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- [Alex] In our final talk[br]in monopoly,

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we're going to discuss[br]the costs of monopoly,

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but also the potential benefits.

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The major costs of monopoly[br]is that compared to competition,

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monopoly is inefficient.

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

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Let's remind ourselves[br]about the gains from trade

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under competition[br]and then we can compare

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with monopoly.

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Here we'll simplify[br]with a flat supply curve,

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a constant cost industry.

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In this case the total gains[br]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[br]from trade or total welfare

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is under monopoly.

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We choose exactly[br]the same demand curve

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and the same constant cost curve.

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

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Consumers, not surprisingly,[br]get less under monopoly

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since the price is higher.

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Now some of what the consumers lose[br]is transferred to the monopolist

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

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at least someone is getting[br]these gains from trade.

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So the transfer is neutral.

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What's bad however,[br]is that total welfare falls

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under monopoly[br]because no one gets this area,

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the deadweight loss.

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

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

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of producing these goods.

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These trades, however,[br]don't happen.

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Even though they're socially[br]beneficial they don't happen

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because they aren't profitable,[br]they aren't privately beneficial.

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Think of a movie theater[br]that is half empty.

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Surely there are some people[br]out there who would value

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

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

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Because to do so it would have[br]to lower the price to everyone

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and that would reduce[br]total profits.

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So the basic lesson is this.

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Consumers buy a good[br]so long as the value to them

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exceeds the price.

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Under competition price[br]is equal to marginal cost,

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

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is a greater[br]than the marginal cost.

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That's efficient.

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Under monopoly, consumers[br]also buy so long as the value

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to them is greater than the price,[br]but since price is greater

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than marginal cost,[br]we get too few units produced.

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We get a loss[br]in the gains from trade.

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Let's remind ourselves[br]what deadweight loss

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looks like in practice.

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GSK prices Combivir[br]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[br]of the trades that do not occur

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because price is greater[br]than marginal cost.

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

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or $4, or even $1 per pill[br]and those prices

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would more than cover[br]the cost of producing those pills.

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But those trades don't occur

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because they aren't[br]profitable to GSK.

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Many monopolies around the world[br]are born of government corruption.

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In Indonesia, Tommy Suharto,[br]the president's son,

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was given the highly profitable[br]clove monopoly.

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He used the profits[br]from that monopoly

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to buy Lamborghini.

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Not a Lamborghini --[br]he bought the entire company.

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These kinds of monopolies[br]are unredeemed.

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They have costs[br]and no social benefits at all.

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Some monopolies however,[br]do have countervailing benefits.

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Consider what would happen[br]if the U.S. eliminated patents

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for pharmaceuticals.

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Competition, it's true,[br]would drive down the price

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of existing drugs to marginal cost,[br]as happens today

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as soon as patents expire,[br]usually within 10 to 15 years

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after the drug first enters[br]the market.

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But it costs about[br]a billion dollars

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to bring the average new drug[br]to market in the United States,

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

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As the saying goes,[br]it costs about a billion dollars

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to create the first pill,[br]50 cents to create the second pill.

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50 cents is the marginal cost,[br]the cost of an additional pill,

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but to bring that first pill[br]to market costs

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about a billion dollars.

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If price were quickly pushed[br]down to marginal cost,

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

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and the result would be[br]fewer new drugs.

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Once the drug is created,[br]the patent, the monopoly,

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creates inefficiency,[br]we get too few units produced.

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But the patent increases[br]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[br]reduces static efficiency,

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the quantity produced,[br]but can increase

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dynamic efficiency, the incentive[br]to do research and development.

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This trade-off applies[br]to other goods

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with high development cost,[br]not just pharmaceuticals.

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Information goods,[br]goods like music, movies,

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computer programs,[br]new chemicals, new materials,

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new technologies.

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These typically have high[br]development costs

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and low marginal cost[br]of production.

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And that suggests there may be[br]possible benefits to patent

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or copyright production.

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

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which we always want[br]to keep in mind.

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That is lower prices today[br]may generate fewer new ideas

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in the future.

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Nobel prize winning[br]economic historian, Douglas North,

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for example, has argued,[br]"The failure to develop

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systematic property rights[br]in innovation

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up until fairly modern times[br]was a major source

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of the slow pace[br]of technological change."

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

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Perhaps.

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Suppose that the government[br]bought up a pharmaceutical patent

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

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Competitors would enter[br]and drive the price of the drug

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down to marginal cost,[br]thus we would have

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static efficiency.

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At the same time,[br]since the government

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was paying firms[br]their monopoly profits,

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we would still have lots[br]of incentive to do research

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and development --[br]dynamic efficiency.

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Thus we could have[br]the best of all worlds.

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Of course, there may be[br]some downsides as well.

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Higher taxes to pay[br]for the patent also have

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their own deadweight loss,[br]and it might be difficult

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to say exactly[br]how much a patent is worth.

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And there could be[br]possible corruption.

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Nevertheless, this is an idea[br]we're thinking about,

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and perhaps worth[br]experimenting with.

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Prizes are another way[br]of navigating the trade-off.

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As with patent buyouts,[br]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[br]only pays the firm

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if it achieves a certain goal.

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And if that goal is achieved,[br]the technology goes

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into the public domain[br]and could be used by anyone.

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SpaceShipOne, for example,[br]won $10 million

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for being the first privately[br]developed manned rocket

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capable of reaching space[br]and returning

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in a short period of time.

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And prizes are being used[br]more often.

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The government set up a prize[br]for better light bulbs,

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for example,[br]and that worked quite well.

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

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

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that the monopolist[br]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,[br]the monopolist can charge

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different prices[br]to different people --

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price discrimination.

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

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price discrimination explains a lot[br]about how products are priced

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and it also has some costs[br]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[br]to test yourself,

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click "Practice Questions."

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

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