A neglected welfare cost of monopoly - - and most other product market

A neglected effect of monopoly is the distortion in the quantity of resources supplied. Monopoly not only affects the economy's output mix, it also results in factor prices that are below social marginal value products. This latter distortion is shown to be quantitatively important when other policies, such as taxes on labor earnings, also depress factor prices. Under plausible conditions, the welfare cost due to this distortion of monopoly is shown to be between five and fifteen times larger than the more familiar "Harberger triangle" output mix distortion of monopoly. It is suggested that the resource supply effects of many other policies are similarly likei'., to be more important than their commonly evaluated output market effects. A burgeoning recent literature on environmental policy has emphasized the interdependence between environmental policies (especially pollution taxes) and the tax system. What this literature demonstrates is that the introduction of a pollution tax will generally aggravate the distortions of pre-existing taxes in addition to ameliorating pollution, so the net effect on welfare is not as obviously positive as previous discussions may have suggested. ! As Oates has pointed out *Corresponding author. Tel.: + 1 409 8547355. 'Of course, this literature covers a lot more ground than this, but the important conclusions all flow from a recognition of the interaction between environmental policy and pre-existing taxes. Significant recent contributions to this literature include