That depends on what you define as a market that isn't broken. In a perfect free market the oil producers make zero profits and this is a move towards fixing the market
In a perfect free market for a commodity price is the marginal cost: in other words if there is demand for N barrels of oil per day at the market price, that market price is the cost of production for the Nth most cheapest production cost. Anybody whose cost of production is cheaper makes money.
For a long time that marginal cost was Canadian oil sands oil, which cost about $40 a bbl to extract and $10 to ship. The Saudis who can produce at $10 a bbl were making money hand over fist.
Most definitions of perfect free markets include some element of perfect competition. The math essentially assumes there are an infinite number of saudis producing at $10 a barrel that compete with eachother down to marginal cost. Obviously these aren't realistic assumptions and pretty much everyone has some form of monopoly power, such as the saudis in your case which have monopoly power coming from lower cost of goods.
> Obviously these aren't realistic assumptions and pretty much everyone has some form of monopoly power, such as the saudis in your case which have monopoly power coming from lower cost of goods.
That's not what "monopoly" means. Monopoly power isn't just a fancier word for market power. Monopoly power is power derived from the fact that nobody else is selling what you're selling.
Note that in this example, the Saudis can't raise the price of oil above $50 / barrel. Setting a price of $60 would send their sales to 0 rather than to whatever the level of demand is at $60. They can't do it because they don't have monopoly power.
(If you expand the example a little, saying that world oil demand exceeds the amount Canada can produce, then you can claim that Saudi Arabia has monopoly power by virtue of being able to sell oil that Canada can't sell. But in the model where Canada can produce any amount of oil at $50 / barrel and Arabia can produce any amount at $20 / barrel, there is no monopoly power anywhere.)
Pricing power is a better word that monopoly power in this case then, should have been more precise in wording. They arent price takers is the point. They have price making power and a downward sloping demand curve until 50 bucks a barrel
no, economists and policymakers agree with your usage of monopoly power. monopolies aren't simply a function of number of market participants. semantic digressions like these are non-sequiturs and should be ignored.
> economists and policymakers agree with your usage of monopoly power
Policymakers may; they'll agree with most definitions of a Bad Thing.
Economists have to be more careful. Saying Saudi Arabia has monopoly power in the oil market because it produces oil at a lower cost than other suppliers is crazy. What power they have to manipulate the market doesn't come from what they're already doing -- it comes from what they could do. They have a marginal cost of production which is below the current market price. The fact that their average cost of production is below the current market price is not relevant.
Consider a world where Arabia, Canada, Russia, and Venezuela all produce oil and sell it at the world price of $50 / barrel. In this world, Arabia's strategy is "pump all the oil we can sell at a profit". They have a marginal cost of production of $70 / barrel, above the market price, and an average cost of production of $20 / barrel, well below the market price. They're making money hand over fist.
No one considers them to have monopoly power here. What would it mean? How would they exercise it?
See e.g. The Concept of Monopoly and the Measurement of Monopoly Power ( https://sci-hub.tw/https://link.springer.com/chapter/10.1007... ), which would define Arabia's monopoly power in the hypothetical I've described as, on a scale from 0 to 1, negative 0.4.
But again, profits are determined by average cost, not marginal cost. There is no reason to expect average cost to equal marginal cost.
I agree, and I'm basically trying to appease the hn crowd with the semantics. I didn't think my statement was controversial or incorrect enough to be hit with that many downvotes (I am an econ major - trying to balance layperson definitions with hyper technical ones) but clearly that ended up not being the case.
Marginal cost isn't a useful term if you assume infinites. If you have infinite number producing at the same price you can just say "cost" instead of "marginal cost". Marginal cost is only a useful term if each product has a different cost.
Marginal cost is the amount it costs to produce additional unit of a good, cost overall would include fixed costs. Price is different from cost as well, since that's what people pay, not how much it costs (though in perfect competition price will equal marginal cost - but not the case in monopolies). These are nitpicky technical things but they do give you different answers when you do out the math.
Even in the real world the idea that "companies exist to make profit" sounds wrong. Companies exist to ideally output goods or services, and profit is a tool to ensure they can continue making those goods or services. It can be hard for a company to exist without making a profit, but not the reason they exist.
Perfect here refers to the mathematical model of a perfect market and perfect competition, not an external normative sense of the word as some societal ideal.
Don't quote me, it is ages since I had my economics book open last time, but if I recall correctly, there is a confusing terminology here. Zero profit means in the context of economice profits that exceed risk adjusted return. That is, even in a perfect market, in the models you are allowed to pay a decent return to your capital, but not more. These extra profits are called almost as confusingly "rents" in economics. That's why "rent-seeking" is considered bad even if it is fine that your landlord collects rents from you. Two different things and one word.
Your answer and the others reinforce why I allways avoided everything with economics in university. The definitions and models are (mostly) just weird.
I would intuitively define a free market, as a (virtual) place, where people can trade freely (goods or labour) without restrictions. And they profit, if they are better off with the trade, than without. The more free the market, the less restrictions.
It's actually too oversimplified to be a great model for most things. Extend your intuition to imagine that you have perfect competition where there are infinitely many identical goods all competing to the lowest price either no differentiation, and people will price at zero profit. To extend that to the real world requires more and more complications like the time value of money etc
"Extend your intuition to imagine that you have perfect competition where there are infinitely many identical goods all competing to the lowest price either no differentiation, and people will price at zero profit. "
But this is not reality.
I doubt doing abstractions like these are helpful in understanding anything, when the base is so far off.
Right, never said that was attainable or good. The point is that some people view perfect free markets as the ideal, and this is a move towards that, so people might view the market as getting g fixed rather than being broken.
Basic economics. The problem with basic economics is that all models are wrong and there are not in fact infinitely many perfectly fungible producers of identical commodities in perfect competition with eachother, but under perfect competition, nobody makes economic profits.
Profit is market inefficiency, whether due to missing information or inadequate competition. Perfect efficiency drives prices down to the marginal cost of a good or service. Micro 101 stuff.
Zero profits in economic models are usually in the context of economic profits, not accounting profits. So yeah, kind of (though there's risk adjustment needed, but when you start bringing in real world stuff like that your econ 101 supply curve/demand curve abstraction really starts breaking down, there are far more sophisticated economic tools for that). Perfect competition doesn't also really exist so we're just being guided by the math.
"Profit is market inefficiency" Profit is motive to do something.
No profit = no motive.
"perfect efficiency" means "no market" in this definition. It's a make believe process that will literally never happen. Companies that work with perfect efficiency close their doors.
Well, sorta but um no. If no profit includes a situation where everyone involved is paid at least enough that they are willing to do the work, then there is by definition motive to do the work.
These economic models are simplistic to the point of stupidity. But motivation to do the work can be totally priced in to the equations as a cost of doing business. Profit beyond that is what must, in the models, end up at zero to be efficient.
Not necessarily the stock market, but yes of course all models are wrong. Some are useful though, including these models. You can see that a pharma company with a government granted monopoly with patent power has high gross margins, while a more undifferentiated retail firm like walmart has far lower gross margins. That understanding can be drawn from using these models to understand how businesses will behave under a set of given assumptions (they want to maximize profit etc)
Yep. Perfect markets dont actually exist in any realistic way, and the US constitution itself deliberately breaks perfect markets by providing for patents.
