Airlines, oil companies, and the free market

[jimtron]

How much should the U.S. gubmint regulate the airlines and oil companies? Is it hypocritical for Americans who sing the praises of free market capitalism, and bristle at the idea of anything remotely resembling socialism, to complain about high gas prices? Shouldn't oil companies be free to make as much profit as they like, and set prices at whatever the market will bear?

Should the government bail out ailing airlines (hey, I'm going to start a new company--Ailing Airlines!)? Again I wonder about free market capitalism. If the airlines restrict how many bags you can check in, and overbook flights, and often have significant delays--should the government step in and regulate? Can't consumers simply not choose to do business with airlines they don't like?

Also, it bugs me that some airlines complain that their costs are steep and competition fierce, so it's difficult to make profit, or even break even. That's how business is--it's a challenge, and if it doesn't work then you need to try something else. Or should we have the government run the airlines?

Libertarians, what do you think? Republicans, Dems? These are sincere, not rhetorical questions; I'm interested to hear what you all think.

[Francesca R]

Airlines are very highly regulated in what they do. And there are more of them (airline companies) than there would be if they were not. Restrictions on take-off/landing slots are highly pervasive in the industry. Several airlines are effectively nationalised flag-carriers.

Oil is less so (apart from the matter of exploration and drilling rights . . . which is as corrupt as the governments making the decisions are)

Libertarianism, OTOH, is a rather unrelated idea :)

[egslim]

Also, it bugs me that some airlines complain that their costs are steep and competition fierce, so it's difficult to make profit, or even break even. That's how business is--it's a challenge, and if it doesn't work then you need to try something else. Or should we have the government run the airlines?
Unless oil prices drop airline tickets will become ever more expensive, which means their market reduces in size.

Lower margins + fewer customers = fewer viable airlines. Their number will probably fall significantly, for the next 20 years. I don't blame them for complaining, but very little can be done about the fundamentals.

On the other hand, a case can be made that the aircraft industry is important to national security. From that perspective government intervention might serve the public interest. Though I would want to focus on more fuel-efficient aircraft, instead of cheaper fuel.

[jimtron]

Airlines are very highly regulated in what they do. And there are more of them (airline companies) than there would be if they were not. Restrictions on take-off/landing slots are highly pervasive in the industry. Several airlines are effectively nationalised flag-carriers.

Oil is less so (apart from the matter of exploration and drilling rights . . . which is as corrupt as the governments making the decisions are)

Libertarianism, OTOH, is a rather unrelated idea :)

Aren't Libertarians for the most part against the government regulating businesses, or do I have a mistaken impression?

Should oil companies be allowed to make as much profit as they like, and charge whatever they like, or should the government limit these things--in your view?

[jimtron]

Unless oil prices drop airline tickets will become ever more expensive, which means their market reduces in size.

Lower margins + fewer customers = fewer viable airlines. Their number will probably fall significantly, for the next 20 years. I don't blame them for complaining, but very little can be done about the fundamentals.

On the other hand, a case can be made that the aircraft industry is important to national security. From that perspective government intervention might serve the public interest. Though I would want to focus on more fuel-efficient aircraft, instead of cheaper fuel.

So you are for government regulation when it comes to the airlines? What about the oil companies--should the government limit their profits and/or regulate their pricing?

[egslim]

So you are for government regulation when it comes to the airlines? What about the oil companies--should the government limit their profits and/or regulate their pricing?
The issue has both a business and a military-strategic perspective. The free market tends to be fairly good for the former and lousy for the latter.

For the airlines I oppose any government intervention on fuel costs, because that would merely distort an inevitable long term trend. I'm fine with the free market killing off a few of the weakest airlines, that only improves the industry's overall health. As long as 1) a sufficient number of airlines continues to exist to provide competition between them, and b) the aircraft industry (R&D, construction and operation) remains as a strategic asset.

Unless there is evidence that the oil industry drives up prices as a cartel I want the government to stay away from oil prices and profits.

[bobrayner]

Unless oil prices drop airline tickets will become ever more expensive, which means their market reduces in size.

I think you've missed out the possibility of external influences affecting the size of the market; for instance an increase in wealth or an improvement in technology.

Airlines handle far more passenger-km now than they did twenty years ago, despite much higher fuel prices. Why? Because airplanes (and other parts of the system) have got better, and the public have got richer, and because protectionist barriers have been removed (see below). Are you sure these influences won't continue in future?

On the other hand, a case can be made that the aircraft industry is important to national security. From that perspective government intervention might serve the public interest. Though I would want to focus on more fuel-efficient aircraft, instead of cheaper fuel.

There have been many attempts at making this case. There is little basis for it, but economic nationalism is always tempting. This has given us scores of mollycoddled "flag carriers" who waste taxpayers' money and who can scarcely survive in an open market.

Thankfully, the tide's been going the other way recently, so services are increasingly operated by the airline that does it best rather than the airline with the right flag painted on the tail. This means better services and less waste.

[egslim]

I think you've missed out the possibility of external influences affecting the size of the market; for instance an increase in wealth or an improvement in technology.
It all depends on oil prices. In developed countries technological advancements increase wealth per capita by about 2% per year - long term average. If the price of oil rises sufficiently fast then that increase in wealth is inflated away by more expensive oil derivatives.

