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The Costs and Benefits of Monopoly

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

Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics

Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/costs-benefits-monopoly-pharmaceutical-companies#QandA

Next video: http://mruniversity.com/courses/principles-economics-microeconomics/introduction-price-discrimination

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Video Language:
English
Team:
Marginal Revolution University
Project:
Micro
Duration:
08:40

English subtitles

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