Transcript Harberger’s Method - Rasmusen Homepage

G604, History of Thought, policy , 23 March 2006
Coase TheoremFriedman, HarbergerSmit-Stigler
Eric Rasmusen, [email protected]
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• Classics: Public Policy
George J. Stigler (1971) "The Theory of
Economic Regulation" The Bell Journal of
Economics and Management Science, 2(1): 3-21
(Spring 1971)
David Friedman, Law's Order, chapters 4 and
5, pages 36-62, on the Coase Theorem and
Calabresi and Melamed. (See
http://www.daviddfriedman.com/laws_order. )
Arnold C. Harberger (1954) "Monopoly and
Resource Allocation," The American Economic
Review, Papers and Proceedings of the Sixtysixth Annual Meeting of the American Economic
Association, 44(2): 77-87 (May 1954)
I have posted my lecture notes and powerpoint
slides on Stigler, Coase-Friedman, and Harberger.
Adam Smith, The Wealth of Nations (1776) "Of
the Causes of Improvement in the productive
Powers of Labour, and of the Order according to
which its Produce is naturally distributed among
the different Ranks of the People," Book I,
chapters 1-3. (skip the intro and chapters 4 and
on).
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Adam Smith
The Wealth of Nations
• The policy of some nations has
given extraordinary
encouragement to the industry
of the country; that of others to
the industry of towns. Scarce
any nation has dealt equally
and impartially with every sort
of industry.
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The Division of Labor
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… is commonly supposed to be carried furthest in some
very trifling [industries];
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not perhaps that it really is carried further in them than
in others of more importance: but in those trifling
manufactures which are destined to supply the small
wants of but a small number of people, the whole
number of workmen must necessarily be small; and
those employed in every different branch of the work
can often be collected into the same workhouse, and
placed at once under the view of the spectator.
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In those great manufactures, on the contrary, which
are destined to supply the great wants of the great body
of the people, every different branch of the work
employs so great a number of workmen, that it is
impossible to collect them all into the same workhouse.
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We can seldom see more, at one time, than those
employed in one single branch.
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Though in such manufactures, therefore, the work
may really be divided into a much greater number of
parts, than in those of a more trifling nature, the division
is not near so obvious, and has accordingly been much
less observed.
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Pin Making
One man: 1-20/day
Ten men: 48,000/day
Leonard Read, "I, Pencil," The
Freeman (December 1958).
http://www.econlib.org/library/E
ssays/rdPncl1.html.
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Advantage
• The corn of Poland, in the same degree of
goodness, is as cheap as that of France,
notwithstanding the superior opulence and
improvement of the latter country.
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The corn of France is, in the corn provinces, fully
as good, and in most years nearly about the same
price with the corn of England, …
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The corn-lands of England, however, are better
cultivated than those of France, and the cornlands of France are said to be much better
cultivated than those of Poland.
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But though the poor country, notwithstanding the
inferiority of its cultivation, can, in some measure,
rival the rich in the cheapness and goodness of its
corn, it can pretend to no such competition in its
manufactures; at least if those manufactures suit
the soil, climate, and situation of the rich country.
• Absolute vs. comparative advantage (Ricardo,
rent)
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A man commonly saunters a
little in turning his hand from
one sort of employment to
another. When he first begins
the new work he is seldom
very keen and hearty; his mind,
as they say, does not go to it,
and for some time he rather
trifles than applies to good
purpose.
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Innovation
• A great part of the machines made
use of in those manufactures in
which labour is most subdivided,
were originally the inventions of
common workmen, who, being
each of them employed in some
very simple operation, naturally
turned their thoughts towards
finding out easier and readier
methods of performing it.
• (the steam engine boy)
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Harberger Triangle article,
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Harberger’s Method
1. Get return on capital in mfgr.
industries, and sales (q)
2. Calculate deviations from average
profit as a percentage of sales. Call this
r.
3. Assume the elasticity of demand, k, for
each industry equals 1.
3. Calculate .5 r^2qk for each industry.
4. Add them up.
5. Multiply 2.2 since we just looked at a
fraction of manuf. industries.
5. The result: about .1% of national
income.
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Harberger’s
Refinements
1. What if there are increasing costs in
industries?
2. Equity capital is measured to include
the value of patents, which capitalizes
monopoly profits. So it is greater than the
amount of real capital supplied, and
monopoly profits might look too low.
3. Sample selection bias. These industries
have an average profit of 10.4%, while for
manufaturign as a whole it was 8%.
4. Aggregation. This smooths out
differences in profit rates across products.
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Some Big Problems
1. Why include the low-profit industries?
2. Why use return on capital instead of
return on equity? Bondholders do not get
monopoly profit.
