Visiting central park recently, I had planned to rent a bike to travel round the area. By cycling through the park to various tourist attractions I could enjoy the beautiful scenery of the park, be safer than on the road, move faster than walking and be cheaper than other forms of transport. Central park provided a tourist’s free lunch. My plans were ruined when I saw that the price was $15 an hour, well above what I was willing to spend. Of course it all made sense when I saw a sign that read that only one licensed company could rent out bikes round central park. When the market price for renting bikes was $3 elsewhere, I thought that this was a classic example of states creating monopolies to gain higher revenue at the expense of the consumer and economic efficiency. I will here explain the economics behind my upset analysis and also the economics behind why I was wrong…
In a market in which there is perfect competition firms are price takers not price makers. With many cutthroat competitors selling at the lowest price they can and still be worth running, a firm cannot raise prices without losing all their customers and cannot lower prices without going bankrupt. This means that the price the consumer pays for a good is equal to the cost the firms experience in producing the good. Consumers in this market buy the socially optimal amount of the good; since, no resources are wasted on providing consumers goods that cost more than the consumer values them and there are no consumers left unhappy who do not buy the good if they value it more than the cost to the firm. In economics jargon, surplus, the difference between the prices firms and consumers are willing to take and the actual price, is maximised. If any business could compete to rent out bikes round central park, the price would fall from $15 to the cost of operating at $3. This would allow all consumers like myself who value cycling between $15 and $3 to gain. Central Park Authorities were not only making cycling too expensive for me, but were also being inefficient – a double injustice! But of course why would the authorities care about efficiency, when, by banning competition their licensed firm could raise prices and create great revenues for the park.
Counter-intuitively I believe the case for the government monopoly is probably better than allowing the market to be let free.
By allowing visitors of the park to contribute to funding it by renting a bike, The government can make users pay more relative to taxpayers. One benefit is that it may seem unfair that taxpayers who do not gain from the park have to pay for it, especially when a lot of the visitors are foreign tourists for which feelings of charity may be a rather lot lower. Furthermore, by funding the park through visitors, the park authorities will spend their money to make the park more enjoyable to gain more revenues. In effect by making the park more like a business it reacts to consumer preferences to invest in the park in relation to how much consumers value the benefits to investment. On the other hand, as some taxpayers use central park less they will also use others more. This means that you would expect some balancing out of everyone‘s tax payments to correspond more closely to what the government spends on them. Nonetheless, there will still be people who would much rather save the money, especially the poor and those who use fewer government services.
But this begs a question: why not privatise the park if we want it to be the consumers who pay for it? This would help to make the owners of the park be even more responsive to consumer preferences and stop cyclists being the unfairly targeted visitor who has to pick up the bill. The most important reason is that it simply would not be politically feasible. Voters like the fact the park is open for everyone; there is some sort of emotive attraction to it, be it because of a feeling of entitlement to a park or the sense of community of everyone contributing to it. Even on a more narrow economic argument, however, I am not sure charging visitors fees to enter parks would be good decision by for profit seeking park owners or their consumers. Having barriers to pay and upkeep creates enormous hassle. Did you remember to bring coins? Are other ways of excluding non-customers worth it? Imagine having security guards asking to see your Central park membership card as you are trying to make out on a rock… and chasing out teenagers who don‘t pay. Charging for other entertainment like park dance classes, carriage rides, advertising, shows, concerts… or bike rental would be smarter.
You can also attempt to charge visitors to the park through bike rental without creating a monopoly. Why not allow any number of firms to rent bikes around the park, whilst asking them all to pay a licence fee for operating? This indirectly charges some visitors to the park whilst also creating perfect competition and thus a perfect solution? You might argue that the monopoly works better at moving the funding to consumers and not taxpayers as it can raise prices on them, but you can just raise the fees to the many sellers instead to create the same revenue. The argument for limiting competition has merit if the firms’ experience economies of scale, providing the tenth bike is a lot cheaper than providing the first as you have already paid for equipment and staff you do not need any more of. With economies of scale it is wise to limit competition so bike rental firms have lower costs allowing the government to extract more funds for the park.
