1. Keith Cowling & Dennis C. Mueller (1978)
COURSE OF INDUSTRIAL ORGANIZATION
INTERNATIONAL BUSINESS ADMINISTRATION PROGRAM
PRESENTED BY: JC PHAM, ID: A1008300

2.  Introduction & Research Background
 Study Objectives
 The Four substantive Criticisms of
Harberger-type approaches
 Methodology & Empirical estimates
of the social cost of monopoly power
 Conclusions

3.  The monopolist charges a higher price than a
perfectly competitive firm would charge
 The monopolist also produces less than a
perfectly competitive market
 It is suspected that monopoly is not good for
consumers

4.  A monopoly (from Greek monos (alone or single) + polein (to
sell)) exists when a specific person or enterprise is the only
supplier of a particular commodity
 Characteristics
 Profit Maximizer: Maximizes profits.
 Price Maker: Decides the price of the good or product to be sold.
 High Barriers to Entry: Other sellers are unable to enter the market
 Single seller: the whole market is being served by a single
company, and for practical purposes, the company is the same as the
industry.
 Price Discrimination: A monopolist can change the price and quality
of the product. He sells more quantities charging less price for the
product in a very elastic market and sells less quantities charging high
price in a less elastic market.
 Sources of monopoly power: three major types of barriers to
entry; economic, legal and deliberate. In addition barriers to
exit may be a source of market power.

5.  Attention to the social welfare loss under monopoly
conditions was led by the pioneering work of
Harberger in 1954
▪ 0.1 of 1% of GNP of USA
▪ Schwartzman (1960), Scherer (1970),Worcester (1973)
 Subsequent writers have considerably expanded our
understanding of the extent of the losses involved
 Kamerschen (1966): the estimate as high as 6%
 Posner (1975): the real problem “the social cost”, as much
as 30% of industry sales in some industries
 Abram Bergson (1973): a “general equilibrium model” with
2 key parameters as an alternative & a series of
hypothetical estimates of welfare losses from monopoly

6.  The monopolist will sell a lesser quantity
of goods at a higher price than would
companies by perfect competition
 Monopoly pricing creates a “deadweight
loss” (DWL) referring to potential gains
that went neither to the monopolist nor
to consumers
 It is often argued that monopolies tend to
become less efficient and less innovative
over time, becoming "complacent“
 This very loss of psychological efficiency
can increase a potential competition
 The theory of “contestable markets”

7.  Traditionally the social loss has measured in terms of
the deadweight loss (DWL) of monopoly, that is
costlessly created and maintained
 The opportunity to earn monopoly rents results in
resources being invested in unproductive activities in
their pursuit that “rent seeking” behaviors occurs
(Tullock;1967).
 Furthermore, resources may be expended wastefully
by opponents to the creation of a monopoly; in other
words, a reaction such as "rent protection" may be
provoked.
 Monopolists will incur both strategic and administrative
expenses

8.  Level several objections against the
Harberger-type approach
 Calculate estimates of the welfare loss
from monopoly, empirical in US and UK
industries
 Employ a partial equilibrium framework
with all the necessary assumptions it
required (Bergson, 1973)
The welfare losses from monopoly are
really Significant!

9.  The interdependence of dpi and dqi
 The measurement of monopoly
profits
 The aggregation biases from using
industry data
 Welfare loss in the acquisition of
monopoly power

10.  In the partial equilibrium formula
for welfare loss is
1/2dpdq, where low value of dp
were observed & low value of dq
were assumed:
 If ti is small, thenWL is
insignificant
 In Harberger’s case, the price
elasticity of demand in all
industries were unitary
 Small estimates of welfare loss

11.  Assuming profit maximizing behavior:
 Price elasticity E = Pi/(Pi-MCi) (1)
 Using (1), we obtain welfare loss (WL) estimate by
individual firms from their price/cost
margins, giving the change in its output implied by
Ei
 To the extent other firms also charge high prices, the
totalWL associated with firm i’s market power exceeds
the welfare loss we estimate
 Since Harberger observed low values of dpi and yet
chose to assume that Ei = 1  dqi was also very small

12.  Assuming interdependence: the WL is calculated by:
 dWi = ½ dpi/pi x dqi/qi x piqi (2)
Where: dpi/pi = 1/Ei and dqi/qi = Ei x dpi/pi = 1
Therefore: dpi piqi
dWi = x (3)
pi 2
Then assuming constant cost, we can rewrite (3) in term
of profits:
∏i piqi ∏i
dWi = x = (4)
piqi 2 2

13.  The obvious measure of monopoly profit is the excess of actual
profits over long-run (LR) competitive returns.
 Economic in equilibrium: the competitive rate is the minimum profit rate
compatible with LR survival
 Monopoly profit is thus the difference btw actual profits and
profits consistent with this minimum rate with:
 All would earn profit equal or greater than the minimum
 Actual estimateWL under monopoly using perfect competition as the
standard of comparison
 While Harberger & all subsequent studies: based the monopoly profit
estimate on the size of the deviation btw actual profit rates and the
mean rate, i.e. an industry whose profit rate was 5% below the mean
profit rate was considered to have created as large a WL as an
industry whose profits are 5% above the mean; and assumed the
degree of monopoly equalized across all firms therefore the estimate of
WL is biased downwards.

