What is the Proper Criterion to Prefer One Theoretical Economy to Another?

Coke being cheap and safe? (The price of Coke should, of course, include hidden costs for civil servants).

-Freedom to engage in business without outside forceful intervention
-Price
-Quality

With the goal of maximum overall welfare, choice B would be preferred.

Choice B allows the independent agents (each company in each industry segment) to determine whether economies of scale will benefit their unique circumstance. If it is beneficial, the companies will merge and product products at greater efficiency. This will lead to wealth creation in the form of higher profits and/or lower prices; dependent on whether the good has substitutes.

There is also a cost (inefficiency) involved with the regulation necessary to guard against mergers under choice B. An active watching agency must be created or additional police forces used for that purpose.

As a side note, politicians will consider short-term returns over the long-run. This may have the effect of controls being preferred, since it gives more economic timing control to those in office. Further, efficiency-maximizing mergers may very well produce short-term job losses as their most noticeable effect. This ignores the additional efficiency produced in the market that allows agents to live better lives at steady or declining wages. It also ignores the change in comparative advantage that will make work in other industries more valuable.

Politicians (the smart ones) will prefer choice A. An omniscient being concerned only with optimal welfare will choose B.

The key criterion is efficiency (without violation of negative rights). This is the only factor needed for a judgement based in practicality rather than morality.

Different levels of quality will be preferred at different price levels, so no overall measure of price OR quality is useful, only the economyâ??s freedom to produce at any level of quality on the quality-demand curve. This applied freedom can best be measured in terms of overall market efficiency.

The criterion for selecting between these two economies is based on the nature and effectiveness of the society's rules governing use of force. The danger of monopoly stands in its concentration of force being improperly applied, first to the government/regulating bodies (if any), and secondly to potential rivals in the marketplace.

I am not currently aware of any (extant) society with rules and organizations strong enough to effectively limit misuse of force from the largest imaginable monopoly.

Therefore the first economy (A) is preferable. Two organizations can collude to exert improper force, but will do so with less efficiency than a single monopoly. The real-world comparison here would be American long-distance carriers exhibiting "Lock-Step" pricing, a classic sign of price collusion in the marketplace, vs Microsoft's destruction of Netscape.

American long-distance carriers do cooperate to cause harm by using force inappropriately - recent attempts to draft legislation to regulate Voice over IP just like POTS had their fingerprints all over it. This harm is lesser because they only deploy it to protect their common "shared" market, while reserving some of their force to exert against each other to maintain market share.

An omniscient being might be able to see where "maximum overall welfare" would come from, but I cannot. If what is meant is the greatest good for the greatest number, the answer is: neither. Any economy so structured has the deck stacked against it ever working, or, at least, against it working for long. The regulatory system is irrelevant. I suppose that's why they're "theoretical."

If the "maximum overall welfare" is defined as maximum economic liberty, then economy B is preferable.

Jonathan,

...Choice B allows the independent agents (each company in each industry segment) to determine whether economies of scale will benefit their unique circumstance. If it is beneficial, the companies will merge and product products at greater efficiency. This will lead to wealth creation in the form of higher profits and/or lower prices; dependent on whether the good has substitutes....

The typical result will be higher profits AND HIGHER prices. Does this affect your answer?

Timothy,

The only explicit use of force in this example is the prohibition of voluntary mergers in economy A. Your example involves the use of government force to enforce monopolies. I deliberately avoided the use of the word monopoly because of its definitional ambiguities in common use. There is an implicit use of force implied to prevent the use of non-market barriers to entry by existing suppliers, such as threatening new entrants with bodily harm.

Regards, Don

Patrick,

I don't care for the expression maximum economic welfare either, but I don't have a better alternative expression. This really is the entire question of the post, what does the omniscient being use to make a choice. I suspect that only some possible economies can be unambiguously compared, and I am willing to take an answer which only fully satisfies those cases.

Regards, Don

At first glance it would depend on the rest of the legal structure. Specifically, are other firms allowed to enter each of the 1000 market segments? Since you take pains to point out that the economies can evolve, I assume the answer is yes. If so, then B would be preferred, since mergers and consolodation is part of an efficiently operating economy. But if not, one might prefer A.

I am generally uncomfortable with the scenario that is shown, mainly due to the fact that it is a simplified model of a highly dynamic and variable ridden process, in other words, much akin to the theoretical constructs most mainstream collge economics classes are so fond of.
That aside I would certainly have to pick option B. It is the only logical course of action and the only one that makes sense based on long range utilitarian good. The market is a dynamic process of endless change, flux and constantly emerging new factors, thus any imposition of static controls, ie; merger restrictions in this case, would only cause some sort of unforseen damage down the road, especially when such controls are imposed by a mechanism that is both disconnected from the dynamics of the market and highly sticky when it comes to the matter of eliminating redundancies, in other words the state. Now Don does state that we are looking at this from the point of view of "omniscience", but realistically what actually would make such a decision would be a government.

Slightly tangential, but it does bear on the Coase-like freedom of businesses to trade risk/assets/etc.:

http://tjic.com/blog/index_oct2004.php#15_Oct_2004_0

Subject: economic ignorance

This is the most economically ignorant thing I've read all day (but, on the other hand, it's only a bit after 9am, so there's time for me to get even more depressed about the ignorance of the main stream media):

http://www.nytimes.com/2004/10/15/national/15rail....

Amtrak Pays Millions for Others' Fatal Errors

It is no mystery why, one spring day two years ago, an Amtrak passenger train jumped the tracks near Crescent City, Fla., and skidded to a stop on its side, killing 4 people and injuring 142.

Investigators concluded that the track, owned by the big freight railroad CSX, had not been properly stabilized and that management's oversight of maintenance had been lax. ...

