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14 November 2006
[Warning: More Boring Economics] Local Monopolies.
So it occurred to me a while ago that the very large marginal increases in popcorn quantity per unit price were indicative of very low variable costs. This would likely have occurred to me quicker if I wasn’t so lazy and actually did my assigned reading for Econ… it was probably in one of the chapters I didn’t read. (Or in Grad School, one of the chapters in the textbook I never bought.) I got an A. So there. Anyways, this is probably in someone’s textbook. But, once again, I’d rather write than research. So maybe it is a new idea. If you find out, please email me because I don’t know.
Prior to Behavioral Economics, Economics relied heavily upon assumptions about a perfect market. This included things like ‘perfect competition,’ ‘no barriers to entry,’ ‘infinite firms,’ lots of stuff that never happens. So then, a few chapters later in the textbook, you get to the chapter on monopolies. Cool. Problem is the origins of the monopoly is never really explained. It’s assumed to be something like Standard Oil or Bell Telephones, where one guy either vertically or horizontally bought everything. Then, because they price everyone else out of the market, or because they are mean and use dirty politicians, or something like that, they stay the only firm in the market. So this is cool and all if you are looking at a product on a national level. We start running into problems, though, as we decrease our level of analysis.
Some products exist competitively on the macroscopic level, yet at the lowest level, they exist in monopolies. This can be ascribed to a breakdown in the assumptions, mostly the infinite firms part. So we can call this resolution problems. But we don’t have to. There is a remarkably interesting subset of firms which take advantage of the failure of these assumptions, in fact intentionally cause these assumptions to fail, in order to operate. They actually create a monopoly in a local area, attract people to that area, and then they use the monopoly profits to maintain the attraction of the area. Crazy, huh? Let’s explore this.
P v. Q. (or Why zero ounces of a Frappuccino costs you $2.40) So there are fixed costs and variable costs. Econ 101 and all. In a totally competitive market, these are going to be put together into the magical Adam Smith price making machine and spit out an equilibrium price and quantity. These are going to be rolled into the unit cost. So we should still expect that our individual price is going to rise in direct correlation to the amount of the good consumed. Stated simpler, if we buy two gallons of gas, we should expect to pay twice as much as one gallon of gas. Straight lining this back to the origin, zero gallons of gas costs us zero dollars. This checks with common sense.
Here’s the weird thing, though. Movie Theater Popcorn. Costs like $6 for a small, and $7 for a large that is twice as big. So if you straight line the curve back to the origin, you find out that no popcorn costs you $5. Obviously, nobody is holding a gun to your head telling you to buy no popcorn for five bucks, and nobody is stupid enough (except in the fashion and art world) to pay a bunch of money for a lot of nothing. We can chalk this up to the fact that there is a monopoly in the theater, and they can just get away with screwing you over. Charge at MC=D. Too bad for you. But you have to deal with it if you want popcorn while watching the movie, and disgustingly we associate popcorn with movie watching. So people pay $7 for a lot of $.00025 popcorn.
That isn’t super surprising. But now let‘s look at coffee shops. We’ll use Starbucks, just to get on the nerves of all the people who have ‘I’m such a non-conformist just like all the other ones’ Starbucks angst. So a big Frappuccino costs, like, $4.40. One half the size costs $3.40. So a zero ounce Frappuccino costs $2.40. Which sort of doesn’t make sense. I mean, the movie theater was about movies. If you want to have popcorn with your movie, they get to screw monopoly profits out of you. But a gas station only sells gas, and zero gallons of gas costs zero bucks, and they’re not even pretending to be a competitive market. A coffee shop sells coffee, so zero coffee should cost zero bucks, like the gas. Unless, of course, they’re not just selling coffee.