While modern aircraft are more fuel efficient than older designs, that is a gradual improvement which currently doesn't even keep pace with rising oil prices. As for other major improvements in aircrafttechnology, I don't count on it for massive adoption in the next 20 years. Face it, a new aircraft takes over 10 years to develop and has a slow rate of production - it takes several decades to replace the entire fleet. Thus massive adoption of a revolutionary technology to save fuel within 20 years is a pipedream.

Airlines handle far more passenger-km now than they did twenty years ago, despite much higher fuel prices.
The problem is that fuel prices now make up a much larger percentage of operating costs than 20 years ago. Which in regards to oil prices is true for the economy in general. So further increases become ever more painful, since there are fewer non-oil related costs where fat can be trimmed. Assuming there is much fat left.

There is little basis for it
That's a pretty dumb remark. A modern airforce needs transport planes, AWACS and aerial refueling planes. All those are more or less modified civilian airliners, bought from the commercial market. Without a national aircraft industry that makes you dependent on foreign companies, which means you're screwed if you ever get into conflict with said foreign country. (Ask the Argentines about the aircraft carrier catapults sent to Britain for revision during the Falklands war.)

A national aircraft industry provides the Civil Reserve Air Fleet and an emergency reservoir of aircraft construction capability, pilots and other facilities.

services are increasingly operated by the airline that does it best rather than the airline with the right flag painted on the tail. This means better services and less waste.
As I said before, there is both a business and a military-strategic perspective to this issue. You focus on the former, while entirely ignoring the latter.

Business prowess has zero meaning unless you, or allies of yours, have the capability to defend it against hostile military threats.

[Francesca R]

Aren't Libertarians for the most part against the government regulating businesses, or do I have a mistaken impression?Ask a libertarian :)

Should oil companies be allowed to make as much profit as they like, and charge whatever they like, or should the government limit these things--in your view?Oil resources originate largely under the ownership of sovereign states, who then sometimes sell them but then sometimes change their minds, confiscate them, blow them up, decide who has access for political reasons or whatever.

It is rather far from today's starting point to talk about whether "the government" (there are many) should limit profit or not. That is not exactly the main story with energy.

[jimtron]

It is rather far from today's starting point to talk about whether "the government" (there are many) should limit profit or not. That is not exactly the main story with energy.

Main story or not, that's what this thread is about. Francesca, do you have an opinion on whether oil companies should be able to charge whatever they like, and make as much profit as they like--or should the government step in?

posts 2 and 9:

Libertarianism, OTOH, is a rather unrelated idea :)
Ask a libertarian :)

Francesca, if Libertarianism is an unrelated idea, please tell me what it is related to.

[Francesca R]

Main story or not, that's what this thread is about. Francesca, do you have an opinion on whether oil companies should be able to charge whatever they like, and make as much profit as they like--or should the government step in?


No, seriously I think that--although this question is being asked--it is the wrong one.

Sure companies should be allowed to pursue profits as long as the rules of capitalism are obeyed (protected rights, legally binding contracts, no thugs, no monopolies, enforcement against externalities . . . .)

But with oil, I think a better question is "Shouldn't governments step out and stop committing atrocities in the interest of securing energy supply, and let profit-maximising capital markets do at least a bit of the resource allocation?"

By the way--Neither OPEC nor "Big Oil" companies fulfil the required criteria of a cartel IMO.

[jimtron]

No, seriously I think that--although this question is being asked--it is the wrong one.

Sure companies should be allowed to pursue profits as long as the rules of capitalism are obeyed (protected rights, legally binding contracts, no thugs, no monopolies, enforcement against externalities . . . .)

But with oil, I think a better question is "Shouldn't governments step out and stop committing atrocities in the interest of securing energy supply, and let profit-maximising capital markets do at least a bit of the resource allocation?"

By the way--Neither OPEC nor "Big Oil" companies fulfil the required criteria of a cartel IMO.

Would you mind elaborating on what you mean by atrocities, and also what you mean by letting the markets do a bit of resource allocation? I'm not sure what you mean.

[JoeEllison]

Since there's no such thing as a "free market", anything based on that idea is only correct by accident. "Free market capitalism" isn't designed to create or encourage healthy nations or even healthy economies, it is designed to exploit every situation for maximum profits and minimum benefit to others.

[JoeEllison]

Can't vouch for the accuracy of this, but it falls right in line with general facts about executive compensation versus worker pay and overall profits:

http://financialservices.house.gov/pdf/HR1257AFACWALetter.pdf

United Airlines CEO Glenn Tilton received $39.7 million in 2006, including salary, bonus, incentives,
perks, above-market returns on deferred compensation and the estimated value of stock options and
awards granted during the year. At the same time, United Flight Attendants continue to experience lifechanging
wage, healthcare and work rule concessions, along with termination of their pension plan.
Incredibly, Tilton’s 2006 compensation exceeded the airline’s entire annual profit of $25 million reported
by United’s parent company UAL, Inc (UAL).

[davefoc]

...What about the oil companies--should the government limit their profits and/or regulate their pricing?

Oil companies should be allowed to make as much money as they can if the government makes the best deal possible for the drilling rights on public land. Although it would probably be politically impossible in the US I think that private ownership of mineral rights should be given a rethink.

Right now, I suspect that US makes less money from the fossil fuels retrieved from public lands than any other country in the world. This seems like a bad idea to me.

