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Mathematical Economics Assignment on Arnold Harberger, ‘'Monopoly and Resource Allocations’’ Is still the Harberger’s work warrented? Luigi Pucci 12668079

The American economist Arnold Harberger, in an article published in 1954 entitled “ Monopoly and Resource Allocation ” which would have changed the world of traditional economics, inaugurating a new school of economic thought, the so-called Chicago School. What differentiated this school of thought was the break with the past, aimed at a structural approach, bringing a new, empirical method, through the use of a graphic model. In particular, Harberger's study proposes to analyze the effects of monopoly deadweight loss, calculating the latter through the famous deadweight loss triangle renamed Harberger's triangle for the unprecedented and effective use that the American author made of it. This method is nowadays used and studied by all economics students in the world. In this essay, I propose to analyze whether the paper written by Harberger is still warranted or not. In his work, Harberger refers to the American manufacturing industry, assuming that monopoly creates a disadvantage in terms of prices and resources, drawing on a previous study from Professor Ralph C. Epstein’s, Industrial Profits in the United States (National Bureau of Economic Research,1934). Epstein takes into consideration the five years between 1924 and 1928. Why specifically this period? Harberger needed to find a time when the market was in a longrun equilibrium or any case a period close to equilibrium. In these circumstances, the five-year period analyzed is ideal as it occurs before the Great Depression. Therefore, analyzing the data of 73 industries, Harberger calculates the deadweight loss of the monopoly that, according to the writer, cannot be done with precision, but only by giving a general view and understanding. It is worth mentioning that the industry data first considered by Epstein and then used by Harberger are accounting data. The American author, consequently, produces three fundamental premises: the average cost is equal to the marginal cost, meaning that each industry operates according to the same cost mechanism. Secondly, the elasticity of demand is equal to 1, and consequently, in a graph, the demand curve is straight downward sloping. The last assumption states that the return on capital is 10%. Based on the data of the 73 industries taking into consideration, Harberger tries to calculate the total welfare loss multiplying the percentage of sales with the divergence of normal profit and then by dividing that outcome by two, the result is as follows: the total welfare loss is 550 million dollars, however, since Epstein's study only covered 45% of the manufacturing industry, Harberger had to assume that the characteristics of the remaining 55% were similar and therefore as a final result we have 1.2 billion dollars, the consideration of 0,1% of the American economy in that day (less than a tenth of a percent of the national income).

Even the economist himself was surprised and amazed by how little the deadweight loss is, compared to the whole economy (Harberger, 1954). Hence now, after having analyzed Harberger's scheme, I would like to make some criticisms and to highlights some inconsistencies. Firstly, Harberger assumes that the price elasticity of demand is unitary, this inevitably leads to a negative value of the welfare loss, distorting the real value of the latter ( low values of dp means low values of dq). The change in price to monopoly and the change in quantity, in Harberger's view, are considered independent, when in reality they are interdependent. (Cowling, & Mueller, 1978). Another problem I would like to raise is, as I mentioned earlier, that Harberger needed to find a historical period of stability in which there was a long-run equilibrium and a price equilibrium. However, this is not always plausible, and indeed the theorem is not always applicable, since the variables are numerous, for example, the great depression which occurred immediately after the period analyzed by Harberger. Furthermore, the data analyzed by Harberger does not consider inflation. Although it can be said, to the detriment of the American writer, that elasticity of demand is taken into consideration only for convenience, to simplify mathematical calculations. Moreover, we shall consider what Harberger himself clearly pointed out in his article, what he intended to confer was a comprehensive vision and he did so, commendably for his time, quantifying deadweight loss as no one had done before. Therefore this study must be taken for what it is since Harberger himself was aware of the approximations due. Nevertheless, it is clear from my conclusions that Harberger's work cannot be considered warranted, for the reasons expressed above. Although his method may have been innovative, in 1954, turning the approach to economics by bringing an empirical method that is unprecedented.

References: -Cowling, K., & Mueller, D. (1978). The Social Costs of Monopoly Power. The Economic Journal, 88(352), 727-748. doi:10.2307/2231975 - Harberger, A. (1954). Monopoly and Resource Allocation. The American Economic Review, 44(2), 77-87. Retrieved October 11, 2020, from http://www.jstor.org/stable/1818325

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