3. What if all industries are monopolized,
and profit rates are all equal? His method
would show zero loss.
4. What about labor monopolies? (unions,
restrictive entry of the kind Stigler
discusses)
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Another Approach
Suppose ALL of the return to equity is
monopoly profit. What is the welfare loss?
US Mfgr corporations had profit of 245
billion dollars in 1998. Sales were 4,591
billion. So the profit rate on sales was .053.
And the triangle loss was .5 (.053)(.053)
(4591) = 6.5 billion dollars. GDP was 8790
billion dollars, so the loss is .07% of GDP.
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Refinement: Fewer
monopoly industries
Suppose ALL of the return to equity is
monopoly profit. What is the welfare loss?
US Mfgr corporations had profit of 245
billion dollars in 1998. Sales were 4,591
billion. So the profit rate on sales was .053.
Suppose a quarter of firms are
monopolies, with profits of 20%, and 3/4
are not, with profits of 0% of sales. Then
the triangle loss is .5 (.20)(.20) (.25) (4591)
= 23.0 billion dollars.
What if prices were double what they
should be, in every industry? Then the
approximation involved gets bad, but we
can compute . 5(1) (1) 4591 = 2296, and
the loss is 26% of GDP.
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• Coase, Ronald.The Problem of
Social Cost, 3 Journal of Law
and Economics 1-44 (1960).
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Coase Theorem
Example
A steel mill’s pollution reduces resort profit
by $200,000 unless $100,000 is paid to
control pollution.
There is a real externality of $200,000. The
Pigouvian tax would be to charge the steel
mill $200,000 if it pollutes. It would then
choose to control the pollution instead.
Coase insight: Suppose the resort could
switch to timber, earning $50,000 less.
Then the Pigouvian tax is inefficient.
Or, just let the steel mill and the resort
negotiate with each other. If the “property
right”– who has the legal right to decide
pollution– is clear, the outcome will be
efficient.
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The Coase Theorem
“If transaction costs are zero, then any
initial allocation of property rights leads to
an efficient outcome. “ (Friedman’s
statement)
What is interesting is to figure out the
implications of transaction costs. A function
of law is to minimize transaction costs.
http://www.daviddfriedman.com/laws_order/
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Property and Liability
Rules
If you are protected by a property rule, you
can go to court and get an injunction to stop
someone from doing X. (court of common law). Good
if transactions are cheap.
Examples: Patent infringement,
someone building a house on your land,
someone stealing your car.
If you are protected by a liability rule, you
can go to court and get damages from
someone who has done X. (court of equity) Good if
courts are cheap.
Examples: tort suits for personal injury,
damages for breach of contract
Calabresi, Guido & Melamed, Douglas, "Property
Rules, Liability Rules and Inalienability: One View
of the Cathedral", 85 Harvard Law Review 1089 19
(1972).
The Train Sparks Example
A railroad chooses whether to install a spark
arrester at cost $1000 or not. 100 farmers each
choose whether to plant clover or wheat. Clover
does not burn, but yields $800 less in revenue.
Wheat burns, for a loss of $400.
Possible Rules (who decides? who pays?):
1. Railroad property right. The railroad can throw
sparks if it so desires.
2. Farmer property right. Any one farmer can
stop the railroad from throwing sparks.
3. Farmer liability right. The railroad can throw
sparks if it pays the farmers for any damage that
results.
4. Railroad liability right. Any one farmer can
stop the railroad from throwing sparks, but he
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must pay the railroad’s cost of installing a spark
arrester.
Train Sparks II
A railroad chooses whether to install a spark arrester at cost
$1000 or not. 100 farmers each choose whether to plant
clover or wheat. Clover does not burn, but yields $800 less in
revenue. Wheat burns, for a loss of $400.
Possible Rules (no contracts enforced)
1. Railroad property right. Farmers plant wheat
and it burns. $400 cost.
2. Farmer property right. RR installs spark
arrester. $1,000 cost.
3. Farmer liability right. Farmers plant wheat and it
burns. $400 cost. The RR pays $400 to the farmer.
4. Railroad liability right. Farmers plant wheat
and it burns. $400 cost. (The farmers could
insist on the spark arrester, but they’d have to
pay the $1,000.)
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Stigler—on regulation,
Bell Journal,
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Stigler: What does
Government Supply?
Answer: The power to coerce. Violence.
1. Direct subsidy (US airlines before 1968,
universities)
2. Entry restrictions (US airlines before 1975,
tariffs)
3. Suppression of substitute goods (margarine,
plastic pipes)
4. Price-fixing (interest rate regulation,
advertising restrictions)
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A blank slide for
writing on
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A link to the course website
http://www.rasmusen.org/g604/0.
g604.htm
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