NP - Klimt 1918 - Dopoguerra
Yesterday while I was walking home, on the side of the road I saw...a brain. Yep, a brain, all pink and wrinkled and, well, rather naked. It was interesting; something different from the usual twigs and leaves and litter. I actually stopped to get a closer look. Obviously it wasn't a real brain: plastic, looked like one of those fake brains they have in schools to teach schoolkids anatomy. It was pretty cool though; should have take a picture, but I didn't think of it at the time.
Anyway I've had this question on my mind for a while now. Its an Economics thing, but its very basic (for those of you who aren't interested, thats you're que to stop reading!).
We're taught that having an infinite number of firms in the market, each of whom is small and has no market power, is good. With such a large number of small firms, each one is a price taker, i.e. they dont affect the price of the good. Price is determined by costs, so that, in a perfectly competitive market, the price equals the marginal cost. Firms thus make zero profits. This maximises consumer surplus and minimises producer surplus. Total welfare is maximised, with zero deadweight loss.
Consider the other extreme, a monopoly. The monopolist can set whatever price he chooses - to maximise profit, he sets his price so that marginal cost equals marginal revenue. This creates profits for him, and so there is a producer surplus. Consumer surplus falls , and - this is the important bit - total welfare falls, as this creates a deadweight loss.
We aren't told, in real terms, what a deadweight loss is. We're taught that its a drop in welfare. Theoretically, this works. But I try to figure it out in real terms. What is a 'loss in welfare'? If we look at welfare strictly as money, well, in a closed economy (an economy with no international trade), the money isnt going anywhere. It stays within the country. Lets look at deadweight loss due to taxes and large government regulation and that. Without getting into details, this causes a deadweight loss, because we (consumers) are paying more of our money in taxes to the government. But this money isnt 'lost'. It goes to pay the lawyers, judges, civil servants, etc. The people who work in the courts to administer this rules, the people who work in the regulating bodies in order to enforce fairness of trade, etc. The money is being redistributed, isnt it? In the case of a monopoly causing deadweight loss, well, lets say a firm is ' inefficient', that is to say, its costs are not as low as they may be. It spends more on wages, equipment, etc., and thus the price of its product(s) is higher. This money isn't lost - its being redistributed. Suppliers to that firm are getting more money, those the firm relies on in order to continue its operations are making increased profits. These profits in turn get redistributed to employees of those firms (as well as to the owners).
My point is that money isnt actually lost, is it? So why is deadweight loss strictly bad? Perhaps I'm missing so simple and basic, and yet it must be fundamental, because this is such a pillar in economics it seems, that deadweight loss is bad (unless offset by efficiency gains somewhere else). I feel pretty stupid asking my lecturers this question, because I'm afraid I've missed something basic. Can anyoe help me out here?
Posted by illogicist at 4:04 AM