Social Justice and the True Costs of Market Power When Firms and Industries are Heterogeneous

The main impact of market power under full resource utilisation is a redistribution of incomes, as reflected in the fact that the share of profits (which is close to the Gini-coefficient) equals the Herfindahl index. The total surplus as traditionally defined is then misleading and can even be higher if profits are sufficiently high. The consumer surplus is distorted only if some firms are inefficient, or in a multi-industry setting, if industries differ when it comes to market power. The variance of the marginal costs given their average is positively related to industry output. Market power can protect inefficient firms, but entry may also reduce output. We propose a welfare measure that also reflects social justice. The gain of reaching the first-best solution can be decomposed according source of distortion, and it can be significant under reasonable conditions, also when the number of firms is endogenous. (#146)