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In perfect price discrimination, all mutually beneficial trades take place, the natural monopoly captures 100% of the surplus, and pareto efficiency is achieved.

However, I've read various sources that mention that, despite this, economists still advocate various taxes, regulations, or nationalization to "fix" the monopoly problem even in theoretical cases of perfect discrimination. Why would these things be advocated if pareto efficiency is achieved?

The only thing I can think of is that, while the lack of competition doesn't remove the incentive for a monopoly to innovate, it hugely slows down the rate of innovation, which would essentially rob society of potential improvements.

Is there anything to this logic? What inefficiency would exist if not pareto inefficiency?

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  • $\begingroup$ I think you have to give additional details about the model if you want to talk about innovation. Like what causes the monopolist to be a monopolist? Know-how, patent, etc. $\endgroup$
    – Giskard
    Mar 15, 2016 at 19:57
  • $\begingroup$ @denesp I edited to specify natural monopoly. Is that sufficient? $\endgroup$
    – B T
    Mar 15, 2016 at 20:32
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    $\begingroup$ I should mention I subsequently found this great paper on this topic: independent.org/pdf/tir/tir_10_3_02_shmanske.pdf $\endgroup$
    – B T
    Jul 5, 2016 at 9:38

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The question seems to be in between theoretical model and reality. In one type of theoretical model one may argue for the monopolist, in another against him. In reality it is worthwhile to mention that no monopoly can achieve first degree price discrimination. It is barely theoretically possible and not technically feasible. Other forms of price discrimination do not necessarily yield Pareto-optimal outcomes. Real world economists usually argue against monopolies in general, not against theoretical first degree price discriminating monopolies.

Even if there were such a monopoly there is an answer to "Why would these things be advocated if pareto efficiency is achieved?"

There may exist a multitude of Pareto-efficient allocations. A rather usual consideration for any social planner is some sort of fairness (or envy-freeness, or inequity-aversion, etc.)

In a setting corresponding to a monopoly with first price discrimination as you say all the surplus is captured by the monopolist. This is such a distribution of surplus/goods/utility that it will probably not meet any of the usual fairness criteria.

So while the monopolist might create an efficient allocation of goods, the allocation might not, and usually will not, meet secondary criteria deemed desirable by society.

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  • $\begingroup$ There is a political logic to that, but that logic doesn't seem very economic. Economists don't suggest anything of the sort for perfect competition where buyers get all the surplus. Are you essentially saying that the most politically feasible pareto-optimum solution is attempted to be chosen? $\endgroup$
    – B T
    Mar 15, 2016 at 20:35
  • $\begingroup$ @BT You ask "Why would these things be advocated if pareto efficiency is achieved?" I think fairness is clearly something that is advocated. I am not claiming that in reality a Pareto-optimal solution is chosen at all. $\endgroup$
    – Giskard
    Mar 15, 2016 at 20:45
  • $\begingroup$ @BT I reworked my answer a bit. $\endgroup$
    – Giskard
    Mar 15, 2016 at 20:55
  • $\begingroup$ Sure, I understand. But my question is about what economists do and should advocate - ie what is optimal for society. I agree fairness is good and often advocated, but what is fair in an economic sense here? Is that something that has any rigorous treatment in econ? $\endgroup$
    – B T
    Mar 15, 2016 at 21:08
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    $\begingroup$ As for perfect price discrimination, i agree its pretty much never technically feasible, but for the same reasons is not even optimal because of the real costs required to reach perfect price discrimination. Various lower degree price discrimination in combination can also achieve Pareto efficiency much more feasibly and so I simplified my question by only asking about the mostly-equivalent perfect price discrimination. $\endgroup$
    – B T
    Mar 15, 2016 at 21:11
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Actually, pareto efficiency is achieved even in a situation with a natural monopoly. The inefficiency is actually the fact that there are possible states more efficient than pareto optimums.

While with perfect price discrimination, you're right that there would be no deadweight loss, there is still the problem of lack of competition that you mentioned. The lack of competition basically means the evolutionary mechanism of the market likely can't work as well as in a market with many competitors (and therefore many possibilities for an improvement to be found, by chance or by skill).

Interestingly tho, there is economic reasoning that natural monopolies might actually have more incentive to innovate, since they can capture more of the value created via that innovation than a company can in a competitive market. This may counteract the lack of competition somewhat. It also should be noted that in any real situation of natural monopoly where government interference doesn't directly prevent competition, there are almost always at least a small number of competitors vying for the top spot.

There is the possibility that in vying for that top spot, companies may decide to do things that destroy wealth up to the amount of the surplus in order to obtain or keep that surplus. This would obviously be suboptimal.

I wrote more about this here: https://governology.substack.com/p/the-role-of-government-part-1

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