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The Costs and Benefits of Monopoly

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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] ♪
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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