Some of the justification for this was that it was a way to reduce average fuel prices in the US. It probably did significantly reduce fuel costs in the US when the US was the principal supplier of US consumed fossil fuels and when the US fossil fuel consumption was the dominant component of fossil fuel consumption in the world.

The fact that the US produces a lot of its own oil probably still does mitigate high oil prices for US consumers but the current system results in a massive loss of revenue to the average American because his government is not very good at getting a good return for him from the oil in the ground.

[davefoc]

Since there's no such thing as a "free market", anything based on that idea is only correct by accident. "Free market capitalism" isn't designed to create or encourage healthy nations or even healthy economies, it is designed to exploit every situation for maximum profits and minimum benefit to others.

I agree with this but I think we would disagree about the particulars of what you said.

If free market capitalism has a mechanism for ensuring that third parties aren't screwed it works very well in a wide variety of situations and a lot of the "fixes" for it have serious unintended consequences that are almost always overlooked by advocates of various schemes to interfere with a free market.

As population density increases the consequences to third parties from operating various enterprises can be very harmful. Unfortunately corporations routinely attempt to bribe congress to avoid having to constrain their activities that harm third parties or to keep from having to reimburse third parties for the damage they cause. The good news is that there seems to be enough integrity in congress that third party interests are protected to some degree at least.

My sense of it is that protecting third party interests is a low priority issue for Republican legislators and their strong connection with business interests make it such that if the country went through a long period of Republican rule only third party interests would be savaged.

From my perspective, promoting free markets and promoting business interests are not necessarily the same and often times the Republican position is pro-business but not pro-free market.

[van_dutch]

Since there's no such thing as a "free market", anything based on that idea is only correct by accident. "Free market capitalism" isn't designed to create or encourage healthy nations or even healthy economies, it is designed to exploit every situation for maximum profits and minimum benefit to others.

Out of curiosity, do you have any background in economics? I will admit that there is no perfectly free market (ie perfect information and perfect competition), but there are markets that are generally regarded as free. The free market is not designed for anything. The term free market is used to denote a group of conditions that we use to examine how the transfer and consumption of goods and services is carried out. The ideal free market equilibrium point maximizes producer and consumer surpluses, a benefit to all. Now there are some deviations from this point as there is not always perfect competition and information as well as issues like externalities.

Now the oil and flights behave a bit differently in terms of market analysis as they are relatively inelastic goods. In other words, people need them and are generally not going to change consumption drastically unless there are large price changes. This, however, doesn't mean that the oil and airline companies will jack up their prices on purpose. First, neither of these industries has a monopoly. There are enough suppliers of both goods that excessive pricing in each will cause others to step in and sell at a lower price, one of the beauties of the free market. There is some issues with the fact that majority of the oil is concentrated in the Middle East but that is because it is not yet economically viable to extract oil from new, untapped fields. As oil becomes more scarce, it will make more sense to explore and tap new fields in the Arctic etc.

Back to the original question. The government should be involved so that the consumer is not being gouged. That being said, I don't feel that we are. It's not as if the oil and airline companies are jacking up prices for the hell of it. The airline companies are responding mostly to the price of fuel. The oil companies are struggling with the increasing global demand and decreasing quantity of economically viable amounts of a non-renewable good.

And for all those wondering, I have a background in economics (a minor) and have taken natural resource economics (where the topic of oil and energy was covered).

[jimtron]

Back to the original question. The government should be involved so that the consumer is not being gouged. That being said, I don't feel that we are. It's not as if the oil and airline companies are jacking up prices for the hell of it. The airline companies are responding mostly to the price of fuel. The oil companies are struggling with the increasing global demand and decreasing quantity of economically viable amounts of a non-renewable good.

What would be gouging--could you cite a real life or hypothetical example?

I agree it's not gouging--in my view it's a natural consequence of capitalism. But it bugs me that many people who are presumably pro- "free market" (or whatever it is that we have in the U.S.) and don't like government limiting profits or necessarily regulating prices, want the government to do something about this.

[van_dutch]

What would be gouging--could you cite a real life or hypothetical example?[/QUOTE]

It is similar to war profiteering - purposefully charging more for metal because you know it is necessary for the building of tanks and cannot be done without. That is the official and legal use. It is a felony in the US and has to do with charging more than a "fair" price in emergency situations.

Basically, I take it as charging more because you know the consumer will pay it regardless of what your cost is. I believe the oil producers have been clear as to why price is increasing. IMHO, price has tracked reasonably with cost. The whole economy in the US is pretty bad (almost in a bear market) resulting in a weak dollar meaning you have to pay more for the same amount of oil.

The Supermajors (the 6 non state owned oil companies ie ExxonMobil, Royal Dutch Shell etc) as well as OPEC are responding to increased risk and uncertainty associated with a weak dollar (what oil is traded in) as well as political strife. In terms of OPEC, a weak dollar results in lower revenue due to the poor exchange rate (those with say the Euro spend less on oil as that currency is strong). The lower revenue results in lower purchasing power and reduces production. The large independent oil companies have to worry about current oil fields that may not be accessible due to weather (ie Katrina which destroyed much oil production in the Gulf of Mexico) or political strife (ie Nigeria, Iraq, and Iran). These large companies are also spending vast sums of money exploring new oil fields as the future production levels from the current ones are uncertain due to the above reasons. Oil price is high but it isn't like big oil and OPEC are trying to stick it to the little guy so they can make a couple extra bucks. There are many factors at work here.

