The Costs and Benefits of Monopoly
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0:00 - 0:04♪ [music] ♪
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0:09 - 0:14- In our final talk in monopoly we're
going to discuss the cost of monopoly but -
0:14 - 0:23also the potential benefits.
The major cost of monopoly is that -
0:23 - 0:28compared to competition, monopoly is
inefficient. It leads to a loss in the -
0:28 - 0:32gains from trade or a deadweight loss.
Let's remind ourselves about the gains -
0:32 - 0:37from trade under competition and then we
can compare with monopoly. Here we'll -
0:37 - 0:42simplify with a flat supply curve. A
constant cost industry. In this case the -
0:42 - 0:47total gains from trade go to consumers in
this blue area right here. Now let's see -
0:48 - 0:52what the total gains from trad or total
welfare is under monopoly. We choose -
0:52 - 0:57exactly the same demand curve and the same
constant cost curve. We find the profit -
0:58 - 1:04maximizing price and quantity in the usual
way. Consumers, not surprisingly get less -
1:05 - 1:11under monopoly since the price is higher.
Now some of what the consumers lose is -
1:11 - 1:16transferred to the monopolist in terms of
profit, and as far as an economist is -
1:16 - 1:21concerned at least someone is getting
these gains from trade. So the transfer is -
1:21 - 1:28neutral. What's bad however, is the total
welfare falls under monopoly because no -
1:29 - 1:35one gets this area, the deadweight loss.
These are trades that from a social point -
1:35 - 1:41of view are beneficial. The demanders are
willing to pay more than what would be the -
1:41 - 1:48cost of producing these goods. These
trades however, don't happen, even though -
1:48 - 1:53they're socially beneficial they don't
happen because they aren't profitable, -
1:53 - 1:58they aren't privately beneficial. Think of
a movie theater that is half empty, surely -
1:59 - 2:03there are some people out there who would
value watching the movie at more than its -
2:03 - 2:07marginal cost, about zero.
So why doesn't the movie theater lower the -
2:07 - 2:14price to these people? Because to do so it
would have to lower the price to everyone -
2:14 - 2:21and that would reduce total profits. So
the basic lesson is this. Consumers buy a -
2:21 - 2:27good so long as the value to them exceeds
the price. Under competition price is -
2:27 - 2:33equal to marginal cost, so consumers will
buy every unit such that the value to them -
2:33 - 2:40is a greater than the marginal cost.
That's efficient. Under monopoly consumers -
2:40 - 2:45also buy so long as the value to them is
greater than the price but since price is -
2:45 - 2:52greater than marginal cost we get too few
units produced, we get a loss in the gains -
2:52 - 2:57from trade. Let's remind ourselves what
deadweight loss looks like in practice. -
2:58 - 3:04GSK prices Combivir at $12.50 per pill,
the marginal cost to 50 cents. -
3:04 - 3:07The deadweight loss is
the value of the trades -
3:07 - 3:10that do not occur because
price is greater than -
3:10 - 3:16marginal cost. Some people would be
willing and able to pay $10 per pill or -
3:16 - 3:21$4, or even $1 per pill and those prices
would more than cover the cost of -
3:22 - 3:28producing those pills. But those trades
don't occur because they aren't profitable -
3:28 - 3:34to GSK. Many monopolies around the world
are born of government corruption. In -
3:34 - 3:39Indonesia Tommy Suharto, the president's
son, was given the highly profitable clove -
3:39 - 3:44monopoly. He used the profits from that
monopoly to buy Lamborghini. Not a -
3:44 - 3:49Lamborghini...he bought the entire
company. These kinds of monopolies are -
3:50 - 3:57unredeemed. They have cost and no social
benefits at all. Some monopolies however, -
3:57 - 4:01do have countervailing benefits. Consider
what would happen if the U. S.eliminated -
4:02 - 4:06patents for pharmaceuticals.
