course, the whole notion is ridiculous; you can’t do that. But whereas Watkins and Brook seem to think it’s obvious that we shouldn’t even if we could, I don’t find that obvious at all. You didn’t earn your IQ (for the most part); you don’t seem to deserve it in any deep sense; so why should you get to keep it, if the world would be much better off if you didn’t? Why should other people barely be able to feed themselves so I can be good at calculus? At best, maybe I’m free to keep it—but given the stakes, I’m not even sure that would be justifiable. Peter Singer is right about one thing: You’re not free to let a child drown in a lake just to keep your suit from getting wet.

Ultimately, if you really want to understand what’s going on with Equal is Unfair, consider the following sentence, which I find deeply revealing as to the true objectives of these Objectivists:

“Today, meanwhile, although we have far more liberty than our feudal ancestors, there are countless ways in which the government restricts our freedom to produce and trade including minimum wage laws, rent control, occupational licensing laws, tariffs, union shop laws, antitrust laws, government monopolies such as those granted to the post office and education system, subsidies for industries such as agriculture or wind and solar power, eminent domain laws, wealth redistribution via the welfare state, and the progressive income tax.” (p. 114)

Some of these are things no serious economist would disagree with: We should stop subsidizing agriculture and tariffs should be reduced or removed. Many occupational licenses are clearly unnecessary (though this has a very small impact on inequality in real terms—licensing may stop you from becoming a barber, but it’s not what stops you from becoming a CEO). Others are legitimately controversial: Economists are currently quite divided over whether minimum wage is beneficial or harmful (I lean toward beneficial, but I’d prefer a better solution), as well as how to properly regulate unions so that they give workers much-needed bargaining power without giving unions too much power. But a couple of these are totally backward, exactly contrary to what any mainstream economist would say: Antitrust laws need to be enforced more, not eliminated (don’t take it from me; take it from that well-known Marxist rag The Economist). Subsidies for wind and solar power make the economy more efficient, not less—and suspiciously Watkins and Brook omitted the competing subsidies that actually are harmful, namely those to coal and oil.

Moreover, I think it’s very revealing that they included the word progressive when talking about taxation. In what sense does making a tax progressive undermine our freedom? None, so far as I can tell. The presence of a tax undermines freedom—your freedom to spend that money some other way. Making the tax higher undermines freedom—it’s more money you lose control over. But making the tax progressive increases freedom for some and decreases it for others—and since rich people have lower marginal utility of wealth and are generally more free in substantive terms in general, it really makes the most sense that, holding revenue constant, making a tax progressive generally makes your people more free.

But there’s one thing that making taxes progressive does do: It benefits poor people and hurts rich people. And thus the true agenda of Equal is Unfair becomes clear: They aren’t actually interested in maximizing freedom—if they were, they wouldn’t be complaining about occupational licensing and progressive taxation, they’d be outraged by forced labor, mass incarceration, indefinite detention, and the very real loss of substantive freedom that comes from being born into poverty. They wouldn’t want less redistribution, they’d want more efficient and transparent redistribution—a shift from the current hodgepodge welfare state to a basic income system. They would be less concerned about the “freedom” to pollute the air and water with impunity, and more concerned about the freedom to breathe clean air and drink clean water.

No, what they really believe is rich people are better. They believe that billionaires attained their status not by luck or circumstance, not by corruption or ruthlessness, but by the sheer force of their genius. (This is essentially the entire subject of chapter 6, “The Money-Makers and the Money-Appropriators”, and it’s nauseating.) They describe our financial industry as “fundamentally moral and productive” (p.156)—the industry that you may recall stole millions of homes and laundered money for terrorists. They assert that no sane person could believe that Steve Wozniack got lucky—I maintain no sane person could think otherwise. Yes, he was brilliant; yes, he invented good things. But he had to be at the right place at the right time, in a society that supported and educated him and provided him with customers and employees. You didn’t build that.

Indeed, perhaps most baffling is that they themselves seem to admit that the really great innovators, such as Newton, Einstein, and Darwin, were scientists—but scientists are almost never billionaires. Even the common counterexample, Thomas Edison, is largely false; he mainly plagiarized from Nikola Tesla and appropriated the ideas of his employees. Newton, Einstein and Darwin were all at least upper-middle class (as was Tesla, by the way—he did not die poor as is sometimes portrayed), but they weren’t spectacularly mind-bogglingly rich the way that Steve Jobs and Andrew Carnegie were and Bill Gates and Jeff Bezos are.

Some people clearly have more talent than others, and some people clearly work harder than others, and some people clearly produce more than others. But I just can’t wrap my head around the idea that a single man can work so hard, be so talented, produce so much that he can deserve to have as much wealth as a nation of millions of people produces in a year. Yet, Mark Zuckerberg has that much wealth. Remind me again what he did? Did he cure a disease that was killing millions? Did he colonize another planet? Did he discover a fundamental law of nature? Oh yes, he made a piece of software that’s particularly convenient for talking to your friends. Clearly that is worth the GDP of Latvia. Not that silly Darwin fellow, who only uncovered the fundamental laws of life itself.

In the grand tradition of reducing complex systems to simple numerical values, I give book 1 a 7/10, book 2 a 5/10, and book 3 a 2/10. Equal is Unfair is about 25% book 1, 25% book 2, and 50% book 3, so altogether their final score is, drumroll please: 4/10. Maybe read the first half, I guess? That’s where most of the good stuff is.

What would an interplanetary economy look like?

JDN 2457397

Today’s post is the second Reader’s Choice topic, chosen by a vote of my Patreons.

Remember, you too can vote on future topics if you pledge at least $10 per month.

Actually, there was a tie between two topics; since I was in an SF mood today, I decided to do this one as the official Reader’s Choice post. The second, “The challenges and possibilities of a global basic income”, I’ll do as a later post. (If I don’t get around to that before the next vote, you can of course always vote for it again.)

Will we ever colonize outer space? Many people thought we’d be there by now.

In Blade Runner, released in 1982, Roy was built and deployed to the outer colonies in 2015, which you may remember as the year that just ended.

Predictions of the future are often wrong, but predictions from the 20th century of the 21st century seem to be consistently overoptimistic about technology. In a past Idiot Free Zone post, I hypothesize that this is due to the confusion between exponential and logistic growth.

Paul Krugman is also a big fan of SF (it is actually about as likely that I’d run into Krugman at Worldcon as at an economics conference), and he wrote a paper on the possibility of interstellar trade way back in 1978. I think he’s kind of satirizing economic theorists actually; he uses sophisticated mathematics to address a problem that doesn’t exist in the real world—just like they do.

