WEBVTT

00:00:00.000 --> 00:00:05.178
♪ [music] ♪

00:00:09.354 --> 00:00:11.293
- [Alex] In our final talk
in monopoly,

00:00:11.293 --> 00:00:13.509
we're going to discuss
the costs of monopoly,

00:00:13.509 --> 00:00:16.458
but also the potential benefits.

00:00:21.451 --> 00:00:24.713
The major costs of monopoly
is that compared to competition,

00:00:24.713 --> 00:00:26.624
monopoly is inefficient.

00:00:26.624 --> 00:00:30.367
It leads to a loss in the gains
from trade or a deadweight loss.

00:00:30.367 --> 00:00:32.832
Let's remind ourselves
about the gains from trade

00:00:32.832 --> 00:00:35.442
under competition
and then we can compare

00:00:35.442 --> 00:00:36.825
with monopoly.

00:00:36.825 --> 00:00:39.442
Here we'll simplify
with a flat supply curve,

00:00:39.442 --> 00:00:41.409
a constant cost industry.

00:00:41.409 --> 00:00:44.764
In this case the total gains
from trade go to consumers

00:00:44.764 --> 00:00:46.923
in this blue area right here.

00:00:46.923 --> 00:00:49.873
Now let's see what the total gains
from trade or total welfare

00:00:49.873 --> 00:00:51.656
is under monopoly.

00:00:51.656 --> 00:00:54.096
We choose exactly
the same demand curve

00:00:54.096 --> 00:00:56.781
and the same constant cost curve.

00:00:56.781 --> 00:01:00.891
We find the profit maximizing price
and quantity in the usual way.

00:01:01.714 --> 00:01:05.819
Consumers, not surprisingly,
get less under monopoly

00:01:05.819 --> 00:01:07.677
since the price is higher.

00:01:08.204 --> 00:01:13.406
Now some of what the consumers lose
is transferred to the monopolist

00:01:13.406 --> 00:01:17.027
in terms of profit, and as far
as an economist is concerned,

00:01:17.027 --> 00:01:19.738
at least someone is getting
these gains from trade.

00:01:19.824 --> 00:01:21.848
So the transfer is neutral.

00:01:22.930 --> 00:01:26.681
What's bad however,
is that total welfare falls

00:01:26.681 --> 00:01:30.462
under monopoly
because no one gets this area,

00:01:30.462 --> 00:01:32.363
the deadweight loss.

00:01:32.363 --> 00:01:36.562
These are trades that from a social
point of view are beneficial.

00:01:36.562 --> 00:01:41.562
The demanders are willing to pay
more than what would be the cost

00:01:41.562 --> 00:01:43.503
of producing these goods.

00:01:44.411 --> 00:01:47.227
These trades, however,
don't happen.

00:01:48.110 --> 00:01:50.952
Even though they're socially
beneficial they don't happen

00:01:50.952 --> 00:01:55.193
because they aren't profitable,
they aren't privately beneficial.

00:01:55.670 --> 00:01:57.718
Think of a movie theater
that is half empty.

00:01:58.247 --> 00:02:00.647
Surely there are some people
out there who would value

00:02:00.647 --> 00:02:04.816
watching the movie at more
than its marginal cost, about zero.

00:02:05.374 --> 00:02:08.411
So why doesn't the movie theater
lower the price to these people?

00:02:09.241 --> 00:02:13.556
Because to do so it would have
to lower the price to everyone

00:02:13.556 --> 00:02:15.964
and that would reduce
total profits.

00:02:16.895 --> 00:02:18.841
So the basic lesson is this.

00:02:20.577 --> 00:02:23.510
Consumers buy a good
so long as the value to them

00:02:23.510 --> 00:02:25.168
exceeds the price.

00:02:25.652 --> 00:02:28.542
Under competition price
is equal to marginal cost,

00:02:29.055 --> 00:02:33.076
so consumers will buy every unit
such that the value to them

00:02:33.076 --> 00:02:35.741
is a greater
than the marginal cost.

00:02:36.388 --> 00:02:38.014
That's efficient.

00:02:38.014 --> 00:02:41.563
Under monopoly, consumers
also buy so long as the value

00:02:41.563 --> 00:02:45.478
to them is greater than the price,
but since price is greater

00:02:45.478 --> 00:02:49.964
than marginal cost,
we get too few units produced.

00:02:50.539 --> 00:02:52.742
We get a loss
in the gains from trade.

00:02:53.917 --> 00:02:55.658
Let's remind ourselves
what deadweight loss

00:02:55.658 --> 00:02:57.436
looks like in practice.

00:02:57.436 --> 00:03:00.828
GSK prices Combivir
at $12.50 per pill.

