The Economics of Welfare

By Arthur C. Pigou

WHEN a man sets out upon any course of inquiry, the object of his search may be either light or fruit—either knowledge for its own sake or knowledge for the sake of good things to which it leads. In various fields of study these two ideals play parts of varying importance. In the appeal made to our interest by nearly all the great modern sciences some stress is laid both upon the light-bearing and upon the fruit-bearing quality, but the proportions of the blend are different in different sciences. At one end of the scale stands the most general science of all, metaphysics, the science of reality. Of the student of that science it is, indeed, true that “he yet may bring some worthy thing for waiting souls to see”; but it must be light alone, it can hardly be fruit that he brings. Most nearly akin to the metaphysician is the student of the ultimate problems of physics. The corpuscular theory of matter is, hitherto, a bearer of light alone. Here, however, the other aspect is present in promise; for speculations about the structure of the atom may lead one day to the discovery of practical means for dissociating matter and for rendering available to human use the overwhelming resources of intra-atomic energy. In the science of biology the fruit-bearing aspect is more prominent. Recent studies upon heredity have, indeed, the highest theoretical interest; but no one can reflect upon that without at the same time reflecting upon the striking practical results to which they have already led in the culture of wheat, and upon the far-reaching, if hesitating, promise that they are beginning to offer for the better culture of mankind. In the sciences whose subject-matter is man as an individual there is the same variation of blending as in the natural sciences proper. In psychology the theoretic interest is dominant—particularly on that side of it which gives data to metaphysics; but psychology is also valued in some measure as a basis for the practical art of education. In human physiology, on the other hand, the theoretic interest, though present, is subordinate, and the science has long been valued mainly as a basis for the art of medicine. Last of all we come to those sciences that deal, not with individual men, but with groups of men; that body of infant sciences which some writers call sociology. Light on the laws that lie behind development in history, even light upon particular facts, has, in the opinion of many, high value for its own sake. But there will, I think, be general agreement that in the sciences of human society, be their appeal as bearers of light never so high, it is the promise of fruit and not of light that chiefly merits our regard. There is a celebrated, if somewhat too strenuous, passage in Macaulay’s Essay on History: “No past event has any intrinsic importance. The knowledge of it is valuable, only as it leads us to form just calculations with regard to the future. A history which does not serve this purpose, though it may be filled with battles, treaties and commotions, is as useless as the series of turnpike tickets collected by Sir Matthew Mite.” That paradox is partly true. If it were not for the hope that a scientific study of men’s social actions may lead, not necessarily directly or immediately, but at some time and in some way, to practical results in social improvement, not a few students of these actions would regard the time devoted to their study as time misspent. That is true of all social sciences, but especially true of economics. For economics “is a study of mankind in the ordinary business of life”; and it is not in the ordinary business of life that mankind is most interesting or inspiring. One who desired knowledge of man apart from the fruits of knowledge would seek it in the history of religious enthusiasm, of martyrdom, or of love; he would not seek it in the market-place. When we elect to watch the play of human motives that are ordinary—that are sometimes mean and dismal and ignoble—our impulse is not the philosopher’s impulse, knowledge for the sake of knowledge, but rather the physiologist’s, knowledge for the healing that knowledge may help to bring. Wonder, Carlyle declared, is the beginning of philosophy. It is not wonder, but rather the social enthusiasm which revolts from the sordidness of mean streets and the joylessness of withered lives, that is the beginning of economic science. Here, if in no other field, Comte’s great phrase holds good: “It is for the heart to suggest our problems; it is for the intellect to solve them…. The only position for which the intellect is primarily adapted is to be the servant of the social sympathies.”… [From the text]

Book Cover

First Pub. Date

1920

Publisher

London: Macmillan and Co.

Pub. Date

1932

Comments

4th edition.

Copyright

Part II, Chapter XVI

SIMPLE MONOPOLY

§ 1. A CONDITION of simple monopoly exists when a single seller only is exercising monopolistic power—whether or not there are other sellers in the market who accept the price fixed by this seller—and when, allowance being made for cost of carriage and so forth, the same price rules throughout the whole of his market. In order that the effects of simple monopoly, as distinguished from simple competition, may be made clear, we must, of course, presume that the economies and technique of production are the same under both.
*66 The fact that in real life they are often not the same gives rise to further problems, which will be discussed in Chapter XXI. Simple monopoly works out in two different ways, according as, on the one hand, the entry to the industry is so far restricted that no resources are drawn into it other than those actually finding employment in it, or, on the other hand, entry to the industry is free. I shall study first industries of restricted entry.

