Economics 101

I believe I've used that title more than once before, and it's normally to trash the way economics is usually taught. But there are a few generally accepted ideas about how markets and capitalism work that get de-emphasized or completely overlooked in most public discourse.

I'm going to oversimplify a bit here, but the details I'm eliding don't matter very much. To put it simply, businesses set prices based on what people are willing to pay for their stuff. As Chucky notes, the situation of perfect competition and the situation of monopoly are different, but the preceding statement is still true, it just plays out differently. One detail I'm going to give short shrift to is that competition is never completely perfect and that there is a continuum between perfect competition and monopoly.

Anyhoo, either way, the more something costs, the less of it people will buy. It might be a luxury they don't really need after all, or they might be able to substitute something else, or they just might not be able to afford it. So a monopolist can't charge an infinite amount. Rather, they'll charge the amount that maximizes their profit, i.e. in simple terms the multiple of volume of sales times the profit per sale. Charge too much, and volume will go down and you won't make as much money. Still, if your product is in demand you can clean up. Note, however, that it makes no difference at all whether some part of that profit is taxed. The firm is still going to set exactly the same price in order to maximize that profit. If they tried to raise the price to compensate for the tax, their profit would go down and they'd end up keeping even less.

In a competitive market, sellers face an additional constraint, which is that if somebody else is selling the product cheaper, people won't buy yours. So the price is really out of your control. It turns out that in theory, the price will be driven down to the point that the net profit of the industry is zero. It won't quite look like zero because part of the cost of doing business is the return on invested capital, in other words in this theoretical perfect world what looks like profit would be identical to the discount rate or bond yield, which is not considered profit. In privately owned businesses, the proprietors pay themselves a salary, so for example over the long run farm price would include enough for farmers to make a living, otherwise nobody would be a farmer, but that isn't really profit either, it's compensation for labor, even though it's going to an owner.

So why are so many corporations profitable, and paying dividends and buying back stock? Why are there multi-billionaires? The answer is that there is imperfect or even no competition in many industries. Some of this is due to patent and copyright protection -- that's why drug companies can make a lot of money, as well as celebrity performers and writers, for example. Part of it is branding and marketing, e.g. people are willing to pay a little bit more for a brand they see advertised on TV. Part of it is barriers to entry -- if there are shortages of expertise or material or it just costs a huge amount to get into a particular business there won't be a lot of competition. There is a certain amount of natural scarcity as well. All sorts of reasons. We can argue about whether these profits are legitimate or good or bad but they'll probably always be with us.

Part of it, however, is collusion and price fixing, which is illegal but certainly happens.  But what has increasingly happened in recent decades is that big companies drive out or buy up competition. Lowes and Home Depot pretty much control their market. National Amusements (that's Viacom and CBS), Disney, TimeWarner, Comcast, News Corp, and Sony pretty much own the entire entertainment industry. Little known fact: 92.5% of all the toilet paper in the U.S. is made by just three companies. Three companies make almost all of the light bulbs. There are basically four food service contractors in the country, and four companies make our appliances (not mostly in the U.S., of course). You can read more about it here. 

One effect of all this is that what economists call the "rent" these companies are extracting is money that flows up from ordinary people into the pockets of their billionaire owners, and wealth is becoming more and more concentrated in the hands of a very few people. The way to fix this is to tax those profits. That's not going to do anything bad -- in fact it will encourage more investment because rather than being left with profits to be taxed, businesses will have an incentive to reinvest more of them. But those profits are ill gotten, and should be returned to the people.