00:03:01.330 --> 00:03:04.024
The marginal cost is 50 cents.

00:03:04.024 --> 00:03:08.442
The deadweight loss is the value
of the trades that do not occur

00:03:08.442 --> 00:03:11.226
because price is greater
than marginal cost.

00:03:11.226 --> 00:03:15.000
Some people would be willing
and able to pay $10 per pill

00:03:15.000 --> 00:03:19.086
or $4, or even $1 per pill
and those prices

00:03:19.086 --> 00:03:23.104
would more than cover
the cost of producing those pills.

00:03:23.889 --> 00:03:26.092
But those trades don't occur

00:03:26.092 --> 00:03:29.108
because they aren't
profitable to GSK.

00:03:29.739 --> 00:03:33.648
Many monopolies around the world
are born of government corruption.

00:03:33.648 --> 00:03:37.074
In Indonesia, Tommy Suharto,
the president's son,

00:03:37.074 --> 00:03:40.723
was given the highly profitable
clove monopoly.

00:03:40.723 --> 00:03:42.443
He used the profits
from that monopoly

00:03:42.443 --> 00:03:43.942
to buy Lamborghini.

00:03:43.942 --> 00:03:47.460
Not a Lamborghini --
he bought the entire company.

00:03:48.071 --> 00:03:50.925
These kinds of monopolies
are unredeemed.

00:03:50.925 --> 00:03:53.674
They have costs
and no social benefits at all.

00:03:54.822 --> 00:03:58.557
Some monopolies however,
do have countervailing benefits.

00:03:59.205 --> 00:04:01.921
Consider what would happen
if the U.S. eliminated patents

00:04:01.921 --> 00:04:03.708
for pharmaceuticals.

00:04:03.708 --> 00:04:06.419
Competition, it's true,
would drive down the price

00:04:06.419 --> 00:04:10.932
of existing drugs to marginal cost,
as happens today

00:04:10.932 --> 00:04:14.811
as soon as patents expire,
usually within 10 to 15 years

00:04:14.811 --> 00:04:17.142
after the drug first enters
the market.

00:04:17.849 --> 00:04:20.911
But it costs about
a billion dollars

00:04:20.911 --> 00:04:24.942
to bring the average new drug
to market in the United States,

00:04:24.942 --> 00:04:29.269
and R&D costs are not included
in marginal cost.

00:04:30.042 --> 00:04:33.477
As the saying goes,
it costs about a billion dollars

00:04:33.477 --> 00:04:38.331
to create the first pill,
50 cents to create the second pill.

00:04:39.196 --> 00:04:42.923
50 cents is the marginal cost,
the cost of an additional pill,

00:04:42.923 --> 00:04:45.171
but to bring that first pill
to market costs

00:04:45.171 --> 00:04:47.355
about a billion dollars.

00:04:47.941 --> 00:04:52.096
If price were quickly pushed
down to marginal cost,

00:04:52.096 --> 00:04:56.062
firms would not be able
to recover their R&D costs,

00:04:56.577 --> 00:04:59.278
and the result would be
fewer new drugs.

00:05:00.579 --> 00:05:03.731
Once the drug is created,
the patent, the monopoly,

00:05:03.731 --> 00:05:06.896
creates inefficiency,
we get too few units produced.

00:05:07.473 --> 00:05:10.816
But the patent increases
the incentive to produce

00:05:10.816 --> 00:05:12.988
the new drugs in the first place.

00:05:13.644 --> 00:05:14.937
So there's a trade-off.

00:05:15.333 --> 00:05:17.996
More monopoly
reduces static efficiency,

00:05:17.996 --> 00:05:20.515
the quantity produced,
but can increase

00:05:20.515 --> 00:05:25.057
dynamic efficiency, the incentive
to do research and development.

00:05:26.968 --> 00:05:29.327
This trade-off applies
to other goods

00:05:29.327 --> 00:05:32.087
with high development cost,
not just pharmaceuticals.

00:05:32.604 --> 00:05:35.465
Information goods,
goods like music, movies,

00:05:35.465 --> 00:05:38.103
computer programs,
new chemicals, new materials,

00:05:38.103 --> 00:05:39.530
new technologies.

00:05:39.530 --> 00:05:42.324
These typically have high
development costs

00:05:42.324 --> 00:05:44.772
and low marginal cost
of production.

00:05:44.835 --> 00:05:48.179
And that suggests there may be
possible benefits to patent

00:05:48.179 --> 00:05:50.260
or copyright production.

00:05:50.756 --> 00:05:54.353
More generally for these types
of goods there's a policy trade-off

00:05:54.353 --> 00:05:56.797
which we always want
to keep in mind.

00:05:56.797 --> 00:06:01.657
That is lower prices today
may generate fewer new ideas

00:06:01.657 --> 00:06:03.390
in the future.

