Who was Harold Hotelling? – Healthcare Economist

Who was Harold Hotelling and what did he contribute to the field of economics? A paper by Gaspard et al. (2024) in the Journal of Economics Literature provides some background on his life, his research and pros and cons of his research contributions. Today I summarize some of his key contributions to the field of economics.

Spatial Competition Model (Hotelling Law)

Hotelling’s most famous contribution is likely his 1929 paper (Hotelling 1929) on spatial competition, which introduced what became known as “Hotelling’s law” or the principle of minimum differentiation. This model analyzed competition between two firms (i.e., a duopoly) in a linear market and showed how the two firms tended to not only locate close to each other in the center, but also minimize their product differentiation.

Why do firms locate next to each other? It would be more socially beneficial if the shops separated themselves and moved to one quarter of the way along the street from each end; in this scenario each shop would still draw half the customers but the average customers travel distance to the shop would be shorter. If this occurred, however, each shop would have an incentive to locate centrally to capture more (i.e., >50%) of the market.

When there are niche products, however, the firm are more likely to position themselves in different sections of the street. This is particularly true when consumers are heterogenous over tastes.

In 1931, Hotelling published an influential paper (Hotelling 1931) on the economics of exhaustible resources, which established “Hotelling’s rule”. This rule states that to efficiently exploitat a non-renewable and non-augmentable resource, the percentage change in net-price per unit of time should equal the discount rate in order to maximize the present value of the resource capital over the extraction period. Hotelling argued that policymakers should tax mining profits for resource conservation; however, he also argued that private monopolies (under these suitable taxation policies) would exhaust resources slower than public monopolies.

Hotelling’s 1932 paper reworked production theory into a choice-theoretic framework based on profit maximization. This helped set the foundations for the modern neoclassical approach to the theory of the firm. Wikipedia summarizes this finding as follows:

The rate of an increase in maximized profits with respect to a price increase is equal to the net supply of the good. In other words, if the firm makes its choices to maximize profits, then the choices can be recovered from the knowledge of the maximum profit function.

Hotelling’s lemma” is still commonly used in microeconomics.

Welfare Economics

His 1938 presidential address to the Econometric Society (Hotelling 1938) introduced the concept of marginal cost pricing as a general welfare proposition.  The History of Economic Thought website states that:

Roughly, that economic efficiency is achieved if every good is produced and priced at marginal cost. This contributed to the development of welfare economics and the fundamental theorems of welfare economics in general equilibrium theory.

To learn more about Harold Hotelling, do read the full Gaspard et al. (2024) article.