14.  Previous studies used industry data at a fairly high
level of aggregation, including earning negative
economic profit firms
 Implicitly assumed that the monopoly profits earned by
the most profitable firms in the industry are somehow
offset those experiencing transitory losses
 The estimates of all previous studies through the
assumption of a constant Ei across all industries
 The profit margin’s appearance as a squared term in the
welfare loss formula & further biases the WL estimate
downwards!

15.  The previous studies underestimate the social
costs of monopoly by failing to recognize the costs
involved in attempts to gain & retain monopoly
power
 Form of investment in excess production
capability, excessive ads or R&D activities…
 Estimate ofWL therefore underestimate social costs of
monopoly in 2 ways:
▪ Understating monopoly rents  understate the distortions in
outputs monopoly produces
▪ Failing to include these additional expenditures as part of the
costs of monopoly

16.  Three adjustments to measureWL :
 Advertising is added to monopoly profit
 All of advertising is added to the welfare losses, this
takes the extreme view that ads as merely an
instrument for secure market power
 All of measured, after-tax profits above the
competitive cost of capital are used as the estimate of
the expenditure incurred by others to obtain control of
the monopoly rents

17.  Let C0 be observed
costs, including investment-
type outlays & P0 observed
price that consistent with
monopoly firm’s demand
schedule D0
 Under more inelastic demand
schedule assumption, both
profits (∏) and welfare loss (L)
are much larger
 An alternative procedure for
calculating WL: estimate
Price/cost margins from data
on demand elasticity?

18.  Provide two sets of estimate, one based on our
assumptions (∆Wk
CM) , the other based on Harberger-
type assumptions (∆Wk
H), both measured at the firm-
level, in US & UK respectively
 Range of four estimate define as following:
 K=1, the one (∆Wk
CM) based on interdependence of dpi and
dqi, the other (∆Wk
H) based on the Harberger methodology
 K=2, the same calculations are performed but in calculating
dpi, ads expenditure (Ai) is deducted from cost
 K=3, we add in Ads as a social cost
 K=4, we also add in monopoly profits after-tax as a further
element of social cost.At this point, the appropriated profit
measure is before tax profit

20.  Sample: companies operating in both intermediate & final
goods markets
 Assumption of demand schedule for an intermediate represents
a derived demand schedule (Marshallian model)
 To estimate monopoly profits: using the return rates in
stock markets:
 Regarded to be fairly close to satisfying the free-entry and – exit
requirement of a competitive industry
 All existing monopoly rents are fully capitalized at the beginning
of the period
 Changes in monopoly rents over the period are accurately
anticipated
 The estimate of the competitive return on capital:
▪ in US :The Fisher- Lorie index of returns (1963-1966): 12%
▪ In UK:The pretax real cost of capital from 1968-69 (Flemming et al.; 1976):
8.15%

21.  The sample of 734 firms on the COMPUSTAT tape in
1963-6 period
 The firms are ranked according to the size ofWL as
measured by ∆Wk
CM
 GM lead the list: annual WL over $1.78billion (>1/4 of 1%
of average GNP during the period)
 Most of the other of the top20 are names expected
 6 of 40 largestWL are accounted for by regulated firms ( 3
telephone companies & 3 airlines) in which ads made up all
or most of the losses
 The obtained estimates ranging btw 4 and 13% of GCPVS.
the range from 0.4 and 7% for the Harberger approach

23.  The same basis as the US estimates, contenting with
an analysis of the top 103 firms in the UK from the
periods 1968/9 and 1970/4, these firms were
responsible for roughly one-third of the GNP
 Ads expenditure was estimated by aggregating up
from the brand level (TV & press)
 BP& Shell dominate the table, whichWL associated with BP
alone is roughly a quarter of 1% of GNP
 The results of periods 1970/4 look much like the 1968/9
despite the rapid inflation in UK in this time
 The aggregate estimates ofWL for ∆Wk
CM range btw 3.9
and 7.2% of GCP for the 1968/9 periodVS. Harberger
approach estimates ofWL btw 0.2 and 3% of GCP

25.  The evidence suggest that significant welfare loss
due to monopoly power
 Any attempts to take large amount of
investment-type expenditures beyond the ads
and adjust demand elasticity accordingly, while
maintaining the assumption that companies do
posses and exercise market power will lead to
larger estimates ofWL.
 The implications of potential important
policies, ex: antitrust towards to most significant
contributors to these losses

26.  Tirole, J., (1988) : TheTheory of Industrial
Organisation, MIT Press, Cambridge (MA).
 Krueger,A. (1972) : "The Political Economy of Rent
Seeking" in American Economic Review.
 Posner, R., (1975) : "The Social Costs of Monopoly
and Regulation" Journal of Political Economy.
 Alan Dunne, Rent Seeking and the Social Costs of
Monopoly, visit
http://www.maths.tcd.ie/local/JUNK/econrev/ser/ht
ml/rent.html on 26Nov, 2012
 Monopoly, visit
http://en.wikipedia.org/wiki/Monopoly#Sources_of
_monopoly_power on 26Nov, 2012

27. THANK YOU VERY MUCH
FOR YOUR ATTENTION!
ANY COMMENTS &
QUESTIONS PLEASE?