00:06:05.356 --> 00:06:08.381
Nobel prize winning
economic historian, Douglas North,

00:06:08.381 --> 00:06:11.916
for example, has argued,
"The failure to develop

00:06:11.916 --> 00:06:14.537
systematic property rights
in innovation

00:06:14.537 --> 00:06:17.664
up until fairly modern times
was a major source

00:06:17.664 --> 00:06:20.726
of the slow pace
of technological change."

00:06:21.956 --> 00:06:24.889
Is there a better way
of navigating this trade-off?

00:06:25.095 --> 00:06:26.622
Perhaps.

00:06:26.622 --> 00:06:29.947
Suppose that the government
bought up a pharmaceutical patent

00:06:29.947 --> 00:06:34.423
for its total monopoly profits
and then they ripped the patent up.

00:06:35.155 --> 00:06:38.648
Competitors would enter
and drive the price of the drug

00:06:38.648 --> 00:06:41.041
down to marginal cost,
thus we would have

00:06:41.041 --> 00:06:42.676
static efficiency.

00:06:42.676 --> 00:06:44.675
At the same time,
since the government

00:06:44.675 --> 00:06:47.971
was paying firms
their monopoly profits,

00:06:47.971 --> 00:06:50.728
we would still have lots
of incentive to do research

00:06:50.728 --> 00:06:53.525
and development --
dynamic efficiency.

00:06:53.525 --> 00:06:56.027
Thus we could have
the best of all worlds.

00:06:56.027 --> 00:06:58.923
Of course, there may be
some downsides as well.

00:06:58.923 --> 00:07:01.441
Higher taxes to pay
for the patent also have

00:07:01.441 --> 00:07:03.980
their own deadweight loss,
and it might be difficult

00:07:03.980 --> 00:07:06.840
to say exactly
how much a patent is worth.

00:07:07.323 --> 00:07:09.346
And there could be
possible corruption.

00:07:09.346 --> 00:07:11.964
Nevertheless, this is an idea
we're thinking about,

00:07:11.964 --> 00:07:14.240
and perhaps worth
experimenting with.

00:07:15.437 --> 00:07:18.172
Prizes are another way
of navigating the trade-off.

00:07:18.720 --> 00:07:21.166
As with patent buyouts,
the idea is that a firm

00:07:21.166 --> 00:07:24.227
is offered up front its R&D costs.

00:07:24.450 --> 00:07:27.299
But the government
only pays the firm

00:07:27.299 --> 00:07:29.360
if it achieves a certain goal.

00:07:29.360 --> 00:07:31.954
And if that goal is achieved,
the technology goes

00:07:31.954 --> 00:07:35.017
into the public domain
and could be used by anyone.

00:07:35.582 --> 00:07:38.125
SpaceShipOne, for example,
won $10 million

00:07:38.125 --> 00:07:41.831
for being the first privately
developed manned rocket

00:07:41.831 --> 00:07:43.770
capable of reaching space
and returning

00:07:43.770 --> 00:07:45.603
in a short period of time.

00:07:45.603 --> 00:07:47.958
And prizes are being used
more often.

00:07:47.958 --> 00:07:50.237
The government set up a prize
for better light bulbs,

00:07:50.237 --> 00:07:53.014
for example,
and that worked quite well.

00:07:53.870 --> 00:07:56.556
There's also a third way
of navigating the trade-off.

00:07:57.263 --> 00:08:01.036
You may have noticed, for example,
that so far we've assumed

00:08:01.036 --> 00:08:03.553
that the monopolist
must charge the same price

00:08:03.553 --> 00:08:05.166
to everyone.

00:08:05.166 --> 00:08:07.207
Is this necessarily true?

00:08:07.207 --> 00:08:09.151
In some cases,
the monopolist can charge

00:08:09.151 --> 00:08:11.381
different prices
to different people --

00:08:11.381 --> 00:08:13.378
price discrimination.

00:08:13.378 --> 00:08:16.516
As we'll see in the next chapter
and set of lectures,

00:08:16.516 --> 00:08:20.138
price discrimination explains a lot
about how products are priced

00:08:20.138 --> 00:08:22.884
and it also has some costs
and some benefits

00:08:22.884 --> 00:08:24.912
which we'll be discussing.

00:08:24.912 --> 00:08:26.455
See you then, thanks.

00:08:27.587 --> 00:08:29.252
- [Narrator] If you want
to test yourself,

00:08:29.252 --> 00:08:31.389
click "Practice Questions."

00:08:31.389 --> 00:08:34.794
Or if you're ready to move on,
just click "Next Video."

00:08:34.794 --> 00:08:38.733
♪ [music] ♪