[jimtron]

Basically, I take it as charging more because you know the consumer will pay it regardless of what your cost is.

That's not illegal. In the U.S., can't a business charge whatever they like, and the idea of capitalism is that the consumer will decide to buy or not? There are no laws against extremely high markups, AFAIK.

IMHO, price has tracked reasonably with cost. The whole economy in the US is pretty bad (almost in a bear market) resulting in a weak dollar meaning you have to pay more for the same amount of oil.

Should there be any limit to what they can charge, or what they can make in profit? If so, where should that line be drawn?

[van_dutch]

Back to this free market is a load of crap idea, I have two thoughts.

First, if free markets are a complete lie, I guess that much of the science of economics is just a coincidence. In other words, the hundred or so years that people have been analyzing the markets is completely unfounded and we should throw out all that the current system is based on. There are some issues with implementing a perfectly free market, but that doesn't mean the current analysis and system is complete garbage. Did you ever wonder why the USSR didn't work out? While there are many factors contributing to its demise, the economy was crap and everyone suffered.

Second thought is about market failures and government actions. Government action may be needed for companies to internalize externalities, but there are also mechanisms in the free market to make that happen. Government action is generally needed in terms of public goods (goods that are nonrival in consumption and not excludable or at least have a very high exclusion cost). Oil is definitely exludable. It is easy not to sell to someone. Oil is also rival in consumption. If I buy a gallon of oil, you cannot buy that gallon. In other words, my consumption directly affects your consumption. These are two features that public goods do not have. Thus, oil is a private good and should be dealt with in a market scenario to be allocated as such. There is a whole discussion as to the optimal allocation which is more geared towards the inequality that JoeEllison got at with the maximize profit for yourself and minimize benefit to others, namely positive or normative economics.

[van_dutch]

That's not illegal. In the U.S., can't a business charge whatever they like, and the idea of capitalism is that the consumer will decide to buy or not? There are no laws against extremely high markups, AFAIK.



Should there be any limit to what they can charge, or what they can make in profit? If so, where should that line be drawn?

The FTC (Federal Trade Commission) is designed to protect the consumer and insure fair competition. They investigate these allegations. Collusion, price fixing and predatory pricing are just some of the things the FTC looks at. They investigated the big oil companies for fixing gas prices in 2006 (http://www.ftc.gov/opa/2006/05/katrinagasprices.shtm). The government is there, investigating these companies.

[jimtron]

Back to this free market is a load of crap idea, I have two thoughts.I don't think anyone said it was a load of crap; I believe the argument is that we don't truly have a free market, as we subsidize farms and airlines and other corporations--the government does intervene to affect pricing, etc.

Government action is generally needed in terms of public goods (goods that are nonrival in consumption and not excludable or at least have a very high exclusion cost).We could argue about whether or not that's a good idea, but either way, it's evidence that we don't have a truly free market. If we did, the government wouldn't take action that affected prices.

The FTC (Federal Trade Commission) is designed to protect the consumer and insure fair competition. They investigate these allegations. Collusion, price fixing and predatory pricing are just some of the things the FTC looks at. They investigated the big oil companies for fixing gas prices in 2006 (http://www.ftc.gov/opa/2006/05/katrinagasprices.shtm). The government is there, investigating these companies.I'm not talking about breaking the law. AFAIK, the oil companies currently are not breaking the law (that we know of), yet many people are complaining that they shouldn't charge so much for gas while making huge profits. My question is--as long as a business doesn't break the law, should they be able to charge whatever price they like, and make as large a profit with as large a markup as they like, or should the government ever be allowed to limit that?

[van_dutch]

Ok, so no one directly said that it was crap, but that is what the message came across as JoeEllison said. I may have interpreted it a little too harshly but the point he was trying to make (correct me if I am wrong) was that the free market system doesn't work.

There are some flaws with a free market and it is necessary for government to step in ie monopolies, certain externalities, public goods and a few others along those lines. The only way a market can be truly free is with perfect information and perfect competition. This is essentially impossible but is useful for a foundation of study.

The point about public goods is that those are an example of extreme government intervention into the free market system to try to fix some of the flaws. Is there government involvement in the oil and airline industries? Yes. That doesn't mean it isn't a free market. The government is not forcing a price generally. They are there watching out for the consumer to make sure that he/she isn't taken advantage of. This is still a free market. It is allowed to run its course, within reason. Now for most things, we have, in the US, a generally free market economy call it a mixed market economy. Just because there are some situations where the government gets involved doesn't mean that they are controlling it.

Think of the government as a guiding force. They try to keep things fair and balanced (not ripping off Fox here). They try to guide the economy in an upwards direction. More money in general means more gets spread around. The may push and nudge the economy here and there but they are using the natural system (free market economy) to get it done.

The point of the public good was to show the difference between a free market and a not free market. In the not free market, the government controls everything. They set the price and quantity. In a free market, the producers and consumers reach an equilibrium point on their own. It just kind of works out that way. The government can take action to make sure the market stays free ie examining mergers, watching out for consumers. The market is still generally free. The law of supply and demand still generally applies. So the government steps in now and again, as is necessary, it is still a generally free market.

