December 18, 2012

Production as Privilege: Introduction

Anyone can produce. What is harder is to get anything in return.

The difficulty we have getting anything in return for our production--getting paid for our handmade tea-cozy on Etsy, for our labor stocking the small appliance section at Walmart, or working the trading desk at an investment bank--is what I want to focus on for this series of posts. If it is all work, then why are some types of production better compensated than others?

The common story in economics, and our broader capitalist society, is that we are paid for our work exactly as much as the rest of the economy values that work. The infamous "invisible hand" idea argues that if we are paid for what society values, we will decide to produce what is valuable to society. This rationale serves to justify the system: it provides people with good incentives.

This marginalist/invisible hand story is certainly true, but it is perhaps not the whole story. The relationship between production and distribution (or rather, who gets the fruits of production) is complex and not something economics has done a particularly good job of explaining. In this series of posts I am hoping to lay out some conceptual tools and frameworks that may be of use to construct a better understanding. Or they may not--some will doubtlessly appear divergent or tangential. Please bear with me (and help me along the way) as I hurl mud at a wall, hoping to end up with a discernable shape. And maybe a better idea of what I am even trying to figure out.

I will do this as a series of posts since I have already worked on it for a while and am nowhere near done, and because serialization is the lifeblood of the web. For the first post, I am going to go over standard explanations (within economics) for economic profit as well as the concept of profit itself. Keep in mind that while I am writing about profit for firms, I am ultimately interested in the allocation of profit to individuals, whether as laborers or owners of firms. Distribution within firms is another step of the process that will be addressed later.

Conceptual Tools #1-3: Standard Explanations for Economic Rents

A foundational concept of modern economics is the "perfectly" competitive market, a market that perfectly matches supply to demand in order to optimally allocates resources. In a perfect market no producer is able to collect economic rents. If you are not familiar with the concept of economic rents, also known as economic profits, the first paragraph of the Wikipedia entry is a fine summary. Basically, making economic rents means getting paid more for something than it costs you to make it.

In the real world, firms are able to collect rents--investors invest and stocks pay dividends. Economics describes a number of reasons this happens, all centering around the idea that supply fails to meet demand, which in turn allows suppliers to charge more for their goods or services than they cost to produce.

1. First Mover Advantage and the Short Run
Supply often fails to meet demand because both demand and supply change frequently, and fast. If demand changes and a business is quicker to catch up than its competitors, this business gains "first mover advantage" and is able to charge more than it costs to make a product. Or if a business creates a new product that is preferable to old products on the market, they are likewise able to charge more. Businesses can also reduce costs in their production process, and if they do so faster than other firms then the market price of a product may remain above their costs.

In all of these scenarios, however, competition will in the long run drive these profits to zero, because new firms will enter new markets. The next two monopoly scenarios describe causes that maintain profit in the long run.

2. State Monopolies
The government often creates barriers that keep firms from entering markets. One of the most well-know and politically acceptible barriers is the patent system, which stops firms from entering markets for new inventions by firms that have patented their processes. The profits that they may realize from their monopoly position in a new, patented market are supposed to give firms an incentive to develop new products, and the public nature of the patent disclosure system is supposed to provide facilitate the eventual elimination of the monopoly.

3. Natural monopolies
Even in the long term, markets may be uncompetitive even without government intervention. Economics 101 courses list different types of markets: perfect competition, monopolistic competition, oligopoly, and monopoly. These types are differentiated by the type of supply they tend towards. The structure of suppliers is determined by technology, regulation, consumer preference, history, and other factors.

Economists typically simplify these factors primarily based on the cost structure of firms. They have a concept of "ideal firm size", which depends on the costs of production and the demand for a good at a variety of prices. Different markets and technologies are conducive to different firm sizes, depending on marginal costs of production and network effects. For a given market size, the "natural number of firms" can be determined by dividing the market size by the ideal firm size. This determines whether firms will be abundant or scarce and, accordingly, how much market power they will have and how much economic rent they will be able to appropriate.


These are some standard explanations for economic rents on a firm level. If we are concerned about distribution to individuals, then we will need to get into the labor market side as well; I will cover that in a future post. I am also going to bring up a range of other "conceptual tools" that will hopefully be of use examining the issue. I am not trying to challenge the standard model of economic rents so much as situate it with a broader conception of production and distribution in today's economy. There is, possibly, a lot more going on.


  1. Even though most readers are probably already up on the concept, it might be helpful to talk about the opportunity cost component of earning zero rents. Otherwise it could seem like the theory says nobody earns a living without having market power. It's not really getting paid for your work that's hard; My interpretation is that what's hard is getting paid more than the minimum amount required to incentivize you to undertake the work.

  2. This is a distinction I want to get into further in other posts focusing more on the labor side, but I think actually IS hard to get paid for your work. Or rather, it's not so hard to get paid for work per say, because work is could be informally defined as "something we would probably not be doing if we were not getting paid." However, out of all the things we can and would like to do, it's a pretty limited subset that we can get paid for. And we get paid for them *because* we have some market power.

    You can only talk about market power in labor markets in a limited way, because you end up bumping into minimum wages and what qualifies as earning "a living" and that sort of thing. These are socially determined because you don't have an easy formula for costs like you do in a business. (This idea was a big take-away from Assumptions.)

  3. That's a fair point. Out of the universe of things that one might get paid for, the subset that one actually can get paid for is quite limited, particularly given the messy reality of needing to get hired by picky employers to do most of them. So you already have quite limited access to ways to get paid from the outset, and then you have to compete for the right to get paid to do one of the few things remaining. Look at blogging, for instance, where I'd guess that fewer than one in a couple thousand people have distinguished their blogs sufficiently to derive income from writing them.