Theory of Market Socialism

Theory of Market Socialism
1.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
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 FoundationsThe 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
-enterprises
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 practiceinformation 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 Langes 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.
a) Major features of participatory economy-Vanek describes the
major features:
enterprises managed by the workers

equitable income sharing
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
labor democratically decides how to distribute the enterprises income;

labor do not receive a fixed salary but the profit is divided equally
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)
8
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.
10
Comparison with Capitalist Firm
Assuming profit () maximization = 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.
11
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
12
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 with13
nonequilibrium prices might be experienced

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Theory of Market Socialism

-central planning board (CPB)

CPB initially sets all prices arbitrarily

Firms follow mkt type rules. Enterprises instructed to

Result will either be a surplus or shortage

State decisions on sectoral expansion

Critics of the Lange Model

3. The Cooperative Variant of Market Socialism

enterprises managed by the workers

state owns non-labor factors of production

labor democratically decides how to distribute the enterprises income;

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

freedom in choice of employment

Where and what to work

Still socialist because of state ownership of non-labor factors

b) Modeling of the Cooperative Market Socialism.

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

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

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

At L1,VMPL > Y/L adding an

In long-run case-labor and capital are variable

Firm maximizes net revenues per worker

Comparison with Capitalist Firm

Assuming profit () maximization = PQ - wL - T

Positive Features of Cooperative Model

Eliminates capitalist dichotomy between management and labor

Greater social justice in distribution of income

Firms will be more socially responsible

Criticism of the Cooperative Model (Ward)

4. The Performance of Market Socialism: Hypotheses

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