Posted by Social Science Research Network
The Story of the Deadweight Loss and What Bathtubs and Swimming Pools Have to Do with Antitrust Adriaan Ten Kate Sr. (Independent)
Abstract: According to conventional wisdom, monopoly increases price and reduces output; it transfers money from consumers to producers, but consumers lose more than what producers gain; the difference is a welfare loss to society, known as deadweight loss. However, this is a partial-equilibrium story, applicable to a single product or industry; it does not account for spillovers to the rest of the economy. In a general-equilibrium setting with full employment of resources the effects of monopoly pricing are as follows. Nominal prices go up but real prices do not; output reductions in the industry are compensated by output increases in the other industries; transfers from consumers to producers depend on who the beneficiaries are of the monetary expansion necessary to keep resources fully employed and, finally, there is indeed a welfare loss, but only to the extent that monopoly pricing departs from average levels. If monopoly pricing is economy-wide and flat, there is no loss at all. It is not monopoly pricing by itself that causes the welfare loss; it is the disparity in monopoly pricing.