But when millions of dollars in damage claims arose from the crash, it was not CSX, a multibillion-dollar corporation, that paid them. It was Amtrak, the perennial money loser that survives only with regular infusions of cash from American taxpayers...

For three decades, Amtrak has been paying these liability claims, regardless of fault, as a condition for using the freight lines' tracks. Not only do these payments shift the burden of paying for negligence from profitable corporations to taxpayers, they remove an incentive for railroads to keep their tracks safe...
Note that there is an agreement between Amtrak and CSX: "Amtrak can expect X level of service for Y dollars".

Note further that Amtrak and CSX are free to negotiate any contract they want. For example, it is perfectly valid for them to negotiate "Amtrak can expect X' level of service for Y' dollars"...but Amtrak and CSX did not choose this option. If the X' level of service is better than the X level of service, we can be forgiven for assuming that the Y' price is higher than the Y price. On the other hand, Amtrak can push the X level of service to 0, and pay 0 dollars. Three different levels of service, three different prices.

Now, choosing a mid-grade amount of service may be a perfectly reasonable choice on Amtrak's part.

I don't know, and it's not my job to know. Certainly is Amtrak was a private company, and if transaction costs to redraw the contract were reasonably low I would expect that the current allocation of risk was the correct one (see also the Coase theorem)

...but let's assume that Amtrak didn't want to assume the risk of paying out for rail problems, and wanted CSX to assume that risk. CSX has two primary options (I'll ignore the spectrum of trade-off options between these two points, for simplicity): (1) ensuring that it's rails are so well maintained that there are never accidents; (2) accept the current level of rail maintenance, and set aside a pot of money to pay for the inevitable accidents.

The marginal cost of reducing rail accidents gets higher and higher as you go. In the limit, you need a guy standing 24x7 alongside every 20' segment of rail in the country, watching to make sure terrorists sneak up and remove a rail...so clearly, the "ensure no accidents" choice will not be taken (at least not with out charging Amtrak infinite dollars). That leaves CSX with accepting some level of accidents, and setting aside a pot of money to pay off the victims.

How big would this pot of money be?

For the current level of service, CSX's pot of money would be the EXACT SAME SIZE as the pot of money that Amtrak uses to pay out to victims.

So if Amtrak is currently paying $C to CSX and $V to victims every year, and instead wants CSX to pay all victims every year, our first guess as the price that CSX might ask for this service is $C + $V.

Rephrased: TANSTAAFL

Note that the NYT isn't getting anywhere near this level of analysis.

They're not even looking at the existence of alternative service levels at different price points. They're just focusing on the fact that Amtrak, while paying middle-tier prices, didn't get top-tier service...of course, they don't even acknowledge the first part of that sentence, because - as is typical of the Left - prices are assumed to be arbitrary, or entirely under the control of the producer. The NYT's argument is merely "CSX isn't delivering first tier service! SHAME! SHAME!". If CSX was forced to sell only first tier service, and raised it's rates accordingly, thus causing Amtrak to raise it's rates, thus causing Amtrak ridership to fall even further below it's currently abysmal money-losing level, we could then expect a new NYT article bemoaning greed, on the one hand, and low train ridership, on the other.

You don't get TCP prices at UDP rates.

Or at least, not for long.

The key is right here, and everyone missed it:
"Both of the above economies are to be considered as starting points, which may further evolve."

The standard theory predicts that if the two scenario-B firms merge, you'll have a monopoly, with reduced supply and increased profits. The analysis typically stops there.

Except that supra-normal profits in the industry attract entrants! There's no reason to believe from the initial setup that the production techniques used in the various industries are somehow secret, or that there are any effective legal means the merged firm could use to keep out competitors.

It's also worth pointing out that while the setup hilighted the tendency to merge, there's no reason to believe it would be stronger than the tendency to divest or spin off.

The choice is easy: B

Travis, the problem with your response to the NYT article is this:

CSX has a monopoly on track ownership and Amtrak cannot build a whole new rail network at any sort of reasonable price.

Amtrak has to operate lines using CSX's network to (say) Florida in order to have passenger rail service considered an alternative to flight in general.

So at any price short of Amtrak's shutdown point (below where it starts taking losses) Amtrak will pay CSX whatever it asks. In order to remain in business it will pay far in excess of $C-costs and $V-reinsured-costs-for-victims. That profit is limited only by Amtrak's ability to pay. CSX has no incentive to take on the expense of $V, as it can already charge Amtrak whatever it likes (up to that shutdown point) and won't be able to charge more regardless of the services it provides.

The above is not specifically relevant to your point however. The key is that no one who can improve CSX's rail lines has any incentive to do so. CSX certainly has no such incentive, as it already has offloaded its responsibilities to Amtrak. Amtrak cannot improve those lines w/o CSX's permission, and any money it would allocate to doing so CSX might as well absorb by raising its rates for use of those rails.

In a competitive rail service market consumers could choose another rail service. This is not a competitive market. There is a commensurate good for some of that service (air travel), but it is more expensive per se, and thus not an alternative for anyone who was considering rail to begin with.

Luckily consumers do have access to another market where they can exercise choice. "National, State and Local Elections" are a flawed market to be sure, but the consumers can luckily choose among options how much they would like to pay (taxes) and what basket of goods and services they will receive. Like the fate of OS/2 Warp customers (from IBM) after enough people switched to Windows, after enough consumers make a choice the others are denied any real access to an alternative choice; the operation of the political market, like the operation of the economic market, does occaisionally leave fewer choices for the consumer rather than more. Luckily everyone can make their choices again, every 2-4 years.

At any rate, consumer choice in the political market can luckily correct for the failures of the economic market.

-RS