I think we will eventually at least reach the point of interplanetary colonization, if not actually interstellar. To begin, let me emphasize that vital distinction. Mars is currently about 60 million kilometers away at its closest approach. The core of the Alpha Centauri system is 4.24 light-years away, which is about 40 trillion kilometers. The distance from Ann Arbor to Toledo is about 84 kilometers. Thus, the difficulty of going to Alpha Centauri is about as much higher than that of going to Mars as the difficulty of going to Mars is compared to going from Ann Arbor to Toledo—each a factor of 700,000 times the distance.

With current technology, we can send robots to Mars (how cool is that? We did get some of the future we were promised). A typical trip takes about half a year. It costs us about $2.5 billion to do that, though India somehow managed to at least make Mars orbit for $75 million. Even if we use the $2.5 billion figure, that still means our current economic output the US and Europe alone could support hundreds of missions per year if we were willing to pay for it. (Devote the entire US military budget to NASA and we could land a new robot on Mars every day.) Interplanetary travel is most definitely feasible.

Interstellar travel on the other hand, is still far out of reach. In principle we are limited by the speed of light; in fact, it’s a good deal worse than that. The fastest we have ever gotten a spacecraft leaving the Solar System is about 60,000 km/h; at that speed it would take almost one billion hours to get to Alpha Centauri, which is over 100,000 years. We will need substantial breakthroughs in spacecraft propulsion before we can even consider sending anything to even the nearest stars. (I wouldn’t give up hope completely, however; in 1901 someone could just as well have criticized H.G. Wells’ The First Men in the Moon on the grounds that no one will ever invent a propulsion system powerful enough to reach the moon.)

By the time we manage interstellar travel, our technology will be so much more advanced it’s hard to even imagine what things will be like. But interplanetary travel we could probably do right now.

So let’s suppose we do in fact establish colonies on other planets—most likely Mars and Mercury, as well as several moons of Jupiter and Saturn. What would our economy look like once we did?

For a decidedly Game of Thrones take on this situation, see The Expanse. Their scientific accuracy is quite good (although they still have sound in space!); so far, their economic accuracy seems pretty good as well, but so far I haven’t seen enough yet to be sure.
One thing I think The Expanse does get right is that asteroid mining is a vital part of the interplanetary trade network. The thing that’s currently keeping us from colonizing other planets is a lack of economic incentives to bear the enormous cost of space travel. Asteroid mining is one thing that might actually provide those incentives, if we can leap just a few more technological hurdles in terms of mining robots and spacecraft propulsion.

Many asteroids contain metals such as silver, gold and platinum at concentrations 20 times as great as anything found on the surface of the Earth. The amount of iron and nickel they contain is even larger; we could supply the entire iron production of the Earth (3.2 billion tonnes) with a single asteroid, 16 Psyche, for the next million years. That one asteroid over 2e19 kg of nearly pure iron-nickel, which is 200 quadrillion tonnes. Many asteroids also contain large concentrations of other useful and rare metals, such as lithium and neodymium.

It is unlikely we would actually try to colonize asteroids (they do in The Expanse, but I’m not sure I buy it). None are large enough to support an atmosphere (kind of by definition), so we’d have to build space stations large enough for permanent habitation. With such ludicrous amounts of iron all around us, that might be possible; but would it be cost-effective? I think it’s more likely that we would have temporary habitats, able to support people for several months or maybe a few years, and people would basically do “tours of duty” working in the asteroids, and then return home. This is similar to how we use space stations right now; you can live there for a long time—the standing record is over a year—but nobody lives their whole life there. It might be a sort of “seasonal” work, where the seasons are decided by large-scale orbital mechanics rather than local planetary axial tilt. (We might have to start doing “seasonal adjustments” to statistics based on this!) Provided that the workers are paid a substantial portion of the spoils—by no means a certainty, as we all know from sweatshops around the world—this work could easily be lucrative enough that you become a millionaire after a tour or two and then retire.

But they might well return home to Mars, since the orbital transfer from the asteroid belt to Mars is considerably easier (it has what we call a lower “delta-v”) than the same transfer all the way back to Earth, and the launch and landing are even easier still. Mars does support an atmosphere—currently very thin and not breathable, but that could change with terraforming. It is also large enough to spread out with room for many homes, greenhouses, power plants, etc., and has enough gravity to at least keep human bodies as a basic level of functioning without too much additional support. (Mars’ gravity is about 40% that of Earth’s.)

Of course, most of the products we make are going to be used on Earth—most of everything is going to be used on Earth, probably for centuries to come. It’s possible that we’ll end up like the British Empire did where the colonies are more populous than the source, but it will take a long time for that to happen. (Moreover, the primary reason—cheap, fertile agricultural land—will not apply unless we happen upon a habitable planet or get very good at terraforming.) This means we will need to ship something from Mars to Earth. But since the delta-v is exceptionally high, we’ll want to ship as little as possible. I think this means that we will do most of the refinement and even manufacturing on Mars, and then ship prefabricated components to Earth. Any process that removes mass will be done on Mars, to minimize the amount of mass that needs to make the trip to Earth.

And what will Earth provide in return? As we import this huge quantity of metal (or metal components), what will we export in return?
Well, one possibility is that we won’t—at first, we (by which I mean “our corporations”) will simply retain ownership of the entire supply chain and do all the accounting as though production were being done entirely on Earth. We won’t think of it as “trade”, just as corporations engaging in a series of prospecting and mining ventures. At least at first.

Yet this will become increasingly unwieldy, just as it became unwieldy for the British Empire to retain control of all its colonies and collect their taxes for the Crown. Communication between Mars, Earth, and the asteroid belt will be relatively fast—a few hours delay at worst—but travel will be very slow and very expensive. Local institutions will form and assert themselves, and may eventually topple the corporate managers, expropriate their assets, and create new governments. The corporations could see the rebellion coming a year in advance from the transmissions, and still be powerless to stop it because the ships will take too long to arrive.

Once new local governments form, we will start thinking of it as “trade”. So what will we be trading? To some extent people on Mars might simply accept Earth currency (perhaps US Dollars, or Euros, or as I like to imagine some unified currency, perhaps the Atlantic Union Dollar); but only if they can then use that Earth currency to buy things they actually need. What will they actually need?

Food, for one. Some amount of food production will be done on Mars by necessity—you can’t survive if you depend entirely on imported food to survive. But it will be expensive, and most likely nutrient-dense but tasteless and monotonous genetically-engineered vegetable products. People will get tired of eating bricks of processed Aresoy(TM) for the 17,000th time and will crave real food; Earth will respond by selling them frozen steaks at $12,000 per kilogram. Probably only luxury foods will be imported, actually; why spend $11,900 for a hamburger when you can spend $12,000 for filet mignon? Nominal income on Mars will be huge—millionaires will be ubiquitous. At purchasing power parity, it may not be so impressive, once you account for the ridiculous cost of food and housing. It’ll be like living in Silicon Valley—on steroids.