If you don't break the law then there is no stopping you from doing anything. The government uses laws to govern and if one isn't broken, they have no legal reason to stop someone from doing something. There is some logrolling in both directions to get certain actions and goals achieved. If there is a situation where the government should be involved to fix a problem with a free market economy, then it should be policy or law and enumerated specifically what should happen otherwise the government should stay out of it. Just because people are crying about having to pay too much doesn't mean anything is wrong (there are some situations where there should be some consideration given ie having to pay for food or gas). Generally Americans want it cheap and fast and if it isn't that way we complain.

Oil companies make huge profits because they are huge. Of the roughly $400 billion in revenue that ExxonMobil had, they had a net income of roughly $40 billion (from wikipedia). Now that doesn't seem like that much. Especially since they have the stockholders to answer to. What do the stockholders want to see? Profit! Who is going to invest in a company if they don't make any money?

[Sefarst]

My question is--as long as a business doesn't break the law, should they be able to charge whatever price they like,

Yes.

and make as large a profit with as large a markup as they like,

Yes.

or should the government ever be allowed to limit that?
If they did, it would become illegal for businesses to do the aforementioned things.

But let's think about this for a second. In order for the government to limit profits, it would require, essentially for the government to limit price. Profit = Revenue - Costs. Costs of oil companies are beyond the scope of the government--something they can't really effect. The only way then to limit profit then is to tinker with revenue. Revenue = Price x Quantity. The political problem is that oil is too expensive. This leaves us with the possible solutions of the government simply restricting price or the government to impose quantity parameters for the oil companies. One way or the other, this forces the government to impose a price ceiling on the industry, below the market equilibrium price, leading to shortages. See the 1970s for more information.

[Jaggy Bunnet]

Costs of oil companies are beyond the scope of the government--something they can't really effect.

Isn't taxation a cost? Government clearly could (although whether they should is a different matter) change the tax system to increase the costs of oil companies.

[geni]

Easyjet and ryanair cannot operate in the US. After that any further goverment involvement is just minor details

[van_dutch]

Isn't taxation a cost? Government clearly could (although whether they should is a different matter) change the tax system to increase the costs of oil companies.

Taxation is not part of cost. Taxation is taxation. The added burden of taxation can be felt by the producers and/or the consumers. It is difficult to say which as there are many factors involved but generally an increase in taxes reduces the consume and producer surpluses, even if the allocation of the good is not optimal. This can change due to the type of tax but generally speaking, taxes are not a good way to change things. What benefit would there be to increasing cost to the oil companies anyways? It would ultimately result in an increase in price, the very thing that people are complaining about.

[Sefarst]

Isn't taxation a cost? Government clearly could (although whether they should is a different matter) change the tax system to increase the costs of oil companies.
You are right in the sense that taxation effects prices, but it cannot be used in any effective way as a price control. If the government levies a tax on profits, that tax is simply passed onto the consumer in the form of higher prices, defeating the original purpose. If the government lowers taxes to try and encourage firms to lower prices, firms will simply recapture the difference (as is the issue with the debate over suspending the gas tax until Labor Day that McCain and Clinton supported but so many economists opposed).

[davefoc]

You are right in the sense that taxation effects prices, but it cannot be used in any effective way as a price control. If the government levies a tax on profits, that tax is simply passed onto the consumer in the form of higher prices, defeating the original purpose. If the government lowers taxes to try and encourage firms to lower prices, firms will simply recapture the difference (as is the issue with the debate over suspending the gas tax until Labor Day that McCain and Clinton supported but so many economists opposed).

This is not quite true I think. It depends on the nature of the market. If the market is mature with many participants I think you are correct. If for instance, the government levied a tax of one dollar on every towel produced that tax would be directly passed on to the consumer. The market for towels is highly competitive and the prices to consumers represent the cost of production and distribution closely. An increase in the cost of production (from the tax) will per force require an increase in the price the consumer pays or the towel manufacturers could not stay in business.

Some markets are not like this. In a monopoly controlled market the price is set to maximize the profit of the monopoly holder which may be well above his cost of production. If the government levies a tax in such a market the tax is not necessarily passed on to the consumers. The price has been set to maximize the monopoly's profits and the imposition of a tax may not shift the monopoly holders profit maximizing price that much and he may choose to pay for some of the tax out of his profits.

That was one of the many problems with McCain's recent screwball scheme to suspend gasoline taxes. The price of oil is set by a partial monopoly and reducing a tax on gasoline might not affect the profit maximizing price for the oil supplier that much and the suspension of the gas tax was in the fairly short run probably going to result in greater profits for the oil companies and no actual reduction in the price of gasoline to the consumer.

[Sefarst]

Some markets are not like this. In a monopoly controlled market the price is set to maximize the profit of the monopoly holder which may be well above his cost of production.

Monopoly power is determined by market demand inelasticity. The more inelastic, the more monopoly power. The market price, IIRC, is ALWAYS set above the cost of production in the case of a monopoly. Quantity is determined graphically by where Marginal Revenue (MR) is equal to Marginal Cost (MC) and from there, you follow it up to the demand curve to get your price. The price will actually increase by MORE than the amount of the tax.