§ 2. In Chapter XI. it was shown that, in the absence of divergences between social and private net product of the
types discussed in Chapter IX., simple competition makes actual output less than ideal output in industries subject to decreasing supply price from the standpoint of the community; equal to ideal output in industries of constant supply price in this sense; and greater than ideal output in industries of increasing supply price in this sense. When simple monopoly prevails, it is to the interest of the monopolist so to regulate his output as to make the excess of his aggregate receipts over his aggregate costs (including earnings of management and so forth) as large as possible. It follows that under simple monopoly output will always, other things being equal, be less than it would have been under simple competition. Hence in industries of decreasing supply price from the standpoint of the community the substitution of simple monopoly for simple competition will cause actual output, which is now below ideal output, to fall further below it: in industries of constant supply price in this sense, it will cause actual output, which is now equal to ideal output, to fall below ideal output; in industries of increasing supply price in this sense, it will cause actual output, which is now above ideal output, to contract, and it
may cause it to contract in a measure that brings it closer to ideal output than it has been hitherto. The conditions in which it will do this can be determined mathematically, but, unless unusual assumptions are introduced, they cannot be stated in simple terms. This, however, does not greatly matter. For in practice simple monopoly is much more likely to be introduced into industries of decreasing supply price from the standpoint of the industry, which, as was shown in Chapter XI.,
in general implies decreasing supply price from the standpoint of the community, than into other industries; and hence there is no uncertainty about the result.

§ 3. When monopolistic power is exercised by a combination of sellers through the agency of a price-agreement, the restrictive influence upon investment may be enhanced in an indirect way by a further circumstance. It is not practicable to make an agreement touching more than one or two roughly defined grades of service. Consequently, since an adapted charge cannot be made for them, the intermediate grades tend to disappear, even though numerous
purchasers—some of whom, as things are, buy nothing—would have bought these grades, if they had been obtainable at a proportionate charge. Therefore resources, which, under a perfectly constructed monopoly agreement, would have been devoted to the production of these grades, are excluded by the imperfect character of actual agreements. This effect is chiefly found among railway and shipping companies, which are bound by freight-rate conventions but compete in the frequency, speed and comfort of their trains or ships.
*67 Thus first-class rapid vessels may be employed to carry things for which they are quite unnecessary, because agreements preclude the offer of lower rates if slower and cheaper vessels are used;
*68 and so forth. The misdirection of resources that arises in this way is additional to the misdirection due to a simple exercise of monopolistic power.

§ 4. Some qualification of the above results is necessary in industries where temporary low prices may lead to the development of new demands. For, when a prospect of this kind exists, particularly if conditions of decreasing supply price rule and if the current rate of interest on investments is low, it may pay a monopolist to accept low prices for a time, even though to do so involves production at a loss, for the sake of the future gain; whereas it would not pay any one among a large number of competing sellers to do this, since only a very small proportion of the future gain resulting from his action would accrue to himself. It is important, however, to observe that the creation of a new demand, which may thus sometimes be credited to monopoly, is only a social gain when the demand is really new, and not when it is merely a substitute for some other demand which is at the same time destroyed. It is not, for example, a social gain if a railway company, by temporary low prices, “develops the traffic” from one district at the expense of destroying the traffic from another equally well-situated district; and it is not a social gain if, by a like
policy, some ring of traders causes people, who used to obtain a given measure of satisfaction from crinolines and no satisfaction from hobble-skirts, to obtain the like given measure of satisfaction from hobble-skirts and no satisfaction from crinolines. This consideration suggests that the transitional advantage of simple monopoly, that has just been set out, is not generally very important in comparison with the long-period disadvantages previously explained.