Competition, it's true, would drive down -
4:06 - 4:12the price of existing drugs to marginal
cost, as happens today as soon as patents -
4:12 - 4:18expire, usually within 10 to 15 years
after the drug first enters the market. -
4:18 - 4:23But it cost about a billion dollars to
bring the average new drug to market in -
4:24 - 4:30the United States, and R&D costs are not
included in marginal cost. As the saying -
4:31 - 4:37goes, it costs about a billion dollars to
create the first pill, 50 cents to create -
4:37 - 4:42the second pill. Fifty cents is the
marginal cost, the cost of an additional -
4:42 - 4:48pill, but to bring that first pill to
market cost about a billion dollars. If -
4:48 - 4:54price were quickly pushed down to marginal
cost, firms would not be able to recover -
4:55 - 5:02their R&D costs, and the result would be
fewer new drugs. Once the drug is created -
5:02 - 5:06the patent, the monopoly, creates
inefficiency, we get too few units -
5:06 - 5:12produced. But the patent increases the
incentive to produce the new drugs in the -
5:12 - 5:18first place. So there's a tradeoff. More
monopoly reduces static efficiency, the -
5:18 - 5:24quantity produced, but can increase
dynamic efficiency, the incentive to do -
5:24 - 5:30research and development. This tradeoff
applies to other goods with high -
5:30 - 5:34development cost, not just
pharmaceuticals. Information goods, goods -
5:34 - 5:38like music, movies, computer programs, new
chemicals, new materials, new -
5:38 - 5:44technologies. These typically have high
development cost and low marginal cost of -
5:44 - 5:49production and that suggests there may be
possible benefits to patent or copyright -
5:49 - 5:54production. More generally for these types
of goods there's a policy tradeoff which -
5:55 - 6:01we always want to keep in mind. That is
lower prices today may generate fewer new -
6:01 - 6:07ideas in the future.
Nobel prize winning economic historian, -
6:08 - 6:13Douglas North, for example, has argued
"the failure to develop systematic -
6:13 - 6:18property rights in innovation up until
fairly modern times was a major source of -
6:18 - 6:24the slow pace of technological change."
Is there a better way of navigating this -
6:24 - 6:29tradeoff? Perhaps. Suppose that the
government bought up a pharmaceutical -
6:29 - 6:35patent for its total monopoly profits and
then they ripped the patent up. -
6:35 - 6:40Competitors would enter and drive the
price of the drug down the marginal cost, -
6:40 - 6:45thus we would have static efficiency. At
the same time since the government was -
6:45 - 6:50paying firms their monopoly profits, we
would still have lots of incentive to do -
6:50 - 6:54research and development; dynamic
efficiency. Thus we could have the best of -
6:55 - 7:00our worlds. Of course, there may be some
downsides as well. Higher taxes to pay for -
7:01 - 7:04the patent also have their own deadweight
loss, and it might be difficult to say -
7:05 - 7:09exactly how much a patent is worth. And
there could be possible corruption. -
7:09 - 7:13Nevertheless this is an idea we're
thinking about and perhaps worth -
7:13 - 7:19experimenting with. Prizes are another way
of navigating the tradeoff. As with patent -
7:19 - 7:25buyouts the idea is that a firm is offered
up front its R&D costs. But the government -
7:26 - 7:31only pays the firm if it achieves a
certain goal and if that goal is achieved, -
7:31 - 7:36the technology goes into the public domain
and could be used by anyone. SpaceShipOne, -
7:36 - 7:42for example, won $10 million for being the
first privately developed manned rocket -
7:42 - 7:46capable of reaching space and returning in
a short period of time. And prizes are -
7:46 - 7:50being used more often. The government set
up a prize for better light bulbs, for -
7:50 - 7:56example, and that worked quite well.
There's also a third way of navigating the -
7:56 - 8:01tradeoff. You may have noticed, for
example, that so far we've assumed that -
8:01 - 8:07the monopolist must charge the same price
to everyone. Is this necessarily true? -
8:07 - 8:11In some cases the monopolist can charge
different prices to different people. -
8:11 - 8:17Price discrimination. As we'll see in the
next chapter and set of lectures, price -
8:17 - 8:21discrimination explains a lot about how
products are priced and it also has some -
8:22 - 8:26costs and some benefits which we'll be
discussing. See you then, thanks. -
8:27 - 8:31- If you want to test yourself,
click "Practice Questions." -
8:31 - 8:35Or if you're ready to move
on, just click "Next Video." -
8:36 - 8:38♪ [music] ♪
- Title:
- The Costs and Benefits of Monopoly
- Description:
-
In this video, we explore the costs and benefits of monopolies. We cover how monopolies and patents breed deadweight loss, market inefficiencies, and corruption. But we also look at what would happen if we eliminated patents for industries with high R&D costs, such as the pharmaceutical industry. Eliminating patents in this case may result in less innovation and, specifically, fewer new drugs being created. We also consider some of the tradeoffs of patents and look at alternative ways to reward research and development such as patent buyouts and using prizes to foster innovation.
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- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 08:40
Martel Espiritu edited English subtitles for The Costs and Benefits of Monopoly | ||
Martel Espiritu edited English subtitles for The Costs and Benefits of Monopoly | ||
Martel Espiritu edited English subtitles for The Costs and Benefits of Monopoly | ||
MRU2 edited English subtitles for The Costs and Benefits of Monopoly | ||
MRU2 edited English subtitles for The Costs and Benefits of Monopoly |