Water, perhaps. This one is not as obvious as it may seem. While Earth does have the largest concentration of liquid water (except for a couple of moons of the gas giants), there is plenty of ice in them thar asteroids. It will most likely be cheaper (albeit not cheap) to obtain water by capturing and melting down asteroid ice than to ship it all the way from Earth.

But I think the most important Earth export will beculture. The main products that Martians will want to buy from us will be books, movies, songs, video games, hologram simulations. They will be blueprints, patents, 3D printer schematics. Those who travel to Mars will be bold, adventurous, many of them loners and misfits—but deep down they will still sometimes long for the comforts of the books they read as children, the songs they listened to as teenagers. The beautiful thing about selling culture is that it can be transported almost for free—just add it to the radio transmissions you were already sending. Mars will also produce its own culture, of course, but the much smaller population and constant struggle for survival will mean that most of the cultural flow will be outward from Earth to the colonies rather than the reverse. The Internet won’t work normally between Earth and Mars due to the time delay, but there will be something like it, a local MarsNet that caches material from the Internet on a delay of a few hours and then shares it with the colony. You won’t download webpages in real time, you’ll request them a day in advance. You won’t send instant messages, but sending email will be hardly any different. (Instead of Nigerian princes we’ll start getting scam spam about Martian mining entrepreneurs.) Whoever owns this communication monopoly will become fantastically rich, perhaps even more so than the mining companies themselves—because the mining companies have overhead.

Overall, the increased availability of previously-scarce metals like gold, lithium, and neodymium will make new technologies possible and also widely available, including battery technologies that might finally allow Earth to wean itself off of carbon emissions. (Unfortunately, our current means of spacecraft launch are all very carbon-intensive. We will need to invent nuclear engines that don’t leave fallout so that we can launch with them from the ground.) Like all trade, the mutual imports and exports between Earth and Mars will benefit both societies.

But unless we change course dramatically as a society, interplanetary trade will make one problem even worse, and that is inequality. I am having trouble foreseeing an interplanetary trade system that doesn’t involve making the middlemen who own the shipping and networking companies rich even beyond the wildest dreams of today’s plutocrats. We will witness the birth of humanity’s first trillionaires, individual men (and let’s face it, probably men, unless we figure out gender equality too) who own as much as not just entire countries, but as entire large First World countries. The GDP of France today is $2.8 trillion per year; the CEO of Aresoy or MarsNet could well make more than that on dividends. Of course, that provides him a great incentive to start the project now—but what will it mean for our societies when one person can buy a spaceship as casually as we would buy a cup of coffee?

Elasticity and the Law of Demand

JDN 2457289 EDT 21:04

This will be the second post in my new bite-size format, the first one that’s in the middle of the week.

I’ve alluded previously to the subject of demand elasticity, but I think it’s worth explaining in a little more detail. The basic concept is fairly straightforward: Demand is more elastic when the amount that people want to buy changes a large amount for a small change in price. The opposite is inelastic.

Apples are a relatively elastic good. If the price of apples goes up, people buy fewer apples. Maybe they buy other fruit instead, such as oranges or bananas; or maybe they give up on fruit and eat something else, like rice.

Salt is an extremely inelastic good. No matter what the price of salt is, at least within the range it has been for the last few centuries, people are going to continue to buy pretty much the same amount of salt. (In ancient times salt was actually expensive enough that people couldn’t afford enough of it, which was particularly harmful in desert regions. Mark Kulansky’s book Salt on this subject is surprisingly compelling, given the topic.)
Specifically, the elasticity is equal to the proportional change in quantity demanded, divided by the proportional change in price.

For example, if the price of gas rises from $2 per gallon to $3 per gallon, that’s a 50% increase. If the quantity of gas purchase then falls from 100 billion gallons to 90 billion gallons, that’s a 10% decrease. If increasing the price by 50% decreased the quantity demanded by 10%, that would be a demand elasticity of -10%/50% = -1/5 = -0.2

In practice, measuring elasticity is more complicated than that, because supply and demand are both changing at the same time; so when we see a price change and a quantity change, it isn’t always clear how much of each change is due to supply and how much is due to demand. Sophisticated econometric techniques have been developed to try to separate these two effects (in future posts I plan to explain the basics of some of these techniques), but it’s difficult and not always successful.

In general, markets function better when supply and demand are more elastic. When shifts in price trigger large shifts in quantity, this creates pressure on the price to remain at a fixed level rather than jumping up and down. This in turn means that the market will generally be predictable and stable.

It’s also much harder to make monopoly profits in a market with elastic demand; even if you do have a monopoly, if demand is highly elastic then raising the price won’t make you any money, because whatever you gain in selling each gizmo for more, you’ll lose in selling fewer gizmos. In fact, the profit margin for a monopoly is inversely proportional to the elasticity of demand.

Markets do not function well when supply and demand are highly inelastic. Monopolies can become very powerful and result in very large losses of human welfare. A particularly vivid example of this was in the news recently, when a company named Turing purchased the rights to a drug called Daraprim used primarily by AIDS patients, then hiked the price from $13.50 to $750. This made enough people mad that the CEO has since promised to bring it back down, though he hasn’t said how far.

That price change was only possible because Daraprim has highly inelastic demand—if you’ve got AIDS, you’re going to take AIDS medicine, as much as prescribed, provided only that it doesn’t drive you completely bankrupt. (Not an unreasonable fear, as medical costs are the leading cause of bankruptcy in the United States.) This raised price probably would bankrupt a few people, but for the most part it wouldn’t affect the amount of drug sold; it would just funnel a huge amount of money from AIDS patients to the company. This is probably part of why it made people so mad; that and there would probably be a few people who died because they couldn’t afford this new expensive medication.

Imagine if a company had tried to pull the same stunt for a more elastic good, like apples. “CEO buys up all apple farms, raises price of apples from $2 per pound to $100 per pound.” What’s going to happen then? People are not going to buy any apples. Perhaps a handful of the most die-hard apple lovers still would, but the rest of us are going to meet our fruit needs elsewhere.

For most goods most of the time, elasticity of demand is negative, meaning that as price increases, quantity demanded decreases. This is in fact called the Law of Demand; but as I’ve said, “laws” in economics are like the Pirate Code: They’re really more what you’d call “guidelines”.
There are three major exceptions to the Law of Demand. The first one is the one most economists talk about, and it almost never happens. The second one is talked about occasionally, and it’s quite common. The third one is almost never talked about, and yet it is by far the most common and one of the central driving forces in modern capitalism.
The exception that we usually talk about in economics is called the Giffen Effect. A Giffen good is a good that’s so cheap and such a bare necessity that when it becomes more expensive, you won’t be able to buy less of it; instead you’ll buy more of it, and buy less of other things with your reduced income.