For the sake of understanding things graphically, I encourage you to go here: http://en.wikipedia.org/wiki/Monopoly and pay attention to the graph they give to illustrate dead weight loss. In that graph, the monopolistic price is Pm and the monopolistic quantity is Qm. Pm is determined by following the intersection of MR and MC up to the demand curve, D (the red line). When an excise tax is levied, the MC curve will shift "upward" (if you've taken an economics class, you may have heard the shift described as something different, but they mean the same thing) and a new intersection of MR and MC will be determined with a lower quantity and a higher price (if you can't picture it in your head, try drawing it out and tracing the new intersection up to the Demand curve).

If the government levies a tax in such a market the tax is not necessarily passed on to the consumers. The price has been set to maximize the monopoly's profits and the imposition of a tax may not shift the monopoly holders profit maximizing price that much and he may choose to pay for some of the tax out of his profits.

It depends on the tax with whether or not it will increase the monopolist's profit margins, but pretty much any tax (that I can think of) will result in a higher price for consumers.

[davefoc]

Were you agreeing with me? What specific things that I said did you disagree with?

I suspect that you are right that some portion of all taxes is passed on to the consumer and I didn't mean to say otherwise. In the case of a competitive market tax increases and decreases are passed on to consumer almost entirely. That is less true in markets where there are elements of the market that are not controlled as much by competition as is the case for oil where there is a limited supply and a limited number of producers who can easily collude on prices. In these kinds of markets it was my claim that not all of a tax increase or decrease would be passed on to consumers and in some markets the amount passed to consumers might be small.

As to the idea that the elasticity of a commodity determines whether that market is a monopoly is something that I hadn't heard. I understood the terms monopoly and oligopoly to be defined by the number of suppliers in a market.

ETA: I read what you wrote more carefully and I realize now that you weren't saying what I understood you to mean when I read your post the first time. Please disregard the above sentence.

[Sefarst]

Were you agreeing with me? What specific things that I said did you disagree with?

I was mostly disagreeing with this line:


If the government levies a tax in such a market the tax is not necessarily passed on to the consumers. The price has been set to maximize the monopoly's profits and the imposition of a tax may not shift the monopoly holders profit maximizing price that much and he may choose to pay for some of the tax out of his profits.

Because it seems you are treating the profit-maximizing level of output and price as something static that might not be passed on to consumers in the event of a tax. Or you seem to suggest that the price won't change "that much," when the case is, according to my understanding of monopolies, the price almost always increases by an amount MORE than the per unit tax. And a monopolist isn't going to choose to reduce his own profits unless the firm is run by very bad managers who aren't going to have jobs much longer.

I suspect that you are right that some portion of all taxes is passed on to the consumer and I didn't mean to say otherwise. In the case of a competitive market tax increases and decreases are passed on to consumer almost entirely.

Correct.

That is less true in markets where there are elements of the market that are not controlled as much by competition as is the case for oil where there is a limited supply and a limited number of producers who can easily collude on prices. In these kinds of markets it was my claim that not all of a tax increase or decrease would be passed on to consumers and in some markets the amount passed to consumers might be small.

It is true that a tax increase will reduce monopolist profits, but the price increase will still be large. What I am trying to explain is that, if I am a monopolist or an oligopolist and I make widgets at a cost of $3 which I then sell, a $1 per unit tax on each of my widgets will most often lead to a MORE than $1 increase in sales price for you, the consumer.

The difference between the perfectly competitive effects of an excise tax and the monopolistic effects is determined by the extra market power the monopolist has. In a perfectly competitive firm, Marginal Revenue=Marginal Cost=Demand=Average Revenue. With a monopoly and oligopoly, however, Marginal Cost and Marginal Revenue separate from the demand curve and the Marginal Revenue curve will have a slope twice that of the Demand=Average Revenue curve, making it twice as steep.

Without being able to draw graphs for you, it's going to sound complicated and boring.

As to the idea that the elasticity of a commodity determines whether that market is a monopoly is something that I hadn't heard. I understood the terms monopoly and oligopoly to be defined by the number of suppliers in a market.

I know you said to disregard this sentence, but I'll elaborate just in case anyone else got confused. I'm referring to monopolistic POWER, not just a monopoly. When we think of monopolies, we think of pure monopolies. However, there are similar conditions in which we have monopolistic competition. A firm can have monopolistic power despite the fact that there are many other firms in the market. It depends on how badly people want your product. To use an example, think of Beanie Babies. Small little stuffed animals filled with plastic beads. The company that made Beanie Babies during the height of its fad was by no means the only stuffed animal maker in the market. It was one of probably several dozen, but they had a great deal of monopolistic power to mark the price of these toys up because demand for them was relatively more inelastic than that of other firms. Even though there were many firms in the market, the company was still able to capture monopolistic power (though, in their case, only for temporarily).

[Sefarst]

I just thought of a much simpler way of explaining things without having to pull in all the lingo and graphs that most people will probably have their eyes glaze over at.

Think about it this way: in a perfectly competitive firm, companies have basically no market power. This is like the market for wheat. 99% of people don't give a damn where their wheat comes from and wouldn't notice if it changed. For this reason, a single producer of wheat has no market power because his wheat is easily substitutable with any other company's wheat. So if he tries to increase the price of his wheat, consumer won't care, they'll just stop buying his wheat and buy one of the other companies'. A monopolist has virtually TOTAL market power, however. Therefore, he can charge the absolute maximum that people are willing to pay for a particular quantity because there are no substitutes. Therefore, if the government increases his costs by adding a tax, the monopolist will decrease his quantity and charge whatever the maximum amount consumers are willing to pay at the new quantity. The difference in price depends on how badly people need the product. In the case of oil, it's pretty badly.

