﻿ Prices and Wages in an Economy of Oligopolistic Market Structures
San José State University

applet-magic.com
Thayer Watkins
Silicon Valley
USA

Prices and Wages in an Economy
of Oligopolistic Market Structures

## Background

A previous study explained why increases in the minimum wage may not increase real wages by considering what happens to the price a monopoly charges when consumers' incomes increase. It was found that if consumers' income increases by x percent and a monopoly's marginal cost increases by the same x percent then the monopoly will raise its prices by x percent. This not because they have to increase their prices but because they can get the higher prices without any loss in sales.

Industries are not typified as monopolies (single sellers) per se, but they do involve what economists call monopolistic competition. Monopolistic competition includes the situation where the market is divided up into trade areas and within a trade area there is only a single seller. The single seller can function as a monopolist as long as the other competitors in the market also function as monopolists and the trade areas remain stable. But monopolistic competition is more general and includes the situation in which there is product differentiation.

Monopolistic competition characterizes most retail business, as in the case of supermarkets. In the case of services stations and fast food outlets there may be multiple sellers in nearby locations but they function as a cartel which accepts a division of the market and avoid price competition with each other. A cartel is just multiple firms functioning as a monopoly.

Provision of governmental sevices is typically a matter of monopoly per se although for smaller cities within a metropolitan area there is an element of monopolistic competition. Public sector monopolies do not function exactly in the same way as private sector monopolies but the respond increases in costs or increaces in what their clientel can pay.

This material is to extend the analysis to markets in which there are a specified number of competitors; in other words oligopolies.

## A Simple Model of Pricing by an Oligopoly

Suppose the demand function of the market is linear and is given as price p as a function of quantity sold q.

The price established by the oligopoly is then

#### p = (1/(n+1))a + (n/(n+1))c

This result includes the case of monopoly as the special case of n equal to 1

The above can be applied to each of the industries. Let N be a diagonal matrix with the numbers of competitors in the various markets nsub>i on the principal diagonal Then column vectors P,. A and C, for prices pi, the demand parameters ai, and marginal costs ci satisfy

#### P = (I + N)−1A + (I + N)−1NC

Note that the sum of coefficient matrices for A and C ia

#### (I + N)−1 + (I + N)−1N = (I + N)−1(I + N) = I

The above rule is that oligopoly price is a weighted average of marginal cost and maximum price that can be obtained for the good or service.

## Marginal Costs

Let qij be the amount of the output of the j-th industry required per unit of output of the i-th industry and rik be the amount of the k-th labor service required per unit of output of the i-th industry, Then

#### C = QP + RW

where W is the column vector of wage rates.

## The Levels of Consumer Demand

The levels of the inverse demand functions are given by the parameters ai are assumed to be proportional to consumers income y; i.e.,

#### ai = ygiand hence A = yG

Consumers' income is assumed to be all wage income, thus

#### y = LTW

where L is the column vector of the K employed labor amounts and LT is the row vector which is the transpose of L. For the moment it is assumed that L is given exogenously.

## Equlibrium Prices

The above expressions for A and C may be substituted into the equation for prices giving

#### P = (I + N)−1G(LTW) + (I + N)−1N( QP + RW) which leads to (I−(I + N)−1NQ)P = [(I + N)−1GLT + (I + N)−1NR]W

where I is the identity matrix.

Let the above matrix equation be represented as

#### HP = [JGLT + KR]W and hence P = H−1[JGLT + KR]W

Let the matrix premultiplying W in the above equation be denoted as M. Then P=MW.

## Effect of a Proportional Increases in Wages

Suppose the government can set all wage rates and increases all wage rates by a proportional amount x; i.e.,

#### W' = (1+x)W

Then from the above the new prices are given by

#### P' = MW' = M(1+x)W = (1+x)MW = (1+x)P

Thus the ratios of prices to wages rates remain unchanged and likewise for the ratios of wages to prices, the real wage rates remain unaffected.

Here is the time series on the real wage rates

The previous analysis presumed that the utilization of labor services L remained constant when all wages were increased by a constant fraction x. Under this assumption prices all increase by the same constant fraction x. This means that for W'=(1+x)W

is a solution.

## Computation of the Effect of a General Increase in Wages on Employment

The vector of the utilization of labor services is given by

#### L = RX

The inverse demand functions have the form P=A−BX, were B is a diagonal matrix. In order for P' to equal (1+x)P at the same value of X when W→(1+x)W it must be that A'=(1+x)A and B'=(1+x)B. In particular this will give the same X* at which P=0 for W and (1+x)W. For more on the effect of a proportional income increase on A see Inverse Demand Functions.

Given that P=A−BX, outputs are given by

#### X = B−1(A−P) and hence X = B−1(A− ((I + N)−1A + (I + N)−1NC)) and furthermore X = B−1((I− ((I + N)−1)A − (I + N)−1NC))

If B'=(1+x)B then

Therefore

#### X' = B'−1(A'−P') = B'−1[(I−(I + N)−1A' − (I + N)−1NC'] which reduces to X' = (1/(1+x))B−1((1+x)(I −(I + N)−1)A − (1+x)(I + N)−1NC) and further to X' = B−1[(I − ((I + N)−1)A − (I + N)−1NC) = X

Since X'=X, L'=RX' is equal to L'=RX=L .

Thus as a result of W→(1+x)W

#### X → X L → L y →(1+x)y A → (1+x)A B → (1+x)B C → (1+x)C

And real wage rates remain constant. Thus, to the extent that prices are set by oligopolistic structures, an increase in nominal income through wage increases set by fiat is canceled out by price increases. Therefore it would not be surprising if real wage rates remained constant despite increases in the federal minimum wage. Here are the relevant.graphs.

Real increases in income in such an economy can only come through real changes in the economy such as increases in productivity, improved competition in terms of trade areas or reduced supplies of labor.

(To be continued.)

## Conclusion

There may be market forces connected with general oligopolistic competition throughout the economy that prevent measures like increases in the minimum wage rate from increasing the average real wage rate.

Any notion of price increases driving up wages is canceled out by wage increases driving up prices through increased costs and higher demand.