It’s very hard to come up with empirical examples of Giffen goods, but it’s an easy theoretical argument to make. Suppose you’re buying grapes for a party, and you know you need 4 bags of grapes. You have $10 to spend. Suppose there are green grapes selling for $1 per bag and red grapes selling for $4 per bag, and suppose you like red grapes better. With your $10, you can buy 2 bags of green grapes and 2 bags of red grapes, and that’s the 4 bags you need. But now suppose that the price of green grapes rises to $2 per bag. In order to afford 4 bags of grapes, you now need to buy 3 bags of green grapes and only 1 bag of red grapes. Even though it was the price of green grapes that rose, you ended up buying more green grapes. In this scenario, green grapes are a Giffen good.

The exception that is talked about occasionally and occurs a lot in real life is the Veblen Effect. Whereas a Giffen good is a very cheap bare necessity, a Veblen good is a very expensive pure luxury.

The whole point of buying a Veblen good is to prove that you can. You don’t buy a Ferrari because a Ferrari is a particularly nice automobile (a Prius is probably better, and a Tesla certainly is); you buy a Ferrari to show off that you’re so rich you can buy a Ferrari.

On my previous post, jenszorn asked: “Much of consumer behavior is irrational by your standards. But people often like to spend money just for the sake of spending and for showing off. Why else does a Rolex carry a price tag for $10,000 for a Rolex watch when a $100 Seiko keeps better time and requires far less maintenance?” Veblen goods! It’s not strictly true that Veblen goods are irrational; it can be in any particular individual’s best interest is served by buying Veblen goods in order to signal their status and reap the benefits of that higher status. However, it’s definitely true that Veblen goods are inefficient; because ostentatious displays of wealth are a zero-sum game (it’s not about what you have, it’s about what you have that others don’t), any resources spent on rich people proving how rich they are are resources that society could otherwise have used, say, feeding the poor, curing diseases, building infrastructure, or colonizing other planets.

Veblen goods can also result in a violation of the Law of Demand, because raising the price of a Veblen good like Ferraris or Rolexes can make them even better at showing off how rich you are, and therefore more appealing to the kind of person who buys them. Conversely, lowering the price might not result in any more being purchased, because they wouldn’t seem as impressive anymore. Currently a Ferrari costs about $250,000; if they reduced that figure to $100,000, there aren’t a lot of people who would suddenly find it affordable, but many people who currently buy Ferraris might switch to Bugattis or Lamborghinis instead. There are limits to this, of course: If the price of a Ferrari dropped to $2,000, people wouldn’t buy them to show off anymore; but the far larger effect would be the millions of people buying them because you can now get a perfectly good car for $2,000. Yes, I would sell my dear little Smart if it meant I could buy a Ferrari instead and save $8,000 at the same time.

But the third major exception to the Law of Demand is actually the most important one, yet it’s the one that economists hardly ever talk about: Speculation.

The most common reason why people would buy more of something that has gotten more expensive is that they expect it to continue getting more expensive, and then they will be able to sell what they bought at an even higher price and make a profit.

When the price of Apple stock goes up, do people stop buying Apple stock? On the contrary, they almost certainly start buying more—and then the price goes up even further still. If rising prices get self-fulfilling enough, you get an asset bubble; it grows and grows until one day it can’t, and then the bubble bursts and prices collapse again. This has happened hundreds of times in history, from the Tulip Mania to the Beanie Baby Bubble to the Dotcom Boom to the US Housing Crisis.

It isn’t necessarily irrational to participate in a bubble; some people must be irrational, but most people can buy above what they would be willing to pay by accurately predicting that they’ll find someone else who is willing to pay an even higher price later. It’s called Greater Fool Theory: The price I paid may be foolish, but I’ll find someone who is even more foolish to take it off my hands. But like Veblen goods, speculation goods are most definitely inefficient; nothing good comes from prices that rise and fall wildly out of sync with the real value of goods.

Speculation goods are all around us, from stocks to gold to real estate. Most speculation goods also serve some other function (though some, like gold, are really mostly just Veblen goods otherwise; actual useful applications of gold are extremely rare), but their speculative function often controls their price in a way that dominates all other considerations. There’s no real limit to how high or low the price can go for a speculation good; no longer tied to the real value of the good, it simply becomes a question of how much people decide to pay.

Indeed, speculation bubbles are one of the fundamental problems with capitalism as we know it; they are one of the chief causes of the boom-and-bust business cycle that has cost the world trillions of dollars and thousands of lives. Most of our financial industry is now dedicated to the trading of speculation goods, and finance is taking over a larger and larger section of our economy all the time. Many of the world’s best and brightest are being funneled into finance instead of genuinely productive industries; 15% of Harvard grads take a job in finance, and almost half did just before the crash. The vast majority of what goes on in our financial system is simply elaborations on speculation; very little real productivity ever enters into the equation.

In fact, as a general rule I think when we see a violation of the Law of Demand, we know that something is wrong in the economy. If there are Giffen goods, some people are too poor to buy what they really need. If there are Veblen goods, inequality is too large and people are wasting resources competing for status. And since there are always speculation goods, the history of capitalism has been a history of market instability.

Fortunately, elasticity of demand is usually negative: As the price goes up, people want to buy less. How much less is the elasticity.

What does it mean to “own” an idea?

JDN 2457195 EDT 11:29.

For a long time I’ve been suspicious of intellectual property as current formulated, but I’m never quite sure what to replace it with. I recently finished reading a surprisingly compelling little book called Against Intellectual Monopoly, which offered some more direct empirical support for many of my more philosophical concerns. (Fitting their opposition to copyright law, the authors, Michele Boldrin and David Levine, offer the full text of the book for free online.)

Boldrin and Levine argue that they are not in fact opposed to intellectual property, but intellectual monopoly. I think this is a bit of a silly distinction myself, and in fact muddles the issue a little because most of what we currently call “intellectual property” is in fact what they call “intellectual monopoly”.

The problems with intellectual property are well-documented within, but I think it’s worth repeating at least the basic form of the argument. Intellectual property is supposed to incentivize innovation by rewarding innovators for their investment, and thereby increase the total amount of innovation.

This requires three conditions to hold: First, the intellectual property must actually reward the innovators. Second, innovation must be increased when innovators seek rewards. And third, the costs of implementing the policy must be exceeded by the benefits provided by it.

As it turns out, none of those three conditions to hold. For intellectual property to make sense, they would all need to hold; and in fact none do.