ETA: changed "price" to "quantity" in the third to last sentence.

[van_dutch]

When it comes down to taxes, what matters is the elasticity of supply and the elasticity of demand. Those primarily determine where the tax burden falls. Either way, with an increased tax, the total social surplus, regardless of who bears the burden, will be less than without the increase. Monopoly or not, there will be an increase is price and a decrease in quantity. That is how taxes work. Levying a tax will not magically make producers sell for less. In order for price to decrease and quantity to remain the same, cost has to be decreased, something that isn't terribly feasible in this market, or the scarcity has to decrease. The problem with oil is that it is high demand. China is buying up more oil than ever. This results in less oil available for others and price will go up. There are also stability issues which translate to risk as well as problems with a weak dollar. The whole US economy is weaker than when oil was cheap. This results in less buying power so oil producers are going to sell elsewhere because those consumers are able to purchase more, resulting in higher revenue. To a certain extent oil is artificially scarce due to the desire to continue production. This gets at the issue of when is the optimal point to extract the resource, a whole other topic.

[Sefarst]

When it comes down to taxes, what matters is the elasticity of supply and the elasticity of demand. Those primarily determine where the tax burden falls. Either way, with an increased tax, the total social surplus, regardless of who bears the burden, will be less than without the increase. Monopoly or not, there will be an increase is price and a decrease in quantity. That is how taxes work. Levying a tax will not magically make producers sell for less. In order for price to decrease and quantity to remain the same, cost has to be decreased, something that isn't terribly feasible in this market, or the scarcity has to decrease. The problem with oil is that it is high demand. China is buying up more oil than ever. This results in less oil available for others and price will go up. There are also stability issues which translate to risk as well as problems with a weak dollar. The whole US economy is weaker than when oil was cheap. This results in less buying power so oil producers are going to sell elsewhere because those consumers are able to purchase more, resulting in higher revenue. To a certain extent oil is artificially scarce due to the desire to continue production. This gets at the issue of when is the optimal point to extract the resource, a whole other topic.
Indeed.

And now, to somewhat tie all this back to the original point and (hopefully) end the tangent about monopoly power and the effects of a tax on price, government interference to bring the cost of oil down would require a fiddling with the revenue side of the equation, i.e. price and quantity. This will require a virtual price ceiling on the price of oil, a tactic that is by nature inefficient and leads to shortages ala the 1970's.

Should the government ever be allowed to limit a company's profit? In a way, governments all ready limit companies' profits. There are laws against price gouging and laws against collusionary agreements and anticompetitive behavior. These are forms of limiting profits, but they are special cases. Every time the government makes a decision to regulate a business for one of the aforementioned reasons, it requires careful consideration. I'm afraid, "Gas is too expensive, force the prices down!" is not a good enough reason.

[van_dutch]

Thanks Sefarst. You said it better than I could (I may know the stuff but I am not the best at explaining what I know unfortunately). I've been trying to get at that point but got a bit bogged down by the taxation piece and trying to explain why gas prices are so high, among other things.

[Jaggy Bunnet]

Taxation is not part of cost. Taxation is taxation. The added burden of taxation can be felt by the producers and/or the consumers. It is difficult to say which as there are many factors involved but generally an increase in taxes reduces the consume and producer surpluses, even if the allocation of the good is not optimal. This can change due to the type of tax but generally speaking, taxes are not a good way to change things. What benefit would there be to increasing cost to the oil companies anyways? It would ultimately result in an increase in price, the very thing that people are complaining about.

Please note that I was not suggesting that the government SHOULD use the tax system in this way, just disagreeing with the statement that the government COULD not effect the costs of oil companies when clearly they can. If the government chooses to increase the tax rate applicable to oil companies that is a cost increase in exactly the same way as employees negotiating higher salaries is.

Why do you say taxation is not part of cost? It is a cash outflow from the company. Why does it matter that it goes to the government rather than to an employee, or a landlord or a supplier.

[Jaggy Bunnet]

You are right in the sense that taxation effects prices, but it cannot be used in any effective way as a price control. If the government levies a tax on profits, that tax is simply passed onto the consumer in the form of higher prices, defeating the original purpose. If the government lowers taxes to try and encourage firms to lower prices, firms will simply recapture the difference (as is the issue with the debate over suspending the gas tax until Labor Day that McCain and Clinton supported but so many economists opposed).

I was not arguing that they should, simply that they COULD.

[Jaggy Bunnet]

Indeed.

And now, to somewhat tie all this back to the original point and (hopefully) end the tangent about monopoly power and the effects of a tax on price, government interference to bring the cost of oil down would require a fiddling with the revenue side of the equation, i.e. price and quantity. This will require a virtual price ceiling on the price of oil, a tactic that is by nature inefficient and leads to shortages ala the 1970's.

I agree, however the other way the government could interfere in the free market (which is what the opening post was about) would be to increase taxes because "too much" profit was being made.

As you have shown in your previous posts this would also have negative impacts on consumers as prices increase.

