Baumol on Excess Capacity

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Professor Baumol is mostly credited for his study of contestable markets as markets enjoying monopoly power which could potentially turn into competitive ones due to the lack of sunk costs and entry or exit barriers. We reveal Baumol’s view of the welfare aspects of monopolistic competition. Discussing the so called “excess capacity theorem,” formulated by Robinson and Chamberlin, and basing his analysis on Machlup’s writings, Baumol justifies competition on account of the nonexistence of excess capacity. This reveals Baumol as a true proponent of competition.
Keywords: William Baumol, monopolistic competition, excess capacity, competition
JEL codes: B21, B31, D41, D43

Posted for comments on 21 Apr 2022, 3:30 pm.

Comments (1)

  • Referee 1 says:

    Referee report on Baumol on Excess Capacity

    The topic dealt with in this paper is potentially very interesting and worth analyzing from the
    historical perspective. However, the paper in its current form cannot be published for the
    following reasons.

    Structure of the paper:
    This is a 14-page paper, structured as follows:
    Extended abstract (1 p.)
    1. Introduction (1 p.)
    2. Baumol on excess capacity (8 pp.)
    3. Conclusion (1 p.)
    4. References (3 pp.)

    Notice that there is an extended abstract, as well as both the abstract and the introduction.
    Section 2 is too long (8 pages) for a single section and is has no internal divisions (suggestion for an internal structuring: 2.1. Chamberlin’s formulation;2.2. Reactions to Chamberlin;2.3. Baumol’s
    theory; 2.4. Welfare implications).
    These 8 pages are the only pages in which the core of the topic is dealt with, and they are too few for a deep and contextualized analysis of the topic. The other sections (excluding the references) are repetitive.

    Aim of the paper
    The aim of the paper is not explicitly illustrated by the author. Where is its thesis statement? A thesis statement is not just a description or a summary, it has to be demonstrated, and it has to be open to counterarguments.
    Not only should this paper explicitly state its main historical question, it should also demonstrate that it is a good historical question. In other words: why it is worthwhile to reconstruct this history?

    Secondary literature
    The paper doesn’t mention the secondary literature on the history of the concept of excess capacity (examples: Schmalensee 1972, Hovenkamp 1988, 1991; Mosca 2018; etc.). Without it, it is impossible to identify the original contribution of this paper in relation to the existing literature on the topic. The author should specify how the paper positions itself with respect to that literature.

    The paper is not well contextualized

    1. within Baumol’s intellectual path. Example: the fact that Baumol’s contribution to the excess capacity theory preceded by almost 20 years the elaboration of his contestable markets’ theory is not properly focused on, nor are its effects on the development of Baumol’s economic categories. On p. 3 the author says: “An analysis of his earlier views can thus help us figure out what was new to his later theoretical contributions”, this is a good line of research, but it is not developed in the rest of the paper.

    2. within intellectual history: the author often says that there was nothing before Chamberlin on excess capacity. Example: p. 3 “economists have completely neglected before”. Actually, there were J.S. Mill, Cairnes, Wicksell, Pareto, Barone, etc. However, the history of the theory from Chamberlin to Baumol is well reconstructed.

    3. The paragraph on the similarity of the environment in which Baumol and Machlup lived goes in the right direction (p. 8).

    The paper is rather difficult to read
    1. The writing is not clear.
    On p. 4, Chamberlin’s excess capacity theorem is not clearly illustrated, for example when the author writes: “Chamberlin (1952) viewed excess capacity as an important phenomenon, although he insisted that it was wrongly identified as the departure from the minimum point on the cost curve”, the reader is left confused.

    Pp. 7-9 are very difficult to follow. So much so, that when on p. 9 the author mentions the “industries where excess capacity existed”, the reader doesn’t understand which ones they are: those with “real” rents, those with artificial product differentiation, those with “true” market power, those who “compete freely bringing monopoly profits all the way down to zero”? In reading this part of the paper, which should illustrate the core of Baumol’s position, the reader feels the need to read Baumol’s original book in order to understand his thought, which is not a good sign. It needs to be re-written with clarity, depth and order in the exposition.

    2. The arguments are presented without precision.
    Examples: p. 1 “Baumol (1964) discussed three possible outcomes”, where are they listed in the paper?

    P. 3 “This is broadly consistent with his later theory of entrepreneurship and innovation”, why? how?

    P.4 “Cassels (1937) distinguished between excess capacity and overinvestment”, followed by a definition of excess capacity for Cassels but not his definition of overinvestment.

    The author mentions “the neoclassical school” (p. 4), and “neoclassical writers” (p. 6) without further explanation. Which writers is the author referring to?

    On p. 10 there are two paragraphs on welfare economics that do not seem to be linked to the main topic.

    The differences (if any) in the contributions by Chamberlin and Robinson on the issue of excess capacity are not specified.

    The author often writes that contestable markets are markets with monopoly power, examples:
    p. 1: “contestable markets as markets enjoying monopoly power”
    p. 2: “competitive outcome could be achieved even in industries which exhibited market power”
    p.3: Baumol was a proponent of market power”
    p. 10: “in market structures exhibiting monopoly power”
    p. 11: “Baumol was an advocate of firms with market power”

    According to the contestable market theory, the firms in these markets do not enjoy monopoly power, simply because the markets are contestable. Maybe the author means: markets with scale economies, or natural monopolies, or oligopolies, or markets with a low number of firms.

    3. Statements contradict each other
    Example: Abstract: “This reveals Baumol as a true proponent of competition” vs. p. 9 “These measures completely contradicted the perception of deregulation”.

    P. 7: “where rents are real, excess capacity must also be real” vs. p. 9 “In the case where firms use capacity fully, we are condemned of (sic! to) monopoly rents”.

    This paper is not an article yet, it contains the skeleton of an article, but it could become a good article if the author specifies properly the aim of his paper, contextualizes Baumol’s contribution, does further research on the secondary literature, and rewrites it clearly and in a better organized way.

    Hovenkamp H. (1988) The antitrust movement and the rise of industrial organization, Texas Law
    Review, 68(1), 105-168
    Hovenkamp H. (1991) Enterprise and American Law. 1836-1937. Cambridge and London, Harvard
    University Press.
    Mosca M. (2018) Monopoly Power and Competition: The Italian Marginalist Perspective,
    Cheltenham (UK), Elgar.
    Schmalensee R. (1972) A Note on Monopolistic Competition and Excess Capacity, Journal of
    Political Economy,80(3),

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