Local Monopolies. How’s this for a thought experiment. Imagine your favorite coffeeshop. (Note that all the ‘we’re so anti-corporate’ coffeeshops do the same exact corporate pricing strategy. Poseurs.) Imagine instead of having one counter serving coffee, now they have two counters serving coffee, each owned by different firms. Over time, barring collusion, they bid against each other until they reach an equilibrium price. No more zero ounce drinks costing $2.40. The true economic cost of the drinks (with a perfect pricing strategy) can be found by taking the same slope of the P v. Q line and moving it down so it starts at the origin. If there were two firms bidding against each other, then they would drive each other down to the actual cost of the coffee. New price structure is $1.00 for a small and $2.00 for a large twice as big (using the real prices previously cited. I read them right off the menu.) So both firms would cover their fixed and variable costs, K and L and all that, and would return normal profit at the equilibrium price for coffee. Here’s the problem, though. Nice couches, pretty pictures on the walls and nice, seasonal music aren’t factors of production for coffee. So at the equilibrium price for coffee, neither of the two firms (barring collusion) would be able to pay for new seasonal décor, or even for the couches to start with. And it seems as if it is the mood and the conversation that draws people in. So with perfect microscopic competition, the coffee shop never gets off the ground. Oops. So we aren’t just selling coffee.
Starbucks is making monopoly profits, but only inside of the premises of the Starbucks. (Drive thrus being an afterthought, after the role of the coffee shop is established.) There can even be a coffee shop next door, and Starbucks will still make monopoly profits inside of its doors. So you can have a macroscopically competitive climate where monopolies (and hence monopoly profits) exist on the microscopic level. We’ll call these ‘local monopolies.’ Since we probably need a definition, let’s try ‘an area within a macroscopically competitive market where a single firm is the sole supplier due to practical, social or formal barriers to entry.’
There are two subsets of local monopolies. The first, explicit access cost firm, is the least interesting. This is the movie theater and the theme park. You enter into the local monopoly’s zone of influence by purchasing admission for a service. During the service, you have to pay monopoly profits to the providers of the service who are the owners of the zone of influence. Of course you have to pay a lot for food at Six Flags, cause you cant bring in food, and it isn’t worth leaving and driving an hour to save $5 on food when you’re paying $50 to be there all day. The more interesting type is the implicit access cost firm. This is the coffee shop, the bar and the dance club (sometimes.) You enter into the local monopoly’s zone of influence in order to enjoy a service theoretically offered freely. In order to recoup the environmental creation costs, the implicit firm hides the costs in the good it offers.
Dynamics of Implicit Monopolies. In order to make an implicit local monopoly out of the ether, we have to mix together a few elements. Attraction + Association + Barriers = Implicit Local Monopoly. Attraction: there has to be something that attracts consumers to the local monopoly’s zone of control. Otherwise, nobody shows up. This is generally theoretically free things, like conversation or atmosphere. Association: the good offered by the local monopoly has to be associated with the attraction. If Starbucks sold folded newspaper hats instead of coffee, they would go out of business, unless we felt as if we couldn’t have a good conversation without each person wearing today’s paper on their head. Fortunately for them, coffee is associated with the total enjoyment of a coffeehouse. Barriers: If it wasn’t weird to bring in coffee from another vendor when sitting at Starbucks, I’d suggest a start-up set up booths selling coffee right outside the doors of Starbucks, selling gourmet Frappa-milkshakes a dollar cheaper than the Starbucks brand. Of course, this would be seen as pretty lame. So there are implicit barriers to entry for the local monopoly. The local monopoly then attaches access costs to the good. In effect, they hide the charge for admission to the environment in the cost of the good.
So we put all of these things together, and we find a local monopoly. Inside the zone of control, Starbucks has a monopoly, and they get to pocket monopoly profits from all the people they can draw into that zone. Of course, creating the attractor, in the case of Starbucks, creating the environment, costs money. So there is something working against the monopoly profits. Just as coffee production costs impact the slope of the pricing structure, the environmental creation cost () must be less than the monopoly profits of the local monopoly, or it would be foolish to start up the firm. Once created, though, the firm would continue to produce to the monopoly shutdown point. (Monopoly shutdown point is where the monopoly can no longer cover its costs even producing at any price. This is the point where the demand curve is tangent to the downwardly sloping region of ATC. The theoretical minimum shutdown point requires zero elasticity of demand, and is at the minimum point on the ATC curve, or where ATC=MC.) Using the price structure graph, the monopoly profits can be restated as the access costs (price offset off of the origin for Q=0) multiplied by the aggregate quantity. Either way, >= for the local monopoly.