Related to the point about the bike monopoly being a good way to raise revenue for the park, is that it’s also generally a great way to raise revenue from citizens. One of Ricardo’s principles of taxation is that a tax should distort incentives as little as possible. If putting up stamp duty on housing creates huge disincentives to moving house, there is a huge opportunity cost from all the benefits of moving house. Making bike rental around central park a monopoly is a bit like raising a tax that has small effects on incentives. Demand for bikes in central park is price inelastic – only a few stingy tourists are going to stop renting a bike even though the price increased by 400%. Most tourists are there for a nice holiday and are willing to take the hit to their wallet. This means that cyclists who keep renting just have money transferred to the government. Very few people, like myself, who stop buying result in a loss to society by no longer providing revenue to the government and losing the gains from cycling. This means that the bike monopoly’s efficiency is hardly different from perfect competition, a lot more efficient than income taxes that reduce incentives to produce or stamp duty keeping many people in places they would rather not be.
Perhaps the best argument for this government monopoly comes from the theory of second best. The loss of welfare from limiting bike rentals through higher prices might be a good thing if cyclists actually reduce the welfare of others. The more cyclists there are in central park, the more traffic there is. This is annoying for pedestrians having to dodge bikes, parents whose children could get hurt, or the government by having to invest more in wider cycle paths. Because there is an external cost to cycling that consumers don’t experience, raising the price with a monopoly makes the cyclists internalise the costs they create for others. This ensures people only cycle if their joy of cycling is not only greater than the cost of providing the bikes, but also greater than the costs imposed to others. The inefficiency of cyclists not internalising the cost they give to others and the inefficiency of monopoly reducing output actually cancel each other out. You could argue that the monopoly over reduces output because the external costs of cycling are small, but the many other benefits described are surely more valuable? And if it is not sufficiently reducing output then the government needs to further increase prices, further going against my initial impression that the price was too high. There is a lot of wisdom to the phrase ‘Two wrongs don’t make a right’. But in economics sometimes ‘Two inefficiencies create efficiency‘.
Applying basic theories in economics can often lead to the wrong conclusions. PERFECT competition in this scenario is IMPERFECT. An irony, not for this post, is that it is rarely perfect. The monopoly is a good compromise way to ensure taxpayers pay less for parks they don’t use, park authorities invest appropriate amounts in the parks, governments can raise revenues at only a slight cost to welfare but most importantly, in this example, reducing output by monopoly actually raises efficiency.
Why didn’t I use some graphs or mathematical models to explain my thoughts? The models all exist and it would have allowed me to more precise about my points. I could have given visual descriptions of the exact sizes of net losses to society. I could have not used ‘cost‘ to ambiguously refer to marginal, average, net, gross, total, accounting and economic costs if I had a graph to explain which ones I was describing. . It would also have been a good way of checking my arguments. If I could not put my arguments into equations and graphs then I could have been fudging my arguments. Looking back on the piece, to someone who knows little (or quite a bit) economics, it is difficult to know that I have, in places, proven that certain gains/losses to surplus outweighed other gains/losses.
So let me explain why I chose not to use the maths:
1) It’s boring
2) It makes the piece much longer
3) I might have had to been explicit about distracting and uncontroversial assumptions like diminishing marginal utility for the demand curve, or increasing marginal cost.
4) The maths is not the best medium for intuiting certain economic principles. You can visually show perfect competition maximising surplus, but that doesn’t help much in giving you a feeling for why the loss of monopoly profits is outweighed by consumer gains
5) Related to 4), unless I as the author can explain important economic lessons just with words, then I am not intuiting those lessons.
6) This is not an economics exam, it is an analysis of a policy choice.