Introduction

‘The main effects of monopoly are to misallocate resources, to reduce aggregate welfare, and to redistribute income in favour of monopolists.’ (Harberger, 1954: 2) It is for this reason that monopoly power is generally condemned by neoclassical economists. Super-normal profits generated in both short and long run are a function of supra competitive prices being charged. And although vast amounts of wealth accrue to monopolists in an economy, such market failures remain unsolved. The objective of this paper is to review and critique the various attempts at measuring the ‘Deadweight Loss’ and examine alternative views on monopolistic behaviour.

Monopoly

The Monopolist sets its price and allows the market to determine the quantity it will demand: ‘Law of One Price.’ Where a firm in perfect competition produces output at a price equal to its marginal cost [1] , the Monopolist produces where the marginal cost of each unit equals its marginal revenue. This results in a constrained level of output below that which would be supplied under competitive conditions, thus representing the inefficiency of the operation. Perfectly competitive markets are in this way viewed as being productively efficient since in the long run no firm could survive without producing at the lowest point on its average cost curve. In contrast, monopolists restrict output below the technically most productive level in order to raise price. (O’Toole, 2008) Clarke and Davies (1982) show that the extent to which price exceeds marginal cost can be related to the level of market concentration, as measured by the Lerner index. Since the demand curve is downward sloping,

< 0, the monopolist must reduce its price in order to increase output (sales). Marginal revenue is the price at which the monopolist can sell the marginal unit, reduced by a loss of revenue on output that could have been sold at a higher price.

being the elasticity of demand, which is in tandem with the fact that is negative.

Lerner’s (1934) index of market power: gives us the output decision of the monopolist:

The ‘Deadweight Loss’ welfare triangle shows the lost (Marshallian) consumer and producer surplus, while rectangle L represents a transfer of income from the consumer to the Monopolist. Such a reallocation is said to be Pareto inefficient [2] , and it is this welfare loss associated with Monopolistic behaviour that exposes it to such flak on the economic and political front. Deadweight Loss, however, places producers and consumers on the same plane, whereas the income transfer from consumers to producers is not considered a social welfare loss because it is offset by monopoly profits which accrue to owners of the monopoly firm. (Martin, 1994)

Estimating the Welfare Triangle

‘If this estimate is correct, economists might serve a more useful purpose of they fought fires or termites instead of monopoly.’ (Stigler: 1956: 34)

The premier estimate of Deadweight Loss is attributed to the pioneering work of Arnold Harberger (1954) at the University of Chicago. The American manufacturing industry was examined over the period 1924-1928, using a sample of 2,046 corporations which account for 45% of the manufacturing industry. The time frame was selected mainly for its stable prices and resemblance to long run equilibrium.