Economists View on Monopolies and Their Effects
Economists have continually propelled the view that monopolies are bad for the economy from the consumer’s standpoint. The general view has been that the existences of monopolies result to misallocation of resources, redistribution of income in favor of the monopolists, and the loss in aggregate welfare[1]. These effects can best be demonstrated using the monopoly deadweight loss curve as shown below.
Figure 1: Monopoly Inefficiency
On the first effect, economists postulate that since monopolists have the power to control prices (price makers), they can produce less than optimum output to earn supernormal profits. That is, under monopoly, the price charged PM is higher than the competitive price PC. Secondly, monopolists redistribute income in their favor by “eating up” the consumer surplus as shown in figure 1. The initial consumer surplus was the large triangle PcQc, but the new consumer surplus is the smaller triangle PmQm. Finally, the existence of monopolies result to loss in social welfare as represented deadweight loss in the figure above. It is on the third effect that Arnold Harberger founded his revolutionary paper ‘Monopoly and resource allocation.'
Discussion
The reduction in aggregate welfare prompted one of the simplest yet revolutionary questions: by how much? Before ‘Monopoly and resource allocation,' the US made efforts to minimize the existence of monopolies which she deemed hazardous to the welfare of the American people. Policies such as heavy taxation, restricted trading practices, and the high cost of acquiring patents on pharmaceutical companies, cosmetics, tobacco, and automobile industries is an example of government intervention to control monopolies. However, Harberger uncovered a misconception on the view of the loss of welfare by monopolies.
In his article, Harberger concludes that: “Our economy emphatically does not seem to be monopoly capitalism in big red letters.” The conclusion emanates from a study of the US manufacturing industries between the period of 1924 and 1928. Harberger determined that the loss of welfare by monopoly misallocation of resources could not be more than a thirteenth of a percent of the national income. In today’s estimations, that value is $1.40 per capita[2].
Harberger’s assertions were revolutionary in the sense that it was the first documented research in defense of monopolies. But how true was his conclusion to which he admitted were shocking? Harberger argued that misallocation of resources arose due to the inefficiencies of the industries as opposed to the existence of monopolies. To that end, Harberger proposed the transfer of resources from low-profit making industries (which had too many resources) to high-profit industries. This argument is warranted by virtue that market inefficiencies exist due to policies such as high tariffs, trade barriers, and incomplete information, and existence of externalities, to name a few.
The conclusion “Our economy emphatically does not seem to be monopoly capitalism in big red letters” drew from the fact that many assumed that profits arose from monopoly power and practices. Harberger rightfully disqualified this assumption on two accounts: one, identifying monopoly power is possible by simply ranking the high-profit companies; and two, it is implausible that these high-profits are monopoly-driven profits.
Challenges to Harberger's Conclusion
While Harberger’s conclusion may be warranted, it relied heavily upon two assumptions that are otherwise erroneous and misleading. First, the degree of substitutability among products produced by different firms is not necessarily high. To that end, it is wrong to assume that they have a unitary elasticity of demand. Secondly, long-run costs are increasing for firms especially in the manufacturing industry as opposed to remaining constant. As such, obtaining a constant rate of return on capital invested is rather unrealistic.
Harberger arrived at the value of the loss of welfare by making the assumption of unit elasticity of the manufacturing products. The excess profits earned, therefore, served as the proxy for the amount of labor and capital to reallocate to ensure a constant rate of profits prevailed in the industry. With a constant rate of profits, it was possible to minimize the misallocation of resources that lead to a loss of social welfare. Suffice to say that the above approach was rather conservative and cautious on Harberger’s end.
There were certain factors that may have led Harberger to underestimate the loss of welfare while others might have led to an overestimation. Also, the study did not examine the redistribution of income effect arising from the existence of monopolies in the economy. Finally, the article was merely to point the fact that monopolies loss of welfare effects was rather insignificant as opposed to advocating for a policy change. Harberger only called for efficient resource allocation by manufacturing industries across the US. It is safe to say, therefore, that the results were not downwardly biased by its research approach.
Conclusion
Harberger’s seminal paper ‘Monopoly and resource allocation’ is one of the most significant studies in the field of economics. It was able to revolutionize the way economists perceive the problem of welfare loss under monopolistic markets. The conclusion that monopolies loss of welfare effect was exaggerated is indeed warranted. Nevertheless, future studies should look to further on the weaknesses of the research through the use of different approaches and assumptions to ensure that the findings by Harberger stand the test of time.
Bibliography
Harberger, A.C., 1995. Monopoly and resource allocation. In Essential Readings in Economics (pp. 77-90). Palgrave, London.
[1]
Harberger, A.C., 1995. Monopoly and resource allocation. In Essential Readings in Economics (pp. 77-90). Palgrave, London.
[2]
Harberger, A.C., 1995. Monopoly and resource allocation. In Essential Readings in Economics (pp. 77-90). Palgrave, London.
