[Public Lecture Series] Economics #4 Market Oligopoly and Market Failure

Hello everyone!
Last time, we talked about the beauty of the market's "invisible hand," where prices are determined precisely by the balance of supply and demand. At the point where the graphs intersect, goods in society are distributed most efficiently. It seemed like a perfect system, didn't it?
However, today's theme is the dark side of the market, where that "invisible hand" completely breaks down.
The unit is "Market Oligopoly" and "Market Failure." By taking today's class, you will clearly understand the reasons behind the contradictions in modern society, such as "why do all companies set similar base rates for smartphones and prices for potato chips?" and "why can't environmental problems like air pollution and global warming ever be solved just by leaving them to the market?"
Let's take a peek at the "reality" of economics, which doesn't end with just pretty stories.

1. The Winning Strategy of Giant Corporations (Market Oligopolization)
The "law of supply and demand" we covered in the last class actually cannot hold true without the premise (perfect competition market) that "there are countless small shops and customers in the market, and everyone is competing freely." However, take a look at the real world.
How many "telecommunications carriers (network companies)" or "smartphone OSs" are there in Japan that you use?
You can probably only think of three or four, at most a number you can count on one hand.
As business competition continues, the cost per unit decreases as more goods are produced (this is called economies of scale, or scale benefits), so shops with greater financial strength become increasingly advantageous.
As a result, a small number of giant corporations proceed to market occupation (capturing market share) and create a state where they dominate the market. This is oligopoly. (*If there is only one company, it is called a monopoly).
Once this happens, the "invisible hand" from last time stops working.
Since there are only a few rivals, they start watching each other's reactions.

① The Forbidden Move "Cartel" and Reading the Room
The thing you must absolutely not do is collude behind the scenes.
A secret agreement that says, "Let's both raise our product prices by double starting next month. If we do it at the same time, customers can't escape, so we'll make a huge profit." This is called a cartel (corporate alliance). Of course, since consumers lose out significantly, it is strictly prohibited by law.
However, even without whispering behind the scenes (cartels), when the industry-leading company raises prices, other companies may "read the room" and automatically set their prices accordingly, thinking, "Oh, I guess we'll follow suit and set it around this much." This leading company is called a price leader.

② The Mystery of Why Prices Don't Drop (Downward Price Rigidity)
A strange phenomenon occurs. Even when technology advances and goods can be produced more cheaply, large corporations rarely lower their prices. This is because they know that if one company lowers its price, it will lead to a "quagmire war of price destruction," and everyone will lose money. In this way, in an oligopolistic market, a property where prices are difficult to lower (downward price rigidity) is created.
If they cannot compete on price (lowering prices), how should large corporations fight their rivals?
If the prices are the same, they have no choice but to differentiate themselves in other areas. They appeal by saying, "Our product is different from the others!" through design, features, brand image, idol commercials, and luxurious bonuses.
This is called product differentiation, and the intense battle in areas other than price is called non-price competition.
For example, think of cola or potato chips. The prices are roughly the same everywhere, but they are desperately appealing by releasing seasonal flavors or collaborating with popular anime. This is a typical example of non-price competition.
The law created to stop such excessive runaway behavior by large corporations and to restore healthy competition is the Antimonopoly Act. And the independent government agency that acts like the police of the economy, keeping a sharp eye out every day for "Are they forming cartels behind the scenes?" or "Are they engaging in unfair monopolies?" is called the Japan Fair Trade Commission.

2. The Limits of the "Invisible Hand" (Market Failure)
Well, up until now, we've been talking about how "large corporations are too strong, making the market weird," but from here on, we'll talk about how, even if everyone is competing in earnest, there are genres where the market mechanism itself structurally cannot circulate money well. This phenomenon, where society does not function well if left only to the market, is collectively called market failure. There are three major patterns.

Pattern ①: The Great Nuisance of "Negative Externalities"
In economics, causing trouble for someone "outside" the market (the relationship of buying and selling by paying money at a shop) is called negative externality.

• Case/Background: A factory produced cheap and convenient plastic products in large quantities and sold them cheaply on the market. Both the seller and the buyer were very satisfied. However, if that factory was dumping harmful smoke and wastewater for free, the surrounding residents would get sick, and the fish in the river would be wiped out.

Since the factory side doesn't lose money from their own wallet even if they pollute the environment (it doesn't become a cost), if left only to market rules (supply and demand), they will continue to emit pollutants. That is precisely why the government must intervene by regulating with laws or imposing fines.

Pattern 2: 'Public Goods' that no one produces
In the previous class, we talked about public goods (education, social security, police, national defense etc.). These are not at all suitable for market-based business.
What would happen to society if a private company started a 'paid police service for 100,000 yen per visit'?
It would become a society with terrible public safety where only the rich are protected, right?
Public goods have the characteristics of 'not being able to exclude those who haven't paid (non-excludability)' and 'not diminishing even when everyone uses them at the same time (non-rivalry)'.
Imagine a 'street light' illuminating the night streets. You can't do something clever like saying, 'I didn't pay, so I won't look at the light from this street light!' If it can be used for free, no one will spend their own money to build a street light. If left to the market, things necessary for society will never be produced, so this also becomes a market failure. That is why the government builds them with tax money.

Pattern 3: Deceived consumers 'Information Asymmetry'
Information asymmetry refers to a state where there is an overwhelming difference (imbalance) in the amount or quality of information held between the 'seller' and the 'buyer' of a product.

• An example directly related to real life: Suppose you go to buy a used car. The shopkeeper selling it says, 'This car has no accident history and is excellent!' but it might actually be a car with hidden defects that was submerged in water in the past. The professional seller knows everything, but you, as an amateur, cannot see through it, right?

If left to the market while information is unequal, buyers become afraid and cannot shop, causing the market to shrink. Therefore, in modern times, the government must create rules such as the 'Cooling-off system' and the 'Consumer Contract Act' to protect vulnerable consumers.

Today's 'Current Status' and Summary
In the era of Adam Smith, it was shouted that 'Laissez-faire is the best!', but our modern society is built on the bitter lesson that 'The market is convenient and fundamental, but if left alone, it will become oligopolistic, destroy the environment, and lead to a shortage of public goods. Therefore, appropriate rules and monitoring by the government are absolutely necessary.'
Let's organize today's points.

• Oligopoly In the market, downward price rigidity is created, and instead of price, non-price competition (product differentiation) intensifies. Monitoring this are the Antimonopoly Act and the Japan Fair Trade Commission.

• Market failure's three major causes are external diseconomies such as pollution, public goods such as police and parks, and information asymmetry, which is the difference in knowledge between sellers and buyers.

Do not be deceived by the beauty of graphs; look at the real distortions of society. That is the true fun of learning public economics.
Well then, that's all for today's class! Thank you for your hard work.