Let’s revisit our assumption of a macroscopically competitive market. Let’s say our town has infinite identical coffee shops, all of which have access to the same interior decorator and DJ, who charges the exact same for creating the mood in each coffee shop. The existence of macroscopic competition will not eliminate local monopolies. Instead, the competition will drive the economic profits into equilibrium with the environmental creation costs (=.) In effect, the sale of the coffee (or the facilitative good) implicitly represents two markets in one market interaction. Accordingly, macroscopic competition will create equilibria in both markets, which will then be represented in the agglutinated (both markets at once) price of the good. The access costs will equal environmental creation costs, and supply will reach an equilibrium with demand for the good of the coffee (or whatever.) There is still a resolution complication: both the good and the access cost exist in somewhat distinct markets, if the facilitative good were not linking them. Access is typically sold something along the lines of one admissions ticket per person. Coffee is sold in accordance with how much you can drink. Bundling these two distinct quantities in one good does create a certain amount of resolution problems. In effect, people ordering coffee through the drive-thru are unknowingly subsidizing my sitting here and typing on my computer on a somewhat comfortable couch. Too bad for them. That’s why I don’t buy Starbucks coffee from drive-thrus.
Conclusion. The local monopoly in effect captures or creates an attractive environment, either in physical space, cultural space, or informational space, and sells access. Microscopic monopolies allows the local monopoly to recoup environmental creation costs. Implicit local monopolies accomplish this through selling a facilitative good. This is not solely an informational or stylistic good, but a hybrid good. The good may in fact fill a need, or at least enhance the experience of the attractive environment. Macroscopic competition will drive the access market and the good market to an equilibrium. Yet, in the case of the implicit local monopoly, the macroscopic equilibrium mechanism requires that firms retain the ability to capture local monopoly profits. So Starbucks is a monopoly. And it is a firm in a competitive market. All at once. Weird, huh?
This applies to more than just coffee. The hybrid good idea (bundled good? Sounds like a word I learned once. Maybe this is what they were talking about in class. Probably should have read that chapter rather than written this paper.) can be applied to anything where social additives are mixed with goods. Consider fashion. Fashion exists in cultural space, and idea space, rather than physical space. When someone buys Diesel jeans (and is not cheap and weasel-like like me, who buys them from Indonesia off of eBay. I know they’re fake. They wear just as well, and I like them.) they’re buying exclusivity and looking cool and whatever else. They are entering a zone of attraction and control created by Diesel’s advertising to buy from their local monopoly on jeans. So product differentiation in a monopolistic competition environment is the same thing as a local monopoly in physical space. The costs incurred in the differentiation and bundling of the good with the ether-good (coolness or whatever) need to be recompensed by the local (in info-space) monopoly profits of the firm. So it is the same thing still, the image is the access cost. And now we can bundle and market fuzzy sociological things by attaching them to goods. Which goes to class differentiation in a market society, which of course always happens. As the economy becomes better at packaging such things, the trappings of wealth (conspicuous consumption) becomes more important, and actual physical capital becomes less so. This is kind of weird, given Marx’s materialistic bias (which would seem to emphasize the importance of physical capital amongst the wealthy) and his ideas on class consciousness (which it seems are supported by increased conspicuous consumption.) Talking about this more would probably make me look stupid, and more importantly to you, make this boring paper even longer. So I’ll stop (mostly.)
It seems that we are marketing things that (in the past that never was) were a natural part of a free society (De Tocqueville, Putnam, etc.) I don’t know whether this is dangerous or not. People used to talk at the Rotary club, and now they pay Starbucks so they can talk. Of course, the Rotary club demanded membership dues. And people talked while bowling (as Putnam cites) and that has an explicit access cost (along with overpriced and unpleasant fried food.) These seem like sociological questions, and I’m an amateur pretend economist, not a sociologist. So I’ll stick to analyzing the effectiveness of means instead of the worth of ends. At least in this paper. See ‘ya next time, kids.
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