Saturday, June 22, 2019

Deadweight Loss or Utopian Benefit?

I am in Colorado attending the Law & Economics Center’s 34th Economics Institute for Law Professors. It’s a fantastic conference, and I highly encourage you to attend if you can. You can view this year’s agenda here. (If you have trouble with the links, try a different browser.  If that doesn't work, let me know.)

This past Wednesday, during the “Economics of Innovation and Dynamic Competition” class, Prof. John Yun discussed the difference between static and dynamic models of competition, and how this might impact our assessment of monopolists. One aspect of this discussion focused on the concept of “deadweight loss.” For those of you not familiar with this concept, go watch the following 3-minute video from “ACDC Econ”: .

The video provides the standard assessment that monopolies create “deadweight loss” and that this deadweight loss is inefficient. Consequently, the conventional wisdom is that government regulation/intervention is therefore justified. However, this analysis is based on comparing the expected behavior of a monopolist with a static model of perfect competition. One of the problems with using a static model is that it fails to take into account where we’ve been or where we’re actually likely to go. A more dynamic view might prompt questions such as, “If monopoly pricing power didn’t exist, would we ever get the innovation that creates monopoly power in the first place?” Or, “If perfect competition rarely, if ever, exists in the real world, why are we using it as a benchmark for regulation?” Put another way, does it really make sense to regulate away the incentive to innovate that is created by monopoly pricing power (and the accompanying consumer and producer surplus) merely because we theorize that if we lived in the magical world of perfect competition we’d have even more surplus?

The foregoing led me to ask whether it might not be better to use “utopian benefit” rather than “deadweight loss” to describe the difference between what we get with monopoly pricing as opposed to what we’d expect to get with perfect competition. It is natural to react to a “loss” of surplus as something that should be made up, corrected, or restored – but calls to put innovation at risk in order to pursue a “utopian benefit” might lead to more appropriate caution and humility when it comes to regulation.  Let's see if we can get "utopian benefit" to catch on as an alternative to "deadweight loss."

Stefan J. Padfield | Permalink


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