First—and worst—of all, intellectual property does not actually reward innovators. It instead rewards those who manipulate the intellectual property system. Intellectual property is why Thomas Edison was wealthy and Nikola Tesla was poor. Intellectual property is why we keep getting new versions of the same pills for erectile dysfunction instead of an AIDS vaccine. Intellectual property is how we get patent troll corporations, submarine patents, and Samsung owing Apple $1 billion for making its smartphones the wrong shape. Intellectual property is how is proposing to sue an entire genre of video games.

Second, the best innovators are not motivated by individual rewards. This has always been true; the people who really contribute the most to the world in knowledge or creativity are those who do it out of an insatiable curiosity, or a direct desire to improve the world. People who are motivated primarily by profit only innovate as a last resort, instead preferring to manipulate laws, undermine competitors, or simply mass-produce safe, popular products.

I can think of no more vivid an example here than Hollywood. Why is it that every single new movie that comes out is basically a more expensive rehash of the exact same 5 movies that have been coming out for the last 50 years? Because big corporations don’t innovate. It’s too risky to try to make a movie that’s fundamentally new and different, because, odds are, that new movie would fail. It’s much safer to make an endless series of superhero movies and keep coming out with yet another movie about a heroic dog. It’s not even that these movies are bad—they’re often pretty good, and when done well (like Avengers) they can be quite enjoyable. But thousands of original screenplays are submitted to Hollywood every year, and virtually none of them are actually made into films. It’s impossible to know what great works of film we might have seen on the big screen if not for the stranglehold of media companies.

This is not how Hollywood began; it started out wildly innovative and new. But did you ever know why it started in Los Angeles and not somewhere else? It was to evade patent laws. Thomas Edison, the greatest patent troll in history, held a stranglehold on motion picture technology on the East Coast, so filmmakers fled to California to get as far away from there as possible, during a time when Federal enforcement was much more lax. The innovation that created Los Angeles as we know it not only was not incentivized by intellectual property protection—it was only possible in its absence.

And then of course there is the third condition, that the benefits be worth the costs—but it’s trivially obvious that this is not the case, since the benefits are in fact basically zero. We divert billions of dollars from consumers to huge corporations, monopolize the world’s ideas, create a system of surveillance and enforcement that makes basically everyone a criminal (I’ll admit it; I have pirated music, software, and most recently the film My Neighbor Totoro, and I often copy video games I own on CD or DVD to digital images so I don’t need the CD or DVD every time to play—which should be fair use but has been enforced as copyright violation). When everyone is a criminal, enforcement becomes capricious, a means of control that can be used and abused by those in power.

Intellectual property even allows corporations to undermine our more basic sense of property ownership—they can prevent us from making use of our own goods as we choose. They can punish us for modifying the software in our computers, our video game systems—or even our cars. They can install software on our computers that compromises our security in order to protect their copyright. This is a point that Boldrin and Levine repeat several times; in place of what we call “intellectual property” (and they call “intellectual monopoly”), they offer a system which would protect our ordinary property rights, our rights to do what we choose with the goods that we purchase—goods that include books, computers, and DVDs.

That brings me to where I think their argument is weakest—their policy proposal. Basically the policy they propose is that we eliminate all intellectual property rights (except trademarks, which they rightly point out are really more about honesty than they are about property—trademark violation typically amounts to fraudulently claiming that your product was made by someone it wasn’t), and then do nothing else. The only property rights would be ordinary property rights, which would know apply in full to products such as books and DVDs. When you buy a DVD, you would have the right to do whatever you please with it, up to and including copying it a hundred times and selling the copies. You bought the DVD, you bought the blank discs, you bought the burner; so (goes their argument), why shouldn’t you be able to do what you want with them?

For patents, I think their argument is basically correct. I’ve tried to make lists of the greatest innovations in science in technology, and virtually none of them were in any way supported by patents. We needn’t go as far back as fire, writing, and the wheel; think about penicillin, the smallpox vaccine, electricity, digital computing, superconductors, lasers, the Internet. Airplanes might seem like they were invented under patent, but in fact the Wright brothers made a relatively small contribution and most of the really important development in aircraft was done by the military. Important medicines are almost always funded by the NIH, while private pharmaceutical companies give us Viagra at best and Vioxx at worst. Private companies have an incentive to skew their trials in various ways, ranging from simply questionable (p-value hacking) to the outright fraudulent (tampering with data). We know they do, because meta-analyses have found clear biases in the literature. The NIH has much less incentive to bias results in this way, and as a result more of the drugs released will be safe and effective. Boldrin and Levine recommend that all drug trials be funded by the NIH instead of drug companies, and I couldn’t agree more. What basis would drug companies have for complaining? We’re giving them something they previously had to pay for. But of course they will complain, because now their drugs will be subject to unbiased scrutiny. Moreover, it undercuts much of the argument for their patent; without the initial cost of large-scale drug trials, it’s harder to see why they need patents to make a profit.

Major innovations have been the product of individuals working out of curiosity, or random chance, or university laboratories, or government research projects; but they are rarely motivated by patents and they are almost never created by corporations. Corporations do invent incremental advancements, but many of these they keep as trade secrets, or go ahead and share, knowing that reverse-engineering takes time and investment. The great innovations of the computer industry (like high-level programming languages, personal computers, Ethernet, USB ports, and windowed operating systems) were all invented before software could be patented—and since then, what have we really gotten? In fact, it can be reasonably argued that patents reduce innovation; most innovations are built on previous innovations, and patents hinder that process of assimilation and synthesis. Patent pools can mitigate this effect, but only for oligopolistic insiders, which almost by definition are less innovative than disruptive outsiders.

And of course, patents on software and biological systems should be invalidated yesterday. If we must have patents, they should be restricted only to entities that cannot self-replicate, which means no animals, no plants, no DNA, nothing alive, no software, and for good measure, no grey goo nanobots. (It also makes sense at a basic level: How can you stop people from copying it, when it can copy itself?)

It’s when we get to copyright that I’m not so convinced. I certainly agree that the current copyright system suffers from deep problems. When your photos can be taken without your permission and turned into works of art but you can’t make a copy of a video game onto your hard drive to play it more conveniently, clearly something is wrong with our copyright system. I also agree that there is something fundamentally problematic about saying that one “owns” a text in such a way that they can decide what others do with it. When you read my work, copies of the information I convey to you are stored inside your brain; do I now own a piece of your brain? If you print out my blog post on a piece of paper and then photocopy it, how can I own something you made with your paper on your printer?

I release all my blog posts under a “by-sa” copyleft, “attribution-share-alike”, which requires that my work be shared without copyright protection and properly attributed to me. You are however free to sell them, modify them, or use them however you like, given those constraints. I think that something like this may be the best system for protecting authors against plagiarism without unduly restricting the rights of readers to copy, modify, and otherwise use the content they buy. Applied to software, the Free Software Foundation basically agrees.

