Adam Smith’s
‘invisible hand’, attains a Pareto-efficient allocation of resources.
But most
real-world markets violate at least some of the assumptions which
underlie the
economists’ idealised free-market model. Such deviations of real
markets from
the efficient model economy are called ‘market failures’. Market
failure can
arise for four main reasons: 1. monopoly power, 2. externalities,
3. public goods, and 4.
information asymmetries.
Monopoly power
The distortionary effects of monopoly have
already been analysed.
Monopoly
involves a breach of the rule that marginal cost # price by introducing
a wedge
between marginal cost of production of a good and the utility it provides
the marginal
consumer as measured by prices. Monopoly pricing also creates an
income
distribution effect. Monopoly profits are earned at the expense of the
consumers, who
pay a higher price relative to what they would pay in a competitive
market. This
is the reason why consumer organisations oppose monopolies
and cartels,
and lobby their governments for stricter competition legislation.
However, the gain of monopoly producers at
the expense of consumers can
involve
serious losses at both domestic and international level. The World Bank
has estimated
that cumulative overcharges to developing countries over the life
of the cartels
in vitamins, citric acid, lysine ,steel tubes and graphic electrodes ranged
from $3bn to $7bn._8 Uncompetitive behaviour also reduces economic efficiency.
As we move from a competitive situation, with a large quantity supplied at a
low price, to a monopoly, where a smaller quantity is supplied at a higher
price, what occurs is not a zero-sum redistribution of income from consumers to
producers, but a net loss of utility to society at large. This is the
‘deadweight loss’ of monopoly.
The deadweight loss, as described above, is
a static phenomenon relating to the
market
situation at one point in time. Empirical estimates of the deadweight
losses caused
by existing monopolies or oligopolies typically amount to only
a few
percentage points of the values of total sales in the particular industry.
A forerunner
in trying to measure the deadweight loss, Arnold Harberger was surprised to
find that such welfare losses amounted to a mere 0.1 per cent of US
national
income in the 1920s._9 Later, detailed studies have come up with much
higher estimates,
though these have been subject to a wide range of variation.
As readers will recall from Chapter 7, the
efficiency losses from monopoly
occur over
time. Monopolists or oligopolists have less of an incentive than competitive firms
to maintain efficiency, to innovate and to improve their services.
Indeed, as
Hicks once noted in a famous dictum, ‘the greatest of monopoly profits
is a quiet
life’._10 This is a central theme of the Austrian School .
The pressure of
competition
forces firms to aim at lowering their costs continuously,
while
sheltered firms do not have to be so concerned about their costs and the
improvement of
output quality. The losses due to such so-called X-inefficiencies
are even more
difficult to estimate empirically than deadweight losses.
Nevertheless,
in many circumstances they outweigh the deadweight losses
stressed by
economic theory. The Cecchini Report, for example, estimated that
the
X-efficiency losses of nontariff barriers on intra-European trade amounted to
2 per cent of GNP in the late
1980s.
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