Normative Narratives


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Economic Outlook: Inelastic Demand, Imperfect Competition, and Price Regulation

Talk is cheap, which is why makes sense for business owners to claim prices will increase and / or mass layoffs will result if regulations are put in place. What this really means is that profits will fall, so it is worth it to talk (which, remember, is cheap), and hire lobbyists (which are relatively cheap for big business compared to the benefits they deliver) to support these claims.

In most cases, markets decide pricing. Increase prices, and people can substitute your good for a competitors. Lay people off to make a political statement, and you forego market-share that will be readily snapped up by competitors. In competitive markets, these problems tend to regulate themselves. While true Perfect Competition doesn’t exist in reality, some markets are closer to this ideal than others.

Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Also, consumers have many substitutes if the good or service they wish to buy becomes too expensive or its quality begins to fall short.

When a good is necessary for living (healthcare) or for social mobility (college), imperfect markets can price lower income people out.

bls data

Base Year 1978 (Prices = 100)

Healthcare:

ACA–companies justify price increases:

Rate Review helps protect you from unreasonable rate increases. Insurance companies must now publicly justify any rate increase of 10% or more before raising your premium.

Price controls imposed as part of the ACA are at least partially responsible for the dramatic slowdown in healthcare cost increases over the past few years (the Great Recession was another major factor).

But since health insurance is a composite of a number of inputs, including cost of being seen by a doctor and cost of prescription drugs, each of these inputs would need to be regulated to keep health insurance costs down.

The current approach used to try to keep prescription drug prices down–naming and shaming price gauging companies–does not work.

College:

While a college education is not a silver bullet, it is an important element of the social mobility puzzle. As the graph above shows, college costs have skyrocketed in recent decades, leading poorer students to take on increasing levels of debt to afford a degree.

Those who complete their degree still tend to realize a strong return on investment, but the high (and increasing) debt burden is a huge stressor, which likely contributes to poor graduation rates (especially among lower class students). The combination of non-completion (and related low earnings) and high debt can result in an inescapable debt cycle.

A good proxy for the “necessity” of a good or service is it’s elasticity of demand:

Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases.

The availability of substitutes…is probably the most important factor influencing the elasticity of a good or service. In general, the more substitutes, the more elastic the demand will be.

Imperfect markets result in a lack of substitutes, as barriers to entry result in little competition. Policymakers can start with a matrix of competitiveness and necessity (elasticity of demand); goods and services that are both necessities and exist in highly imperfect markets are primary candidates for price regulation. Two obvious tools for regulating these markets are:

  1. Price controls (making companies justify price increases over a certain threshold)
  2. Tying federal funding to price oversight

 

Price controls may seem like a blunt tool, but they can actually be quite nuanced. Take the ACA’s “Rate Review”. A company can has an opportunity to make its case that a price increase is justified; if it justified is, the government will allow it. It is in no ones interest to see businesses fail in the name of price control regulation. Such failures hurt the economy, and undermine support for the regulatory policies that lead to their failure.

What is the American dream? Is it meritocracy and social mobility, or is it the freedom to charge whatever the market will bear regardless of the social cost?

Admitting their are limits to what perfect competition market models can achieve in the real world does not make you a socialist. It makes you a good economist and policy analyst. There is room for these industries to remain private and profitable. That does not mean we cannot regulate them in ways that make them work for society as a whole (considering the social benefits when they are widely available, and the social costs when they are not).

It is the job of politicians to identify these markets and call owners on their bluffs. Failure to do so reinforces power asymmetries that stifle social mobility. The Commerce Department’s mandate should be expanded to help balance the power asymmetry that exists between consumers and producers of necessities in the most imperfect markets.

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