Self consumption is considered greedy, but Robin Hood is altruistic

Published: Monday, May 28 2012 7:27 p.m. MDT

SALT LAKE CITY — One of the basic assumptions of economic theory is that people as economic agents make decisions with the goal of becoming as well-off as possible. Economists call this maximizing utility, where the term utility roughly corresponds to well-being, level of satisfaction, or maybe happiness. This key assumption seems to reflect human nature, at least as an approximation.

This is especially true when we realize that utility can be defined in ways that are consistent with all sorts of observed behavior. For example, a parent donating a kidney to a child would seem to violate utility maximization, since it involves painful surgery which presumably decreases the parent's level of satisfaction. However, if the utility of the parent depends on the well-being of the child, then the pain of surgery could be more than offset by the knowledge that the child has a better shot at living a healthy life. This type of altruistic behavior occurs even though agents are behaving in way that seems selfish at first glance.

A corollary assumption is that firms behave in ways that maximize profits. Since firms are just collections of individuals, the way to maximize the utility of the firm's owners is often to maximize the profits the firm generates.

The distinction between utility maximization and greed is subtle. Greed might be as defined as an excessive focus on one's own well-being at the expense of that of other people. This amounts to defining greed as a particular type of preferences. Hence, a thief that steals from the poor in order to increase his own consumption is greedy, but Robin Hood is altruistic.

Monopoly is a market structure where there is a single seller of a good. We often associate monopolists with greed, but this is not necessarily so. Exclusive selling rights can arise from a variety of causes. Ultimately, monopolies are the result of some sort of barrier to entry, and these barriers may be natural or unnatural.

One barrier to entry occurs when individuals have unique resources or talents. Professional athletes and entertainers earn great deals of money because they have unique talents for which the talents of most other people are poor substitutes. Another barrier is a large fixed cost of operation which makes entry by new small firms unprofitable. In these cases, excessive focus on profits — i.e., greed — plays little or no role.

Many monopolies are not natural, however. Instead, they are enforced by the government. For example, to operate cab in New York City a government-issued medallion is required. The number of medallions is fixed, and this generates profits for the initial owners of these medallions. These profits are not due to a unique set of talents or resources or to a large fixed cost. Instead, they come about by an artificial restriction of the supply of cabs that is enforced by the city government. In the absence of government regulation or enforcement of the medallion requirement, many more cab operators would enter the market and drive the prices and profits of existing cab operators down.

Often government enforcement of monopolies is justified as an attempt to solve some sort of market failure. For example, New York City enforces the medallion rules under the assumption that without restricting cabs there would be greater congestion in the city.

Greed enters into the analysis when government enforcement of monopolies is imposed not to increase the total well-being of society, but to increase the well-being of some subset being granted a monopoly. Since monopolists earn above average profits, they are often willing to pay some portion of those profits to government policy makers to ensure the monopoly is imposed or remains in place. This is one of the functions of the lobbying industry.

In a competitive market, competition imposes limits on how greedily a seller can behave. Increasing the price will simply drive potential customers to buy from competitors. Greed, per se, does not lead to economic problems unless it is coupled with the ability to bring coercion to bear.

Monopolies are inefficient, at least at any point in time. The benefits they generate for the monopolist are smaller than the costs they impose on consumers. Consider a cab ride across Manhattan that could be provided at a cost of $5. A passenger might be willing to pay $10 for the ride, but due to the shortage of cab medallions the price of the ride is $20. Society would be better off if the passenger paid $8 for the ride. The cab operator would earn $3 in profit and the passenger would get $2 of excess benefit.

In a dynamic context, however, monopolies can actually improve welfare. Consider a drug company developing a new heart medication. The company will pay millions of dollars in research and development costs discovering and perfecting the drug without selling anything to generate revenue. It does so anticipating that it will be able to sell the drug under a patent (a form of government-enforced monopoly) over some period of time and recover the large development costs. Eliminating the monopoly eliminates the incentive to produce new and better drugs.

Greed in and of itself is not a problem if markets are competitive. It is only when monopoly power can be imposed that economic inefficiencies arise.

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