Which is why I ignore those who say "the government should do something" about high oil prices unless they can tell me what they think that "something" should be and why that would help.

[Francesca R]

I believe the argument is that we don't truly have a free market, as we subsidize farms and airlines and other corporations--the government does intervene to affect pricing, etc.
This is true but I don't see much point in statements (not attributed to yourself) that "We don't have a completely free market". It's like "We don't have completely straight lines". Free <---> Not free is a continuuum

Would you mind elaborating on what you mean by atrocities, and also what you mean by letting the markets do a bit of resource allocation? I'm not sure what you mean.Atrocities: Well things like the Chinese government quietly pardoning attacks againt Darfur to secure oil contracts from Sudan etc. Rather off-topic.

And by "markets doing resource allocation" I am referring to what's known as the "invisible hand"

[Francesca R]

The fact that the US produces a lot of its own oil probably still does mitigate high oil prices for US consumersIt makes no difference. Crude oil and oil derivatives have a single world price. The only way for US consumers to have cheaper gasoline is by way of less government tax, or government subsidy. The US producing oil (compared to not having any) causes the world price of oil to be lower than it otherwise would be--which affects everyone.

If free market capitalism has a mechanism for ensuring that third parties aren't screwed it works very well in a wide variety of situations and a lot of the "fixes" for it have serious unintended consequences that are almost always overlooked by advocates of various schemes to interfere with a free market.Capitalism does not do that (ensure third parties are not screwed). The mechanism by which that is done is law. Indeed unfettered capitalism itself cannot arise without legal enforcement of contracts and rights.

From my perspective, promoting free markets and promoting business interests are not necessarily the sameAt the level of an individual business, they are actually opposed. An individual business does not "want" a free market.

[Sefarst]

At the level of an individual business, they are actually opposed. An individual business does not "want" a free market.
Unless it's their competitor that is benefitting from the government intervention.

[davefoc]

It makes no difference. Crude oil and oil derivatives have a single world price. The only way for US consumers to have cheaper gasoline is by way of less government tax, or government subsidy. The US producing oil (compared to not having any) causes the world price of oil to be lower than it otherwise would be--which affects everyone.

I think that is largely correct but not exactly correct. The distribution costs for locally recovered oil are less and that might reduce local prices some. There are also political consequences for oil companies when they export oil and that might force them to sell most of the oil recovered in the US in the US. It seems like this might reduce US prices also. And maybe more significantly the existence of US produced oil creates an industry with the power to lobby for reduced taxes on oil. This clearly reduces the price the consumer pays (and benefits the oil companies by the increased consumption resulting from the lower taxes).




Capitalism does not do that (ensure third parties are not screwed). The mechanism by which that is done is law. Indeed unfettered capitalism itself cannot arise without legal enforcement of contracts and rights.

At the level of an individual business, they are actually opposed. An individual business does not "want" a free market.

I think only semantics separates us on this. The mechanism for ensuring protection of third parties that I had in mind was laws enforced by the government.

This is a slight digression, but one place it seems to me that economic libertarianism goes off track is when it ignores consequences to third parties. The advantages of private ownership and allowing free markets to operate are overwhelming but almost all economic activity involves hidden costs to third parties and a very important role of government, IMHO, is to ensure that those costs are dealt with fairly.

[van_dutch]

I think that is largely correct but not exactly correct. The distribution costs for locally recovered oil are less and that might reduce local prices some. There are also political consequences for oil companies when they export oil and that might force them to sell most of the oil recovered in the US in the US. It seems like this might reduce US prices also. And maybe more significantly the existence of US produced oil creates an industry with the power to lobby for reduced taxes on oil. This clearly reduces the price the consumer pays (and benefits the oil companies by the increased consumption resulting from the lower taxes).

There is an optimal rate at which to import versus purchase a locally produced good. For a given demand curve and two supply curves (local and import) one can find the optimal allocation of the resource. The resulting price is always than just importing alone, so assuming that the local supply cannot accommodate all of the local demand, the best is to import some and then whatever else is needed is purchase from domestic suppliers. The domestic production that isn't bought locally is sold on the world market. Every industry has a lobby going for it. Logrolling as it is known, occurs in many areas. Lowering taxes may not be the answer. More and more people want more and more oil. Due to the nature of oil (a nonrenewable, scarce resource), this drives cost up. Increasing total quantity (developing new fields), reducing risk and uncertainty (stabilizing areas like Nigeria and Iran), and reducing production cost (not very easy to do) will reduce the price of oil.



This is a slight digression, but one place it seems to me that economic libertarianism goes off track is when it ignores consequences to third parties. The advantages of private ownership and allowing free markets to operate are overwhelming but almost all economic activity involves hidden costs to third parties and a very important role of government, IMHO, is to ensure that those costs are dealt with fairly.

These are known as externalities (additional impacts that can be positive or negative that are not accounted for in the economic transaction). There are ways of dealing with externalities with and without government intervention. The methods range from government regulation (ie tax, law, subsidiaries etc) to private methods such as private bargaining (if the Coase Theorem is met) and mergers. There is no perfect method for getting these effect internalized so the solution is very dependent on the situation.

What does this all boil down to? The need for government intervention is a tough call to make. There are many economists under the employ of the government and analyze the situation and determine policy. I believe in the power of the market. In other words, government intervention should be limited and carefully thought out.