Boldrin and Levine do not, however; they think that even copyleft is too much, because it imposes restrictions upon buyers. They do agree that plagiarism should be illegal (because it is fraudulent), but they disagree with the “share-alike” part, the requirement that content be licensed according to what the author demands. As far as they are concerned, you bought the book, and you can do whatever you damn well please with it. In practice there probably isn’t a whole lot of difference between these two views, since in the absence of copyright there isn’t nearly as much need for copyleft. I don’t really need to require you to impose a free license if you can’t impose any license at all. (When I say “free” I mean libre, not gratis; free as in speech, not as in beerRed Hat Linux is free software you pay for, and Zynga games are horrifically predatory proprietary software you get for free.)

One major difference is that under copyleft we could impose requirements to release information under certain circumstances—I have in mind particularly scientific research papers and associated data. To maximize the availability of knowledge and facilitate peer review, it could be a condition of publication for scientific research that the paper and data be made publicly available under a free license—already this is how research done directly for the government works (at least the stuff that isn’t classified). But under a strict system of physical property only this sort of licensing would be a violation of the publishers’ property rights to do as they please with their servers and hard drives.

But there are legitimate concerns to be had even about simply moving to a copyleft system. I am a fiction author, and I submit books for publication. (This is not hypothetical; I actually do this.) Under the current system, I own the copyright to those books, and if the publisher decides to use them (thus far, only JukePop Serials, a small online publisher, has ever done so), they must secure my permission, presumably by means of a royalty contract. They can’t simply take whatever manuscripts they like and publish them. But if I submitted under a copyleft, they absolutely could. As long as my name were on the cover, they wouldn’t have to pay me a dime. (Charles Darwin certainly didn’t get a dime from Ray Comfort’s edition of The Origin of Species—yes, that is a thing.)

Now the question becomes, would they? There might be a competitive equilbrium where publishers are honest and do in fact pay their authors. If they fail to do so, authors are likely to stop submitting to that publisher once it acquires its shady reputation. If we can reach the equilibrium where authors get paid, that’s almost certainly better than today; the only people I can see it hurting are major publishing houses like Pearson PLC and superstar authors like J.K. Rowling; and even then it wouldn’t hurt them all that much. (Rowling might only be a millionaire instead of a billionaire, and Pearson PLC might see its net income drop from over $500 million to say $10 million.) The average author would most likely benefit, because publishers would have more incentive to invest in their midlist when they can’t crank out hundreds of millions of dollars from their superstars. Books would proliferate at bargain prices, and we could all double the size of our libraries. The net effect on the book market would be to reduce the winner-takes-all effect, which can only be a good thing.

But that isn’t the only possibility. The incentive to steal authors’ work when they submit it could instead create an equilibrium where hardly anyone publishes fiction anymore; and that world is surely worse than the one we live in today. We would want to think about how we can ensure that authors are adequately paid for their work in a copyleft system. Maybe some can make their money from speaking tours and book signings, but I’m not confident that enough can.

I do have one idea, similar to what Thomas Pogge came up with in his “public goods system”, though he primarily intended that to apply to medicine. The basic concept is that there would be a fund, either gathered from donations or supported by taxes, that supports artists. (Actually we already have the National Endowment for the Arts, but it isn’t nearly big enough.) This support would be doled out based on some metric of the artists’ popularity or artistic importance. The details of that are quite tricky, but I think one could arrange some sort of voting system where people use range voting to decide how much to give to each author, musician, painter, or filmmaker. Potentially even research funding could be set this way, with people voting to decide how important they think a particular project is—though I fear that people may be too ignorant to accurately gauge the important of certain lines of research, as when Sarah Palin mocked studies of “fruit flies in Paris”, otherwise known as literally the foundation of modern genetics. Maybe we could vote instead on research goals like “eliminate cancer” and “achieve interstellar travel” and then the scientific community could decide how to allocate funds toward those goals? The details are definitely still fuzzy in my mind.

The general principle, however, would be that if we want to support investment in innovation, we do that—instead of devising this bizarre system of monopoly that gives corporations growing power over our lives. Subsidize investment by subsidizing investment. (I feel similarly about capital taxes; we could incentivize investment in this vague roundabout way by doing nothing to redistribute wealth and hoping that all the arbitrage and speculation somehow translates into real investment… or, you know, we could give tax credits to companies that build factories.) As Boldrin and Levine point out, intellectual property laws were not actually created to protect innovation; they were an outgrowth of the general power of kings and nobles to enforce monopolies on various products during the era of mercantilism. They were weakened to be turned into our current system, not strengthened. They are, in fact, fundamentally mercantilist—and nothing could make that clearer than the TRIPS accord, which literally allows millions of people to die from treatable diseases in order to increase the profits of pharmaceutical companies. Far from being this modern invention that brought upon the scientific revolution, intellectual property is an atavistic policy borne from the age of colonial kings. I think it’s time we try something new.
(Oh, and one last thing: “Piracy”? Really? I can’t believe the linguistic coup it was for copyright holders to declare that people who copy music might as well be slavers and murderers—somehow people went along with this ridiculous terminology. No, there is no such thing as “music piracy” or “software piracy”; there is music copyright violation and software copyright violation.)

Monopoly and Oligopoly

JDN 2457180 EDT 08:49

Welcome to the second installment in my series, “Top 10 Things to Know About Economics.” The first was not all that well-received, because it turns it out it was just too dense with equations (it didn’t help that the equation formatting was a pain.) Fortunately I think I can explain monopoly and oligopoly with far fewer equations—which I will represent as PNG for your convenience.

You probably already know at least in basic terms how a monopoly works: When there is only one seller of a product, that seller can charge higher prices. But did you ever stop and think about why they can charge higher prices—or why they’d want to?

The latter question is not as trivial as it sounds; higher prices don’t necessarily mean higher profits. By the Law of Demand (which, like the Pirate Code, is really more like a guideline), raising the price of a product will result in fewer being sold. There are two countervailing effects: Raising the price raises the profits from selling each item, but reduces the number of items sold. The optimal price, therefore, is the one that balances these two effects, maximizing price times quantity.

A monopoly can actually set this optimal price (provided that they can figure out what it is, of course; but let’s assume they can). They therefore solve this maximization problem for price P(Q) a function of quantity sold, quantity Q, and cost C(Q) a function of quantity produced (which at the optimum is equal to quantity sold; no sense making them if you won’t sell them!):


As you may remember if you’ve studied calculus, the maximum is achieved at the point where the derivative is zero. If you haven’t studied calculus, the basic intuition here is that you move along the curve seeing whether the profits go up or down with each small change, and when you reach the very top—the maximum—you’ll be at a point where you switch from going up to going down, and at that exact point a small change will move neither up nor down. The derivative is really just a fancy term for the slope of the curve at each point; at a maximum this slope changes from positive to negative, and at the exact point it is zero.



