Welfare Losses of Monopoly and Oligopoly Welcome to ES3820 Welfare Losses of Monopoly and Oligopoly

Plan for Today Introduction Harberger (1954) Diagram Algebra Other Harberger type studies Limitations of the model The role of Competition Extensions Posner (1975) Cowling and Mueller (1978) Masson and Shaanan (1984) A broader approach/introduction and an alternative

Introduction Look at Welfare Costs Partial Equilibrium Next time Marshallian tradition CS ceteris paribus Aggregate up! Next time Rival approaches

How big are the potential gains to society moving from M to PC? Basic Model Harberger (1954) Traditional argument against monopoly Exploitation of market power QM < QC PM > (PC=MC) => Sub Pareto optimality Key question: How big are the potential gains to society moving from M to PC? Why important? Competition policy Costs of enforcing vs benefit from gain!

Simple Welfare Loss Q P PM AC=MC QC QM

Some maths! (1.) DWL= 0.5.DP.DQ DP= Change (Difference in P) between M and PC DQ= Change (Difference in Q) between M and PC (2.) m=(DQ/DP).(PM/QM) rearrange (solve for DQ) (3.) DQ=m (DP/PM).QM What is the relative price distortion under: Define M? (4.) M=(PM-PPC)/PM=DP/PM or M=DP/PM (5.) DP=M.PM We can sub (5.) into (3.) (6.) DQ=m M.QM Substituting (5.) and (6.) into (1.) (7.) DWL= 0.5(M.PM)(m M.QM)= 0.5(m M2.PM.QM)

DWL= 0.5(m M2.PM.QM) Thus “approximately” the DWL can be estimated using: M the price-cost margin m the market price elasticity of demand PM.QM market sales revenue Such results known but not really used for years Harberger (1954) uses to estimate DWL for US

Harberger proceeds by calculating the deviation of industry P rates for the average for all manuf.. These deviations were then translated into dollars of “excess profits” and expressed as a proportion of sales to give the value of M. Assumption m =1 PM.QM are calculated for each industry Each industry’s DWL calculated Then all industries added up! Harberger finds welfare loss in US manuf. (1924-28) $59m. Or 0.08% of GNP =>Welfare losses of monopoly not important!!! Or are they?

Cowling and Mueller (1978) C&M use firm level data on Price-Cost Margins use to give estimates of mi (I.e. PED for each firm!) and hence the competitive rate of return and level of excess Ps. C&M base their approach on 4. weaknesses in Harberger’s approach!

Firms max Pi via : Mi=(Pi-MCi)/Pi=1/mi or mi=1/Mi 1. By using separate estimates of PCM and m Harberger ignored the interdependencies between the P distortion and the Q distortion! Firms max Pi via : Mi=(Pi-MCi)/Pi=1/mi or mi=1/Mi If demand linear and returns constant (MCi=ACi=Ci) 0.5(m Mi2.Pi.Qi) 0.5((1/Mi). Mi2.Pi.Qi) 0.5((Mi).Pi.Qi) 0.5((Pi-MCi)/Pi).Pi.Qi) 0.5((Pi.Pi.Qi/Pi)-(Ci.Pi.Qi)/Pi) 0.5((Pi.Qi)-(CiQi) 0.5.Pi. DWL= half of monopoly profit!

Since rents are calculated in the calculation of mean Ps 2. C&M attack H for using competitive rates of return as the mean profit rate! Since rents are calculated in the calculation of mean Ps this overestimates the competitive rate this underestimates the monopoly rate Measuring deviations form the mean H effectively estimated the gains from equalizing the rates! C&Ms solution = an independently arrived at competitive rate of return!

If Advertising itself is viewed negatively one might DWL= A+(0.5(P+A)) 4. C&M also include an estimate of expenditure on acquiring monopoly position! Advertising! DWL= 0.5(P+A) If Advertising itself is viewed negatively one might DWL= A+(0.5(P+A)) Further they argue that after Tax excess profits P* might also be included as a measure of resources spend in competing for these profits DWL= P*+A+(0.5(P+A)) Estimates for WL in UK (7.2%) and US (13.1%)

C&Ms results also highlight the importance of some firms BP (0.25% of GDP) and Shell (0.09 of GDP)

Austrians Austrians critical of those who regard competition as a market structure and ignore the competitive process ignore the serious investigation of the sources of market power the ephemeral nature of market power except where granted by the state! Static equilibrium models of monopoly monopoly is eternal! No forces in the model to erode it! Dynamic process models highlight incentives given to discover new products/process

This quest for new monopoly costs “money” New products/processes by pass the old monopoly in search of a new monopoly This quest for new monopoly costs “money” Different - entrepreneurs will be better/worse at the this than others This has implications for understanding welfare calculations Social welfare is increased by the consumer surplus + monopoly profits A gain! - “The glass is half full” Alternative is 0 welfare from the market! Furthermore over time these Ps will attract entry Ps will be eroded and society gets full surplus!