In every debate about the goals of antitrust policy, or, more broadly, economic and regulatory policy, proponents of diametrically opposed positions use the same words to (favorably) describe the ends of their policies. Consumer welfare, for example, is touted as a goal by both consumer advocates (who favor regulation) and economic conservatives (who abhor it). Efficiency is another positive, for which each camp claims to have the monopoly. And what about perfect competition and its assumption of many small firms? Populists use the model to defend an ideal of a decentralized economy, yet perfect competition is the bedrock of the neo-classical revolution and Chicago school economics, that led to near-monopoly mergers and did all but away with restraints on vertical mergers, checks on tying, and monopolization offenses such as predatory pricing. Without taking sides in the debate (for now, at least), let’s try to disentangle some of these concepts.

Efficiency is the guiding principle of modern economic policy.

• Allocative efficiency is realized, when all mutually beneficial trades have been made, and all goods are in the hands of those who value them most.
• Productive efficiency ensures that whatever is being made is produced in the most efficient manner, that is, no change in the mix of inputs would result in increased output, given the current technological constraints. A firm produces efficiently, if it moves along the production possibilities frontier. The greater allocative and productive efficiency, the greater the economic pie, that is, the quantity, quality, and variety of goods produced. Maximizing allocative and production efficiency therefore maximizes total welfare. How that welfare is being distributed between (and among) suppliers and consumers is a different matter.

Consumer welfare, the stated goal of U.S. antitrust policy, appears to take sides in the debate about distribution, as consumer welfare implies (i) the creation of the greatest possible pie (efficiency) and (ii) giving the entire pie to the consumer (distribution). The means to achieve both goals (i) and (ii) is perfect competition. Under perfect competition, marginal revenue equals marginal utility equals marginal cost equals price for all products. Allocative efficiency and maximum consumer welfare are the direct results. Against this backdrop, market power, the ability of a firm to charge prices in excess of marginal costs, is a twofold evil.

• First, supra-competitive prices as a result of market power are inefficient, because now there are units whose marginal utility exceed marginal cost that are not being made and cannot travel to those who value them most. Profitable stuff that doesn’t get made as a result of market power constitutes the deadweight loss. (By the way, pointing to the resources that are being saved as a result of producing less does not mitigate the problem, because those resources are now being put to less valued uses.)
• Second, charging supra-competitive prices also violates the distributive ideal of consumer welfare, as it channels the monopoly profits into the pockets of the suppliers and their shareholders. (Note that inherent in the ideal of perfect competition is the justification for antitrust regulation, as deviations from the ideal require governmental action to restore competition.)

While perfect competition may be the only way to maximize both, efficiency and consumer welfare, efficiency without consumer welfare is not conditioned upon competition. A monopolist with the ability to perfectly price discriminate would achieve the same output as an industry under conditions of perfect competition. For every unit sold, marginal revenue would equal marginal utility would equal price (which would now be different for each unit), even though marginal revenue would exceed marginal cost. And even though the delta between marginal revenue and marginal cost that used to be the consumer’s surplus would now be the supplier’s surplus, there would be no deadweight loss. From a total welfare point of view, both models are equally efficient. As to increased production efficiencies, the monopolist could point to economies of scale and scope. (Whether a monopolist could sustain those advantages over time is another question.)

Contrasting consumer welfare with corporate welfare (pun intended) is instructive, because it serves as a litmus test for advocates of consumer welfare. Most proponents of consumer welfare, in reality, only embrace the efficiency prong but not the distributive ideal. One cannot consistently advocate for consumer welfare and, at the same time, support policies that ensure significant corporate profits. However, there is nothing inconsistent about a policy of increasing efficiency, which may benefit both, consumers and firms; this is simply to say that we should grow the pie so that there is more for everyone to eat. Thus, we are left with a bit of a quandary. With respect to the use of the term consumer welfare, both consumer advocates and economic conservatives alike take somewhat of a pick and choose approach. Consumer advocates focus on the distributive ideal and the “many small firms” element of the perfect competition model, but otherwise don’t necessarily see efficiency as the overriding economic policy goal. Economic conservatives focus on the efficiency prong, usually placing greater weight on the productive than on the allocative efficiencies, and discount the distributive ideal. A further complicating factor is that there is more to efficiencies than the static concepts of allocation and production. It is hard to deny that total welfare has been primarily increased through the discovery of new technologies. So it may well be more beneficial for society, at least in the long run (which is getting increasingly shorter, another implication of Moore’s Law) to trade some allocative and productive efficiency for greater corporate profits, if such profits and the additional capital that they attract are being re-invested in research and development.

Against this backdrop, it seems that the discussion about the goals of antitrust and economic policy would benefit if we abandoned the consumer welfare or consumer benefit rhetoric for more explicit statements about how we want to make the pie (that is, what kind of efficiencies we promote), and how we propose to slice it (that is, what distributive mechanism and criteria we prefer).

(Note: This post first appeared on the Law & Society Weblog in May 2005.)

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