This is a general solution, but it’s easier to understand if we use something more specific. As usual, let’s make things simpler by assuming everything is linear; we’ll assume that demand starts at a maximum price of P0 and then decreases at a rate 1/e. This is the demand curve.


Then, we’ll assume that the marginal cost of production C'(Q) is also linear, increasing at a rate 1/n. This is the supply curve.


Now we can graph the supply and demand curves from these equations. But the monopoly doesn’t simply set supply equal to demand; instead, they set supply equal to marginal revenue, which takes into account the fact that selling more items requires lowering the price on all of them. Marginal revenue is this term:


This is strictly less than the actual price, because increasing the quantity sold requires decreasing the price—which means that P'(Q) < 0. They set the quantity by setting marginal revenue equal to marginal cost. Then they set the price by substituting that quantity back into the demand equation.

Thus, the monopoly should set this quantity:


They would then charge this price (substitute back into the demand equation):


On a graph, there are the supply and demand curves, and then below the demand curve, the marginal revenue curve; it’s the intersection of that curve with the supply curve that the monopoly uses to set its quantity, and then it substitutes that quantity into the demand curve to get the price:


Now I’ll show that this is higher than the price in a perfectly competitive market. In a competitive market, competitive companies can’t do anything to change the price, so from their perspective P'(Q) = 0. They can only control the quantity they produce and sell; they keep producing more as long as they receive more money for each one than it cost to produce it. By the Law of Diminishing Returns (again more like a guideline) the cost will increase as they produce more, until finally the last one they sell cost just as much to make as they made from selling it. (Why bother selling that last one, you ask? You’re right; they’d actually sell one less than this, but if we assume that we’re talking about thousands of products sold, one shouldn’t make much difference.)

Price is simply equal to marginal cost:


In our specific linear case that comes out to this quantity:


Therefore, they charge this price (you can substitute into either the supply or demand equations, because in a competitive market supply equals demand):


Subtract the two, and you can see that monopoly price is higher than the competitive price by this amount:


Notice that the monopoly price will always be larger than the competitive price, so long as e > 0 and n > 0, meaning that increasing the quantity sold requires decreasing the price, but increasing the cost of production. A monopoly has an incentive to raise the price higher than the competitive price, but not too much higher—they still want to make sure they sell enough products.

Monopolies introduce deadweight loss, because in order to hold the price up they don’t produce as many products as people actually want. More precisely, each new product produced would add overall value to the economy, but the monopoly stops producing them anyway because it wouldn’t add to their own profits.

One “solution” to this problem is to let the monopoly actually take those profits; they can do this if they price-discriminate, charging a higher price for some customers than others. In the best-case scenario (for them), they charge each customer a price that they are just barely willing to pay, and thus produce until no customer is willing to pay more than the product costs to make. That final product sold also has price equal to marginal cost, so the total quantity sold is the same under competition. It is, in that sense, “efficient”.

What many neoclassical economists seem to forget about price-discriminating monopolies is that they appropriate the entire surplus value of the product—the customers are only just barely willing to buy; they get no surplus value from doing so.

In reality, very few monopolies can price-discriminate that precisely; instead, they put customers into broad categories and then try to optimize the price for each of those categories. Credit ratings, student discounts, veteran discounts, even happy hours are all forms of this categorical price discrimination. If the company cares even a little bit about what sort of customer you are rather than how much money you’re paying, they are price-discriminating.

It’s so ubiquitous I’m actually having trouble finding a good example of a product that doesn’t have categorical price discrimination. I was thinking maybe computers? Nope, student discounts. Cars? No, employee discounts and credit ratings. Refrigerators, maybe? Well, unless there are coupons (coupons price discriminate against people who don’t want to bother clipping them). Certainly not cocktails (happy hour) or haircuts (discrimination by sex, the audacity!); and don’t even get me started on software.

I introduced price-discrimination in the context of monopoly, which is usually how it’s done; but one thing you’ll notice about all the markets I just indicated is that they aren’t monopolies, yet they still exhibit price discrimination. Cars, computers, refrigerators, and software are made under oligopoly, a system in which a handful of companies control the majority of the market. As you might imagine, an oligopoly tends to act somewhere in between a monopoly and a competitive market—but there are some very interesting wrinkles I’ll get to in a moment.

Cocktails and haircuts are sold in a different but still quite interesting system called monopolistic competition; indeed, I’m not convinced that there is any other form of competition in the real world. True perfectly-competitive markets just don’t seem to actually exist. Under monopolistic competition, there are many companies that don’t have much control over price in the overall market, but the products they sell aren’t quite the same—they’re close, but not equivalent. Some barbers are just better at cutting hair, and some bars are more fun than others. More importantly, they aren’t the same for everyone. They have different customer bases, which may overlap but still aren’t the same. You don’t just want a barber who is good, you want one who works close to where you live. You don’t just want a bar that’s fun; you want one that you can stop by after work. Even if you are quite discerning and sensitive to price, you’re not going to drive from Ann Arbor to Cleveland to get your hair cut—it would cost more for the gasoline than the difference. And someone is Cleveland isn’t going to drive all the way to Ann Arbor, either! Hence, barbers in Ann Arbor have something like a monopoly (or oligopoly) over Ann Arbor haircuts, and barbers in Cleveland have something like a monopoly over Cleveland haircuts. That’s monopolistic competition.

Supposedly monopolistic competition drives profits to zero in the long run, but I’ve yet to see this happen in any real market. Maybe the problem is that conceit “the long run”; as Keynes said, “in the long run we are all dead.” Sometimes the argument is made that it has driven real economic profits to zero, because you’ve got to take into account the cost of entry, the normal profit. But of course, that’s extremely difficult to measure, so how do we know whether profits have been driven to normal profit? Moreover, the cost of entry isn’t the same for everyone, so people with lower cost of entry are still going to make real economic profits. This means that the majority of companies are going to still make some real economic profit, and only the ones that had the hardest time entering will actually see their profits driven to zero.

Monopolistic competition is relatively simple. Oligopoly, on the other hand, is fiercely complicated. Why? Because under oligopoly, you actually have to treat human beings as human beings.

What I mean by that is that under perfect competition or even monopolistic competition, the economic incentives are so powerful that people basically have to behave according to the neoclassical rational agent model, or they’re going to go out of business. There is very little room for errors or even altruistic acts, because your profit margin is so tight. In perfect competition, there is literally zero room; in monopolistic competition, the only room for individual behavior is provided by the degree of monopoly, which in most industries is fairly small. One person’s actions are unable to shift the direction of the overall market, so the market as a system has ultimate power.

