Are Entrepreneurs Insufficiently Incited to Compete in Markets…


Recently, I had occasion to discuss economics and economic policy with very bright students pursuing graduate degrees at elite universities. One of these students, who I’ll call “Alex” (which isn’t his real name), was unusually loquacious. My exchange with these students, and especially with Alex, revealed just how differently many graduate students at elite universities think about economics and the economy from the way that George Mason University students and faculty think about these matters.

Our discussion began with Alex telling me of a recent study that purports to identify yet another negative effect of income inequality. (Alex expressed throughout our conversation a deep obsession with such inequality.) Specifically, this new study claims that inflation in Britain hits lower-income people harder than it hits higher-income people.

Don: “Why would that be so?

Alex: “It’s because inflation causes the prices of goods bought by low-income people to rise by more than it causes the prices of goods bought by high-income people to rise.”

Don: “Hmmm. That’s strange. If inflation causes the purchasing power of the British pound to fall by, say, five percent, the prices expressed in pounds of all goods and services should eventually rise by five percent. That’s how inflation works. Why would the percentage rise in prices of goods and services bought by poor people be higher than the percentage rise in prices of goods and services bought by richer people?”

Alex: “It’s simple: Markets serving rich people are more competitive than markets serving poor people.”

Don: “With respect, it’s not at all simple. Even if markets in which poor people buy goods and services are completely monopolized while markets serving rich people are hyper-competitive, in both markets the price hikes fueled by inflation should be the same. Inflation represents a decrease in the purchasing power of the monetary unit, and that decrease will raise nominal prices in competitive markets by the same percentage as it raises nominal prices in monopolized markets.”

Alex: “That’s not what the study found.”

Don: “Perhaps the study is flawed. It sure wouldn’t be the first.”

Alex: “The study seems very sound to me. Very convincing. It makes sense that entrepreneurs care more about selling to rich people than selling to poor people.”

Don: “I want to challenge your claim about what it makes sense for entrepreneurs to care about. But before I do so I must insist again that even if you’re correct about entrepreneurs being unduly interested in catering to rich people, a study that finds that inflation is higher in markets that serve low-income people than it is in markets that serve high-income people doesn’t pass the smell test. But putting that issue aside, let’s get to a deeper issue: why do you suppose that entrepreneurs are more interested in selling to rich people than to poor people?”

Alex: “Rich people have more disposable income. That makes them more attractive customers than poor people. So more entrepreneurs compete for rich people’s money than for poor people’s money. This greater competition is what constrains sellers in markets that serve rich people from raising prices. No similar competitive constraint keeps prices low in markets that serve poor people.”

Don: “So you believe that prices for goods and services bought by low-income people are excessively high because of insufficiently intense competition in the markets in which those people buy. Is that correct?”

Alex: “Yes.”

Don: “Well then, why don’t the entrepreneurs who greedily compete to sell goods and services to rich people – but who are constrained by competition from raising their prices too much in rich-people markets – turn their attention to markets for goods and services bought by poor people? According to your story, that’s where the excess profits are.”

Alex: “Low-income people don’t have enough disposable income to attract more businesses to serve them.”

Don: “Really? How can that be given that you’ve just admitted that low-income people do have enough disposable income to pay prices that are monopolistically high? Precisely because low-income people are more sensitive to price increases than are high-income people, entrepreneurs who enter markets that serve low-income people will have an especially easy time at competing these consumers away from the current crop of merchants who insist on charging monopolistically high prices.”

Alex: “Markets don’t really take account of the preferences of people without money.”

Don: “Ummm, what? You’re changing the subject. Of course, by definition markets don’t take account of the preferences of people who have no resources with which to participate in markets. But even the poorest people in wealthy countries such as the UK and US have enough resources to participate in markets. Indeed, even you admit that poor people in the UK not only have resources to participate in markets, but enough resources to be able to pay monopolistically high prices. So again, those prices should attract more businesses to serve lower-income communities.”

Alex: “But once more, the empirical evidence says they don’t!”

Don: “As I said, I’m suspicious of the empirical study that you keep talking about. But let me here grant for the moment that it’s accurate. We then must ask: If low-income people are indeed beset by monopoly prices, why don’t entrepreneurs sweep in to compete those prices down to competitive levels? After all, such competition takes place for goods and services sold to high-income people, who are less sensitive to price changes than low-income people. The answer for any such lack of competition can’t be that entrepreneurs aren’t interested in earning profits by selling to poor people. The answer, instead, must be that merchants who would enter markets to compete for those monopoly profits are blocked from doing so by some artificial obstacle or obstacles.”

Alex: “I don’t know enough about the UK to say if that’s so.”

Don: “Nor do I. But I do know enough about economics – and about economic history – to be certain that the story that you’re telling about how inflationary price hikes are higher for low-income consumers than for high-income consumers makes no sense unless there exist artificial barriers to competition for the patronage of low-income consumers.”

Our conversation continued, but I didn’t come close to convincing Alex to question his belief that markets serve only rich people, while unjustly exploiting – when not altogether ignoring – poor people. His tone throughout our conversation revealed a young man who is supremely confident in his beliefs and conclusions. He was willing to hear objections to his arguments, but there is no sign that he was open to listening to objections to his arguments.

Cocky and mistaken students are found at all schools and across the ideological spectrum. But one of the jobs of higher education is to scrub students of such dogmatism – to open their minds to the possibility that they are mistaken and that those with whom they disagree are correct. I don’t know how representative Alex is of the Ivy League’s current crop of doctoral students. I hope not very.

I believe that the study that Alex had in mind is this one. If so, the reason for the difference across income groups in inflation’s effects isn’t monopoly power. Rather, it seems that higher-income people are better able than lower-income people to substitute quickly out of goods the prices of which rise significantly, and into goods the prices of which don’t rise by as much. (But even so, the effects of inflation should be such that in the long run the percentage rise in nominal prices paid by ‘the rich’ will be the same as the percentage rise in nominal prices paid by ‘the poor.’)



This article was originally published by a www.aier.org . Read the Original article here. .