§ 5. There should be added a further consideration of some importance. It was shown in Part II. Ch. III. § 11 that to hold back new inventions and so on in order to keep up the value of existing forms of equipment
in general inflicts more damage on the public than the benefits it confers on the owners of the equipment, and it was shown further that under simple competition there is no tendency for this kind of hold-up to occur. Under monopoly, on the other hand, there always is such a tendency; for the private monopolist is interested in the gain to him that monopoly implies, but not in the associated loss of consumers’ satisfaction. It was recognised in the chapter cited that, when the introduction of new models of finished goods lessens the satisfaction which owners get from existing models, there is a substantial set-off to the gains of “progress,” so that this tendency of private monopoly need not always be anti-social. But, when it is a question of new instruments and processes for making finished goods, there can be no such set-off, and hold-up policies must be socially injurious. The point is of great practical interest in view of the rapidity with which new inventions and minor improvements of method are normally made. This is illustrated by the fact that in the United States, over industry in general, twice as much is, it is estimated, normally written down against obsolescence as against depreciation;
*69 and by the further fact that, out of 200 representative firms questioned for the President’s Survey, 43.6 require new equipment to return its cost in two years: 64.1 per cent in three years or less.
*70

§ 6. In the discussion so far we have assumed the entry to industries, in which simple monopoly prevails, to be so
far obstructed or restricted that no resources are drawn into them other than those actually finding employment there. As a rule this condition is fulfilled, because, when it is not fulfilled, the trouble of forming monopolistic agreements will seldom be worth undertaking. Still, monopolistic agreements without restriction of entry are sometimes made. It is easy to show that, under these agreements, the national dividend suffers more than it would do if the same monopolistic price policy prevailed in conjunction with restriction of entry to the industry. For, broadly speaking, what happens is this. The marginal social net product of resources actually finding employment in the monopolized industry is the same as it would be under a system of restricted entry. But, besides these resources, other resources have been drawn away from employment elsewhere and have become attached to the industry. These extra resources will either be all idle themselves, or will make a corresponding quantity of resources already in the industry idle. The dividend, therefore, will be reduced below what it would have been under a system of restricted entry, by the difference between the productivity of that quantity of resources which it pays to set to work in the monopolised industry and the productivity of that quantity for which the receipts of the industry would suffice to provide normal earnings. This consideration does not, of course, prove that restriction of entry to an industry, in which monopoly prevails, is socially desirable; for it may well happen that free entry would compel the monopolist to change his policy, and to adopt one approximately equivalent to that dictated by competition. It only proves that restriction is advantageous in those—probably exceptional—monopolies where the removal of restriction cannot affect price policy.
*71

66.

Thus, if
y be the aggregate output of an industry and
x the output of a firm of typical size, then, writing F(
x, y) for the total cost of its output to this firm, we have
x determined by the equation

We must
not suppose monopoly to come about because the introduction of a new technique has changed F into
ψ, in such wise that, for a given value of
y,

gives a larger value of
x than

does, thus reducing the number of firms in that industry, and so making the formation of a price agreement easier. We must suppose F to be the same under both systems.

67.

The agreements, short of pooling, between railways sometimes embrace agreements as to speed; those between the members of some, but not all, shipping conferences, agreements as to the relative number of sailings permitted to the various members (
Royal Commission on Shipping Rings, Report, p. 23).

68.

Royal Commission on Shipping Rings, Report, p. 108.

69.

Changes in the Structure of World Economics since the War, p. 158.

70.

Recent Economic Changes, p. 139.

71.

Attention may be called here to a peculiar case. Suppose the same process to yield two joint products, one of which is controlled monopolistically but the other is not. Then, as shown above, if entry to the industry can be restricted, simple monopoly will make the outputs of both products less than they would be under simple competition. The whole of the non-monopolised joint product that is produced will be sold, but, provided that the demand for the monopolised product has an elasticity less than unity, and that, in respect of the most profitable scale of output, the demand price for the non-monopolised product exceeds the supply price of the process that produces both products, a
part of the monopolised product will be thrown away. If entry to the industry is not restricted, more resources will flow into it than would so flow under simple competition. On the assumption that these are actually set to work and not left standing idle, this will mean that, in the above conditions, the output and sale of the non-monopolised joint product is larger than it would have been under simple competition. It is
possible, though improbable, that, as a net result, there may be evolved a larger sum of consumers’ surplus than simple competition would allow.

Part II, Chapter XVII