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Theory of Market Socialism. Definition Market socialism is an ES that combines public/social ownership of capital and market allocation. Public ownership of non-labor factors of production Decentralized decision making structure (firms & hhlds) Decentralized information structure

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Market socialism is an ES that combines public/social ownership of capital and market allocation.

Public ownership of non-labor factors of production

Decentralized decision making structure (firms & hhlds)

Decentralized information structure

Coordination by markets

Both material and non-material rewards

The most famous theoretical model of mkt socialism is the trial and error model proposed by the polish economist Oscar Lange

2. Theoretical Foundations—The Lange Model

Combines public ownership and a trial & error approach to determine output and equilibrium

State owns non-labor factors of production and consumer goods are allocated by market (state ownership and resource allocated by markets)

A more centralized version of market socialism

Three decision-making levels

-central planning board (CPB)

-industrial ministries


CPB initially sets all prices arbitrarily

enterprises face parametric prices just as perfectly competitive firms do

Firms follow mkt type rules. Enterprises instructed to

minimize costs

produce output at which MC=P

Result will either be a surplus or shortage

if surplus, price adjusted downward

if shortage, price adjusted upward

The CBP sets the prices and would adjust prices to equilibrium until supply=demand

Households supply labor

The CPB allocates social dividends (rents and profits):

to finance investment to achieve growth goals (state control over investment& the rate of econ growth)

to achieve distributional goals (with state ownership, the rate & direction of econ activity would be determined in large by state; distribution will be more even)

State decisions on sectoral expansion

Control of pricing can be used to correct externalities

Because the state manipulates prices, it will account for externalities. Decisions made at higher levels rather than lower levels will be better in terms of preventing environmental effects

State control over savings and investment would reduce cyclical instability

Critics of the Lange Model

Computationally inefficient

Unmanageable in practice—information needs too great; many tasks of the CPB leads to large bureaucracy

what motivates managers to follow the rules?

what motivates managers of perfectly competitive firms to follow the P=MC rule? Or to use resources efficiently;

How to make mrkts work when private individuals do not own capital.

Lack of managerial incentives

The Lange’s model has sparkled great interest b/c most existing socialist systems use a crude form of trial and error for the setting of prices at least for the consumer.

3. The Cooperative Variant of Market Socialism

Market socialist system in which labor participates in decisions at the enterprise level. The people should participate in making the decisions that affect their well being.

Major features of participatory economy-Vanek describes the major features:

enterprises managed by the workers

equitable income sharing

labor democratically decides how to distribute the enterprise’s income;

labor do not receive a fixed salary but the profit is divided equally

state owns non-labor factors of production

the workers must pay a fee, and the fee should not be minimal, but should reflect the scarcity, or opportunity cost

market coordination

decentralized decision making, mkt prices are determined by ss&dd

Producers make their own decisions based on mkt rules (as opposed to Lange, where CPB sets prices)

freedom in choice of employment

Where and what to work

The firm is free to hire or not to hire

Closer to a true market system than the Lange version of market socialism

prices set by markets, not by planners

From these characteristics is clear that the objective of the labor-managed firm will be different from a capitalist firm or centrally planned firm

Under capitalism, profit-max; centrally planned-the objective derives from the preferences of planners, communist party but not the workers.

Still socialist because of state ownership of non-labor factors

b) Modeling of the Cooperative Market Socialism.

Resources with exception of labor are owned by the state & the enterprise pay a fee to the state. Ss& dd determine the prices of producer and consumer goods. Enterprises will be managed by workers (or may hire a professional manager). Given these conditions the cooperative firm behave:

Objective to be maximized

maximize per-worker (or average) dividend (= revenue minus cost, not including labor cost)

Let Q be the quantity of output

L is the quantity of labor

K is the quantity of capital

If labor and capital are the only two inputs, the production function, which shows the relationship between output and inputs, is: Q = f (L, K)

In short-run case -variable supply of labor L and fixed capital K

The enterprise pays the government a tax (T) for the capital it is using

Since K is fixed in the short run, T is fixed

If we let Y = total dividend and P = the mkt price of the output, then Y= PQ - T

The firm will max per worker dividend Y/L = (PQ-T)/L

Max solution is: P MPL = (PQ-T)/L

Maximum net income per worker will be achieved when the amount of labor hired is such that the value of the MP of the last worker hired is the same as the average net earnings per worker

P MPL is the value of marginal product (VMP) of labor

At L1,VMPL > Y/L adding an additional unit of L will raise Y/L

Thus, to maximize per worker dividend, the firm must employ just that quantity of labor such that the VMP of labor is equal to the per worker dividend Y/L.

In long-run case-labor and capital are variable

r=rental rate per unit of capital

The firm will max Y/L = (PQ-rK)/L

K-amount of capital; r-charge per unit of capital

Max solution is: P MPK = r and P MPL = (PQ-rK)/L

Where P MPK is the value of marginal product of capital

If the VMPK is greater than r more capital should be hired to utilized until the return and the cost are equal (perfectly competitive firm)

Firm maximizes net revenues per worker

Households maximize utility to supply labor services.

Comparison with Capitalist Firm

Assuming profit (Π) maximization Π = PQ - wL - T

where w = wage

At the profit maximizing employment of labor P MPL = w

Value of labors’ marginal product equals wage

The cooperative model has been analyzed by Jaroslav Vanek (defend) and Benjamin Ward (criticized). Strong support for the cooperative features comes from Vanek who argues that the participatory economy is element of social evolution

Positive Features of Cooperative Model

Eliminates capitalist dichotomy between management and labor

Enterprises are managed by the workers;

Workers participate in decision making

Greater social justice in distribution of income

distribution according to decision of the workers involve

Firms will be more socially responsible

E.g. environment (pollution)

The workers who control a participatory firm live locally, they are more likely to “internalize” the externality of pollution and trade lower monetary awards for a better environment.

Criticism of the Cooperative Model (Ward)

theoretically rigorous , but its real world applications are limited

cooperative monopolist, inefficiency

If supplies big quantities of product and realize that, behaves as monopolist—hires less labor, produces less output and charges a higher price.

misallocation of labor

Ward argues that if two cooperatives, producing identical product, use different technologies there will be misallocation of labor that would not occur if the two firms were capitalist.

if VMPL = w and all firms face same wage, then all firms’ VMPL will be the same

no such mechanism to equate VMPs in market socialism

if VMP1 > VMP2 then greater value can be produced by reallocating labor from Enterprise 2 to Enterprise 1

motivation of managers

When the cooperative hires professional management how to motivate to follow the rules

4. The Performance of Market Socialism: Hypotheses

a. Income Distribution

State ownership, capital belongs to the state; worker-managed enterprises, the state must be paid a fee for use of capital, and the state would presumably divide such income among the population on a fairly equal basis.

more nearly equally under mkt socialism than capitalism

b. Economic Growth

Relatively high rates of growth since the earnings from capital will go back into economy, but need to consider if there is pressure on the state to put “social dividends” into current consumption and subsidy

Not sure of high investment rates


c. Efficiency

Individual participation in decision making, lack of monopoly, attention to externalities; therefore more efficient than capitalism

However motivation problems


d. Stability

Greater econ stability since the state will have greater control over the investment rate

But if it is difficult to adjust prices to equilibrium, macroecon instabilities associated with nonequilibrium prices might be experienced