Under oligopoly, on the other hand, there are a handful of companies, and people know their names. You as a CEO have a reputation with customers—and perhaps more importantly, a reputation with other companies. Individual decision-makers matter, and one person’s decision depends on their prediction of other people’s decision. That means we need game theory.

The simplest case is that of duopoly, where there are only two major companies. Not many industries are like this, but I can think of three: soft drinks (Coke and Pepsi), commercial airliners (Boeing and Airbus), and home-user operating systems (Microsoft and Apple). In all three cases, there is also some monopolistic element, because the products they sell are not exactly the same; but for now let’s ignore that and suppose they are close enough that nobody cares.

Imagine yourself in the position of, say, Boeing: How much should you charge for an airplane?

If Airbus didn’t exist, it’s simple; you’d charge the monopoly price. But since they do exist, the price you charge must depend not only on the conditions of the market, but also what you think Airbus is likely to do—and what they are likely to do depends in turn on what they think you are likely to do.

If you think Airbus is going to charge the monopoly price, what should you do? You could charge the monopoly price as well, which is called collusion. It’s illegal to actually sign a contract with Airbus to charge that price (though this doesn’t seem to stop cable companies or banks—probably has something to do with the fact that we never punish them for doing it), and let’s suppose you as the CEO of Boeing are an honest and law-abiding citizen (I know, it’s pretty fanciful; I’m having trouble keeping a straight face myself) and aren’t going to violate the antitrust laws. You can still engage in tacit collusion, in which you both charge the monopoly price and take your half of the very high monopoly profits.

There’s a temptation not to collude, however, which the airlines who buy your planes are very much hoping you’ll succumb to. Suppose Airbus is selling their A350-100 for $341 million. You could sell the comparable 777-300ER for $330 million and basically collude, or you could cut the price and draw in more buyers. Say you cut it to $250 million; it probably only costs $150 million to make, so you’re still making a profit on each one; but where you sold say 150 planes a year and profited $180 million on each (a total profit of $27 billion), you could instead capture the whole market and sell 300 planes a year and profit $100 million on each (a total profit of $30 billion). That’s a 10% higher profit and $3 billion a year for your shareholders; why wouldn’t you do that?

Well, think about what will happen when Airbus releases next year’s price list. You cut the price to $250 million, so they retaliate by cutting their price to $200 million. Next thing you know, you’re cutting your own price to $150.1 million just to stay in the market, and they’re doing the same. When the dust settles, you still only control half the market, but now you profit a mere $100,000 per airplane, making your total profits a measly $15 million instead of $27 billion—that’s $27,000 million. (I looked it up, and as it turns out, Boeing’s actual gross profit is about $14 billion, so I underestimated the real cost of each airplane—but they’re clearly still colluding.) For a gain of 10% in one year you’ve paid a loss of 99.95% indefinitely. The airlines will be thrilled, and they’ll likely pass on much of those savings to their customers, who will fly more often, engage in more tourism, and improve the economy in tourism-dependent countries like France and Greece, so the world may well be better off. But you as CEO of Boeing don’t care about the world; you care about the shareholders of Boeing—and the shareholders of Boeing just got hosed. Don’t expect to keep your seat in the next election.

But now, suppose you think that Airbus is planning on setting a price of $250 million next year anyway. They should know you’ll retaliate, but maybe their current CEO is retiring next year and doesn’t care what happens to the company after that or something. Or maybe they’re just stupid or reckless. In any case, your sources (which, as an upstanding citizen, obviously wouldn’t include any industrial espionage!) tell you that Airbus is going to charge $250 million next year.

Well, in that case there’s no point in you charging $330 million; you’ll lose the market and look like a sucker. You could drop to $250 million and try to set up a new, lower collusive equilibrium; but really what you want to do is punish them severely for backstabbing you. (After all, human beings are particularly quick to anger when we perceive betrayal. So maybe you’ll charge $200 million and beat them at their own conniving game.

The next year, Airbus has a choice. They could raise back to $341 million and give you another year of big profits to atone for their reckless actions, or they could cut down to $180 million and keep the price war going. You might think that they should continue the war, but that’s short-term thinking; in the long run their best strategy is to atone for their actions and work to restore the collusion. In response, Boeing’s best strategy is to punish them when they break the collusion, but not hold a grudge; if they go back to the high price, Boeing should as well. This very simple strategy is called tit-for-tat, and it is utterly dominant in every simulation we’ve ever tried of this situation, which is technically called an iterated prisoner’s dilemma.

What if there are more than two companies involved? Then things get even more complicated, because now we’re dealing with things like what A’s prediction of what B predicts that C will predict A will do. In general this is a situation we only barely understand, and I think it is a topic that needs considerably more research than it has received.

There is an interesting simple model that actually seems to capture a lot about how oligopolies work, but no one can quite figure out why it works. That model is called Cournot competition. It assumes that companies take prices and fixed and compete by selecting the quantity they produce at each cycle. That’s incredibly bizarre; it seems much more realistic to say that they compete by setting prices. But if you do that, you get Bertrand competition, which requires us to go through that whole game-theory analysis—but now with three, or four, or ten companies!

Under Cournot competition, you decide how much to produce Q1 by monopolizing what’s left over after the other companies have produced their quantities Q2, Q3, and so on. If there are k companies, you optimize under the constraint that (k-1)Q2 has already been produced.

Let’s use our linear models again. Here, the quantity that goes into figuring the price is the total quantity, which is Q1+(k-1)Q2; while the quantity you sell is just Q1. But then, another weird part is that for the marginal cost function we use the whole market—maybe you’re limited by some natural resource, like oil or lithium?

It’s not as important for you to follow along with the algebra, though here you go if you want:


Then the key point is that the situation is symmetric, so Q1 = Q2 = Q3 = Q. Then the total quantity produced, which is what consumers care about, is kQ. That’s what sets the actual price as well.


The two equations to focus on are these ones:


If you plug in k=1, you get a monopoly. If you take the limit as k approaches infinity, you get perfect competition. And in between, you actually get a fairly accurate representation of how the number of companies in an industry affects the price and quantity sold! From some really bizarre assumptions about how competition works! The best explanation I’ve seen of why this might happen is this 1983 paper showing that price competition can behave like Cournot competition if companies have to first commit to producing a certain quantity before naming their prices.

But of course, it doesn’t always give an accurate representation of oligopoly, and for that we’ll probably need a much more sophisticated multiplayer game theory analysis which has yet to be done.

And that, dear readers, is how monopoly and oligopoly raise prices.