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♪ [music] ♪

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- [Alex] In our final talk
in monopoly,

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we're going to discuss
the costs of monopoly,

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but also the potential benefits.

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The major costs of monopoly
is that compared to competition,

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monopoly is inefficient.

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It leads to a loss in the gains
from trade or a deadweight loss.

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Let's remind ourselves
about the gains from trade

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under competition
and then we can compare

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with monopoly.

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Here we'll simplify
with a flat supply curve,

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a constant cost industry.

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In this case the total gains
from trade go to consumers

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in this blue area right here.

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Now let's see what the total gains
from trade or total welfare

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is under monopoly.

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We choose exactly
the same demand curve

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and the same constant cost curve.

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We find the profit maximizing price
and quantity in the usual way.

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Consumers, not surprisingly,
get less under monopoly

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since the price is higher.

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Now some of what the consumers lose
is transferred to the monopolist

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in terms of profit, and as far
as an economist is concerned,

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at least someone is getting
these gains from trade.

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So the transfer is neutral.

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What's bad however,
is that total welfare falls

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under monopoly
because no one gets this area,

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the deadweight loss.

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These are trades that from a social
point of view are beneficial.

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The demanders are willing to pay
more than what would be the cost

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of producing these goods.

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These trades, however,
don't happen.

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Even though they're socially
beneficial they don't happen

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because they aren't profitable,
they aren't privately beneficial.

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Think of a movie theater
that is half empty.

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Surely there are some people
out there who would value

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watching the movie at more
than its marginal cost, about zero.

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So why doesn't the movie theater
lower the price to these people?

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Because to do so it would have
to lower the price to everyone

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and that would reduce
total profits.

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So the basic lesson is this.

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Consumers buy a good
so long as the value to them

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exceeds the price.

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Under competition, price
is equal to marginal cost,

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so consumers will buy every unit
such that the value to them

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is a greater
than the marginal cost.

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That's efficient.

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Under monopoly, consumers
also buy so long as the value

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to them is greater than the price,
but since price is greater

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than marginal cost,
we get too few units produced.

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We get a loss
in the gains from trade.

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Let's remind ourselves
what deadweight loss

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looks like in practice.

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GSK prices Combivir
at $12.50 per pill.

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The marginal cost is 50 cents.

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The deadweight loss is the value
of the trades that do not occur

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because price is greater
than marginal cost.

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Some people would be willing
and able to pay $10 per pill

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or $4, or even $1 per pill
and those prices

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would more than cover
the cost of producing those pills.

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But those trades don't occur

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because they aren't
profitable to GSK.

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Many monopolies around the world
are born of government corruption.

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In Indonesia, Tommy Suharto,
the president's son,

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was given the highly profitable
clove monopoly.

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He used the profits
from that monopoly

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to buy Lamborghini.

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Not a Lamborghini --
he bought the entire company.

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These kinds of monopolies
are unredeemed.

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They have costs
and no social benefits at all.

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Some monopolies however,
do have countervailing benefits.

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Consider what would happen
if the U.S. eliminated patents

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for pharmaceuticals.

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Competition, it's true,
would drive down the price

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of existing drugs to marginal cost,
as happens today

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as soon as patents expire,
usually within 10 to 15 years

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after the drug first enters
the market.

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But it costs about
a billion dollars

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to bring the average new drug
to market in the United States,

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and R&D costs are not included
in marginal cost.

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As the saying goes,
it costs about a billion dollars

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to create the first pill,
50 cents to create the second pill.

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50 cents is the marginal cost,
the cost of an additional pill,

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but to bring that first pill
to market costs

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about a billion dollars.

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If price were quickly pushed
down to marginal cost,

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firms would not be able
to recover their R&D costs,

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and the result would be
fewer new drugs.

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Once the drug is created,
the patent, the monopoly,

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creates inefficiency,
we get too few units produced.

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But the patent increases
the incentive to produce

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the new drugs in the first place.

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So there's a trade-off.

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More monopoly
reduces static efficiency,

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the quantity produced,
but can increase

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dynamic efficiency, the incentive
to do research and development.

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This trade-off applies
to other goods

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with high development cost,
not just pharmaceuticals.

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Information goods,
goods like music, movies,

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computer programs,
new chemicals, new materials,

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new technologies.

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These typically have high
development costs

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and low marginal cost
of production.

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And that suggests there may be
possible benefits to patent

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or copyright protection.

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More generally for these types
of goods there's a policy trade-off

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which we always want
to keep in mind.

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That is lower prices today
may generate fewer new ideas

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in the future.

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Nobel prize winning
economic historian, Douglas North,

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for example, has argued,
"The failure to develop

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systematic property rights
in innovation

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up until fairly modern times
was a major source

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of the slow pace
of technological change."

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Is there a better way
of navigating this trade-off?

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Perhaps.

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Suppose that the government
bought up a pharmaceutical patent

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for its total monopoly profits
and then they ripped the patent up.

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Competitors would enter
and drive the price of the drug

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down to marginal cost,
thus we would have

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static efficiency.

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At the same time,
since the government

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was paying firms
their monopoly profits,

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we would still have lots
of incentive to do research

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and development --
dynamic efficiency.

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Thus we could have
the best of all worlds.

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Of course, there may be
some downsides as well.

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Higher taxes to pay
for the patent also have

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their own deadweight loss,
and it might be difficult

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to say exactly
how much a patent is worth.

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And there could be
possible corruption.

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Nevertheless, this is an idea
we're thinking about,

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and perhaps worth
experimenting with.

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Prizes are another way
of navigating the trade-off.

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As with patent buyouts,
the idea is that a firm

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is offered up front its R&D costs.

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But the government
only pays the firm

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if it achieves a certain goal.

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And if that goal is achieved,
the technology goes

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into the public domain
and could be used by anyone.

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SpaceShipOne, for example,
won $10 million

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for being the first privately
developed manned rocket

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capable of reaching space
and returning

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in a short period of time.

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And prizes are being used
more often.

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The government set up a prize
for better light bulbs,

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for example,
and that worked quite well.

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There's also a third way
of navigating the trade-off.

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You may have noticed, for example,
that so far we've assumed

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that the monopolist
must charge the same price

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to everyone.

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Is this necessarily true?

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In some cases,
the monopolist can charge

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different prices
to different people --

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price discrimination.

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As we'll see in the next chapter
and set of lectures,

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price discrimination explains a lot
about how products are priced

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and it also has some costs
and some benefits

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which we'll be discussing.

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See you then, thanks.

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- [Narrator] If you want
to test yourself,

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click "Practice Questions."

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Or if you're ready to move on,
just click "Next Video."

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♪ [music] ♪