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This may be one of the more 'elementary' questions on this site.. But I really can't wrap my head around it and a search on the web hasn't yielded much.

Given that Pareto efficiency is defined as when the allocation cannot make any party better off without making anyone worse off, it seems that something like breaking up monopolies is in fact not a Pareto improvement, as it's making the consumers better off by making the monopolist worse off?

I'm inclined to say that antitrust measures are (theoretically) a Pareto improvement, because that's moving closer to the allocative efficient level in a perfectly competitive market. However I don't know how to incorporate the definition of Pareto improvement into this.

Would be extremely grateful for any help!!

Many many thanks, Shine

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First of all good question. I tried myself on that one, but if any other member of this wonderful site has additional input please also answer :)

In a monopol we know there exists a consumer who would be willing to pay a price for an additional unit of the good that is higher than the additional cost to produce that unit. Possibility of Pareto improvement: monopolist produces one additional unit and receives marginal cost from consumers. Giving away one unit for marginal costs does not make the monopolist worse off in the first case. But if the monopolist wants to sell an additional unit, he must lower the price not only for the last unit, but also for all remaining units. This is the result of one critical assumption: no perfect price discrimination. But from the perspective of a social planner one could produce an additional unit and find a trade where $MC \leq P$ by allowing the monopolist only to change price for its last produced unit. In absence of such a planner the monopolist falls back to the old logic.

This leads us to the definition of market failure: individual rational behaviour leads to collective irrational outcomes.

Pareto optimality is also a very narrow definition, take for example the Kaldor Hicks criteria which states: An economic policy measure is welfare increasing, if in the society as a whole, increases in benefits outweighs the losses of benefits. This simply means winners could compensate losers, or in other words the sum of gains needs to be greater than the sum of losses (independent from individual changes). This holds true for the destruction of the monpoly because sum of consumer and producer surplus will increase. The pareto criterium is often criticised to favourite the status quo, while Kaldor Hicks creates more possibilities for restructuring in exchange for violating the methodological individualism.

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  • $\begingroup$ Thanks! Would I be right to say that had it been a monopolist with first degree price discrimination, then that would be an available Pareto improvement over the simple monopolist equilibrium? And if we were to define Pareto efficiency using the Kaldor Hicks criteria then that would agree with our instinct of antitrust measures being Pareto improvements? Thanks a lot for your help! $\endgroup$
    – shine yang
    Jan 10 at 3:30
  • $\begingroup$ @shine yang yes the monopolist with perfect price discrimination creates a pareto optimal outcome. Regarding the second question i assume you mean the right thing but efficiency is the general concept and you can operationalise it by either using the the difinition that was proposed by Pareto or that one brought up by Kaldor Hicks. You cannot define Paretos solution to be the Kaldor Hicks definition nor the other way around. $\endgroup$
    – Armenthus
    Jan 10 at 12:07

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